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Business Strategy
Chapter 3
Quantitative Demand Analysis
Overview
I. Elasticities of Demand
Linear
Log-Linear
Elasticities of Demand
How responsive is variable G to a change
in variable S
EG , S
%G
%S
%QX
%PX
EQX , PX 1
Inelastic: EQ X , PX 1
Unitary:
EQX , PX 1
Price
D
D
Quantity
Perfectly Elastic
Quantity
Perfectly Inelastic
Own-Price Elasticity
and Total Revenue
Elastic
Inelastic
Unitary
Elastic
8
6
Inelastic
4
2
D
1
Quantity
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.
Time allows consumers to seek out available substitutes.
Expenditure Share
Goods that comprise a small share of consumers budgets
tend to be more inelastic than goods for which consumers
spend a large portion of their incomes.
%QX
%PY
+ Substitutes
- Complements
Income Elasticity
EQX , M
%QX
%M
+ Normal Good
- Inferior Good
Michael R. Baye, Managerial Economics and Business
Uses of Elasticities
Pricing
Managing cash flows
Impact of changes in competitors prices
Impact of economic booms and recessions
Impact of advertising campaigns
And lots more!
Answer
Calls would increase by 25.92 percent!
EQX , PX
%QX
8.64
%PX
%QX
8.64
3%
d
3% 8.64 %QX
d
%QX 25.92%
Michael R. Baye, Managerial Economics and Business
Answer
AT&Ts demand would fall by 36.24 percent!
EQX , PY
%QX
9.06
%PY
%QX
9.06
4%
d
4% 9.06 %QX
d
%QX 36.24%
Michael R. Baye, Managerial Economics and Business
Demand Functions
Mathematical representations of demand curves
Example:
d
QX 10 2 PX 3PY 2 M
X and Y are substitutes (coefficient of PY is
positive)
X is an inferior good (coefficient of M is
negative)
Michael R. Baye, Managerial Economics and Business
QX 0 X PX Y PY M M H H
d
P
EQX , PX X X
QX
Own Price
Elasticity
EQX , PY
PY
Y
QX
Cross Price
Elasticity
M
EQX , M M
QX
Income
Elasticity
Qd = 10 - 2P
Own-Price Elasticity: (-2)P/Q
If P=1, Q=8 (since 10 - 2 = 8)
Own price elasticity at P=1, Q=8:
(-2)(1)/8= - 0.25
Log-Linear Demand
log QX 0 X log PX Y log PY M log M H log H
d
X
Cross Price Elasticity : Y
Income Elasticity :
M
Example of Log-Linear
Demand
log Qd = 10 - 2 log P
Own Price Elasticity: -2
D
Q
Linear
Log Linear
Regression Analysis
Used to estimate demand functions
Important terminology
An Example
Use a spreadsheet to estimate log-linear
demand
log Qx 0 x log Px e
Summary Output
Regression Statistics
Multiple R
0.41
R Square
0.17
Adjusted R Square
0.15
Standard Error
0.68
Observations
41.00
ANOVA
df
Regression
Residual
Total
Intercept
ln(P)
SS
1.00
39.00
40.00
MS
3.65
18.13
21.78
3.65
0.46
t Stat
5.29
-2.80
Significance F
7.85
0.01
P-value
0.000005
0.007868
Lower 95%
Upper 95%
4.68
10.48
-1.44
-0.23
Summary