1. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 1 1

2. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 2 2

3. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 3 Law of Demand Holding all other things constant (ceteris paribus), 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

4. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 4 Components of Demand: The Substitution Effect Assuming that real income is constant: –If the relative price of a good rises, then consumers will try to substitute away from the good. Less will be purchased. –If the relative price of a good falls, then consumers will try to substitute away from other goods. More will be purchased. The substitution effect is consistent with the law of demand.

5. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 5 Components of Demand: The Income Effect The real value of income is inversely related to the prices of goods. A change in the real value of income: –will have a direct effect on quantity demanded if a good is normal. –will have an inverse effect on quantity demanded if a good is inferior. The income effect is consistent with the law of demand only if a good is normal.

6. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 6 Individual Consumer’s Demand Qd X = f(P X, I, P Y, T) quantity demanded of commodity X by an individual per time period price per unit of commodity X consumer’s income price of related (substitute or complementary) commodity tastes of the consumer Qd X = P X = I = P Y = T =

7. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 7 Qd X = f(P X, I, P Y, T)  Qd X /  P X < 0  Qd X /  I > 0 if a good is normal  Qd X /  I < 0 if a good is inferior  Qd X /  P Y > 0 if X and Y are substitutes  Qd X /  P Y < 0 if X and Y are complements

8. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 8

9. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 9

10. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 10 Market Demand Curve Horizontal summation of demand curves of individual consumers Exceptions to the summation rules –Bandwagon Effect collective demand causes individual demand –Snob (Veblen) Effect conspicuous consumption a product that is expensive, elite, or in short supply is more desirable

11. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 11

12. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 12 Market Demand Function QD X = f(P X, N, I, P Y, T) quantity demanded of commodity X price per unit of commodity X number of consumers on the market consumer income price of related (substitute or complementary) commodity consumer tastes QD X = P X = N = I = P Y = T =

13. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 13 Demand Curve Faced by a Firm Depends on Market Structure Market demand curve Imperfect competition –Firm’s demand curve has a negative slope –Monopoly - same as market demand –Oligopoly –Monopolistic Competition Perfect Competition –Firm is a price taker –Firm’s demand curve is horizontal

14. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 14 Demand Curve Faced by a Firm Depends on the Type of Product Durable Goods –Provide a stream of services over time –Demand is volatile Nondurable Goods and Services Producers’ Goods –Used in the production of other goods –Demand is derived from demand for final goods or services

15. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 15

16. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 16 Linear Demand Function Q X = a 0 + a 1 P X + a 2 N + a 3 I + a 4 P Y + a 5 T PXPX QXQX Intercept: a 0 + a 2 N + a 3 I + a 4 P Y + a 5 T Slope:  Q X /  P X = a 1

17. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 17 Linear Demand Function Example Part 1 Demand Function for Good X Q X = 160 - 10P X + 2N + 0.5I + 2P Y + T Demand Curve for Good X Given N = 58, I = 36, P Y = 12, T = 112 Q = 430 - 10P

18. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 18 Linear Demand Function Example Part 2 Inverse Demand Curve P = 43 – 0.1Q Total and Marginal Revenue Functions TR = 43Q – 0.1Q 2 MR = 43 – 0.2Q

19. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 19

20. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 20

21. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 21

22. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 22

23. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 23 Price Elasticity of Demand Linear Function Point Definition

24. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 24 Price Elasticity of Demand Arc Definition

25. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 25 Marginal Revenue and Price Elasticity of Demand

26. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 26 Marginal Revenue and Price Elasticity of Demand PXPX QXQX MR X

27. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 27 Marginal Revenue, Total Revenue, and Price Elasticity TR QXQX MR<0MR>0 MR=0

28. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 28 Determinants of Price Elasticity of Demand The demand for a commodity will be more price elastic if: It has more close substitutes It is more narrowly defined More time is available for buyers to adjust to a price change

29. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 29 Determinants of Price Elasticity of Demand The demand for a commodity will be less price elastic if: It has fewer substitutes It is more broadly defined Less time is available for buyers to adjust to a price change

30. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 30

31. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 31 Income Elasticity of Demand Linear Function Point Definition

32. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 32 Income Elasticity of Demand Arc Definition Normal GoodInferior Good

33. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 33

34. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 34 Cross-Price Elasticity of Demand Linear Function Point Definition

35. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 35 Cross-Price Elasticity of Demand Arc Definition SubstitutesComplements

36. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 36

37. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 37 Example: Using Elasticities in Managerial Decision Making A firm with the demand function defined below expects a 5% increase in income (M) during the coming year. If the firm cannot change its rate of production, what price should it charge? Demand: Q = – 3P + 100M –P = Current Real Price = 1,000 –M = Current Income = 40

38. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 38 Solution Elasticities –Q = Current rate of production = 1,000 –P = Price = - 3(1,000/1,000) = - 3 –I = Income = 100(40/1,000) = 4 Price –%ΔQ = - 3%ΔP + 4%ΔI –0 = -3%ΔP+ (4)(5) so %ΔP = 20/3 = 6.67% –P = (1 + 0.0667)(1,000) = 1,066.67

39. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 39

40. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 40 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

41. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 41

42. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 42 Chapter 3 Appendix

43. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 43 Indifference Curves Utility Function: U = U(Q X,Q Y ) Marginal Utility > 0 –MU X = ∂ U/ ∂ Q X and MU Y = ∂ U/ ∂ Q Y Second Derivatives –∂M U X / ∂ Q X < 0 and ∂M U Y / ∂ Q Y < 0 –∂M U X / ∂ Q Y and ∂M U Y / ∂ Q X Positive for complements Negative for substitutes

44. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 44 Marginal Rate of Substitution Rate at which one good can be substituted for another while holding utility constant Slope of an indifference curve –dQ Y /dQ X = -MU X /MU Y

45. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 45

46. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 46 Indifference Curves: Complements and Substitutes QYQY QXQX QYQY QXQX Perfect Complements Perfect Substitutes

47. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 47 The Budget Line Budget = M = P X Q X + P Y Q Y Slope of the budget line –Q Y = M/P Y - (P X /P Y )Q X –dQ Y /dQ X = - P X /P Y

48. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 48 Budget Lines: Change in Price GF: M = $6, P X = P Y = $1 GF’: P X = $2 GF’’: P X = $0.67

49. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 49

50. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 50 Budget Lines: Change in Income GF: M = $6, P X = P Y = $1 GF’: M = $3, P X = P Y = $1

51. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 51 Consumer Equilibrium Combination of goods that maximizes utility for a given set of prices and a given level of income Represented graphically by the point of tangency between an indifference curve and the budget line –MU X /MU Y = P X /P Y –MU X /P X = MU Y /P Y

52. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 52

53. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 53 Mathematical Derivation Maximize Utility: U = f(Q X, Q Y ) Subject to: M = P X Q X + P Y Q Y Set up Lagrangian function –L = f(Q X, Q Y ) + (M - P X Q X - P Y Q Y ) First-order conditions imply – = MU X /P X = MU Y /P Y

54. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 54

55. C opyright  2007 by Oxford University Press, Inc. PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.Slide 55