badm4300-module3

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JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

MANAGERIAL

ECONOMICS

BADM 4300 UNIT III

DEMAND ANALYSIS:Functions &

Elasticities


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DEMAND FUNCTIONS&

ELASTICITIES OF DEMAND

Definition ofDEMAND:Refers to the number of units of a particular good or

service that consumers are willing to buy under stated conditions oftime, place, price, and so forth.(Ceteris Paribus)

Thus demand is a function of a number of independent

variables or demand determinants; it can be expressed as an

algebraic equation or by a graph ortable.


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Demand Applications Problem #1: The Pueblo Viejo Company, a department

store, conducted a study of the demand for mens ties. Itfound out that the average daily demand, Q, in terms ofprice, P, is given by the following equation:

Q = 60 5P.a) How many ties per day can the store expect to sell at a price

of $3 per tie?

b) If the store wants to sell 20 ties per day, what price should itcharge?

c) What would be the demand if the store offered to give the

ties away?d) What is the highest price that anyone would be willing to

pay for these ties?

e) Plot the demand curve.


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Demand Applications

Problem #2: Digimill, Inc.


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Answer to Problem #1

a) Replace P by 3 in the equation:

Q = 60 5(3)

Q = 60 15

Q = 45 ties

b) Replace Q by 20 in the equation:

20 = 60 5P

20 60 = -5P

-40 = -5P

$8 = P


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c) We should assume that P = 0, and substitute P by its value inthe equation:

Q = 60 5(0)

Q = 60 0Q = 60 ties

d)We should assume that the highest price that someone will bewilling to pay is the price to buy the minimum units, that is 1:

1 = 60 5P1 60 = -5P

-59 = -5P

P = $11.80

Continuation


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P Q TR MR

12$

10

8

64

2

0

DEMAND TABLE

Continuation

Use the following equation to fill on the TR column: TR = P x Q


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P Q TR MR

12$ 0

10 10

8 206 30

4 40

2 50

0 60

Substituting Pby its corresponding value in the demandequation, Q = 60 - 5P, you can fill the Q column.

DEMAND TABLE


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P Q TR MR

12$ 0 0

10 10 100

8 20 1606 30 180

4 40 160

2 50 100

0 60 0

Multiplying column 1 and 2, you obtain the resultsfor the 3rd. Column: TR = P x Q

DEMAND TABLE


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Demand Equation

Qd = 60 5P Demand Table Demand Curve

0

2

4

6

810

12

14

Quantity

Price

P Q

12$ 0

10 10

8 20

6 30

4 40

2 500 60

20 40 60


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DEMAND LAW

Inverse relationship between price (P) and

quantity demanded (Qd):

When Price increases, quantity demanded decreases. P Qd

When price decreases, quantity demanded increases.

P

Qd


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DEMAND LAW

Continuation There are 2 effects which explain the inverse

relationship between the price of a product and the

quantity demanded: 1. The Substitution Effect:

When the price of a product decreases, new buyers will enter

the market. The product will be cheaper relative to other

products and the consumers will substitute them for the

product whose price has decreased,

2. The Income Effect:

Consumers will by more when the price is lower.


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QUANTITY DEMANDED

VS

CHANGE IN DEMAND Change in Quantity Demanded( Qd):

Movement along the demand curve from point A to pointB and is caused only by a change in the price of the

product. Change in Demand ( D):

A shift in the demand curve caused by a change in any ofthe factors determinants of demand (Ceteris Paribus),

other than the price of the product, such as: Number of consumers in the market. Tastes and preferences of the consumers,

Consumers income,

Price of other products,

Price expectations.


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ELASTICITIES OF DEMAND

Price elasticity of demand

d = % Qd / % P

Income elasticity of demand

d = % Qd / % TR

Cross elasticity of demand

dx/y = % Qdx / % Py

Advertising elasticity

d = % Qd / % PE


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DETERMINANTS OF

DEMAND The determinants of demand are variables

that affect the amount of a product

purchased. 1. Number of Consumers:

More consumers in a market, greater demand,

Less consumers in a market, less demand

2. Consumers Tastes & Preferences:Mode or Fad


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DETERMINANTS OF

DEMAND Continuation 3. Consumers Income

Normal Goods: goods for which demand is

positively (directly) related to income, e.g., steak,

clothes, leisure time.

Income elasticity of demand dis positive

Inferior Goods: goods for which demand isnegatively (inversely) related to income, e.g.,

potatoes, bread.

Income elasticity of demand dis negative


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DETERMINANTS OF

DEMAND Continuation 4. Price of Closely Related Goods

A) Substitutes. If products A and B are substitutes, a price increase in A will generate anincrease in the demand for B.Example, when the price of beef increases, the demand forchicken increases.

Cross elasticity of demand dx/y is positive. B) Complements. If products a and B are complements, a price increase in A will

generate a decrease in the demand for

B.Example, when the price of bread increases, the demand for jelly decreases.

Cross elasticity of demand dx/y is negative

5. Consumer Expectations

Do consumers expect incomes and prices to increase or decrease in the near future?


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PRICE ELASTICITY OF

DEMANDDefined as a percentage of change in the

quantity demanded that is caused by a one percent

change in price, ceteris paribus.

General Formula:

d = % Qd / % P


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DETERMINANTSof

PRICE-ELASTICITY 1)Luxury Goods - more elastic and

Necessity Goods less elastic.

2) Expensive Goods more elastic andCheap Goods less elastic.

3) More Substitutes more elastic and

Less Substitutes less elastic. 4) Time Period: the longer the time period more elastic.


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TYPES OF ELASTICITY

MEASUREMENTS Point-Elasticity Formula

Q1 Q0 P1 P0 or Q/Q0

Q0 P0 P/P0

Arc-Elasticity Formula

Q1 Q0 P1 P0 Q1 + Q0 P1 + P0

2 2


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ELASTIC VS INELASTIC

If =, demand is perfectly elastic

If

> 1, demand is elastic If = 1, unitary elasticity

If < 1, demand is inelastic

If = 0, perfectly inelastic


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DEMAND, REVENUE &

PRICE ELASTICITY Elastic Demand:

If Price increases, Total Revenue decreases

If Price decreases, Total Revenue increases

Unitary elasticity: If Price increases, Total Revenue constant

If Price decreases, Total Revenue constant

Inelastic Demand If Price increases, Total Revenue increases If Price decreases, Total Revenue decreases


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MARGINAL REVENUE &

PRICE ELASTICITY Elastic Demand:

Marginal Revenue is positive

As P , Qdand TR.

Unitary elasticity:

Marginal Revenue is equal to 0

As TRreaches it maximum.

Inelastic Demand

Marginal Revenue is negative

As P , Qdand TR.


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Page 27 Cross-Elasticity of Demand

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