Lecture 4

Demand

September 2021
Reading list
• Essential reading
• Anderton, A – Chapters 8, 9 & 10
• Additional reading
• Core Econ – Unit 7
• Anderton, A – Chapter 7
 Part 1
Demand
The demand curve The demand curve plots the effective
demand, the quantity consumers are willing
to buy at different prices.
Price
There might be a demand for health care in
£ Contraction due to
higher price poorer communities, but it is not effective. 
P2 = 15
The demand curve has a downward slope
Expansion due to due to the law of diminishing marginal
P1 = 10 lower price utility.
There is an extension of demand when the
P3 = 4 quantity demanded rises.
There is a contraction of demand when the
quantity demanded falls.
D
What ceteris paribus assumptions are
0 12
3 5 Quantity made?
Consumer surplus
Price
£
Consumer surplus is the
As the price falls
P2 = 15
A consumer surplus difference between how
increases.
B much buyers are
P1 = 10
C prepared to pay and what
P3 = 4
they actually pay.

Demand
0 12
3 5 Quantity
Consumer surplus and a shift in demand
Price A rightward shift in the demand curve
£ would cause consumer surplus to
increase from the triangle A to the
B triangle A + B. The area B represents
A the gain in consumer surplus.
P

D1
D
0 12
5 Quantity
Shifts in the demand curve
Conditions of demand
Price
Population
£
Advertisement
Substitute goods
Income P = 10

Interest rate
Fashion D2
D
Expectation D1
0 20 50 80 Quantity
Complementary goods
Demand and income
An increase in income

Price
£

Normal good
P

D normal
D
D inferior
0 20 50 80 Quantity
Inferior good
 Part 2
Price elasticity of demand
Price elasticity of demand
• When the price of a good rises, the quantity demanded will fall.

• But by how much?

• That will depend on the elasticity.

• Price elasticity of demand measures the responsiveness of

consumers to price change.
• It is usually represented by Ɛ (Greek epsilon).

• But you don’t have to bother. It just looks cool.

Formula

% change in quantity demanded

PƐD =
% change in price

% Δ QD
You queue before you pee. %ΔP
Interpreting numerical values
• Elasticity is always calculated in percentage changes.
• PƐD is always negative.
• Only considering the magnitude:
• PƐD > |1| (elastic) i.e. %𝚫QD > %𝚫P
• PƐD < |1| (inelastic) i.e. %𝚫QD < %𝚫P
• PƐD = |1| (unitary) i.e. %𝚫QD = %𝚫P
• The further away from zero, the more elastic is the demand.
Solution to (a)
120 - 100
% Δ QD 20%
100 =
%ΔP -40%
3-5
5
Answer: PƐD is -0.5
Representing on a diagram
Price 1. Calculate the PƐD of D1 and D2 as price falls from
£ £12 to £10.
2. Interpret your findings.
3. Explain the slopes of D1 and D2.

12

10

D1 D2

100 110 150 Quantity

Answer
1. Calculate the PƐD of D1 and D2 as price falls from £12 to £10.
D1 → ΔQD = (110 – 100)/ 100 = 10% →ΔP = (10 – 12)/12 = -16.7%
PƐD = 10%/-16.7% = -0.5988024 or -0.6

Price D2 → ΔQD = (150 – 100)/ 100 = 50% →ΔP = (10 – 12)/12 = -16.7%

£ PƐD = 50%/-16.7% = -2.99 or -3

2. Interpret your findings.
3. Explain the slopes of D1 and D2.

12

10

D1 D2

100 110 150 Quantity

PƐD along a demand curve
PƐD = ∞
elastic

PƐD = -1

inelastic

PƐD = 0
 Estimated PƐD for various goods
Determinants of PƐD Goods PƐD

• Closeness of substitute goods Salt 0.1

Airline travel, short-run 0.1
• Proportion of income spent on the
good Coffee 0.25
Fish consumed at home 0.5
• Habitual consumption (addiction)
Private education 1.1
• Whether the purchase can be
delayed Restaurant meals 2.3
Airline travel, long-run 2.4
• Necessity or luxury?
Automobiles, short-run 1.2 – 1.5
• The time period
Chevrolet automobiles 4.0
• Width of market definition
Fresh tomatoes 4.6
• Cost of substituting Harvard handout 1991
Importance of PƐD
• Total Consumer Expenditure (TE)
• TE = P x Q
• TE = TR
• When deciding to set the price, why is it important
to know the product’s PƐD?
Economic Guidance for Business
• If demand is elastic
• Lowering prices will raise total revenue
• If demand is inelastic
• Raising prices will raise total revenue
• If demand is unit elastic (PƐD = -1)
• Total revenue is maximised
Using PƐD in government policy
• Government choices:
• Raise tax revenue
• Reduce the consumption of unhealthy products
• How can price elasticity help?
• PƐD for cigarettes (-0.78 to -0.35) (source)

• PƐD for fizzy drinks (SSB) in Mexico (-1.06 to -1.16) (source)

 Part 3
Income and cross elasticity of
demand
Income elasticity of demand
What happens to the demand of a good when income rises?
Formula

% change in quantity demanded

YƐD =
% change in income

% Δ QD
%ΔY
Interpreting numerical values
• Elasticity is always calculated in percentage changes.
• YƐD is positive for normal goods.
• YƐD is negative inferior goods.
• Once you have determined whether YƐD is positive or negative and
considering only the magnitude:
• |YƐD| > 1 (elastic) i.e. %𝚫QD > %𝚫Y
• |YƐD| < 1 (inelastic) i.e. %𝚫QD < %𝚫Y
• |YƐD| = 1 (unitary) i.e. %𝚫QD = %𝚫Y
• The further away from zero, the more elastic is the demand.
Cross-price elasticity of demand
What happens to the demand of a good when the price of
another good rises?
Formula
% change in quantity demanded (A)
XƐD =
% change in price (B)

% Δ QDA
% Δ PB
Interpreting numerical values
• Elasticity is always calculated in percentage changes.
• XƐD is positive for substitute goods.
• XƐD is negative complementary goods.
• Once you have determined whether XƐD is positive or negative and
considering only the magnitude:
• |XƐD| > 1 (elastic)
• |XƐD| < 1 (inelastic)
• |XƐD| = 1 (unitary)
• The further away from zero, the more elastic is the demand.
Bye for now and see you in the seminar.