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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
Demand Analysis (Cont.)
  • Managerial Economics

Lect. In managerial economics

slide2
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
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
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

slide5
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

slide6
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

slide7
Formula for elasticity of demand:
  • % change of quantity demanded divided %change of price = 1.5

Lect. In managerial economics

elasticity of demand1
Elasticity of demand
  • Formula for elasticity of demand:

Lect. In managerial economics

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

Lect. In managerial economics

elasticity
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
Arc elasticity

Lect. In managerial economics

point elasticity
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

slide13

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
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
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 revenue1
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 revenue2
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
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

slide20

Cross price elasticity

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

Lect. In managerial economics

advertising elasticity
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 elasticity1
Advertising elasticity
  • Determinants
    • The level of sales
    • Advertisement by other firms
    • Cumulative of past advertisement

Lect. In managerial economics

elasticity of price expectation
Elasticity of Price expectation

Lect. In managerial economics

application
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

elasticities1
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

slide26

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 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 reconsider1
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