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6. Demand CharacteristicsElasticities, Market Demand

Individual Market Demand Functions

Economy has n consumersi = 1,n

Consumer is ordinary demand function for commodity j:

All consumers price-takers market demand function for commodity j:

all consumers are identical then ( = nm! :

market demand cur"e hori#ontal sum of indi"idual consumers demand cur"es

Example:

$ consumers i = A%

Why Use an elasticity measure

Application:

o &nly seller of 'ood (maye only desi'ner of custom )esite for local usiness community!

onopoly

o if you sell at lo)er price sell more units

o )ant to kno):

)ill price cut increase re"enue per period (increase in * of )esites sold 'et 'reater

increase in re"enue than is lost y cuttin' price! decrease re"enue (price cut reduces re"enue more that +uantity chan'e increases it!

Application:

o nion ne'otiator

o ucceed in )inin' 'eneral )a'e increase union memers )ill 'et hi'her incomes, others

laid o.o /ant to kno):

/ill increase income to those still employed e0ceed loss of income to those losin'

their jos

Application:

o 2o"t trade policy-maker

o /ant to impose import +uota on some imported 'ood to 3protect domestic produces from

3lo)-price forei'n compo /ant to kno):

%y ho) much must the )ith-+uota domestic price of imports increase in order to allo)

domestic produces to sur"i"e ()4e increase prices to uyers!

Interested in !ensitivity 5o) sensiti"e is +uantity to a chan'e in price

Elasticity"ratioof chan'es

Economic #$$lication o% Elasticity

se elasticities to measure sensiti"ity of:

o QDof commodity i )ith respect to 6 of commodity i (o&n'$riceelasticity of demand!

o 7emand for commodity i )ith respect to 6 of commodity j (cross'$riceelasticity of demand!

o 7emand for commodity i )ith respect to income (income elasticityof demand!

o QSof commodity i )ith respect to commodity i (o&n'$riceelasticity of supply!

o 8 of commodity i )ith respect to )a'e rate (elasticity of )ith r to 6 of laour!

o 9

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(rice Elasticity o% Demand

demandprice elastic )hen 87 is veryresponsi"e to a chan'e in products o)n price

demandinelastic )hen 78 is "ery unresponsi"e to chan'es in its price

price elasticity of 7 is related to slope of demand cur"e not e0actly the same

)&n'(rice Elasticity o% Demand

)hy not use 7emand cur"es slope to measure sensiti"ity of 87 to a chan'e in commoditys o)n

price

o )hich case if 87 01 more sensiti"e to chan'es in p1

ame in oth cases

;alue of sensiti"ity then depends upon the units of measurement used for 87 < scale ofmeasurements on a0is

Usin*Absolute Changes to Indicate Elasticity

Example:

$ 'oods, price for each reduced y 61 87 for 'ood 3> rises 1 units

87 for 'ood 3? rises y 1, units

/hich is more sensiti"e to price chan'es

o 5o) si'ni@cant is price chan'e of 61

&ri'inal 61 i' chan'e (d"ds!

&ri'inal 6 not that much of di.erence (laptops!

o 5o) si'ni@cant is +uantity chan'e of 141, units

&ri'inal 7 is 1 i' chan'e (houses!

&r'inal 7 1,, not that much (timmies co.ee!

easure that Bncorporates i'ni@cance

akin' account ho) much a chan'e mattersratio

o Dercent chan'e in 87 to associated percent chan'e in price

2eneral form for elasticity:

Elasticities

measures sensiti"ity of 1 "ariale )ith respect to another

elasticity of > )ith respect to ?

Droperty of Elasticity easures

independent of units of measure (6, +uantity!

chan'e in +uantity measured in same units as ase +uantity units cancel

chan'e in price measured in same units as ase price so units cancel

o end up )ith pure numer

Example:

can compare price elasticity of ;s )ith price elasticity of 'asoline

can compare )hen oth money units and +uantity units di.er

ex.demand for milk in rance (litres, euros! compared to milk in Cali (+uarts, 6!

complication:

o )hat to use as 3ase price and +uantity

computin' percent chan'es (use startin' "alues as ases!

used )hen computin' growth rates

example:

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)e dont )ant $ elasticity "alues for the same inter"al of the demand cur"e

o especially if one is price elastic+as value o% $rice elastic - /

)hile other in inelastic +as value o% $rice elastic 0/

prefer measure that indicates uni+ue elasticity o"er inter"al irrespecti"e to price

increasin'4decreasin'

solution:

o for arc elasticity F lar'e mo"ements in price