Transcript Managerial Economics in a Global Economy

MANAGERIAL ECONOMICS IN A GLOBAL
DOMINICK SALVATORE
THE BASIC OF DEMAND, SUPPLY
AND EQUILIBRIUM
Lecture for MM CORDEV -11 (PJJ)
Bandung, 2 -9- 13
By : Teguh Widodo
[email protected]
Twitter : broTeguh
02135126126
Scope
• Demand side of market
– Demand theory and curve
– Effect of non-price to demand
• Supply side of market
– Supply teory and curve
– Effect of non-price to supply
• Equilibrium & Change of equilibrium
• Elasticity
The Nature of Managerial Economics
Management Decision Problem
Economic Theory:
Microeconomics,
Macroeconomics
Decesion Science:
Math. Economics
Econometrics
MANAGERIAL ECONOMICS
Aplication of economic theory and
decision science tools to solve
managerial decision problems
OPTIMAL SOLUTION TO MANAGERIAL
DECISION PROBLEM
DEMAND AND SUPPLY



Economics begins and ends with the “Law” of supply and
demand. The laws of supply and demand are an important
beginning in the attempt to answer vital questions about the
working of a market system.
Demand for a good or service is defined as quantities of a
good or service that people are ready (willing and able) to
buy at various prices within some given time period, other
factors besides price held constant.
The supply of a good or service is defined as quantities of a
good or service that people are ready to sell at various prices
within some given time period, other factors besides price
held constant.
Demand Side
• Every market has a demand side and a supply side.
• The demand side can be represented by a market
demand curve which shows the amount of commodity
buyers would like to purchase at different prices.
• Demand curves are drawn on the assumption that
buyers’ tastes, income, the number of consumers in the
market and the price of related commodities are
unchanged.
LAW OF DEMAND
The inverse relationship between the price of the
commodity and the quantity demanded per period
is referred to as the law of demand.
 A decrease in the price of a good, all other things
held constant (ceteris paribus), will cause an
increase in the quantity demanded of the good.
 An increase in the price of a good, all other things
held constant, will cause a decrease in the
quantity demanded of the good.

Change in Quantity Demanded
Price
An increase in price
causes a decrease in
quantity demanded.
P1
P0
Q1
Q0
Quantity
Change in Quantity Demanded
Price
A decrease in price
causes an increase in
quantity demanded.
P0
P1
Q0
Q1
Quantity
Changes in Demand
• Changes in price result in changes in the
quantity demanded.
– This is shown as movement along the
demand curve.
• Changes in nonprice determinants result
in changes in demand.
– This is shown as a shift in the demand
curve.
Changes in Demand
• Change in Buyers’ Tastes
Today’ consumer purchases leaner meats compared to old
generations due to the level of blood cholesterol and body
weight
• Change in Buyers’ Incomes
– Normal Goods : i.e., shoes, steaks, travel, automobiles,
education
– Inferior Goods: i.e., potatoes, hotdogs, hamburger
• Change in the Number of Buyers
• Change in the Price of Related Goods
– Substitute Goods : i.e., Carrots can be replaced by
cabbage
– Complementary Goods : i.e., cars and gasoline or electric
stove and electricity.
Change in Demand
An increase in demand
refers to a rightward shift
in the market demand
curve.
Price
P0
Q0
Q1
Quantity
Change in Demand
A decrease in demand
refers to a leftward shift
in the market demand
curve.
Price
P0
Q1
Q0
Quantity
Demand, Supply and Equilibrium
• Every market has a demand side and a supply
side. The Supply side can be represented by a
market supply curve which shows the amount of
commodity sellers would offer a sale at various
prices.
• Supply curves are drawn on the assumption of
technology and input or resources (as such labor,
capital and land) and prices.
Law of Supply
• The direct relationship between the price of the
commodity and the quantity supplied per period is
referred to as the law of supply.
• A decrease in the price of a good, all other things held
constant (ceteris paribus), will cause a decrease in the
quantity supplied of the good.
• An increase in the price of a good, all other things held
constant, will cause an increase in the quantity supplied
of the good.
Change in Quantity Supplied
A decrease in price
causes a decrease in
quantity supplied.
Price
P0
P1
Q1
Q0
Quantity
Change in Quantity Supplied
An increase in price
causes an increase in
quantity supplied.
Price
P1
P0
Q0
Q1
Quantity
Changes in Supply
• Nonprice determinants of supply
– Costs and technology
– Prices of other goods or services offered by
the seller
– Future expectations
– Number of sellers
– Weather conditions
Changes in Supply
• Change in Production Technology
- An improvement in the technology and a reduction in input prices
would make it possible to produce a commodity at a lower cost. This
indicates that sellers would be willing to sell more the goods at each
price
• Change in Input Prices
-↓ in agriculture product, ↓ price of lamb meat, ↑ quantity supplied
so rightward shift in the market supply curve
• Change in the Number of Sellers
- ↑ in no of sellers, the market supply curve shifts to right or ↓ in no
of sellers, the market supply curve shifts to left
• Prices of other goods or services offered by the seller
- i.e., BMW, Mercedes, Woswagen (Subs. Goods)
- i.e., lamp meat and lamp leather (comp. Goods)
19
Change in Supply
An increase in supply
refers to a rightward shift
in the market supply curve.
Price
P0
Q0
Q1
Quantity
Change in Supply
A decrease in supply refers
to a leftward shift in the
market supply curve.
Price
P0
Q1
Q0
Quantity
Market Equilibrium
• Market equilibrium is determined at the intersection of the
market demand curve and the market supply curve.
• Equilibrium price: The price that equates the quantity
demanded with the quantity supplied.
• Equilibrium quantity: The amount that people are willing
to buy and sellers are willing to offer at the equilibrium
price level.
• The equilibrium price causes quantity demanded to be
equal to quantity supplied.
• An increase or decrease in the demand or supply curve, it
defines a new equilibrium point.

Market Equilibrium
Price
D
S
P
Q

If the quantity
supplied of a
commodity exceeds
the quantity
demanded, this is
called excess supply
or surplus between
D and S over point p.
If the quantity
demanded of a
commodity exceeds
the quantity
supplied, this is
called excess
demand or shortage
between D and S
below point p.
Market Equilibrium
• Shortage: A market situation in which the
quantity demanded exceeds the quantity
supplied.
– A shortage occurs at a price below the
equilibrium level.
• Surplus: A market situation in which the
quantity supplied exceeds the quantity
demanded.
– A surplus occurs at a price above the
equilibrium level.
Market Equilibrium
Market Equilibrium
Price
D0
D1
S0
An increase in demand
will cause the market
equilibrium price and
quantity to increase.
P1
P0
Q0 Q1
Quantity
Market Equilibrium
Price
D1
D0
S0
A decrease in demand
will cause the market
equilibrium price and
quantity to decrease.
P0
P1
Q1 Q0
Quantity
Market Equilibrium
Price
D0
S0
P0
P1
Q0 Q1
S1
An increase
in supply
will cause
the market
equilibrium
price to
decrease and
quantity to
increase.
Quantity
Market Equilibrium
Price
D0
S1
P1
P0
Q1 Q0
S0
A decrease in
supply will
cause the
market
equilibrium
price to
increase and
quantity to
decrease.
Quantity
The Demand Schedule and the demand curve-Example

How can the relationship between quantity
demanded and price be portrayed?

Demand schedule

Demand curve
PERMINTAAN
Harga
(IDR)
5000
4000
3000
2000
1000
DBadu
Ceteris
Paribus
Buku yg diminta ( ribu unit)
Ali
Badu
Pasar
10
10
20
15
15
30
30
20
50
50
30
80
70
45
115
Efek harga thd permintaan
Permintaan Ali thd Buku
6000
Price (IDR)
5000
P1
4000
3000
P2
DAli
2000
1000
Q2
0
0
20
40
Quantities (ribu unit)
60
80
The Market Supply Curve
7
7
6
6
5
5
4
4
Price
Price ($)
The Market Demand Curve
Pd = -0,001*Qd + 8
3
2
2
1
1
0
Ps = 0,05*Qs + 2
3
0
0
1000
2000
3000
4000
5000
6000
7000
0
2000
Quantities
4000
6000
8000
10000
8000
10000
Quantities
Ceteris
Paribus
Q demand
Q supply
6
2000
8000
5
3000
6000
4
4000
4000
3
5000
2000
2
6000
0
The Equilibrium Price
7
Excess Supply
6
5
Price
P ($)
PE
E
4
3
2
Excess Demand
1
QE
0
The Equilibrium Price at 4$
0
2000
4000
6000
Quantities
Shifting of Demand Curve
7
D1
6
D0
D2
Price ($)
5
4
3
2
P = -0,001*Q + 8
1
0
0
1000
2000
3000
4000
5000
Quantities
The Effect of Non-Price to
Demand Curve
•
HARGA BARANG LAIN
–
–
–
•
PENDAPATAN PARA PEMBELI
–
–
–
–
•
Barang pengganti (kopi – teh)
Barang pelengkap (gula – kopi/teh)
Barang netral (beras – buku tulis)
Barang inferior (gaplek): negatif
Barang esensial (sembako): netral
Barang normal (pakaian): positif
Barang mewah (mobil): positif
FAKTOR LAIN
–
–
–
–
Distribusi pendapatan
Citra rasa masyarakat
Jumlah penduduk
Ekspektasi masa depan
6000
7000
8000
9000
Shifting of Supply Curve
7
6
Q = 0,05*P + 2
Price
5
4
3
2
1
0
0
2000
4000
6000
8000
The Effect of Non-Price to
Supply Curve
Quantities
• KENAIKAN HARGA BARANG LAIN 
• BIAYA FAKTOR PRODUKSI -• TUJUAN OPERASI PERUSAHAAN --
• Profit optimation.
• Profit maximation.
• TINGKAT TEKNOLOGI YG DIGUNAKAN --
• Increasing production
• Cost efficiency  increasing profit.
10000
12000
Price
7
6
5
4
3
2
1
0
E1
E0
0
2000
4000
6000
8000
10000
Quantities
Price
The Equilibrium Shifting
7
6
5
4
3
2
1
0
0
2000
E0
E2
4000
6000
Quantities
8000
10000
12000
Individual Demand function

The demand for a commodity arises from the
consumers’ willingness and ability to purchase the
commodity. Consumer demand theory postulates
that the quantity demanded of a commodity is a
function of / or depends on the price of the
commodity, the consumers’ income, the price of
related commodities, and the tastes of the
consumer.
Individual Consumer’s Demand
QdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X
by an individual per time period
PX = price per unit of commodity X
I = consumer’s income
PY = price of related (substitute or
complementary) commodity
T = tastes of the consumer
Functional form

Qdx= (Px, I, Py, T)

An inverse relationship is expected between
the quantity demanded of a commodity and
its price (law of demand). That is, when the
price rises, the quantity purchased declines,
and when the price falls, the quantity sold
increases.
QdX = f(PX, I, PY, T)
QdX/PX < 0 if a good is superior
QdX/I
> 0 if a good is normal
QdX/I
< 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements
HORIZONTAL SUMMATION: FROM
INDIVIDUAL TO MARKET DEMAND
Market Demand Function
QDX = f(PX, N, I, PY, T)
QDX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers on the market
I = consumer income
PY = price of related (substitute or
complementary) commodity
T = consumer tastes
DEMAND FACED BY A FIRM

Market Structure





Monopoly
Oligopoly
Monopolistic Competition
Perfect Competition
Type of Good
Durable Goods
 Nondurable Goods
 Producers’ Goods - Derived Demand

LINEAR DEMAND FUNCTION
QX = a0 + a1PX + a2N + a3I + a4PY + a5T
PX
Intercept:
a0 + a2N + a3I + a4PY + a5T
Slope:
QX/PX = a1
QX
ELASTICITY OF DEMAND
PRICE ELASTICITY OF DEMAND

The price elasticity of demand (Ep) is mainly
depends on the following factors:
 Existence of substitutes effect
e.g. Oil product cannot easily be
substituted-demand of oil product is
inelastic.
e.g. The demand for taxi services is
expected to be elastic. Instead, You may
use bus, train etc..

The price elasticity of demand (Ep) is mainly
depends on the following factors:
 The portion of money allocated in the
budget
o A change in the price of a product do not
influence consumers’ budget in a negative
way.
e.g. An increase in black pepper will not
decrease the demand of consumers on
black pepper due to their small portion of
money allocated in their budget.

The price elasticity of demand (Ep) is mainly
depends on the following factors:
 The time period after changes in price
o As long as time period gets longer, the
demand becomes more elastic.
e.g. When oil prices increase, consumers cannot
find a solution to change the current system to
another alternative system in a short run
period. This shows us demand for oil will
remain same to a certain extent and an
increase or a decrease in demand will be
depend on time.
Price Elasticity of Demand

The price elasticity of demand (Ep) is
measured by the percentage change in the
quantity demanded of the commodity
divided
by the percentage change in
commodity’s price, holding constant all other
variables in the demand function.
Q / Q Q P
EP 


P / P P Q
PRICE ELASTICITY OF DEMAND
Point Definition
Q / Q Q P
EP 


P / P P Q
Arc Definition
Q2  Q1 P2  P1
EP 

P2  P1 Q2  Q1
Calculus approach
P ($)
Q (unit)
A
B
C
D
E
F
G
6
5
4
3
2
1
0
0
100
200
300
400
500
600
Market
Px
Point
8
A
6
4
2
0
0
Q = 600-100P
B
200
C
400
D
600
Qdx
E
800
F
1000
G
1200
Point Elasticity of Demand- Example


Find Ep at point A, B, C and G
Ep=(ΔQ/ ΔP) (P/Q)
 At point A, Ep=(-200)/(6-5)*(6/0)
Ep=-200 (6/0)= - indefinite
 At point B, Ep= (200-400/5-4) (5/200)=-5
 At point C, Ep=(400-600/4-3) (4/400)=-2
 At point G, Ep=(-200) (0/1200)=0
Arc Elasticity of Demand- Example


Find arc Ep between points B and C
 Ep=(Q2-Q1)/(P2-P1)*(P2+P1)(Q2+Q1)
 Ep= (400-200)/(4-5) (4+5)/(400+200)
 Ep=-3
Absolute value of Ep
 Greater than 1- elastic
 Equals 1- unit elastic
 Less than 1- inelastic
PRICE ELASTICITY, TOTAL REVENUE AND MARGINAL REVENU
Q
Point P ($)
(unit)
A
B
C
D
E
F
G
6
5
4
3
2
1
0
0
100
200
300
400
500
600
Ep =
∆Q/∆P *
P/Q
-∞
-5
-2
-1
-0,5
-0,2
0
TR= MR =
P*Q ∆TR/∆Q
0
500
800
900
800
500
0
5
3
1
-1
-3
-5
Calculus Solution
Fungsi permintaan Q = 600 – 100 P. Hitung elastisitas permintaan bila jml yg
diminta .
a.Q = 100
b.Q = 300
c.Q = 500
a. Q = 600 – 100P  dQ/dP = -100
P = 6 - Q/100  Q = 100  P = 6-1 = 5
Ep = dQ/dP * P/Q
= -100* 5/100
=-5
b. Q = 600 – 100P  dQ/dP = -100
P = 6 - Q/100  Q = 300  P = 6-3 =3
Ep = dQ/dP * P/Q
= -100* 3/300
=-1
Calculus approach:



Find MR by using P and Ep at Px =$4 and $3
MR= P{1+(1/Ep)}
 At Px =$4 MR=4{1+(1/-2)=$2
 At Px =$3 MR=3{1+(1/-1)=0
Based on the previous table:
 P decreases TR increases when Ep is elastic
 TR max or unchanged when Ep is unitary
elastic
 TR decreases when Ep is inelastic
Demand, TR, MR and Price Elasticity
P ($)
Q=
600100*P
MR =
6-Q/50
0
100
200
300
400
500
600
6
4
2
0
-2
-4
-6
Ep =
(dQ/dP)
* P/Q
1000
900
800
-∞
-5
-2
-1
-0,5
-0,2
0
700
Ep = (dQ/dP)(P/Q) = -100.3/300= -1
Jika permintaan elastis thd harga (0300 unit) maka penurunan harga
menaikan TR. TR maks pd unitary
price, yi Q =300.
Jika demand tidak elastis (yi Q>300),
maka setiap penurunan harga
menurunkan TR, dan MR negatif.
7
6
5
4
3
2
1
0
0
500
800
900
800
500
0
TR
600
500
400
300
200
100
0
0
100
200
300
400
500
600
700
6
5
4
3
D
2
MR
1
0
0
100
200
300
400
500
600
700
LATIHAN ELASTISITAS
1. Fungsi permintaan P = 150 -2Q. Hitung elastisitas permintaan bila jml
yg diminta .
a. Q = 35
b. Q = 37,5
c. Q = 50
2. Fungsi permintaan P = 150 – 1/3 Q. Hitung elastisitas permintaan bila
harganya :.
a. P = 5
b. P = 45
3. Bila tingkat harga $ 2 , jml yg diminta 8 unit, bila $4 yg diminta 6 unit.
Dg menganggap fungsi permintaan adalah linear, berapa elastisitas
permintaan pada harga
1. $3,2. $4,4. Pada fungsi permintaan Q = 20 – 2 P^2, hitung elastisitas permintaan
pada harga $ 2,- per unit.
MARGINAL REVENUE AND PRICE
ELASTICITY OF DEMAND

1 
MR  P 1 

 EP 
MARGINAL REVENUE AND PRICE
ELASTICITY OF DEMAND
PX
EP  1
EP  1
EP  1
QX
MRX
MARGINAL REVENUE, TOTAL REVENUE,
AND PRICE ELASTICITY
TR MR>0
EP  1
EP  1 MR=0
MR<0
EP  1
QX
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
Demand for a commodity will be more elastic if:
 It has many close substitutes
 It is narrowly defined
 More time is available to adjust to a price change
DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
Demand for a commodity will be less elastic if:
 It has few substitutes
 It is broadly defined
 Less time is available to adjust to a price change
INCOME ELASTICITY OF DEMAND
Point Definition:
Arc Definition:
Q / Q Q I
EI 


I / I
I Q
Q2  Q1 I 2  I1
EI 

I 2  I1 Q2  Q1
Calculus approach:
Normal Good
Inferior Good
EI  0
EI  0
CROSS-PRICE ELASTICITY OF DEMAND
Point Definition
Linear Function
E XY
QX / QX QX PY



PY / PY
PY QX
E XY
PY
 a4 
QX
CROSS-PRICE ELASTICITY OF DEMAND
Arc Definition
E XY
QX 2  QX 1 PY 2  PY 1


PY 2  PY 1 QX 2  QX 1
Calculus approach:
Exy = dQ/dPy * Py /Qy
Substitutes
EXY  0
Complements
EXY  0
OTHER FACTORS RELATED TO DEMAND
THEORY

International Convergence of Tastes
Globalization of Markets
 Influence of International Preferences on Market
Demand


Growth of Electronic Commerce
Cost of Sales
 Supply Chains and Logistics
 Customer Relationship Management

1.
Di Kota Bandung terdapat tiga perguruan tinggi (PT) yang membutuhkan buku dari
agen tunggal PT Globook. Respons dari masing2 PT terhadap harga berbeda-beda
dengan data sbb:
Buku yg dijual
Buku yg diminta
Harga (IDR)
PT X
PT Y
PT Z
PT Globook
50000
100
100
150
2000
40000
150
150
200
1400
30000
300
200
300
800
20000
500
300
400
10000
700
450
500
200
0
Denganpasar diasumsikan ceteris paribus,
1. Gambarkan kura permintaan dan penawaran pasar.
2. Hitung harga ekuilibrium pasar.
3. Apa yang terjadi jika PT Globook mematok harga jual Rp 40.000,00; bagaimana pula
jika penjual mengobral buku dg harga Rp 30.000,00?
4. Hitung elastisitas busur pada setiap terjadi perubahan harga dari Rp 50.000,00 ke Rp
40.000,00 ke Rp 30.000,00 dan ke 20.000,00.
INCOME ELASTICITY OF DEMAND

Point Definition

Linear Function
EI 
Q / Q Q I


I / I
I Q
EI  a3 
I
Q
69
INCOME ELASTICITY OF DEMAND
Arc Definition
Normal Good
E
I
 0
Luxuries Good
E
I
 1
Q2  Q1 I 2  I1
EI 

I 2  I1 Q2  Q1
Inferior Good
EI  0
Necessities Good
0 <I E < 1
70
CROSS-PRICE ELASTICITY OF DEMAND
Point Definition
Linear Function
QX / QX QX PY
E XY 


PY / PY
PY QX
E XY
PY
 a4 
QX
71
CROSS-PRICE ELASTICITY OF DEMAND
Arc Definition
QX 2  QX 1 PY 2  PY 1
EXY 

PY 2  PY 1 QX 2  QX 1
Substitutes
Complements
EXY  0
EXY  0
No relationship
EXY 0
72
INCOME, CROSS AND ARC ELASTICISES- EXAMPLE
Px
73
Find arc EI between two levels of income i.e I=$10000 and I=$
11000 when the demand for commodity X is 400.
Market
 Ep={(Q2-Q1)/(I2-I1)}*{(I2+I1)/(Q2+Q1)}
8
A
6
B
C
4
 Ep= {(600-400)/(11-10)}*{(11+10)/(600+400)}
D
E
2
F
0
 EI= 4.2
0
200 400 600 800 1000
Qdx
 Thus commodity X is normal and luxury.
Find arc Exy between two levels of price Y i.e Py=$ 1 and Py =$ 2
when the demand for commodity X is 400.
 Ep={(Q2-Q1)/(P2-P1)}*{(P2+P1/)/(Q2+Q1)}
XY
 Ep= {(600-400)/(2-1)}*{(2+1)/(600+400)}
Substitutes
 EI= 0.6
E
G
1200
0
 Thus commodity Y is substitute compared to commodity X
USING ELASTICISES IN MANAGERIAL DECISION MAKINGEXAMPLE
74
A firm selling coffee brand X and estimated relevant
demand regression as follows:
Qx=1.5 - 3Px + 0.8I + 2Py - 0.6Ps + 1.2A

Qx is sales of coffee brand X,
I is disposable income,
Py is price of competitive coffee brand,
Ps is price of sugar and
A is advertising expenditures for coffee brand X.

Suppose:




Px=$2,
I=$2.5,
Py=$1.80,
Ps=$0.50 and
A=$1
USING ELASTICITIES IN MANAGERIAL DECISION MAKING
EXAMPLE
Calculate Qx and the elasticities of sales with respect to each variable
in the relevant demand function
Qx=1.5-3.0 Px+0.8 I+2.0 Py-0.6 Ps+1.2 A
Qx=1.5-3.0(2)+0.8(2.5)+2(1.8)-0.6(0.5) +1.2(1)
=2 million pounds coffee
75

Calculate the elasticities of the demand for coffee brand X


Ep=-3(2/2)=-3,Ei=0.8(2.5/2)=1, Exy=2(1.8/2)
ES= -0.6(0.5/2)=-0.15, EA=1.2(1/2)=0.6
RECALL the Formula
P
P
EP  a1 
E XY  a4  Y
Q
QX
EI
I
 a3 
Q
USING ELASTICISES IN MANAGERIAL DECISION MAKINGEXAMPLE
76
Next year, the firm would like to increase PX by 5%, A
by 12%, I by 4%, and PY 7% whereas Ps fall by 8%.
Determine sales of coffee brand X in the next year.
Qxx
=
QX+ {QX(∆PX/PX)EP + Qx(∆I/I)EI
Qx(∆Py/Py)Exy + Qx(∆A/A)EA }

Qxx=2+2(5%)(-3)+2(4%)(1)+2(7%)(1.8)+2(-8%)(-0.15)+2(12%)(0.6)

Qxx=2.2 or 2,200,000 pounds
+
HOW DO YOU INTERPRET?
77
HOW DO YOU INTERPRET?

78
1 percent increase in price leads to a reduction in
the quantity demanded of clothing of 0f 0.90
percent in the short-run and 2.90 percent in the
long-run.
Price elasticity of demand for gasoline is three
times higher in the long-run.
Both elasticities are very small.
It seems that people cannot find suitable substitutes
for gasoline.



HOW DO YOU INTERPRET?
79
HOW DO YOU INTERPRET?

80
Income elesticity of demand is 2.59 for wine and 0.36 for flour. This means that a 1 percent increase
in consumers’ income leads to a 2.59 percent
increase in expenditure on wine but to a 0.36
percent reduction in expenditures on flour.
Thus wine is a luxury while flour is a inferior good.
Electricity is also a luxury and so European cars,
Asian cars, and domestic cars in the U.S. While
cigarettes, beer, chicken and pork are necessities.
Beef is a borderline commodity


HOW DO YOU INTERPRET?
81
HOW DO YOU INTERPRET?

82
The cross price elesticity of demand of margarine with
respect to the price of butter is 1.53 percent. This means
that a 1 percent increase in the price of butter leads to a
1.53 percent increase in the demand for margarine.
Thus margarine and butter are substitutes in the U.S.
The cross price elesticity of demand of cereals (e.g.
Bread) with respect to the price of fresh fish is -0.87
percent. This means that a 1 percent increase in the
price of cereals leads to a 0.87 percent reduction in the
demand for fresh fish.
Thus cereal and fresh fish are complements.



HOW DO YOU INTERPRET?
83
HOW DO YOU INTERPRET?

84
The price elesticity of demand of beer is -0.23 percent.
This means that a 10 percent increase in the price of beer
leads to a 2.3 percent reduction in the quantity of beer
demanded and thus an increase in consumer expenditures
on beer.
The price elesticity of wine is -0.40 and spirits is -0.25 so
that an increase in their price also leads consumers to
demand a smaller quantity of wine and spirits, but also to
spend more on the alcoholic beverages.
The cross price elesticity of demand for beer with respect
to the price of wine is 0.31 and with respect to spirits is
0.15. This means that wine and spirits are substitutes for
beer, with wine being better substitute.


HOW DO YOU INTERPRET?



85

Thus a 10 percent increase in the price of wine will
lead to a 3.1 percent increase in demand for beer, while
a 10 percent increase in the price of spirits leads to a
1.5 percent increase in demand for beer.
a 10 percent increase in consumer income will lead to
a 0.9 percent reduction in the demand for beer, but
50.3 percent increase in demand for wine, while a 12.1
percent increase in demand for spirits.
Thus beer can be considered an inferior good, while
wine and spirits can be regarded as a luxury goods.
Wine seems much stronger luxury than spirits.
THE IMPORTANT STEPS BY USING ELASTICITIES

86
The analysis of the forces or variables that affect on demand and
reliable estimates of their quantitative effect on sales (elasticities)
are essential in order for firm to make best operating decisions in
shor-run and to plan for its growth in the long-run.
The firms can use the elasticities of demand of the variables
under their controls to find out best policies as well as to
maximize their profits.
If the demand for the firm’s product is price inelastic, the firm
will want to increase the product price since that would increase
its total revenue and reduce its total cost.
If the elasticity of the firm’s sales wrt the variable beyod its
control or If the cross-price elasticity of demand for the firm’s
product is very high, the firm will need to respond quickly to a
competitor’s price reduction otherwise losing a great deal of its
sales.



THE IMPORTANT STEPS BY USING ELASTICITIES

87
The size of the price elasticity of demand is larger, the
closer and the greater is the number of available
substitutes for the commodity. For example, sugar is more
price elastic than table salt (e.g. honey)
In general, the greater is its price elasticity of demand,
the greater will be the number of substitutes
For a given price change, the quantity response is likely
to be much larger in the long run than short run so the
price elasticity of demand is likely to be much greater in
the long run than short run .


1. Permintaan mobil Chevrolet di US dimodelkan sbb:
Qc = 100000 – 100Pc + 2000N + 50I + 30Pf – 1000Pg + 3A + 40000Pi
Dimana
Qc = quantity demanded per year of Chevrolet automobiles
Pc = price of Chevrolet automobile
N = population of US, in millions
I = per capita dispossible income
Pf = price of Ford automobiles, in dollars
Pg = real price of gasoline, in cents per gallon
A = advertizing expenditure by Chevrolet, in dollars per year
Pi = credit incentives to purchase Chevrolets, in percentage points below the rate of
interest on borrowing in the absence of incentive.
1. Tunjukan perubahan pembelian Chevrolets tiap tahun untuk setiap unit perubahan
pada variabel bebas .
2. Turunkan kurva permintaan jika diketahui harga Chevrolet rata-rata $9.000, jumlah
penduduk 200 juta, pendapatan per kapita $ 10.000,00, harga mobil Ford $8.000,00,
harga bensin $8 sen per galon, biaya iklan $ 50.000,00 per triwulan dan Chevrolet
memberikan insentif kredit $ 1,00. Berapa jumlah Chevrolet yg diminta?
3. Buat analisis seandainya harga Chevrolet naik 10% dan harga mobil Ford naik 10%
dan harga bensin naik 25% dan pendapatan per kapita naik 5% sedangkan lainnya
tetap.
Interpretation of elasticities
Midwest Cable TV has estimated the demand for its service to be
given by the following function:
Q = 9,83 P -1,2 A2.5 Y 1,6 P0 1,4
where
Q
P
A
Y
P0
=
=
=
=
=
monthly sales in units
price of the service in $
promotional expenditure in $’000
average income of the market in $’000
price of ‘home movies’ in $
The current price of Midwest is $60, promotional expenditure is
$120,000, average income is $28,000, and the price of
‘homemovies’ is $45.
Indicate whether the following statements are true or false, giving
your reasons and making the necessary corrections.
a. If Midwest increases its price this will reduce the number of its
customers.
b. If Midwest increases its price this will reduce its revenues.
c. People’s expenditure on the cable TV service as a proportion of their
income will increase when their income increases.
d. If Midwest increases its price this will increase the sales of ‘home
movies’.
e. ‘Home movies’ are a substitute for cable TV.
f. A 5 per cent increase in income will increase demand by 16 per cent.
g. A 10 per cent increase in price will reduce demand by 12 per cent.
h. Current sales are over a million units a month.
i. The demand curve for Midwest is given by: Q=9,83P1,2
j. Midwest’s sales are more affected by the price of ‘home movies’ than
by the price of its own service.
k. If Midwest increases its price this will reduce its profit.
1. True; customers and quantity demanded are synonymous in this
case, and there is an inverse relationship between Q and P, as seen
by the negative price elasticity.
2. True; demand is elastic, since the PED is greater than 1 in absolute
magnitude. Therefore an increase in price causes a greater than
proportional decrease in quantity demanded and a fall in revenue.
3. True; this is because the YED is greater than 1, indicating that cable
TV is a luxury product. Note that the statement would be false if the
good were a staple. For staples, although expenditure on the roduct
increases as income increases, expenditure as a proportion of
income falls, since expenditure rises more slowly than income.
4. False; the two products are complementary, shown by the CED
being negative; therefore an increase in the price of one product will
reduce the sales of the other. It appears therefore that ‘home movies’
is a cable channel.
5. False; the two products are complementary, shown by the CED
being negative.
7. False; YED = 1,6; therefore using the simple elasticity formula
(reasonably accurate for small changes) the change in demand will
be 1,6 * 5% = 8%.
8. False; change is 1,2 * 10% = 12%, but this is a change in quantity
demanded, corresponding to a movement along a demand curve
(unlike the previous part of the question, which involves a shift in the
demand curve).
9. False; current sales are given by
Q=9.83(60)1,2 (120)2,5 (28)1,6 (45)1,4 = 11.420 units.
10. False; the demand curve is given by Q = 9,83P1,2 1202,5 281,6 451,4 .
Or Q = 1.554.039P1,2.
11. True; the CED is larger in absolute magnitude than the PED. This is
an unusual situation but arises because of the nature of cable TV
service. The service is only a means to an end, that of receiving
certain channels.
12. False; since demand is elastic, an increase in price has an unknown
effect on profit. More information would be required.
Marginal effects and elasticity PK Corp estimates that its demand
function is as follows:
Q = 150 + 5,4P + 0,8A + 2,8Y + 1,2P*
where
Q = quantity demanded per month (in 1000s)
P = price of the product (in £)
A = firm’s advertising expenditure (in £’000 per month)
Y = per capita disposable income (in £’000)
P = price of BJ Corp (in £).
a. During the next five years, per capita disposable income is
expected to increase by £2,500. What effect will this have on the
firm’s sales?
b. If PK wants to raise its price by enough to offset the effect of the
increase in income, by how much must it raise its price?
c. If PK raises its price by this amount, will it increase or decrease the
PED? Explain.
d. What is the relationship between PK and BJ? Explain
your answer.
e. If next year PK intends to charge £15 and spend £10,000
per month on promotion, while it believes per capita
income will be £12,000 and BJ’s price will be £3, calculate
the income elasticity of demand. What does this tell you
about the nature of PK’s product?
f. What effect would an increase in advertising of £1000
have on profitability, if each additional unit costs £10 to
produce?
a. Use the marginal effect of income on quantity demanded:
∆Q/∆Y = 2,8 - ∆Y = 2,5
 ∆Q/2,5 = 2,8
∆Q = 2,8 * 2,5 = 7; or 7.000 units
b. Use the marginal effect of price on quantity demanded:
∆Q/∆P = 5,4 - 7/ ∆P = 5,4
- ∆P = 7/5,4 = £1:30
c. PED = (dQ/dP)*(P/Q) = 5,4 (P/Q)
As P increases and Q stays constant (because of rising income),
PED increases in absolute magnitude, meaning that demand
becomes more elastic.
d. The two companies make complementary products
because the marginal effect of the price of BJ on the
quantity of PK is negative.
e. YED = (dQ/dY)* (Y/Q)
= 2,8 * 12/(150 - 5,4*15 + 0,8*10 + 2,8*12 - 12 *3)
= 0,3140
f. If ∆A = 1; ∆Q = 0,8 = 800 units; ∆R = 800*15 = 12.000
C = 800*10 (production) + ∆A (£1.000) = £9.000
Thus every additional £1,000 spent on advertising
increases profit by £3.000.