Managerial Economic Quantitative Demand Analysis

Quantitative Demand Analysis

1. Chapter 3 Quantitative Demand Analysis

2. © 2022 by McGraw-Hill Education. All Rights Reserved. 2 Learning Objectives 5- 2

3. Elasticity A measure of the responsiveness of one variable to changes in another variable; the percentage change in one variable that arises due to a given percentage change in another variable. © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 3 The Elasticity Concept

4. © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 4 Own Price Elasticity of Demand Own price elasticity of demand Measures the responsiveness of a percentage change in the quantity demanded of good X to a percentage change in its price. Sign: negative by law of demand. Magnitude of absolute value relative to unity: : Elastic. : Inelastic. : Unitary elastic.  

5. 5 © 2022 by McGraw-Hill Education. All Rights Reserved.

6. © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 6 Linear Demand, Elasticity, and Revenue (Figure 3.1) Quantity Price Demand $40 $20 $10 20 30 $5 40 $15 $30 $25 $35 10 50 60 70 80 Linear Inverse Demand: Demand:   Revenue = $ Elasticity: Conclusion: Demand is elastic.   Revenue = $ Elasticity: Conclusion: Demand is unitary elastic.   Revenue = $ Elasticity: Conclusion: Demand is inelastic.   Observation: Elasticity varies along a linear (inverse) demand curve

7. Elasticity and Total Revenue (Figure 3.1) Total Revenue is maximized when elasticity is = 1, Unitary Elastic In the elastic range, total revenue can be increased by decreasing price. In the inelastic range, total revenue can be increased by increasing price. © 2022 by McGraw-Hill Education. All Rights Reserved. 7 7

8. When demand is elastic: A price increase (decrease) leads to a decrease (increase) in total revenue. When demand is inelastic: A price increase (decrease) leads to an increase (decrease) in total revenue. When demand is unitary elastic: Total revenue is maximized. © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 8 Total Revenue Test

9. © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 9 Perfectly Elastic and Inelastic Demand (Figure 3.2) Quantity Demand Price Perfectly Inelastic   Demand   Perfectly elastic

10. Three factors can impact the own price elasticity of demand: Availability and number of substitutes If consumers can easily switch to alternatives when the price of a good increases, the demand tends to be more elastic. 2. Time/duration of purchase horizon In the short term, consumers may have less flexibility to adjust their behavior, making demand less elastic. Over the long term, consumers may find alternatives or adjust their habits, making demand more elastic. 3. Expenditure share of consumers’ budgets It reflects how consumers distribute their financial resources among various spending categories to meet their needs and preferences © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 10 Factors Affecting the Own Price Elasticity

11. Cross-price elasticity Measures the responsiveness of a percent change in demand for good X due to a percent change in the price of good Y. If , then and are substitutes. If , then and are complements.   © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 11 Cross-Price Elasticity

12. Cross-price elasticity is important for firms selling multiple products. Price changes for one product impact demand for other products. Assessing the overall change in revenue from a price change for one good when a firm sells two goods is:   © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 12 Cross-Price Elasticity

13. Income elasticity Measures the responsiveness of a percent change in demand for good X due to a percent change in income. If , then is a normal good . If , then is an inferior good .   © 2022 by McGraw-Hill Education. All Rights Reserved. 3- 13 Income Elasticity