Managerial Economics in a

Global Economy, 5th Edition

by
Dominick Salvatore

Chapter 3
Demand Theory

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 1
 Law of Demand
• There is an inverse relationship
between the price of a good and the
quantity of the good demanded per time
period.

• Substitution Effect
• Income Effect

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 2
 Individual Consumer’s Demand
QdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X
by an individual per time period
PX = price per unit of commodity X
I = consumer’s income
PY = price of related (substitute or
complementary) commodity

T= tastes of the consumer

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 3
 QdX = f(PX, I, PY, T)

QdX/PX < 0
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 4
 Market Demand Curve
• Horizontal summation of demand
curves of individual consumers

• Bandwagon Effect
• Snob Effect

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 5
 Horizontal Summation: From
Individual to Market Demand

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 6
 Market Demand Function
QDX = f(PX, N, I, PY, T)
QDX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers on the
market
I=
consumer income
PY =
price of related (substitute or
complementary) commodity
T=
consumer tastes
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 7
 Demand Faced by a Firm
• Market Structure
– Monopoly
– Oligopoly
– Monopolistic Competition
– Perfect Competition
• Type of Good
– Durable Goods
– Nondurable Goods
– Producers’ Goods - Derived Demand
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 8
 Linear Demand Function
QX = a0 + a1PX + a2N + a3I + a4PY + a5T

PX Intercept:
a0 + a2N + a3I + a4PY + a5T

Slope:
QX/PX = a1

QX
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 9
 Price Elasticity of Demand

Q / Q Q P
Point Definition EP   
P / P P Q

P
Linear Function EP  a1 
Q

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 10
 Price Elasticity of Demand

Q2  Q1 P2  P1
Arc Definition EP  
P2  P1 Q2  Q1

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 11
 Marginal Revenue and Price
Elasticity of Demand

 1 
MR  P 1  
 EP 

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 12
 Marginal Revenue and Price
Elasticity of Demand
PX
EP  1
EP  1

EP  1

QX
MRX
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 13
 Marginal Revenue, Total
Revenue, and Price Elasticity
TR MR>0 MR<0
EP  1 EP  1

QX
EP  1 MR=0
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 14
 Determinants of Price
Elasticity of Demand
Demand for a commodity will be more
elastic if:
• It has many close substitutes
• It is narrowly defined
• More time is available to adjust to a
price change

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 15
 Determinants of Price
Elasticity of Demand
Demand for a commodity will be less
elastic if:
• It has few substitutes
• It is broadly defined
• Less time is available to adjust to a
price change

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 16
 Income Elasticity of Demand

Q / Q Q I
Point Definition EI   
I / I I Q

I
Linear Function EI  a3 
Q

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 17
 Income Elasticity of Demand

Q2  Q1 I 2  I1
Arc Definition EI  
I 2  I1 Q2  Q1

Normal Good Inferior Good

EI  0 EI  0

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 18
Cross-Price Elasticity of Demand

QX / QX QX PY
Point Definition E XY   
PY / PY PY QX

Linear Function PY
E XY  a4 
QX

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 19
Cross-Price Elasticity of Demand

QX 2  QX 1 PY 2  PY 1
Arc Definition E XY  
PY 2  PY 1 QX 2  QX 1

Substitutes Complements
E XY  0 E XY  0

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 20
 Other Factors Related to
Demand Theory
• International Convergence of Tastes
– Globalization of Markets
– Influence of International Preferences on
Market Demand
• Growth of Electronic Commerce
– Cost of Sales
– Supply Chains and Logistics
– Customer Relationship Management
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 21