In this chapter we examined the demand function, which expresses the dependence of the quantity demanded (or sales) of a particular product upon a variety of independent variables. We examined the impact we would expect changes in these variables to have upon the quantity demanded of a particular product. The demand curve was defined as part of the demand function when price is the only variable independent factor. That is to say, when all other factors remain constant and price changes along a particular demand curve. If any other factor does not remain constant we must expect a shift of the demand curve, which will cause a differing quantity to be demanded at the prevailing price level.
The relationship between price, quantity demanded, total revenue, and marginal revenue was examined, and it was determined that for any negatively sloping demand curve, total revenue would initially increase as a price is reduced but would later decline. Consequently, marginal revenue would initially be positive and later negative.
Several measures of the elasticity of quantity demanded were discussed. Price elasticity of demand is particularly useful for indicating the direction of change in total revenue when there is a particular directional change in price. Moreover, when a firm has several products, the relative price elasticities of these products will indicate which of these products can best sustain a price increase versus those for which a price increase would be a poor strategy. Income elasticity of demand is important for growth and stability considerations in the firm, since the demand for luxury products will tend to be relatively responsive to changes both up and down in the aggregate level of activity. Similarly, we argued that necessity goods are relatively recession proof and that inferior goods are expected to exhibit countercyclical demand patterns.
Cross elasticities of demand allow the summary and classification of the relationships existing between a particular product and all other products. The decision maker should be interested in knowing which of the other products on the market represent the most serious competition for his or her product. Similarly, negative values of cross elasticity indicate product complementarity and the relative strength of this complementarity.
The concepts and principles outlined in this chapter will be called upon in subse-
quent chapters. Pricing the firm’s product requires a strong knowledge of the demand conditions existing in a particular market, and an understanding of the responsiveness of demand to the various factors that influence that demand is therefore of considerable importance.