Chapter 4 part_2_copy1

4-1

Market Demand

Individual demand curves may be aggregated (summed up) to form the market demand curve.

This process is known as horizontal summation.

Individual demand curves may also be aggregated algebraically.

4-2

Figure 4-16: Generating Market Demand from Individual Demands

4-3

Market Demand

What happens if all consumers are identical?

Suppose there n consumers with the demand curve given by P = a – bQi. What will the market demand curve be?

4-4

Figure 4-18: Market Demand with Identical Consumers

4-5

Price Elasticity of Demand

Price elasticity of demand is the percentage change in quantity demanded as a result of a 1% change in price.

Price elasticity is always negative, why?

4-6

Price Elasticity of Demand

ε < -1 elastic

ε > -1 inelastic

ε = -1 unit elastic

ε = ΔQ/Q

ΔP/P

4-7

Figure 4-19: Three Categoriesof Price Elasticity

4-8

A Geometric Interpretation of Price Elasticity

ε = ΔQ.P

ΔP Q

ΔP slope of the demand curve.

ΔQ

Point slope method : ε = P. 1 1

Q slope

4-9

Figure 4-20: The Point-Slope Method

4-10

A Geometric Interpretation of Price Elasticity

Linear market demand curve gives rise to 3 important properties of elasticities :

Price elasticity is different at every point along the demand curve

Price elasticity is never positive

Price elasticity is inversely related to the slope of the demand curve.

4-11

Figure 4-21: Two Important Polar Cases

4-12

Figure 4-22: Elasticity is Unit-Free

4-13

Elasticity and Total Expenditure

If the price of a product changes, how will the total amount spent on the product be affected?

Use price elasticity of demand to answer this question.

4-14

Figure 4-23: The Effect on Total Expenditure of a Reduction in

Price

4-15

Elasticity and Total Expenditure

General rules for small price reductions :Total revenue increases if and only if the absolute value of price elasticity is more than 1.

Total revenue decreases if and only if the absolute value of price elasticity is less than 1.

4-16

Figure 4-24: Demand and Total Expenditure

4-17

Determinants of Price Elasticity of Demand

Factors that govern the size of the price elasticity of demand :

Substitutability

Budget share

Direction of income effect

Time

4-18

Figure 4-26: Price Elasticity Is Greater in the Long Run than in

the Short Run

4-19

The Dependence of Market Demand on Income

The quantity of a good demanded depends not only on its price but also on the person’s income.

Engel curves at the market level relate the quantity demanded to the average income level in the market.

4-20

Figure 4-27: The Engel Curve for Food

of A and B

4-21

Figure 4-28: Market Demand Sometimes Depends on the

Distribution of Income

4-22

Figure 4-29: An Engel Curveat the Market Level

4-23

Figure 4-30: Engel Curves for Different Types of Goods

4-24

Income Elasticity of Demand

Income elasticity of demand measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good.

η = ΔQ/Q

ΔY/Y

4-25

Income Elasticity of Demand

Necessities : 0 < η < 1

Luxuries : η > 1

Inferior Goods : η < 0

η = 1 straight Engel curve passing through the origin.

4-26

Income Elasticity of Demand

An easier interpretation : η = Y.ΔQ

Q ΔY

When distinguishing between the Engel curves for necessities and luxuries, one needs to compare the slopes of the Engel curves with the corresponding rays.

4-27

Cross-Price Elasticities of Demand

Cross-price elasticity of demand is the percentage change in quantity demanded of one good caused by a 1 percent change in the price of another good.

єxz = ΔQx/Qx

ΔPz/Pz

Compliments : єxz < 0

Substitutes : єxz > 0