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Demand Analysis (Cont.)

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Demand Analysis (Cont.). Managerial Economics. Your firm’s research department has estimated the income elasticity of demand for chicken to be -1.94.

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Demand Analysis (Cont.)
• Managerial Economics

Lect. In managerial economics

Your firm’s research department has estimated the income elasticity of demand for chicken to be -1.94.
• You have just read in an economic newspaper that due to an upturn in the economy, consumer incomes are expected to rise by 10% over the next three years.
• As a manager of a chicken processing plant, how will this forecast affect your purchase of chicken?

Lect. In managerial economics

Elasticities
• When one of the determinants changes, demand will also change
• The next issue is how much?
• We analyse the magnitude of the change And hence we refer to ELASTICITIES

Lect. In managerial economics

ELASTICITY OF DEMAND
• Price in 2007= Rs20: Demand (Sales)= 43
• Price in 2008= Rs10: Demand (Sales) =75
• When price change by Rs10, demand changes by 32 units. Can we say that for each Rs1, demand rises by (32/10) 3.2 units? Yes
• However, to compare different goods, we take the percentage change

Lect. In managerial economics

Percentage change in demand

=[(New-old)/old] X 100

= [(75-43)/43]

= 75%

• Hence, demand has increased by 75%
• Percentage change in price

=(10-20)/20= -50%

• Hence, price has decreased by 50%

Lect. In managerial economics

Conclusion:
• When price falls by 50%, demand rises by 75%

It follows that when price changes by 1%, demand will rise by (75%/50%) = 1.5%

1.5 is called elasticity

Lect. In managerial economics

Formula for elasticity of demand:
• % change of quantity demanded divided %change of price = 1.5

Lect. In managerial economics

Elasticity of demand
• Formula for elasticity of demand:

Lect. In managerial economics

Calculation
• Elastic demand = >0
• Inelastic demand = <0
• Elasticity = Unitary = 1

Lect. In managerial economics

Elasticity
• Calculate: prices move from P1 to P2:
• P1=10 Q1=100
• P2=20 Q2=50
• Elasticity= 50%/100% = 0.5%
• When price changes by 1%, demand falls by 0.5%

Lect. In managerial economics

Arc elasticity

Lect. In managerial economics

Point elasticity
• Requirements: understand slope of a demand curve
• Slope = change in vertical/change in horizontal = 40/80=1/2

40

A

35

B

6

5

72

80

Lect. In managerial economics

Calculate elasticity at A =2 X (35/5)=14%

• Calculate elasticity at B = 2 X (6/72) = 0.16%
• At A, demand is elastic
• At B, demand is inelastic

Lect. In managerial economics

Calculating elasticity from demand function
• Suppose
• Q = 100 – 5P
• Change in Q/Change in P =-5
• Elasticity = -5(P/Q)

Lect. In managerial economics

Elasticity and Total revenue
• Suppose :
• P1=10 Q1=100 TR= P1Q1=1000
• P2=20 Q2=75 TR = P2Q2 = 1400
• Elasticity= 25%/100% = 0.25%
• When price rises by 1%, demand falls by 0.25%
• Outcome: Total Revenue rises
• Marginal revenue is positive

Lect. In managerial economics

Elasticity and Total revenue
• Conclusion 1: when demand is elastic (>1), (when price rises, TR falls),

can not raise the price

• Conclusion 2: when demand is inelastic (<1), when price rises, TR rises

always raise prices

Lect. In managerial economics

Elasticity and Total revenue
• P1= 10 Q1= 100 TR = 1000
• P2=15 Q2=40 TR = 600
• Elasticity = 60%/50%=1.2%
• When price rises by 1%, quantity demanded falls by more than 1% (1.2%):
• Total revenue: Falls
• Marginal revenue: negative

Lect. In managerial economics

Determinants of Price elasticity
• Availability of substitutes
• Elasticity is high when there are substitutes
• Nature of commodity
• Luxury, durable = elastic; necessity, non-durable = inelastic;
• Weightage in the total consumption
• When proportion is large = elastic; when prop. is low = inelastic
• Time factor in adjustment of consumption
• The longer the time to adjust, the higher the price elasticity
• Range of commodity use
• Multi-purpose goods = high elasticity
• Proportion of Market supplies
• The proportion of consumers who are satisfied: if less than 50%, demand will be elastic

Lect. In managerial economics

Cross price elasticity

• Substitutes and complements
• Income elasticity
• Normal, necessities , inferior
• Advertising elasticity
• Elasticity of price expectations

Lect. In managerial economics

Advertising elasticity

=0: sales do not respond to advertisement

>0 but <1: less than proportionate increase in advertising

=1 proportionate increase in advertising

>0 more than proportionate increase in advertising

Lect. In managerial economics

Advertising elasticity
• Determinants
• The level of sales
• Advertisement by other firms
• Cumulative of past advertisement

Lect. In managerial economics

Elasticity of Price expectation

Lect. In managerial economics

Application

Qc = 50 – 1.5Pc + 0.5Y + 2.0 Ps + 0.8A

Qc = number of PCs demanded

Pc = Price of PC

Y = buyers income

Ps = substitutes brand

A = advertising

Starting points: Pc = 40, Y= 60, Ps = 30, A = 25

Lect. In managerial economics

Elasticities
• Price Elasticity - Ep = -0.6
• Income Elasticity - Ey = 0.3
• Cross Elasticity - Es = 0.6
• Advertising Elasticity - Ea = 0.2

Lect. In managerial economics

Your firm’s research department has estimated the income elasticity of demand for non-fed ground beef to be -1.94. You have just read in an economic newspaper that due to an upturn in the economy, consumer incomes are expected to rise by 10% over the next three years. As a manager of a meat-processing plant, how will this forecast affect your purchase of non-fed cattle?

Lect. In managerial economics

Elasticity and Demand functions (reconsider)
• Elasticity of demand for linear demand function:
• Own price elasticity =
• Cross price elasticity =
• Income elasticity = e

Lect. In managerial economics

Elasticity and Demand functions (reconsider)
• Elasticity of demand for non-linear demand:
• Own price elasticity = c
• Cross-price elasticity = d
• Income elasticity = e

Lect. In managerial economics