CDAE Class 12 Oct. 4 Last class: 3.Individual demand curves 4.Market demand and elasticities Quiz 3 Today: Result of Quiz 3 4. Market demand and elasticities Next class: 4. Market demand and elasticities Important dates: Problem set 3: due today Midterm exam: Tuesday, Oct. 16

Result of Quiz 3 N = 59Range = 2.5 – 10Average = 7.1

4. Market demand and elasticity 4.1. Market demand curves 4.2. A general definition of elasticity 4.3. Price elasticity of demand 4.4. Income elasticity of demand 4.5. Cross-price elasticity of demand 4.6. Empirical studies of demand 4.7. Applications

4.1. Market demand curves (1) Basic concepts Market demand: The total quantity of a good or service demanded by all potential buyers in a market. Market demand curve: A curve that represents the relationship between the total quantity demanded for a good or service and its price, holding all other factors constant.

4.1. Market demand curves (2) Construction of a market demand curve -- A graphical analysis (Fig. 4.1) -- Another definition of a market demand curve: A market demand curve is the horizontal sum of individual demand curves.

4.1. Market demand curves (3) General notations regarding a market: Q = Quantity demanded in a market P = Market price Other factors are held constant

4.1. Market demand curves (4) Shifts in the market demand curve -- A change in individuals’ income -- A change in population -- A change in the price of another good ……

4.2. A general definition of elasticity (1) How to measure the response of demand to a change price? e.g., what will be the change in quantity demanded for a good when its price changes by $1? e.g., what will be the percentage change in quantity demanded for a good when its price changes by 1%?

4.2. A general definition of elasticity (2) Definition of elasticity: The percentage change in one variable (Y) brought about by a 1% change in another variable (X). (3) A mathematical notation: Elasticity of Y with respect to X =

4.2. A general definition of elasticity (4) How to calculate a percentage change? e.g., If X increased from 10 to 12, what is the percentage change in X? Percentage change in X If X decreased from 12 to 10, what is the percentage change in X?

4.2. A general definition of elasticity (5) How to calculate an elasticity? e.g., when X increased from 10 to 12, Y increased from 100 to 110, what is the elasticity of Y with respect to X? Elasticity of Y with respect to X e Y, X = =

4.3. Price elasticity of demand (1) What is price elasticity of demand? --Definition: The percentage change in the quantity demanded of a good in response to a 1 percent change in its price. -- Mathematical definition:

Class Exercise (Thursday, Oct. 4) 1. Mr. Smith’s demand for hair cut decreased from 10 times per year to 8 times per year when the price increased from $15 to $18, what is his demand elasticity of price for hair cut? 2. For demand function Q = P, what is demand elasticity of price when P = 8?

4.3. Price elasticity of demand (2) Factors that affect price elasticity of demand: --Possibility of substitution -- Time of adjustment …… (3) Range of price elasticity of demand: < -1 elastic = -1unit elastic > -1inelastic

4.3. Price elasticity of demand (4) How to calculate price elasticity of demand? (a) When we have two observations on Q and P: e.g., Q decreased from 100 to 80 when P increased from $10 to $11 per unit, what is the price elasticity of demand?

4.3. Price elasticity of demand (4) How to calculate price elasticity of demand? (b) When we have a demand function: e.g., P = Q or Q = P when P = 40, Q = 20, e Q,P = -4 when P = 25, Q = 50, e Q,P = -1 when P = 10, Q = 80, e Q,P = Conclusion: Price elasticity of demand changes from one point to another point on the same demand curve.

4.3. Price elasticity of demand (5) Relation between TR and price elasticity (a) TR and market share (b) Relation between market share and e Q,P Elastic: Inelastic: Unit elastic:

4.3. Price elasticity of demand (5) Relation between TR and price elasticity (a) TR and market share (b) Relation between market share or TR and e Q, P -- How to calculate market share of each company? -- When the demand is elastic (e.g., e Q, P = -2): ↑ P  TR = P*Q ↓ P  TR = P*Q -- When the demand is inelastic (e.g., e Q, P = -0.6): ↑ P  TR = P*Q ↓ P  TR = P*Q -- When the demand is unit elastic (i.e., e Q, P = -1):

Take-home exercise (Thursday, Oct. 4) When the price of U.S. cigarettes increased from 20 to 24 in the Chinese market, the demand for U.S. cigarettes decreased from 100 to 90 units. (a) What is the price elasticity of demand for U.S. cigarettes in China? (b) If the U.S. wants to increase its market share in the Chinese cigarette market, should the U.S. cigarette price in China be increased or decreased?