Demand function.
• A simple demand function uses its own price to describe the quantity demanded.
• Economists assume the two have a linear relationship.
• Thus, price changes will have a constant effect on changes in quantity demanded at different
price points.
• Dx = f (Px) or
• Dx = a – b (Px)
• Where a = constant (represents total demand at zero price)
• b = ∆D/∆P (constant, which represents the change in Dx produced by Px)
• If we don’t know the impact and significance of each demand determinant, we can write the
demand function as follows:
• Qd = f(P, Y, R…..) We read the function as “the quantity demanded for a product is a function of
its own price, consumer income, and the price of the related product.”
• In the linear demand function, AD/AP is constant and the resultant
demand curve is a straight line.
• For example, let’s translate this function into the following
mathematical equation:
• Qd = α – β1 * P + β2 * Y + β3 * PR
• β represents the coefficient. It shows us how much influence each
variable has on the quantity demanded.
• The negative sign on the coefficient shows the price has a negative
effect on the quantity demanded. If the price increases by Rs.1, the
quantity demanded will decrease by β1. On the other hand, if the
price decreases by Rs.1, the quantity demanded will increase by β1.
• The mathematical equation, needs to be convert into an inverse
demand function.
• And to do so, we rearrange the above formula into an inverse
demand function as follows:
• P = (α/β1) – (Qd/β1) + (β2/β1) * INC + (β3/β1) * PR
• Since there are 3 variables to describe demand, it is difficult to
describe it in a two-dimensional graph.
• For this reason, economists only use the price variable to simplify the
model.
• First, we must find the quantity demanded for each price point to
draw a demand curve.
• Then, we plot the combination of price and quantity demanded onto
a curve.
• For example, the relationship between the demand for gasoline (Q)
and factors such as its price (P), consumer income (Y), and the price
of cars (PC) is defined as follows:
• Qd = 9.3 – 0.7P + 0.2Y – 0.03 PC
• Qd is in liters and P, Y, and PC are in Rs.
• It can be read as, The constant 9.3 represents the quantity of gasoline
demanded even when there is no change in price, consumer income,
or the price of cars.
• The quantity demanded (Qd), and price (P) have a negative relationship
with a coefficient of 0.7. It shows that price and quantity are inversely
related. And if the price increases by Rs.1, then the quantity demanded will
decrease by 0.7 and vice versa.
• Consumer income (Y) positively correlates with the quantity demanded
(Qd). Thus, a Rs.1 increase in consumer income leads to an increase in
gasoline demand by 0.2 liters and vice versa.
• The sign on the price of the car (PC) is negative, indicating the car price is
inversely related to the demand for gasoline (Qd). Thus, if the car price
increases by Rs.1, the demand for gasoline decreases by 0.03 liters and vice
versa. Specifically, the negative relationship shows cars are complementary
goods to gasoline.
• 0.7P = 9.3 – Qd
• P = (9.3/0.7) – (1/0.7)*Qd
• P = 13.3 – 1.4Qd
• 1.4 represents the slope of the demand curve. Meanwhile, the
negative sign indicates a downward sloping curve.
• By solving this equation Qd = 9.3 – 0.7P , we will get the gasoline
price and quantity data, we assume the value of P to get the value of
Qd which is as follows:
Rs.
• Economists usually use linear functions as examples because they are
easier to explain and understand for us. As we know, economic models try
to describe reality more simply.
• Nonlinear function means the relationship between the quantity
demanded and the price forms other than a straight line if we plot it.
• For example qdx = 8/px.
• The equation for non-linear demand function is as follows:
• Dx = a (Px)-b and
• Dx = (a/Px + c)-b
• Where, a or b or c >0
• The curve above shows that demand has different responsiveness in
response to price changes.
• For example, at the price of Rs.2 gasoline, a Rs.1 increase in price (to
Rs.3) would decrease the demand for 0.9 liters (5.8 – 4.9).
• However, when the price was already high and reached Rs.12, the
Rs.1 increase (to Rs.13) had little effect on the quantity demanded,
which remained at around 2.8 liters.
