Managerial Economics in a

Global Economy

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 Consumers 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 = consumers 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