The aim of this handout is to serve as a reminder of a principles-level course in economics. However make sure you master this tools because the rest of the topics that we will cover will assume that you have a thorough working knowledge of this material.
 

DEMAND THEORY

The model of supply and demand constitutes one of the most important managerial tools because it assists the manager in predicting changes in product and input prices.

Market Demand Curve: A curve indicating the total quantity of a good all consumers are willing and able to purchase at each possible price, holding the prices of related goods, income, advertising, and other variables constant.

  1. Change in quantity demanded: Changes in the price of a good lead to a change in quantity demanded of that good. This correspond to a movement along a given demand curve
  2. Change in demand: Changes in variables other than the own price of the good, such us income or prices of other related goods lead to a change in demand. This corresponds to a shift in the entire demand curve.

Elasticity is a measure of the responsiveness of one variable to changes in another variable; the percentage change in one variable that arises due to a given percentage change in another variable.

Own Price Elasticity: is a measure of the responsiveness of the quantity demanded of a good to a change in its own price.

  • Elastic Demand: demand is elastic if the absolute value of the own price elasticity is greater than 1.

  • Inelastic Demand: demand is inelastic if the absolute value of the own price elasticity is less than 1.

  • Unitary Elastic: demand is unitary elastic if the absolute value of the own price elasticity is equal to 1.

  • Perfectly Elastic: demand is perfectly elastic if the own price elasticity is infinite in absolute value. In this case the demand curve is horizontal.
  • Perfectly Inelastic: demand is perfectly inelastic if the own price elasticity is zero. In this case the demand curve is vertical.

Cross-Price Elasticity: is a measure of the responsiveness of the demand for a good to changes in the price of a related good.

  • If the cross price elasticity greater than 0 then the goods are complements.

  • If the cross price elasticity is smaller than 0 then the goods are substitutes.

Income Elasticity: is a measure of the responsiveness of the demand for a good to changes in consumer income.

  • Goods with negative income elasticity are defined as inferior goods.
  • Normal goods have positive income elasticity values. If the value is in between 0 and 1 the good is called a necessity. If the value is greater than 1 the good is called a luxury.