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Chapter 4: Individual and Market Demand
Chapter 4: Individual and Market Demand
Overview:
▪Impersonal market
▪No haggling, bluffing, or other forms of strategic behaviour
to influence prices.
Econ 203 Chapter 4 page 3
This sensitivity measures how much the firm’s total revenue will
change in response to a price change.
Price
At the lower price, the
firm can sell more
P1 A units and TR increases.
B
P2
Demand
0 Q1 Q2 Quantity
Suppose price falls: At the new lower price of P2, the quantity
demanded is Q2. → Total revenue is P2*Q2.
In this case, total revenue _______, but this is not always the case.
Econ 203 Chapter 4 page 6
(2) unitary elastic if total revenue does not change when the price
changes.
ΔQ
Q ΔQ P
ηP = = • ⇐ Point Elasticity of Demand
Δ P ΔP Q
P
∂Q P
ηP = ×
∂P Q
Figure 1:
Demand Curve With ____ Price Elasticity of Demand
Price
Demand Curve
0 Quantity
Figure 2:
Demand Curve with ________ Price Elasticity of Demand
Price
Nothing can be
sold if the price
Demand Curve if the price is
increased
slightly.
0 Quantity
Figure 3:
Values of the Price Elasticities Of Demand Along a Linear Demand Curve
Price
Unitary Elasticity
η p is inelastic
Demand
0
MR ηp
$, TR Max TR If demand is price
elastic, MR is positive
and as Quantity
increases, TR increases
00 Q* Quantity
Econ 203 Chapter 4 page 12
ΔQ
(Q1 + Q2 ) 2 ΔQ P1 + P2
ηp = = •
ΔP ΔP Q1 + Q2
( P1 + P2 ) 2
Econ 203 Chapter 4 page 13
Just like the point elasticity of demand, the arc elasticity of demand
has three possible outcomes:
Price
C B
P2
P1 A
DL Long-Run Demand
DS Initial Demand
0 Q3 Q2 Q1 Quantity
Qy
As the price of X
decreases, the budget
Y1 A C constraint rotates.
Y3 B The consumer purchases
Y2 I3 different baskets to
maximize utility.
I2 The demand curve for
I1
Qx good X is derived as the
price of X changes.
Price of X
P1
P2
P3
0 X1 X2 X3 Qx
Econ 203 Chapter 4 page 21
D0 D1
I1
A
I0
0 X 1 X2 QA X1 X2 QA
Econ 203 Chapter 4 page 24
When the price of a good changes and the quantity demanded of another
good changes in the ____ direction, with the price of the other good held
constant, the two goods are referred as substitute goods.
QB PA
D1 D0
B Px
I1
A
I0
0 X 2 X1 QA X2 X1 QA
Examples:
IBM computers and Dell computers
Econ 203 Chapter 4 page 25
E BPA = • A A
Δ PA B1 + B2
Econ 203 Chapter 4 page 26
The only difference with this equation with the arc price elasticity
of demand is that the change in the quantity of A has been replaced
by the change in the quantity of B, and the sum of the units of A by
the sum of the units of B.
ΔB
If A and B are complements, then Δ PA is _______ and the arc cross
price elasticity of demand is negative.
ΔB
If A and B are substitutes, then Δ PA is positive and the arc cross
price elasticity of demand is positive.
Econ 203 Chapter 4 page 27
2) Consumer Surplus
Marginal Value
Econ 203 Chapter 4 page 28
So:
I-C Curve
B
S1
A I1
S0
I0 BL1
BL0
X0 X1 Units of X
X1 Examples: Fruit
Fresh meat
X0
Income
M0 M1
Econ 203 Chapter 4 page 36
S1 B
I1
BL0
S0 A BL1
I0
X1 X0 Units of X
Units of X
Examples:
X0 Hamburger
used cars
used shoes
X1 Engel Curve
Income
M0 M1
ΔQx
QX ΔQx M
ηM = = •
ΔIncome ΔM QX
M
Econ 203 Chapter 4 page 40
ηM =
( QX 0 + QX 1 ) 2 ΔQx ( M 0 + M1 )
= •
ΔIncome ΔM ( Q X 0 + Q X 1 )
( M 0 + M1 ) 2
Econ 203 Chapter 4 page 41
Examples: Vacations
Econ 203 Chapter 4 page 42
Examples: food
Clothing
Soap
Econ 203 Chapter 4 page 43
Substitution Effect:
Other Goods
S0 A
BL1
S1 BL0 B
I
BL2
0 X0 X1 Units of X
Sub. Effect
Price
Other Goods P2
P1 d
X1 X2 Price decrease:
B
A
I1
C
BL1
BL0
I0
BL2
0 X0 X1 X2 Units of X
Econ 203 Chapter 4 page 49
Price
d
Other Goods P0
P1
X2 X0
I1
BL2
A
C BL1
BL0 I0
0 X2 X0 X1 Units of X
The price of X falls and the budget constraint rotates out to BL1
Econ 203 Chapter 4 page 53
The total change from the decrease in the price of good X can
be separated into two components:
Other Goods P0
P1
d
X0 X2
B
I1
A
BL2
C BL1
BL0 I0
0 X0 X0 X1 Units of X
Econ 203 Chapter 4 page 56
ΔX
Δ P can be determined by measuring how the quantity
demanded changes along an indifference curve as the relative
price of the good X changes.
When the price of the good falls, the amount of income available
to spend on goods is equal to:
ΔM = −( ΔP) X
Looking at this expression, the greater is the change in income the
larger is the amount of X the consumer is currently consuming.
⎛ ΔX ⎞
⎜ ⎟
⎝ ΔM ⎠ equals the increase in the quantity demanded of X per dollar
increase in income.
⎛ ΔX ⎞ ΔX ⎛ ΔX ⎞
⎜ ⎟= − X⎜ ⎟
⎝ Δ P ⎠ ΔP U =c
⎝ ΔM ⎠ Slutsky Equation
Consumer Surplus
$1.75 $1.50
$0.75
0 20 35 Quantity
Econ 203 Chapter 4 page 67
Discriminatory pricing!
0 5 15 Quantity