Transcript Managerial Economics & Business Strategy

Chapter 2 homework
Numbers 7, 10, and 13
Managerial Economics &
Business Strategy
Chapter 3
Quantitative Demand Analysis
Anyone heard of
ELASTICITY??
• How responsive is variable “G” to a change in
variable “S”
EG , S
%G

%S
If EG,S > 0, then S and G are directly related.
If EG,S < 0, then S and G are inversely related.
If EG,S = 0, then S and G are unrelated.
The Elasticity Concept Using
Calculus
• An alternative way to measure the elasticity of a
function G = f(S) is
EG , S
dG S

dS G
If EG,S > 0, then S and G are directly related.
If EG,S < 0, then S and G are inversely related.
If EG,S = 0, then S and G are unrelated.
Own Price Elasticity of
Demand
Q Px
%QX


%PX
Px Qx
d
EQX , PX
d
x
• Negative according to the “law of demand.”
Elastic:
EQ X , PX  1
Inelastic: EQ X , PX  1
Unitary:
EQ X , PX  1
Perfectly Elastic &
Inelastic Demand
Price
Price
D
D
Quantity
PerfectlyElastic( EQX ,PX  )
Quantity
PerfectlyInelastic( EQX ,PX  0)
What does this mean??
• EQ ,P = 3
x


X
A 1% increase in price will lead to a 3% decline in quantity
demanded.
Would a firm find this to be a problem?
• EQ ,P = .3
x


X
A 1% increase in price will lead to a 0.3% decline in quantity
demanded.
Would a firm find this to be a problem?
Why would a firm worry about
elasticity?
• Impacts units sold  Total Revenue

Price * Quantity
• Elastic

Increase (a decrease) in price leads to a decrease (an increase) in
total revenue.
• Inelastic

Increase (a decrease) in price leads to an increase (a decrease) in
total revenue.
• Unitary


Total revenue is unchanged
Total revenue is maximized at the point where demand is unitary
elastic.
Elasticity, Total Revenue and Linear
Demand
P
100
TR
Unit elastic
Elastic
Unit elastic
80
1200
60
Inelastic
40
800
20
0
10
20
30
40
50
Q
0
10
Elastic
20
30
40
Inelastic
50
Q
What should the airlines do to
increase cash flow??
•
•
•
•
Increase the price of tickets to raise money
Decrease the price of tickets to raise quantity sold
Elasticity = 1.8
Elastic!!! Reduce price to increase TR
Factors Affecting
Own Price Elasticity

Available Substitutes
• The more substitutes available for the good, the more elastic
the demand.

Time
• Demand tends to be more inelastic in the short term than in
the long term.
• Find substitutes.

Expenditure Share
• Cost more??? Think about it more  More elastic
Cross Price Elasticity of
Demand
Q Py
% Q X


% PY
Py Qx
d
EQ X , PY
d
x
If EQX,PY > 0, then X and Y are substitutes.
If EQX,PY < 0, then X and Y are complements.
Predicting Revenue Changes
from Two Products
Suppose that a firm sells goods that are related (pizza
and beer). If the price of beer (good X) changes, then
total revenue will change by:
 


R  RX 1  EQX , PX  RY EQY ,PX  %PX
What???
• Suppose a firm’s revenues are derived from the sales
of two products, X and Y.

The firm’s revenue would be R = Rx + Ry,
• Rx = PxQx denotes revenues from the sale of product X
• Ry = PyQy denotes revenues from the sale of product Y.

The impact of a given percentage change in the price of product X
on the total revenue of the firm are given by the following formula:
 


R  Rx 1  EQx ,Px  Ry EQy ,Px * %Px
Can we do it??
• You are the owner of a bookstore, and earn revenues
primarily from selling coffee and books. For the
past two years you have consistently earned, on
average, revenues of $500 per week from selling
coffee and $1000 per week from selling books. If
the own price elasticity of demand for coffee is -1.0
and the cross price elasticity of demand between
books and coffee is -1.8, what would happen to your
revenues if you lowered the price of coffee (if coffee
is good X) by 10%?