THEORY OF DEMAND AND SUPPLY

DEMAND FUNCTION

Managerial Economics (Econ605)

Aarushi
Amity Business School
Demand Function
• A product’s demand function describes amount of product that is
demanded for each possible combination of its price and other
factors.
• The general form of the demand function in terms of price and
quantity demanded is: Q = f(P)
• Including other variables it can also be written as: Q = f(P, A, Y, Pr),
• where A represents advertising expenditure, Y represents average
income of the market and Pr represents the price of a related product.

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Demand Function
• For example, we could specify the demand for coffee as a function of
the price of coffee (P), income (Y), the price of sugar (Ps), holding all
other factors constant, the demand function will be:
Q = f(P, Ps, Y)
• This expression shows how the quantity of coffee demanded varies
with the price of coffee, the price of sugar and the income of
consumers.
• The estimated demand function has a linear form –
Q = 8.56 - P - 0.3Ps + 0.1Y
where Q is the quantity of coffee in millions of tons per year, P is the
price of coffee in dollars per pound, Ps is the price of sugar in dollars
per pound, and Y is the average annual household income in high-
income countries in thousands of dollars.
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Demand Function
• When we draw the demand curve, we set Ps and Y at specific values,
say, Ps = $0.20 per pound and Y = $35 thousand per year.
• By substituting these values for Ps and Y in the equation, we can
express the quantity demanded as a function of only the price of
coffee:
Q = 8.56 - P - 0.3Ps + 0.1Y
Q = 8.56 - P - (0.3 × 0.2) + (0.1 × 35)
Q = 12 – P
• The demand function corresponds to linear demand curve.
• The constant term (12) is the quantity demanded if the price is zero.
• i.e. Q = 12, where demand curve hits the quantity axis—when price is
zero.

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How quantity demanded varies with change in
price?
• Using demand function, Q = 12 – P
• If the price falls from P1 to P2, the change in price,
∆P = P2 - P1
• Quantity demanded changes from Q1 to Q2,
∆Q = Q2 - Q1
• The change in the quantity demanded, in response to the price change is –
∆Q = Q2 - Q1
= f(P2) - f(P1)
= (12 - P2) - (12 - P1)
= - (P2 - P1)
= - ∆P
• Thus, the change in the quantity demanded, ∆Q, is - ∆P, indicating inverse
relation between quantity demanded and price.
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Inverse • As we usually graph this relation with the
price of the good on the vertical axis, it is
Demand useful to represent the demand function
with price on the left-hand side and
Function everything else on the right-hand side. This
relation is called an inverse demand
function.
We know that
• It reveals how much consumers are willing
equation of a straight and able to pay for each additional unit of
line is – good X.
y = mx + c • Example, if demand function is –
Where m is the slope Qd = 6060 – 3P
and c is the y- • Then, inverse demand function would be –
intercept. 1
P = 2020 - Qd
3
• Here, the y-intercept is 2020 and the slope
is -1/3.
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Deriving slope of the demand curve
• Given the demand function for coffee,
Q = 12 - P,
• the derivative of the demand function with respect
to price is
𝒅𝑸
= -1
𝒅𝑷
• Therefore, the slope of the demand curve, which
is
𝒅𝑷 𝟏
= 𝒅𝑸 = -1
𝒅𝑸
𝒅𝑷
• The Law of Demand states that the derivative of
the demand function with respect to price is
negative,
𝒅𝑸
<0
𝒅𝑷

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Demand Function Interpretations
• Consider the following linear demand function –
Qdx = α0 + αxPx + αyPy + αMM
• By the law of demand, an increase in Px leads to a decrease in the
quantity demanded of good X. This means that αx < 0.
• The sign of αy will be positive or negative, depending on whether
goods X and Y are substitutes or complements.
• If αy is a positive number, an increase in the price of good Y will lead
to an increase in the consumption of good X; therefore, good X is a
substitute for good Y.
• If αy is a negative number, an increase in the price of good Y will lead
to a decrease in the consumption of good X; hence, good X is a
complement to good Y.

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Demand Function Interpretations
• Consider the following linear demand function –
Qdx = α0 + αxPx + αyPy + αMM
• The sign of αM also can be positive or negative depending on whether
X is a normal or an inferior good.
• If αM is a positive number, an increase in income (M) will lead to an
increase in the consumption of good X, and good X is a normal good.
• If αM is a negative number, an increase in income will lead to a
decrease in the consumption of good X, and good X is an inferior
good

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Reference: Thomas, C. R., & Maurice, S. C. (2016). Managerial economics: Foundations of Business Analysis and
Strategy. 12th ed. McGraw-Hill Education.

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