Managerial Economics

PGP - 1, Section A
Term 1

Lecture 7
Instructor: Tirthatanmoy Das
Indian Institute of Management Bangalore
July 8, 2019
 Previous class

§ Budget line.
§ Consumer’s choice.
§ Individual demand curve.
§ Shifts in demand curve when income changes.
§ Substitute and complements.

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 Market Demand
§ Market demand curve: Curve relating the quantity of a
good that all consumers in a market will buy to its
price.
TABLE 4.2 DETERMINING THE MARKET DEMAND CURVE

(1) (2) (3) (4) (5)

PRICE INDIVIDUAL A INDIVIDUAL B INDIVIDUAL C MARKET
($) (UNITS) (UNITS) (UNITS) UNITS

1 6 10 16 32
2 4 8 13 25
3 2 6 10 18
4 0 4 7 11
5 0 2 4 6
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 Market Demand

§ The market demand curve is obtained by summing our

three consumers’ demand curves DA, DB, and DC

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 Market Demand

Two points :
§ The market demand curve will shift to the right as
more consumers enter the market.

§ Factors that influence the demands of many consumers

will also affect market demand.

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 Elasticity of demand

Denoting the quantity of a good by Q and its price by P,

the price elasticity of demand is
∆𝑄⁄𝑄 𝑃 ∆𝑄
𝐸" = =
∆𝑃⁄𝑃 𝑄 ∆𝑃
Inelastic demand: When demand is inelastic, total
expenditure on the product increases when the price
increases.
Elastic demand: When demand is elastic, total expenditure
on the product decreases as the price goes up.
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 Elasticity of demand

Consumers’ expenditure and elasticity

TABLE 4.3 PRICE ELASTICITY AND CONSUMER EXPENDITURES

DEMAND IF PRICE IF PRICE DECREASES,

INCREASES, EXPENDITURES
EXPENDITURES
Inelastic Increase Decrease
Unit elastic Are unchanged Are unchanged
Elastic Decrease Increase
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 Important questions
How much will the revenue of a firm change after
increasing the price of a commodity by a certain amount?

How much will the quantity demand of the commodity

increase if consumers incomes rises by a specific
amount?

…many more
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 Example: the demand for housing
TABLE 4.4 PRICE AND INCOME ELASTICITIES OF THE DEMAND FOR ROOMS

GROUP PRICE ELASTICITY INCOME

ELASTICITY
Single individuals – 0.10 0.21
Married, head of
household age less than – 0.25 0.06
30, 1 child
Married, head age 30–
– 0.15 0.12
39, 2 or more children
Married, head age 50 or
– 0.08 0.19
older, 1 child
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 Empirical estimation of demand
Data TABLE 4.6 DEMAND DATA
YEAR QUANTITY PRICE INCOME (I)
(Q) (P)
2004 4 24 10
2005 7 20 10
2006 8 17 10
2007 13 17 17
2008 16 10 27
2009 15 15 27
2010 19 12 20
2011 20 9 20
2012 22 5 20 10
 Elasticity from demand function
Suppose demand function is a linear function:
𝑄 = 𝑎 − 𝑏𝑃 + 𝑐𝐼
𝑃: price, 𝐼: income; 𝑎, 𝑏, 𝑐: constants

Δ𝑄
= −𝑏
Δ𝑃
12 " "
Price elasticity: 𝜂" = 1" 2 = −b 2.
If values of 𝑏 is know, 𝜂4 can be computed for each (𝑃, 𝑄)
pair. But how do we know 𝑏? 11
 Estimation: linear regression analysis

Estimation of 𝑎, 𝑏, 𝑐: least square estimation.

Suppose the demand function be: 𝑄5 = 𝑎6 − 𝑎7 𝑃5 + 𝜖5

The method fits the data and estimates 𝑎6 (say 𝑎96 ) and 𝑎7
(i.e. 𝑎97 ).

If other factors affect demand (e.g. I), then estimate the

function: 𝑄5 = 𝑏6 − 𝑏7 𝑃5 + 𝑏: 𝐼5 + 𝑢5 and obtain 𝑏<6 , 𝑏<7 , 𝑏<: .
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 Other sources of data
Interview: obtain demand information through
interviews. may not be effective if people lack
information or interest or even want to mislead the
interviewer.

Experiments: actual sales offers are posed to potential

customers. May suffer from the following issues: costly
wrong experiment; other factors changing at the same
time etc.
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