demand analysis (cont.) managerial economics 1 lect. in managerial economics riad sultan

Demand Analysis (Cont.)Demand Analysis (Cont.)

Managerial Economics Managerial Economics

11Lect. In managerial economicsLect. In managerial economicsRiad SultanRiad Sultan

Your firm’s research department has Your firm’s research department has estimated the income elasticity of estimated the income elasticity of demand for chicken to be -1.94. demand for chicken to be -1.94. You have just read in an economic You have just read in an economic newspaper that due to an upturn in the newspaper that due to an upturn in the economy, consumer incomes are economy, consumer incomes are expected to rise by 10% over the next expected to rise by 10% over the next three years. three years. As a manager of a chicken processing As a manager of a chicken processing plant, how will this forecast affect your plant, how will this forecast affect your purchase of chicken?purchase of chicken?

Riad SultanRiad Sultan Lect. In managerial economicsLect. In managerial economics 22

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ElasticitiesElasticities

When one of the determinants changes, When one of the determinants changes, demand will also changedemand will also change

The next issue is how much?The next issue is how much?

We analyse the magnitude of the change We analyse the magnitude of the change And hence we refer to ELASTICITIESAnd hence we refer to ELASTICITIES

Lect. In managerial economicsLect. In managerial economicsRiad SultanRiad Sultan

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ELASTICITY OF DEMANDELASTICITY OF DEMAND

Price in 2007= Rs20: Demand (Sales)= 43Price in 2007= Rs20: Demand (Sales)= 43Price in 2008= Rs10: Demand (Sales) =75Price in 2008= Rs10: Demand (Sales) =75

When price change by Rs10, demand When price change by Rs10, demand changes by 32 units. Can we say that for changes by 32 units. Can we say that for each Rs1, demand rises by (32/10) 3.2 each Rs1, demand rises by (32/10) 3.2 units? Yesunits? YesHowever, to compare different goods, we However, to compare different goods, we take the percentage changetake the percentage change


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Percentage change in demand Percentage change in demand

=[(New-old)/old] X 100 =[(New-old)/old] X 100

= [(75-43)/43] = [(75-43)/43]

= 75%= 75%– Hence, demand has increased by 75%Hence, demand has increased by 75%

Percentage change in pricePercentage change in price

=(10-20)/20= -50%=(10-20)/20= -50%– Hence, price has decreased by 50%Hence, price has decreased by 50%


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Conclusion:Conclusion:– When price falls by 50%, demand rises by When price falls by 50%, demand rises by

75%75%

It follows that when price changes by 1%, It follows that when price changes by 1%, demand will rise by (75%/50%) = 1.5%demand will rise by (75%/50%) = 1.5%

1.5 is called elasticity1.5 is called elasticity


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Formula for elasticity of demand:Formula for elasticity of demand:

% change of quantity demanded divided % change of quantity demanded divided %change of price = 1.5%change of price = 1.5


Elasticity of demandElasticity of demand

Formula for elasticity of demand:Formula for elasticity of demand:

Price Originalprice inChange

quantity OriginalQuantity inChange

Elasticity


Calculation Calculation

Elastic demand = >0Elastic demand = >0

Inelastic demand = <0Inelastic demand = <0

Elasticity = Unitary = 1Elasticity = Unitary = 1


ElasticityElasticity

Calculate: prices move from P1 to P2:Calculate: prices move from P1 to P2:

P1=10P1=10 Q1=100Q1=100

P2=20P2=20 Q2=50Q2=50

Elasticity= 50%/100% = 0.5%Elasticity= 50%/100% = 0.5%

When price changes by 1%, demand falls When price changes by 1%, demand falls by 0.5%by 0.5%


Arc elasticityArc elasticity

2/)2P

Change

(P1P1-P2

Q2)/2(Q1Q1)-(Q2

priceaverage price inChange

quantityaverage Quantity in

Elasticity


Point elasticityPoint elasticityRequirements: understand slope of a demand curveRequirements: understand slope of a demand curve

Slope = change in vertical/change in horizontal = Slope = change in vertical/change in horizontal = 40/80=1/240/80=1/2

1212

40

80

A

B

35

5

6

72


Calculate elasticity at A =2 X (35/5)=14%Calculate elasticity at A =2 X (35/5)=14%

Calculate elasticity at B = 2 X (6/72) = Calculate elasticity at B = 2 X (6/72) = 0.16%0.16%

At A, demand is elasticAt A, demand is elastic

At B, demand is inelasticAt B, demand is inelastic


Calculating elasticity from demand Calculating elasticity from demand functionfunction

SupposeSuppose

Q = 100 – 5PQ = 100 – 5P

Change in Q/Change in P =-5Change in Q/Change in P =-5

Elasticity = -5(P/Q)Elasticity = -5(P/Q)


Elasticity and Total revenueElasticity and Total revenue

Suppose :Suppose :P1=10P1=10 Q1=100 Q1=100 TR= P1Q1=1000TR= P1Q1=1000P2=20P2=20 Q2=75Q2=75 TR = P2Q2 = TR = P2Q2 = 14001400Elasticity= 25%/100% = 0.25%Elasticity= 25%/100% = 0.25%When price rises by 1%, demand falls by When price rises by 1%, demand falls by 0.25% 0.25% Outcome: Total Revenue rises Outcome: Total Revenue rises Marginal revenue is positiveMarginal revenue is positive



Conclusion 1: Conclusion 1: when demand is elasticwhen demand is elastic (>1), (when price rises, TR falls), (>1), (when price rises, TR falls),

can not raise the pricecan not raise the price

Conclusion 2: Conclusion 2: when demand is inelasticwhen demand is inelastic (<1), when price rises, TR rises(<1), when price rises, TR rises

always raise pricesalways raise prices



P1= 10P1= 10 Q1= 100 TR = 1000Q1= 100 TR = 1000

P2=15P2=15 Q2=40Q2=40 TR = 600TR = 600

Elasticity = 60%/50%=1.2%Elasticity = 60%/50%=1.2%

When price rises by 1%, quantity When price rises by 1%, quantity demanded falls by more than 1% (1.2%):demanded falls by more than 1% (1.2%):

Total revenue: FallsTotal revenue: Falls

Marginal revenue: negativeMarginal revenue: negative


Relationship between marginal Relationship between marginal revenue, and price elasticityrevenue, and price elasticity

pe

11PMR


Determinants of Price elasticityDeterminants of Price elasticity

– Availability of substitutesAvailability of substitutesElasticity is high when there are substitutesElasticity is high when there are substitutes

– Nature of commodityNature of commodityLuxury, durable = elastic; necessity, non-durable = inelastic; Luxury, durable = elastic; necessity, non-durable = inelastic;

– Weightage in the total consumptionWeightage in the total consumptionWhen proportion is large = elastic; when prop. is low = inelasticWhen proportion is large = elastic; when prop. is low = inelastic

– Time factor in adjustment of consumptionTime factor in adjustment of consumptionThe longer the time to adjust, the higher the price elasticityThe longer the time to adjust, the higher the price elasticity

– Range of commodity useRange of commodity useMulti-purpose goods = high elasticityMulti-purpose goods = high elasticity

– Proportion of Market suppliesProportion of Market suppliesThe proportion of consumers who are satisfied: if less than 50%, The proportion of consumers who are satisfied: if less than 50%, demand will be elasticdemand will be elastic


Cross price elasticityCross price elasticity– Substitutes and complementsSubstitutes and complements

Income elasticityIncome elasticity– Normal, necessities , inferior Normal, necessities , inferior

Advertising elasticityAdvertising elasticity

Elasticity of price expectations Elasticity of price expectations



exp.g adversitin Originalexpng adverstisi inChange

sales Originalsales in

Elasticity

Change

2121

=0: sales do not respond to advertisement=0: sales do not respond to advertisement

>0 but <1: less than proportionate >0 but <1: less than proportionate increase in advertisingincrease in advertising

=1 proportionate increase in advertising =1 proportionate increase in advertising

>0 more than proportionate increase in >0 more than proportionate increase in advertisingadvertising



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DeterminantsDeterminants– The level of salesThe level of sales– Advertisement by other firmsAdvertisement by other firms– Cumulative of past advertisementCumulative of past advertisement


Elasticity of Price expectationElasticity of Price expectation

Price currentprice current in Change

nexpectatio price Originalnexpectatio price future in Change

Elasticity


ApplicationApplication

Qc = 50 – 1.5Pc + 0.5Y + 2.0 Ps + 0.8AQc = 50 – 1.5Pc + 0.5Y + 2.0 Ps + 0.8AQc = number of PCs demandedQc = number of PCs demandedPc = Price of PCPc = Price of PCY = buyers incomeY = buyers incomePs = substitutes brandPs = substitutes brandA = advertising A = advertising Starting points: Pc = 40, Y= 60, Ps = 30, A = Starting points: Pc = 40, Y= 60, Ps = 30, A =

2525


ElasticitiesElasticities

Price Elasticity - Ep = -0.6Price Elasticity - Ep = -0.6

Income Elasticity - Ey = 0.3Income Elasticity - Ey = 0.3

Cross Elasticity - Es = 0.6Cross Elasticity - Es = 0.6

Advertising Elasticity - Ea = 0.2Advertising Elasticity - Ea = 0.2


1.1.Your firm’s research department has Your firm’s research department has estimated the income elasticity of demand estimated the income elasticity of demand for non-fed ground beef to be -1.94. You have for non-fed ground beef to be -1.94. You have just read in an economic newspaper that due just read in an economic newspaper that due to an upturn in the economy, consumer to an upturn in the economy, consumer incomes are expected to rise by 10% over incomes are expected to rise by 10% over the next three years. As a manager of a the next three years. As a manager of a meat-processing plant, how will this forecast meat-processing plant, how will this forecast affect your purchase of non-fed cattle?affect your purchase of non-fed cattle?


Elasticity and Demand functions Elasticity and Demand functions (reconsider)(reconsider)

Elasticity of demand for linear demand Elasticity of demand for linear demand function: function:

– Own price elasticity =Own price elasticity =

– Cross price elasticity = Cross price elasticity =

– Income elasticity = eIncome elasticity = e

2727

Me P d P c aQ yxdx

x

x

Q

P c

x

y

Q

P d

xQ

M e


Elasticity and Demand functions Elasticity and Demand functions (reconsider)(reconsider)

Elasticity of demand for non-linear Elasticity of demand for non-linear demand:demand:– Own price elasticity = cOwn price elasticity = c– Cross-price elasticity = dCross-price elasticity = d– Income elasticity = eIncome elasticity = e

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lnM e lnP d lnP c aQ ln yxdx


demand analysis (cont.) managerial economics 1 lect. in managerial economics riad sultan

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