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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