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 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!

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!

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: 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: Own Price Elasticity Cross Price Elasticity Income 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 Take Natural Log of both sides to get general Log-Linear Demand Function:

Example of Log-Linear Demand ln(Qd) = 10 - 2 ln(P). Own Price Elasticity: -2.