2014 Managerial Economics Stefan Markowski Managerial Economics Stefan Markowski How? When? What? The economics of competitive advantage Why? Where? Who? Demand analysis and demand elasticities

Detailed course schedule Day no TopicTextbook ch. 1 (24 Nov; 3 hrs) 1. Introduction. Decision making process and its elements. The scope of economic decision making. Application of marginal analysis Chs (25 Nov; 3 hrs) 2. Demand analysis and demand elasticitiesCh. 3 3 (26 Nov; 3 hrs) 3. Buyer product valuation and choices. Consumer surplus. Buyer pricing decisions Ch. 4 4 (27 Nov; 2 hrs) 4. Production/transformation process. Production technologies and input-output structure Ch. 5 5 (28 Nov; 2 hrs) 5. Cost structure and cost drivers of producer pricing strategies. Production scale and scope. Chs. 5 and 7 6 (1 Dec; 3 hrs) 6. Structure-conduct-performance. Market structures: competition and contestability. Pricing strategies of buyers and sellers Ch. 8 7 (2 Dec; 3 hrs) 7. Market structures: monopoly/monopsony, monopolistic competition and oligopoly. Pricing strategies and strategic behaviour Chs (3 Dec; 3 hrs) 8. Input sourcing and investment. Pricing and market powerChs. 6 and 11 9 (4 Dec; 2 hrs) 9. Decision making under conditions of uncertainty. Informational asymmetries and risk management Ch (5 Dec; 2 hrs) 10. Market research and market analysis. Auction and rings. Strategic behaviour Ch (8 Dec; 2 hrs ) 11. Public sector perspectiveCh (9 Dec; 2 hrs) 12. Revision 13. Examination 13 (11 Dec; 2 hrs) Examination

Topic 2: Demand analysis and demand elasticities Topic Contents 2.1 Managerial perspective 2.2 Demand and the demand schedule 2.3 Demand curve 2.4 Elasticity of demand and revenue implications 2.5Expected demand 2.6Further reading

2.1Managerial perspective

2.2Demand and the demand schedule Demand - willingness and ability to buy a good or a service Quantity demanded - the amount of a good that buyers are willing and able to purchase at an indicated price Demand schedule - a table that shows the relationship between the price of a good and the quantity demanded Law of demand - other things being equal (ceteris paribus), the quantity demanded of a good varies inversely with its own price

2.2Demand and the demand schedule Variables that may affect quantity demanded, Q a –Own price (P a ) –Prices of other goods/services (P o ) –Income (I) –Tastes (T) –Expectations (E) –Number of buyers (n) Demand equation Q a = f (P a, P o, I, T, ….) Example: Q a = A -  P a +  I Q a = 20 -  P a +  I

2.3Demand curve Demand curve - a graph of the relationship between the price of a good and the quantity demanded (of that good) Price ($) Quantity Individual demand Market demand - as the sum of individual demands

2.3Demand curve Price ($) 15 12Movement along Quantity Movement along the demand curve (ceteris paribus conditions)

2.3Demand curve P DecreaseIncrease in demand in demand Q Shifts in the demand curve: increase in demand or decrease in demand

2.3Demand curve Change inImpact on the demand curve a variable Own PriceMovement along IncomeShift Other pricesShift TastesShift ExpectationsShift No. of buyers Shift

2.4Elasticity of demand and revenue implications Own price elasticityOwn price elasticity - the percentage change in quantity demanded that results from one per cent change in own price E a = %  Q a /%  p a –point elasticity (if the price change is very small) –arc elasticity (if the price change is large) Point elasticity E a =  Q a /Q a :  P a /P a =  Q a /  P a P a /Q a Arc elasticity E a =  Q a /Q a :  P a /P a =  Q a P a /  P a Q a

2.4Elasticity of demand and revenue implications Demand is If –ElasticE a < -1 –Unitary elasticE a = -1 –Inelastic -1< E a < 0

2.4Elasticity of demand and revenue implications Cross price elasticity - the percentage change in quantity demanded for a good, Q a, that results from one per cent change in the price of another good, P b E ab = %  Q a /%  P b complements E ab < 0 substitutes E ab > 0 Two goods are: –Substitutes - when an increase in the price of one good increases the demand for the other good –Complements - when an increase in the price of one good decreases the demand for the other good

2.4Elasticity of demand and revenue implications Income elasticity - the percentage change in quantity demanded for a good, Q a, that results from one per cent change in the buyer’s income, I E I = %  Q a /%  A good is: –normal - when, ceteris paribus, an increase in income results in an increase in quantity demanded 0<E I (a necessity if 0 < E I <1) –inferior - when, ceteris paribus, an increase in income results in a decrease in quantity demanded E I <0

2.4Elasticity of demand and revenue implications Total revenue TR = PQ Average revenue AR = TR/Q=P Marginal revenue MR =  TR/  Q Marginal revenue is the change in revenue resulting from one unit change in quantity demanded

2.4Elasticity of demand and revenue implications Price Elasticity and Marginal Revenue Price ($) ElasticUnitary Elastic Inelastic 0 MR Quantity

2.5Expected demand Uncertainty - ‘incomplete’ knowledge Non-quantifiable uncertainty - ordinal measures (e.g., more likely than …..) Quantifiable uncertainty or Risk cardinal measures (e.g., 10% chance of.….) Probability distributions Expected Value N E(V) =  V i P i i=1 where V i is the value of the ith outcome P i is the probability of the ith outcome

2.5Expected demand Variance VAR =  (V i - V(P)) 2 P i i = 1, 2, N Standard Deviation STD = VAR Coefficient of Variation CV = STD/E(V) Used as a measure of risk

2.5Expected demand Example: Bell-shaped distribution applied to demand for an item repair services

2.5Expected demand Preferences for risk bearing –risk neutrality –risk preference –risk aversion –certainty equivalence –risk premium Consider two gifts with equal E(V) but different coefficients of variation, CV. For example, Gift A - $100 cash Gift B - a lottery ticket offering a chance of winning $200 or nothing

2.5Expected demand Risk-neutral person is indifferent between A and B Risk-averse person prefers A to B Risk-loving person prefers B to A Certainty equivalent is a certain activity with E(V) equal to E(V) of some equivalent risky activity (e.g., A is the certainty equivalent of B) Risk premium is the difference between the subjective value of a risky activity and the value of its certainty equivalent (e.g., V(B) - V(A))

2.6Further reading Baye (2010): chs. 3-4