Chapter Fifteen: Market Demand

Chapter Fifteen
Market Demand
From Individual to Market Demand
Functions
 Think of an economy containing n
consumers, denoted by i = 1, … ,n.
 Consumer i’s ordinary demand
function for commodity j is
x*j i (p1 , p 2 , mi )
Functions
 When all consumers are price-takers, the
market demand function for commodity j
is
n *i
X j (p1 , p 2 , m ,, m )   x j (p1 , p 2 , mi ).
1 n
i 1
 If all consumers are identical then
X j (p1 , p 2 , M)  n  x*j ( p1 , p 2 , m)
where M = nm.
Functions
 The market demand curve is the
“horizontal sum” of the individual
consumers’ demand curves.
 E.g. suppose there are only two
consumers; i = A,B.
Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 x*1B
1
Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 x*1B
p1 1
p1’
x*1A  xB
1
Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 x*1B
p1 1
p1’
p1”
x*1A  xB
1
Functions
p1 p1
p1’ p1’
p1” p1”
20 x*A 15 x*1B
p1 1
p1’ The “horizontal sum”

p1” of the demand curves
of individuals A and B.
35
x*1A  xB
1
Elasticities
 Elasticitymeasures the “sensitivity”

of one variable with respect to
another.
 The elasticity of variable X with
respect to variable Y is
% x
 x,y  .
% y
Economic Applications of Elasticity
 Economists use elasticities to
measure the sensitivity of
quantity demanded of commodity i
with respect to the price of
commodity i (own-price elasticity
of demand)
demand for commodity i with
respect to the price of commodity j
(cross-price elasticity of demand).
demand for commodity i with

respect to income (income
elasticity of demand)
quantity supplied of commodity i
with respect to the price of
commodity i (own-price elasticity
of supply)
quantity supplied of commodity i

with respect to the wage rate
(elasticity of supply with respect to
the price of labor)
and many, many others.
Own-Price Elasticity of Demand
 Q:Why not use a demand curve’s

slope to measure the sensitivity of
quantity demanded to a change in a
commodity’s own price?
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1
In which case is the quantity demanded

X1* more sensitive to changes to p1?
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1

10-packs Single Units
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1

10-packs Single Units
p1 p1
slope slope
10 =-2 10 = - 0.2
5 X1* 50 X *
1

It is the same in both cases.
 Q: Why not just use the slope of a

demand curve to measure the
sensitivity of quantity demanded to a
change in a commodity’s own price?
 A: Because the value of sensitivity
then depends upon the (arbitrary)
units of measurement used for
quantity demanded.
*
%  x1
 * 
x1 ,p1 % p
1
is a ratio of percentages and so has no
units of measurement.
Hence own-price elasticity of demand is
a sensitivity measure that is independent
of units of measurement.
Arc and Point Elasticities
 An “average” own-price elasticity of

demand for commodity i over an
interval of values for pi is an arc-
elasticity, usually computed by a
mid-point formula.
 Elasticity computed for a single
value of pi is a point elasticity.
Arc Own-Price Elasticity
pi What is the “average” own-price
elasticity of demand for prices
in an interval centered on pi’?
pi’+h
pi’
pi’-h
X i*
pi’+h
pi’
pi’-h
Xi" Xi '" X i*
pi’+h
pi’ % X*i
 * 
pi’-h Xi ,pi % pi
Xi" Xi '" X i*
pi’+h
pi’ % X*i
 * 
Xi" Xi '" X i*
2h
% pi  100 
pi '
pi’+h
pi’ % X*i
 * 
Xi" Xi '" X i*
2h ( Xi" Xi '")
% pi  100  % X*i  100 
pi ' ( Xi" Xi '") / 2
2h
% pi  100 
* pi '
% Xi
 * 
Xi ,pi % pi ( Xi" Xi '")
% X*i  100 
( Xi" Xi '") / 2
2h
% pi  100 
* pi '
% Xi
 * 
Xi ,pi % pi ( Xi" Xi '")
% X*i  100 
( Xi" Xi '") / 2
So
%X*i pi ' ( Xi " Xi '" )
 X* ,p    .
i i %pi ( Xi " Xi '" ) / 2 2h
is the arc own-price elasticity of demand.
Point Own-Price Elasticity
What is the own-price elasticity
pi of demand in a very small interval
of prices centered on pi’?
pi’+h
pi’
pi’-h
Xi" Xi '" X i*
%X*i pi ' ( Xi " Xi '" )
 X* ,p    .
i i %pi ( Xi " Xi '" ) / 2 2h
pi’+h As h  0,
pi’
pi’-h
Xi" Xi '" X i*
%X*i pi ' ( Xi " Xi '" )
 X* ,p    .
i i %pi ( Xi " Xi '" ) / 2 2h
pi’+h As h  0,
pi’
pi’-h
Xi" Xi '" X i*
%X*i pi ' ( Xi " Xi '" )
 X* ,p    .
i i %pi ( Xi " Xi '" ) / 2 2h
pi’+h As h  0,
pi’
pi’-h
Xi ' X i*
%X*i pi ' ( Xi " Xi '" )
 X* ,p    .
i i %pi ( Xi " Xi '" ) / 2 2h
As h  0,
pi’ pi ' dX*i
 *  
Xi ,pi Xi ' dpi
Xi ' X i*
%X*i pi ' ( Xi " Xi '" )
 X* ,p    .
i i %pi ( Xi " Xi '" ) / 2 2h
*
pi ' dXi
 *  
pi’ Xi ,pi Xi ' dpi
is the elasticity at the
point ( Xi ', pi ' ).
Xi ' X i*
pi dX*i
 *  
Xi ,pi
X*i dpi
E.g. Suppose pi = a - bXi.

Then Xi = (a-pi)/b and
*
dXi 1
  . Therefore,
dpi b
pi  1 pi
 *       .
Xi ,pi ( a  pi ) / b  b a  pi
pi pi = a - bXi*
a/b Xi*
pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a
a/b Xi*
pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a
p0 0
a/b Xi*
pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a
p0 0
 0
a/b Xi*
pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a a a/2
p    1
2 aa/2
 0
a/b Xi*
pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a a a/2
p    1
2 aa/2
a/2   1
 0
a/2b a/b Xi*

pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a a
pa    
aa
a/2   1
 0
a/2b a/b Xi*

pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a   
a
pa    
aa
a/2   1
 0
a/2b a/b Xi*

pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a   
own-price elastic
a/2   1
own-price inelastic
 0
a/2b a/b Xi*

pi
pi = a - bXi*  * 
pi Xi ,pi a  pi
a   
own-price elastic
a/2   1 (own-price unit elastic)
own-price inelastic
 0
a/2b a/b Xi*

pi dX*i
 *  
Xi ,pi
X*i dpi
E.g. X*i  kpia . Then dX*i a 1

 api
dpi
so a
pi a 1 pi
 X* ,p  a
 kapi a
a
 a.
i i kpi pi
pi * a 2 k
Xi  kpi  kpi 
2
pi
  2 everywhere along
the demand curve.
X i*
Revenue and Own-Price Elasticity of
Demand
 If raising a commodity’s price causes
little decrease in quantity demanded,
then sellers’ revenues rise.
 Hence own-price inelastic demand
causes sellers’ revenues to rise as
price rises.
Demand
 Ifraising a commodity’s price causes
a large decrease in quantity
demanded, then sellers’ revenues fall.
 Hence own-price elastic demand
causes sellers’ revenues to fall as
price rises.
Demand
*
Sellers’ revenue is R ( p )  p  X (p ).
Demand
*
*
dR dX
So  X* (p )  p
dp dp
Demand
*
*
dR dX
So  X* (p )  p
dp dp
*  p dX *
 X (p )1  
*
 X (p ) dp 
Demand
*
*
dR dX
So  X* (p )  p
dp dp
*  p dX *
 X (p )1  
*
 X (p ) dp 
 X* (p ) 1    .
Demand
dR
 X* (p ) 1   
dp
Demand
dR
 X* (p ) 1   
dp
dR
so if   1 then 0
dp
and a change to price does not alter

sellers’ revenue.
Demand
dR
 X* (p ) 1   
dp
dR
but if  1    0 then 0
dp
and a price increase raises sellers’

revenue.
Demand
dR
 X* (p ) 1   
dp
dR
And if   1 then 0
dp
and a price increase reduces sellers’

revenue.
Demand
In summary:
Own-price inelastic demand;  1    0
price rise causes rise in sellers’ revenue.
Own-price unit elastic demand;   1
price rise causes no change in sellers’
revenue.
Own-price elastic demand;   1
price rise causes fall in sellers’ revenue.
Marginal Revenue 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.
dR( q)
MR( q)  .
dq
p(q) denotes the seller’s inverse demand
function; i.e. the price at which the seller
can sell q units. Then
R( q)  p( q)  q
so dR( q) dp( q)
MR( q)   q  p( q)
dq dq
 q dp( q) 
 p( q) 1   .
 p( q) dq 
 q dp( q) 
MR( q)  p( q) 1   .
 p( q) dq 
dq p
and  
dp q
 1
MR( q)  p( q) 1   .
so
 
 1
MR( q)  p( q) 1  
 says that the rate

at which a seller’s revenue changes
with the number of units it sells
depends on the sensitivity of quantity
demanded to price; i.e., upon the
of the own-price elasticity of demand.
 1
MR(q)  p(q)1  
 
If   1 then MR( q)  0.
If  1    0 then MR( q)  0.
If   1 then MR( q)  0.
If   1 then MR( q)  0. Selling one
more unit does not change the seller’s
revenue.
If  1    0 then MR( q)  0. Selling one
more unit reduces the seller’s revenue.
If   1 then MR( q)  0. Selling one
more unit raises the seller’s revenue.
An example with linear inverse demand.
p( q)  a  bq.
Then R( q)  p( q)q  ( a  bq)q

and MR( q)  a  2bq.
p
p( q)  a  bq
a/2b a/b q
MR( q)  a  2bq
p Elasticity of Demand
a
MR( q)  a  2bq
p( q)  a  bq
$ a/2b a/b q
R(q)
a/2b a/b q

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Chapter Fifteen

p1’ The “horizontal sum”

 Elasticitymeasures the “sensitivity”

demand for commodity i with

quantity supplied of commodity i

 Q:Why not use a demand curve’s

In which case is the quantity demanded

In which case is the quantity demanded

In which case is the quantity demanded

In which case is the quantity demanded

 Q: Why not just use the slope of a

 An “average” own-price elasticity of

E.g. Suppose pi = a - bXi.

a/2b a/b Xi*

a/2b a/b Xi*

a/2b a/b Xi*

a/2b a/b Xi*

a/2b a/b Xi*

E.g. X*i  kpia . Then dX*i a 1

and a change to price does not alter

and a price increase raises sellers’

and a price increase reduces sellers’

Then R( q)  p( q)q  ( a  bq)q

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E.g. Xi  kpia . Then dXi a 1