1 Welcome to EC 209: Managerial Economics- Group A By: Dr. Jacqueline Khorassani Week Three

2 Class One Monday, September 17 11:10-12:00 Fottrell (AM) 11:10-12:00 Fottrell (AM) The textbook is now available at the bookshop Don’t forget that the first aplia assignment is due before September 25 It is the week 4 assignment Remember that if you don’t ask questions, I assume you know. I did not get any questions on this week’s study guide. So,I will briefly go over what you must know.

3 What does the elasticity measure? It measures how responsive (sensitive) is variable “G” to one percent change in variable “S” It measures how responsive (sensitive) is variable “G” to one percent 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.

4 How can elasticity be shown (measured) using calculus? Suppose G = f (S), then Suppose G = f (S), then Where dG/dS is the partial derivative of G with respect to S

5 What is the own price elasticity of demand? Measures how sensitive the quantity demand is to one percent change in price. Measures how sensitive the quantity demand is to one percent change in price.

6 How is it measured? Is it negative or positive? Is it negative or positive? –Negative, according to the “law of demand.”

7 Let’s practice If quantity demanded for sneakers falls by 12% when price increases 4%, we know that the absolute value of the own-price elasticity of sneakers is –A) 0.3. –B) 0.8. –C) 3.0. –D) 3.3. Answer: C Answer: C

8 What is the difference between elastic, inelastic and unitary elastic demands? Elastic: Inelastic: Unitary elastic:

9 How does elasticity change along a linear demand curve? At any point on demand, the absolute value of elasticity = lower portion of demand /upper portion of demand At any point on demand, the absolute value of elasticity = lower portion of demand /upper portion of demand P Q A B C At point A: What is the elasticity at point B? Zero What is the elasticity at point C? Infinity

10 How does elasticity change along a linear demand curve? The lower half of demand is inelastic The lower half of demand is inelastic The upper half of demand is elastic The upper half of demand is elastic Mid point of demand is unitary elastic Mid point of demand is unitary elastic P Q B C // AInelastic Elastic Unitary elastic

11 How is a perfectly elastic demand curve different from a perfectly inelastic demand curve? D Price Quantity D Price Quantity %ΔP = 0 %Δ Q = 0

12 How does the own price elasticity of demand relate total revenue? QQ P TR

13 Elasticity, Total Revenue and Linear Demand QQ P TR

14 Elasticity, Total Revenue and Linear Demand QQ P TR In the elastic portion of demand, as you lower the price, TR goes up

15 Elasticity, Total Revenue and Linear Demand QQ P TR

16 Elasticity, Total Revenue and Linear Demand QQ P TR In the inelastic portion of demand, as you lower the price, TR goes down.

17 Elasticity, Total Revenue and Linear Demand QQ P TR Elastic

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

19 Elasticity, Total Revenue and Linear Demand QQ P TR Inelastic Elastic Inelastic Unit elastic In the meddle of demand, TR is at its max

20 Managerial Economics Week Three, Class 2 Week Three, Class 2 –Tuesday, September 18 –15:10-16:00 –Cairnes Remember: If you don’t ask, I assume you know. Remember: If you don’t ask, I assume you know.

21 About Aplia Assignments 25% of grade 25% of grade Fees = $20 Fees = $20 –Need to be paid in 5 days or they kick you out of the program –I have no control over this –Course Key: R8WC-VRSZ-SCBQ Assignment 1 is due before noon on September 25 Assignment 1 is due before noon on September 25 –5 grades question sets

22 Let’s practice Assume that the price elasticity of demand is -2 for a certain firm's product. If the firm raises price, the firm's managers can expect total revenue to: Assume that the price elasticity of demand is -2 for a certain firm's product. If the firm raises price, the firm's managers can expect total revenue to: –a) Decrease –b) Increase –c) Remain constant –d) Either increase or remain constant depending upon the size of the price increase. Answer: A Answer: A

23 How does the own-price elasticity related to marginal revenue? What is marginal Revenue, MR? What is marginal Revenue, MR? Revenue resulting from selling one more unit of output Revenue resulting from selling one more unit of output MR = ΔTR/ΔQ MR = ΔTR/ΔQ

24 How does the own-price elasticity related to marginal revenue? MR = P(1 + E)/E MR = P(1 + E)/E Suppose E < -1 which means |E| >1  (elastic), then MR is positive Suppose E = -1  which means |E|=1 then MR is zero Suppose E > -1  which means |E|<1 (inelastic), then MR is negative

25 How does the own-price elasticity related to marginal revenue? Between 0 to Q*  demand is elastic and MR>0 Between 0 to Q*  demand is elastic and MR>0 At Q*  demand is unitary elastic and MR = 0 At Q*  demand is unitary elastic and MR = 0 Above Q*  demand is inelastic and MR <0 Above Q*  demand is inelastic and MR <0 P Q MR D Unitary elastic MR = 0 0 Elastic MR >0 Inelastic MR <0 Q*

26 Which factors affect the own price ? You need to study this one on your own. You need to study this one on your own. –PP –Ask me questions

27 Let’s practice The demand for Adidas brand shoes is The demand for Adidas brand shoes is –A) more elastic than the demand for shoes in general. –B) less elastic than the demand for shoes in general. –C) equally elastic to the demand for shoes in general. –D) none of the above. Answer: A Answer: A

28 Let’s practice Lemonade, a good with many close substitutes, should have an own-price elasticity that is: Lemonade, a good with many close substitutes, should have an own-price elasticity that is: –a) unitary. –b) relatively elastic. –c) relatively inelastic. –d) perfectly inelastic. Answer: B Answer: B

29 What does the cross price elasticity of demand measure? 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. It measures how sensitive the quantity demand for good X is to one percent change in the price of good Y

30 Suppose that a firm sells two related good and the price of one good changes; how can the cross price elasticity help us predict the changes in the total revenue? ΔR = change in total revenue, R x = good X’s revenue, R Y = good Y’s revenue

31 What is the income elasticity? If E Q X,M > 0, then X is a normal good. If E Q X,M < 0, then X is a inferior good. Measure the percentage change in quantity demand for good X as the income of consumer changes by one percent.

32 Uses of Elasticity Example 1: Pricing and Cash Flows (revenue) According to an FTC Report by Michael Ward, AT&T’s own price elasticity of demand for long distance services is According to an FTC Report by Michael Ward, AT&T’s own price elasticity of demand for long distance services is AT&T needs to boost revenues in order to meet it’s marketing goals. 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? To accomplish this goal, should AT&T raise or lower it’s price?

33 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. 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.

34 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? If AT&T lowered price by 3 percent, what would happen to the volume of long distance telephone calls routed through AT&T?

35 Answer Calls would increase by percent!

36 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 According to an FTC Report by Michael Ward, AT&T’s cross price elasticity of demand for long distance services is If competitors reduced their prices by 4 percent, what would happen to the demand for AT&T services? If competitors reduced their prices by 4 percent, what would happen to the demand for AT&T services?

37 Answer AT&T’s demand would fall by percent!

38 Interpreting Demand Functions Mathematical representations of demand curves. Mathematical representations of demand curves. Example: Example: Where M is income Where M is income

39 What can you say about the relationship between good X and good Y? What can you say about the relationship between good X and good Y? –X and Y are substitutes (coefficient of P Y is positive). Is X a normal or an inferior good? Is X a normal or an inferior good? –X is an inferior good (coefficient of M is negative). Holding price of Y and income constant, as price of X goes up by 1, quantity demanded for X goes ______ by ______. Holding price of Y and income constant, as price of X goes up by 1, quantity demanded for X goes ______ by ______. down 2

40 Managerial Economics- Group A Week Three- Class 3 Week Three- Class 3 –Thursday, September 20 –15:10-16:00 –Tyndall Aplia Assignment 1 Aplia Assignment 1 –due before noon on Tuesday, September 25 –25% of grade

41 I received a question on how to calculate own elasticity when we have the demand function and only one price and one quantity Remember Remember Suppose G = f (S), then Suppose G = f (S), then Where dG/dS is the partial derivative of G with respect to S

42 A General Linear Demand Functions Own Price Elasticity = (dQ d x /dP x )*P x /Q x Cross Price Elasticity= (dQ d X /dP y )*P y /Q x Income Elasticity= (dQ d X /dM)*M/Q x

43 Example: What is own elasticity if P = 1 P = 5 – 1/2 Q d P = 5 – 1/2 Q d What is this? What is this? Inverse demand function Inverse demand function Need to change it to a demand function Need to change it to a demand function ½ Q d = 5 – P ½ Q d = 5 – P Q d = P. Q d = P. Own-Price Elasticity = dQ d /dP * P/Q Own-Price Elasticity = dQ d /dP * P/Q = (-2)* P/Q = (-2)* P/Q If P=1, then Q is If P=1, then Q is –8 (since = 8). Own price elasticity at P=1, Q=8: Own price elasticity at P=1, Q=8: (-2)(1)/8= (-2)(1)/8=

44 General Log-Linear Demand Function

45 Example of Log-Linear Demand ln(Q d ) = ln(P). ln(Q d ) = ln(P). Own Price Elasticity: -2. Own Price Elasticity: -2.

46 P Q Q D D LinearLog Linear Graphical Representation of Linear and Log-Linear Demand P Elasticity varies along this demand curve Elasticity is constant along this demand curve

47 Regression Analysis Will not be covered at this time. Will not be covered at this time. –PP:

48 Let’s practice Given a log-linear demand curve, we know that Given a log-linear demand curve, we know that –A) demand is elastic at high prices. –B) demand is inelastic at low prices. –C) demand is unitary elastic at low prices. –D) the elasticity is constant at all prices. Answer: D Answer: D

49 Chapter 4 What are the properties of consumer preferences and what do they mean? What are the properties of consumer preferences and what do they mean? 1.Completeness 2.More is Better 3.Diminishing Marginal Rate of Substitution? 4.Transitivity?

50 Property 1: Completeness Given the choice between 2 bundles of goods (A & B) Given the choice between 2 bundles of goods (A & B) –consumer must have an opinion, meaning that she should prefers bundle A to bundle B: A  B; prefers bundle A to bundle B: A  B; or, prefers bundle B to bundle A: A  B; or, prefers bundle B to bundle A: A  B; or, be indifferent between the two: A  B. or, be indifferent between the two: A  B.

51 Property 2: More is better Bundles that have at least as much of every good and more of some good are preferred to other bundles. Bundles that have at least as much of every good and more of some good are preferred to other bundles. –Example Bundle A: 2 apples and 3 oranges Bundle A: 2 apples and 3 oranges Bundle B: 2 apples and 5 oranges Bundle B: 2 apples and 5 oranges Which one will you prefer? Which one will you prefer? B  A B  A –B is preferred to A

52 Property 3:Diminishing Marginal Rate of Substitution? Marginal Rate of Substitution (MRS) Marginal Rate of Substitution (MRS) –The rate at which a consumer is willing to substitute one good for another and maintain the same satisfaction level. –Example: You are indifferent between You are indifferent between –10 apples + 4 oranges –Or 7 apples +5 oranges MRS of oranges for apples= number of apples you are willing to give up to get 1 more orange and stay as satisfied as before = _________. MRS of oranges for apples= number of apples you are willing to give up to get 1 more orange and stay as satisfied as before = _________. 3

53 Property 3: Diminishing Marginal Rate of Substitution? The more oranges you have, the fewer apples you are willing to give up for an additional orange. The more oranges you have, the fewer apples you are willing to give up for an additional orange. –For the 5 th orange, you gave up 3 apples –For the 6 th orange, you will give up __________apples 2

54 Property 4: Transitivity For the three bundles A, B, and C, the transitivity property implies that For the three bundles A, B, and C, the transitivity property implies that –if C  B and –B  A, –then C  A. If you prefer apples to oranges and oranges to bananas, then If you prefer apples to oranges and oranges to bananas, then You must prefer apples to bananas You must prefer apples to bananas

55 What is an indifference curve and how does it reflect the properties of consumer preferences ? Indifference Curve –A curve that defines the combinations of 2 goods (X and Y) that give a consumer the same level of satisfaction. Consumer is indifferent between these combinations Consumer is indifferent between these combinations