MANAGERIAL

ECONOMICS
BADM 4300 – UNIT III
• DEMAND ANALYSIS:
– Functions &
– Elasticities

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 DEMAND FUNCTIONS
&
ELASTICITIES OF DEMAND

Definition of DEMAND:
Refers to the number of units of a particular good or
service that consumers are willing to buy under stated conditions of
time, 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 or table.

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 Demand Applications
• Problem #1: The Pueblo Viejo Company, a department
store, conducted a study of the demand for men’s ties. It
found out that the average daily demand, Q, in terms of
price, 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 it
charge?
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.
JULY 2008 BADM4300-Demand Analysis-Prof. Devaris
 Demand Applications
• Problem #2: Digimill, Inc.

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 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

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 Answer to Problem #1
Continuation
c) We should assume that P = 0, and substitute P by its value in
the equation:
Q = 60 –5(0)
Q = 60 –0
Q = 60 ties
d) We should assume that the highest price that someone will be
willing to pay is the price to buy the minimum units, that is 1:
1 = 60 –5P
1 – 60 = -5P
-59 = -5P
P = $11.80
JULY 2008 BADM4300-Demand Analysis-Prof. Devaris
 Answer to Problem #1
Continuation
DEMAND TABLE
P Q TR MR
$ 12
10
8
6
4
2
0

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

Use the following equation to fill on the TR column: TR = P x Q
 DEMAND TABLE
P Q TR MR
$ 12 0
10 10
8 20
6 30
4 40
2 50
0 60
Substituting Pby its corresponding value in the demand
equation, Q= 60 - 5P, you can fill the Qcolumn.

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 DEMAND TABLE
P Q TR MR
$ 12 0 0
10 10 100
8 20 160
6 30 180
4 40 160
2 50 100
0 60 0
Multiplying column 1 and 2, you obtain the results
for the 3rd. Column: TR= P x Q

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 Demand Equation
Qd = 60 – 5P
• Demand Table Demand Curve
14
P Q
12
$ 12 0 10
10 10 8

Price
8 20 6
4
6 30 2
4 40 0
2 50 Quantity

0 60

20 40 60
JULY 2008 BADM4300-Demand Analysis-Prof. Devaris
 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 ↑

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 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.

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 QUANTITY DEMANDED
VS
CHANGE IN DEMAND
• Change in Quantity Demanded( ∆ Qd):
– Movement along the demand curve from point A to point
B 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 of
the 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,
JULY 2008 • Price expectations.
BADM4300-Demand Analysis-Prof. Devaris
 ELASTICITIES OF DEMAND

• Price elasticity of demand

– ε d = %∆ Qd / %∆ P

• Income elasticity of demand

– ε = %∆ Qd / %∆ TR
d

• Cross elasticity of demand

– ε dx/y = %∆ Qdx / %∆ Py

• Advertising elasticity
– ε d = %∆ Qd / %∆ PE

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 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

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 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 ε d is positive
– Inferior Goods: goods for which demand is
negatively (inversely) related to income, e.g.,
potatoes, bread.
Income
JULY 2008
elasticity of demand ε d is negative
BADM4300-Demand Analysis-Prof. Devaris
 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 an
increase in the demand for B.Example, when the price of beef increases, the demand for
chicken increases.
• Cross elasticity of demand ε 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 ε dx/y is negative

• 5. Consumer Expectations
– Do consumers expect incomes and prices to increase or decrease in the near future?

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 PRICE ELASTICITY OF
DEMAND
Defined as a percentage of change in the
quantity demanded that is caused by a one percent
change in price, ceteris paribus.
General Formula:

JULY 2008 ε d = %∆ Q / %∆ P d Devaris

BADM4300-Demand Analysis-Prof.
 DETERMINANTS
of

PRICE-ELASTICITY
• 1)Luxury Goods - more elastic and
Necessity Goods – less elastic.
• 2) Expensive Goods –more elastic and
Cheap Goods – less elastic.
• 3) More Substitutes – more elastic and
Less Substitutes – less elastic.
• 4) Time Period: the longer the time period
– more elastic.
JULY 2008 BADM4300-Demand Analysis-Prof. Devaris
 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
JULY 2008 BADM4300-Demand Analysis-Prof. Devaris
 ELASTIC VS INELASTIC
• If ε = ∞, demand is perfectly elastic
• If ε > 1, demand is elastic
• If ε = 1, unitary elasticity
• If ε < 1, demand is inelastic
• If ε = 0, perfectly inelastic

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 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

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

 MARGINAL REVENUE &
PRICE ELASTICITY
• Elastic Demand:
– Marginal Revenue is positive
– As P ↑, ⇒ Qd ↓ and ⇒ TR ↓.
• Unitary elasticity:
– Marginal Revenue is equal to 0
– As TR reaches it maximum.
• Inelastic Demand
– Marginal Revenue is negative
– As P ↑, ⇒ Qd↓ and ⇒ TR ↑.

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris

• Page 27 Cross-Elasticity of Demand

JULY 2008 BADM4300-Demand Analysis-Prof. Devaris