Chapter 2 homework Numbers 7, 10, and 13

Managerial Economics & Business Strategy Chapter 3 Quantitative Demand Analysis

Anyone heard of ELASTICITY?? How responsive is variable “G” to a change in variable “S” If E G,S > 0, then S and G are directly related. If E G,S < 0, then S and G are inversely related. If E G,S = 0, then S and G are unrelated.

The Elasticity Concept Using Calculus An alternative way to measure the elasticity of a function G = f(S) is If E G,S > 0, then S and G are directly related. If E G,S < 0, then S and G are inversely related. If E G,S = 0, then S and G are unrelated.

Own Price Elasticity of Demand Negative according to the “law of demand.” Elastic: Inelastic: Unitary:

Perfectly Elastic & Inelastic Demand D Price Quantity D Price Quantity

What does this mean?? E Q x,P X = 3 n A 1% increase in price will lead to a 3% decline in quantity demanded. n Would a firm find this to be a problem? E Q x,P X =.3 n A 1% increase in price will lead to a 0.3% decline in quantity demanded. n Would a firm find this to be a problem?

Why would a firm worry about elasticity? Impacts units sold  Total Revenue n Price * Quantity Elastic n Increase (a decrease) in price leads to a decrease (an increase) in total revenue. Inelastic n Increase (a decrease) in price leads to an increase (a decrease) in total revenue. Unitary n Total revenue is unchanged n Total revenue is maximized at the point where demand is unitary elastic.

Elasticity, Total Revenue and Linear Demand QQ P TR Inelastic Elastic Inelastic Unit elastic

What should the airlines do to increase cash flow?? Increase the price of tickets to raise money Decrease the price of tickets to raise quantity sold Elasticity = 1.8 Elastic!!! Reduce price to increase TR

Factors Affecting Own Price Elasticity n Available Substitutes The more substitutes available for the good, the more elastic the demand. n Time Demand tends to be more inelastic in the short term than in the long term. Find substitutes. n Expenditure Share Cost more??? Think about it more  More elastic

Cross Price Elasticity of Demand If E Q X,P Y > 0, then X and Y are substitutes. If E Q X,P Y < 0, then X and Y are complements.

Predicting Revenue Changes from Two Products Suppose that a firm sells goods that are related (pizza and beer). If the price of beer (good X) changes, then total revenue will change by:

What??? Suppose a firm’s revenues are derived from the sales of two products, X and Y. n The firm’s revenue would be R = Rx + Ry, Rx = PxQx denotes revenues from the sale of product X Ry = PyQy denotes revenues from the sale of product Y. n The impact of a given percentage change in the price of product X on the total revenue of the firm are given by the following formula:

Can 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%?