Managerial Economics Truett + Truett Eighth Edition Chapter 2: Revenue of the Firm John Wiley & Sons, Inc. Slides by Jim Witsmeer 9/22/2018

Session 2 Outline Consumer/Firm Interactions Demand Function Total and Average Revenue Marginal Revenue Elasticity of Demand Price Elasticity of Demand Other Elasticities of Demand Summary 9/22/2018

Consumer Sovereignty and the Free Market What power does the consumer exert? What limits the suppliers ability to respond? When does the supplier have the power? Does Perfect Competition exist? 9/22/2018

Economic Discussion Economic Value Added Greater Than Normal Profit Market Manipulation Culture and the customer Advertising Market research Creativity and consumer demand 9/22/2018

Demand Function Qx = f(Px,Py,I…) where Qx is quantity demanded, is the Px price of X and Py, I, etc. are determinants of demand. A demand function with more than two independent variables cannot be graphed. We don’t have the ability to do that because we can only see three dimensions. However if Py, I, and the other independent variables remain constant while only Px varies we get a concept we can easily graph, the demand curve. 9/22/2018

Demand Curve Qx = f(Px, ) where Qx is quantity demanded and Px, is the price of X.. The plot of how quantity demanded is related to prices is the demand curve. This is by holding constant all the other relevant variables (determinants of demand). Change in Demand Change in Quantity Demanded 9/22/2018

Demand Function Properties Demand functions are estimates. Their accuracy depends on correctness of the function and available data. Demand Functions are multivariable. The firm may not have knowledge of all relevant variables. Demand Functions are nonlinear. In the region of interest they often can be approximated as linear. 9/22/2018

Revenue Total Revenue (TR) Average Revenue (AR) Marginal Revenue (MR) P = price and Q = quantity The rate of change of total revenue with respect to quantity 9/22/2018

Revenue under Linear Demand Linear Demand Function MR P or AR Total Revenue Marginal Revenue ARC Marginal Revenue 9/22/2018

Determinants of Demand SOME EXAMPLES Consumer income Prices of related goods or services Consumer tastes Number of consumers in market Credit terms on loans New housing starts Fuel prices Advertising 9/22/2018

Determinants of Demand Product or Service Cause Effect Normal Good Incomes Increase Demand Increases Inferior Good Income Increases Demand Decreases Substitute Good Price of Related Product Increases Demand for Substitute Increases Complimentary Good Demand for Second Product Decreases 9/22/2018

Elasticity of Demand Relative Measure of Demand Response Percent change in quantity of X demanded Percent change in Z the Determinant of Demand Elasticity is the percent ratio of rate of change of QX with respect to Z 9/22/2018

ARC Elasticity of Demand Percent change over an interval is the total change divided by the average value. using algebra we find: 9/22/2018

Price Elasticity & Revenue EP MR Classification Impact of Price Change on Total Revenue |EP| > 1 MR > 0 Elastic Price , TR |EP| < 1 MR < 0 Inelastic |EP| = 1 MR = 0 Unitary Elastic TR does not change 9/22/2018

Price Elasticity & Revenue TR = Q•P and Therefore: But we know that: So that: 9/22/2018

New Tricks of the Trade Yield Management Price Matching Everyday Low Pricing Value Pricing 9/22/2018

Other Elasticities of Demand Income Elasticity of Demand Cross Price Elasticity of Demand Advertising Elasticity of Demand Fuel Price Elasticity of Demand : And many others 9/22/2018

How does this relate to profit? Demand is only part of the picture. Profit = Revenue – Cost To understand profit we must learn something about cost. 9/22/2018

Summary Concepts There are two concepts in this chapter that must be understood before proceeding: One, is the invariable interrelationship between the demand, total revenue, and marginal revenue curves and elasticity of demand. ( Figure 2-8 in the textbook) The other, is the difference between the actual or point value at a specific quantity and an approximate value called the average rate of change valid between two quantities. NOTE: The first relationship assumes a linear demand curve and that all buyers are charged identical prices. 9/22/2018

End of Chapter 2 Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the United States copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for resale. The publisher assumes no responsibilities for errors, omissions, or damages, caused by the use of the information contained herein. 9/22/2018