1 market demand molly w. dahl georgetown university econ 101 – spring 2009

1

Market Demand

Molly W. DahlGeorgetown UniversityEcon 101 – Spring 2009

2

From Individual to Market Demand Functions

Consumer i’s demand for commodity j

Market demand for commodity j

x p p mji i* ( , , )1 2

X p p m m x p p mjn

ji i

i

n( , , , , ) ( , , ).*1 2

11 2

1

3

From Individual to Market Demand Functions

The market demand curve is the “horizontal sum” of the individual consumers’ demand curves.

Suppose there are only two consumers, i = A,B.

4

From Individual to Market Demand Functions

p1 p1

x A1* x B

1*20 15

p1’

p1”

p1’

p1”

5

From Individual to Market Demand Functions

p1 p1

x A1* x B

1*

x xA B1 1*

p1

20 15

p1’

p1”

p1’

p1”

p1’

6

From Individual to Market Demand Functions

p1 p1

x A1* x B

1*

x xA B1 1*

p1

20 15

p1’

p1”

p1’

p1”

p1’

p1”

7

From Individual to Market Demand Functions

p1 p1

x A1* x B

1*

x xA B1 1*

p1

20 15

35

p1’

p1”

p1’

p1”

p1’

p1”

The “horizontal sum”of the demand curvesof individuals A and B.

8

Elasticities

Elasticity measures the “sensitivity” of one variable with respect to another.

The elasticity of variable X with respect to variable Y is

x yxy,

%%

.

9

Own-Price Elasticity

pi

Xi*

pi’

What is the own-price elasticityof demand in a very small intervalof prices centered on pi’?

Xi'

X p

i

i

i

ii i

pX

dXdp

* ,

*''

is the elasticity at the point ( ', ' ).X pi i

10

Own-Price Elasticity

Consider a linear demand curve.If pi = a – bXi then Xi = (a-pi)/b and

X p

i

i

i

ii i

p

X

dXdp

* , *

*

.b1

dpdX

i

*i

Therefore,

X p

i

i

i

ii i

pa p b b

pa p

* , ( ) /.

1

11

Own-Price Elasticity

pi

Xi*

pi = a - bXi* X p

i

ii i

pa p

* ,

a

a/b

12

Own-Price Elasticity

pi

Xi*

pi = a - bXi* X p

i

ii i

pa p

* ,

p 0 0

0

a

a/b

13

Own-Price Elasticity

pi

Xi*

a

pi = a - bXi*

a/b

X p

i

ii i

pa p

* ,

pa a

a a

222

1 //

1

0

a/2

a/2b

14

Own-Price Elasticity

pi

Xi*

a

pi = a - bXi*

a/b

X p

i

ii i

pa p

* ,

p aa

a a

1

0

a/2

a/2b

15

Own-Price Elasticity

pi

Xi*

a

pi = a - bXi*

a/b

X p

i

ii i

pa p

* ,

1

0

a/2

a/2b

own-price elastic

own-price inelasticown-price unit elastic

16

Revenue, Price Changes, and Own-Price Elasticity of Demand

Inelastic Demand:Raising a commodity’s price causes a small

decrease in quantity demanded Sellers’ revenues rise as price rises.

Elastic Demand:Raising a commodity’s price causes a large

decrease in quantity demanded Seller’s revenues fall as price rises.

17

Revenue, Price Changes, and Own-Price Elasticity of Demand

R p p X p( ) ( ).* Sellers’ revenue is

18

Revenue, Price Changes, and Own-Price Elasticity of Demand

R p p X p( ) ( ).* Sellers’ revenue is

So dRdp

X p pdXdp

**

( )

19

Revenue, Price Changes, and Own-Price Elasticity of Demand

R p p X p( ) ( ).* Sellers’ revenue is

So

dpdX

)p(X

p1)p(X

*

**

dRdp

X p pdXdp

**

( )

20

Revenue, Price Changes, and Own-Price Elasticity of Demand

R p p X p( ) ( ).* Sellers’ revenue is

So

X p*( ) .1

dpdX

)p(X

p1)p(X

*

**

dRdp

X p pdXdp

**

( )

21

Revenue, Price Changes, and Own-Price Elasticity of Demand

dRdp

X p *( ) 1

so if 1 thendRdp

0

and a change to price does not altersellers’ revenue.

22

Revenue, Price Changes, and Own-Price Elasticity of Demand

dRdp

X p *( ) 1

but if 1 0 thendRdp

0

and a price increase raises sellers’revenue.

23

Revenue, Price Changes, and Own-Price Elasticity of Demand

dRdp

X p *( ) 1

And if 1 thendRdp

0

and a price increase reduces sellers’revenue.

24

Revenue, Price Changes, and Own-Price Elasticity of Demand

In summary:

1 0Own-price inelastic demand:price rise causes rise in sellers’ revenue.

Own-price unit elastic demand:price rise causes no change in sellers’revenue.

1

Own-price elastic demand:price rise causes fall in sellers’ revenue.

1

25

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

A seller’s marginal revenue is the rate at which revenue changes with the number of units sold by the seller.

MR qdR q

dq( )

( ).

26

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

p(q) denotes the seller’s inverse demand function (i.e., the price at which the seller can sell q units). Then

MR qdR q

dqdp q

dqq p q( )

( ) ( )( )

R q p q q( ) ( ) so

p qq

p qdp q

dq( )

( )( )

.1

27

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

MR q p qq

p qdp q

dq( ) ( )

( )( )

.

1

dqdp

pq

and

so MR q p q( ) ( ) .

11

28

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

MR q p q( ) ( )

11 says that the rate

at which a seller’s revenue changeswith the number of units it sellsdepends on the sensitivity of quantitydemanded to price; i.e., upon theof the own-price elasticity of demand.

29

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

1

1)q(p)q(MR

If 1 then MR q( ) .0

If 1 0 then MR q( ) . 0

If 1 then MR q( ) . 0

30

Selling onemore unit raises the seller’s revenue.

Selling onemore unit reduces the seller’s revenue.

Selling onemore unit does not change the seller’srevenue.

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

If 1 then MR q( ) .0

If 1 0 then MR q( ) . 0

If 1 then MR q( ) . 0

31

Marginal Revenue, Quantity Changes, and Own-Price Elasticity of Demand

An example with linear inverse demand.p q a bq( ) .

Then R q p q q a bq q( ) ( ) ( )

and MR q a bq( ) . 2

32

Marginal Revenue and Own-Price Elasticity of Demand

p q a bq( )

MR q a bq( ) 2

a

a/b

p

qa/2b