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Demand

Demand theory and analysis provides many useful insights for business decision making. The success or failure of a business
depends mainly on its ability to generate revenues which in turn depend on demand for the product or service delivered by
the business.

This part of the course considers the theory of demand for managers and business decisions. We divide the contents into two
sets: the first set deals with the concept of demand curve - the individual demand, the market demand and the firm’s demand.
The second one considers the concept of elasticity - price elasticity, income elasticity and cross elasticity. The relationship
between marginal revenue, total revenue and elasticity is also discussed.

The learning objectives are:


(1) Understanding the factors influencing the individual demand, the law of demand, the substitution effect and the income
effect;
(2) The derivation of the market demand curve;
(3) The firm demand curve;
(4) Understanding price elasticity and its determinants;
(5) Point versus Arc Elasticity;
(6) Marginal revenue, total revenue and elasticity;
(7) Income elasticity, inferior goods, necessities, and luxuries
(8) Cross elasticity, substitutes and complements.

Discussion Questions
1(a) Explain the different types of demand functions?
(b) In which type of demand are we most interested in managerial economics and why?

2 (a) State the relationship between the total revenue of a firm and the price elasticity of demand for a price increase along a
linear demand curve.
(b) Explain the reason for this relationship.

(3) Why is the market demand curve usually less elastic that demand curves faced by the individuals firms in the market.

Tutorials
(1) A market consists of three people, A, B, and C, whose individual demand equations are as follows:
A: P = 35 - 0.5QA
B: P = 50 - 0.25QB
C: P = 40 - 2.00QC.
The industry supply equation is given by Qs = 40 + 3.5P
(a) Determine the equilibrium price and quantity.
(b) Determine the amount that will be purchased by each individual.

(2) An analyst tells the company that demand for the firm’s product (Qx) is given by the following equation:
Qx = 12000 - 5000Px + 5I + 500Pc
Where Px is the price charged for the firm’s product;
I is income;
Pc is price charged by competitors.
The values for Px, I, Pc are Rs5. Rs10000, and Rs6 respectively.
(i) Determinant what effect a price increase would have on total revenues.
(ii) Evaluate how sale of the product would change during a period of rising incomes.
(iii) Assess the probable impact if competing firms raise their prices.
(3) A market consists of two individuals. Their demand equations are Q1 = 16 - 4P
Q2 = 20 - 2P, respectively.
(i) What is the market demand equation?
(ii) At a price of Rs2, what is the point price elasticity for each person and the market.

Marginal revenue
(1) The demand equation faced by DuMont electronics for its personal computers is given by P = 10000 - 4Q.
(i) What is the marginal revenue equation?
(ii) Calculate the price and quantity where marginal revenue is zero.

(2) The demand equation for a product is given by


P = 30 - 0.1Q2
(a) Write an equation for the point elasticity as a function of quantity.
(b) At what price is the demand unitary elastic.

(3) The total revenue function of a firm’s product is given by TR = 120Q -0.1Q3
(i) Over what output range is demand elastic.
(ii) Initially, the price is set at Rs71.60. To maximise total revenue, should the price be increased or decreased? Explain.

Production and costs

TC = 1000 + 10Q - 0.9Q 2 + 0.04Q3


Find the rate of output that results in minimum average variable costs.
Determine the lowest price for output that would allow the firm to cover average variable cost.

(1) The total cost functions for a company is given by


TC = 200 + 5Q - 0.04Q 2+0.0001Q3.
Determine the level of fixed cost and equations for average total cost, average variable cost and average fixed
cost.
Determine the rate of output that results in minimum average variable cost.
If fixed costs increase to $500, what output rate will result in minimum average cost?

Market structure: monopoly versus competition

A monopolist has total cost function of


C = Q2 + 3Q + 1.
Demand is given by Q = 11 - P. Calculate the dead weight loss of monopoly. Illustrate your answer with a proper diagram.

The demand for a product is given by


P = 150 – 0.3Q.
The total cost function equals
TC = 1150 + 8Q + 0.1Q2.
Calculate the deadweight loss of the monopolist.

Examine the sources and consequences of monopoly.

Discuss possible regulatory responses to the efficiency problems associated with monopoly.