Managerial Economics & Business Strategy - Get Now PowerPoint

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					Managerial Economics &
   Business Strategy
        Chapter 3
Quantitative Demand Analysis
               Could we do it??
• You are the owner of a bookstore, and earn revenues
  primarily from selling coffee and books. For the
  past two years you have consistently earned, on
  average, revenues of $500 per week from selling
  coffee and $1000 per week from selling books. If
  the own price elasticity of demand for coffee is -1.0
  and the cross price elasticity of demand between
  books and coffee is -1.8, what would happen to your
  revenues if you lowered the price of coffee (if coffee
  is good X) by 10%?
      Income Elasticity

               %QX   Q M
                          d          d
   EQX , M                         x
               %M    M Qx


If EQX,M > 0, then X is a normal good.

If EQX,M < 0, then X is a inferior good.
      Example 1: Pricing and
          Cash Flows
• According to an FTC Report by Michael
  Ward, AT&T’s own price elasticity of
  demand for long distance services is -8.64.
• AT&T needs to boost revenues in order to
  meet it’s marketing goals.
• To accomplish this goal, should AT&T
  raise or lower it’s price?
           Answer: Lower price!
• Since demand is elastic, a reduction in price will
  increase quantity demanded by a greater percentage
  than the price decline, resulting in more revenues for
  AT&T.
         Example 2: Quantifying the
                  Change
• If AT&T lowered price by 3 percent, what would
  happen to the volume of long distance telephone
  calls routed through AT&T?
     Remember AT&T’s own price elasticity of demand for long
      distance services is -8.64
                       Answer
• Calls would increase by 25.92 percent!
                             %QX
                                      d
        EQX , PX    8.64 
                             %PX
                 %QX
                           d
         8.64 
                    3%
         3%   8.64  %QX
                               d


        %QX  25.92%
                   d
    Example 3: Impact of a change
       in a competitor’s price
• According to an FTC Report by Michael Ward,
  AT&T’s cross price elasticity of demand for long
  distance services is 9.06.
• If competitors reduced their prices by 4 percent,
  what would happen to the demand for AT&T
  services?
                      Answer
• AT&T’s demand would fall by 36.24 percent!

                               %QX
                                      d
           EQX , PY    9.06 
                               %PY
                  % Q X
                            d
           9.06 
                    4%
            4%  9.06  %QX
                              d


           %QX  36.24%
                      d
     We can use elasticities to find the
      supply and demand functions
• Midcontinent Plastics makes 80 fiberglass truck
  hoods per day for large truck manufacturers. Each
  hood sells for $500.00. Midcontinent sells all of its
  product to the large truck manufacturers. If the own
  price elasticity of demand for hoods is -0.4 and the
  price elasticity of supply is 1.5.
• Compute the supply and demand for truck hoods.
     Interpreting Demand Functions
• Mathematical representations of demand curves.
• Example:

            QX  10  2 PX  3PY  2M
               d



• X and Y are substitutes (coefficient of PY is
  positive).
• X is an inferior good (coefficient of M is
  negative).
        Linear Demand Functions
• General Linear Demand Function:


        QX  0   X PX  Y P   M M   H H
             d
                               Y


               Q PX
                 d                   Qx PY
                                       d
                                                       Qx M
                                                           d

    EQX , PX    x      EQX , PY             EQX ,M 
               Px QX                Py QX             M QX
      Own Price           Cross Price              Income
      Elasticity          Elasticity               Elasticity
         Example of Linear Demand
• Qd = 10 - 2P.
• Own-Price Elasticity
     (-2){P/Q}.
• If P=1 what does Q equal?
     Q=8 (since 10 - 2 = 8).
• Own price elasticity at P=1, Q=8
     (-2){1/8}= - 0.25.
           Log-Linear Demand
                         x   y    M       H
            Q  cPx Py M
               d
               x                         H
• Take Natural Log of both sides to get general Log-
  Linear Demand Function:
  ln QX   0   X ln PX  Y ln P   M ln M   H ln H
       d
                                   Y



      Own Price Elasticity :  X
      Cross Price Elasticity :  Y
      IncomeElasticity :       M
          Example of Log-Linear
               Demand
• ln(Qd) = 10 - 2 ln(P).
• Own Price Elasticity: -2.

				
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