Question 2(B): What Are the Differences Between a Firm's Demand Curve and Market Demand Curve?

2559 Words Jul 21st, 2012 11 Pages
The demand curve that an individual firm faces is called the residual demand curve: the market demand that is not met by other sellers at any given price. The firm's residual demand function, Dr(p), shows the quantity demanded from the firm at price p. A firm sells only to people who have not already purchased the good from another seller. We can determine how much demand is left for a particular firm at each possible price using the market demand curve and the supply curve for all other firms in the market. The quantity the market demands is a function of the price: Q = D(p). The supply curve of other firms: So(p). The residual demand function equals the market demand function, D(p), minus the supply of all other firms:
Dr(p) = D(p) –
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• The market: A certain set of economic actors who are the potential buyers of that commodity.
• A time frame within which the demand is measured.
• An economic backdrop that includes all the determinants of demand other than the unit price of that commodity.
The market demand curve is a curve drawn with:
• The vertical axis is the price axis, measuring the price per unit of the commodity.
• The horizontal axis is the quantity axis, measuring the quantity of the commodity demanded in total by all the economic actors chosen above.
Obtaining the market demand curve from individual demand curves
The term individual demand curve is used to describe the demand curve for a single economic actor who is part of the market.
The market demand curve is obtained by aggregating (or adding up) the individual demand curves. With the usual way demand curves are drawn, this addition is done horizontally, i.e., for each fixed price (vertical) coordinate, the values of the quantity (horizontal) coordinates for all the economic actors are added.
If we assume that the individual demand curve for each economic actor represents, for each price, the optimal (utility-maximizing) quantity to buy at that price, then the market demand curve represents the optimal quantity for all the economic actors together to buy at that price.
Smoothing out in aggregation
A lot of interesting and quirky phenomena may be obtained at the level of individual demand curves but may

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