MANAGERIAL ECONOMICS 11

th

Edition

By Mark Hirschey

Demand Analysis

Chapter 5

       Chapter 5 OVERVIEW Measuring Market Demand Demand Sensitivity Analysis: Elasticity Price Elasticity of Demand Price Elasticity and Marginal Revenue Price Elasticity and Optimal Pricing Policy Cross-price Elasticity of Demand Income Elasticity

Chapter 5 KEY CONCEPTS           market demand curve elasticity endogenous variables exogenous variables point elasticity arc elasticity price elasticity of demand elastic demand unitary elasticity inelastic demand           optimal price formula substitutes complements cross-price elasticity income elasticity normal goods inferior goods.

counter-cyclical noncyclical normal goods cyclical normal goods

Measuring Market Demand

  Graphing the Market Demand Curve  Market demand is total demand.

Evaluating Market Demand  Demand differs among market segments.

 Add segment demand to get market demand.

Demand Sensitivity Analysis: Elasticity    Elasticity Concept  Elasticity measures sensitivity.

Point and Arc Elasticity   Point elasticity reflects sensitivity of Y to small changes in X, ε X = ∂Y/Y ÷ ∂X/X.

Arc elasticity reflects sensitivity of Y to big changes in X, E X = (Y 2 –Y 1 )/(Y 2 +Y 1 ) ÷ (X 2 -X 1 )/(X 2 +X 1 ).

Advertising Elasticity Example

Price Elasticity of Demand

   Price Elasticity Formula   Point price elasticity, ε P In all cases, ε P < 0 .

= ∂Q/Q ÷ ∂P/P.

Price Elasticity and Total Revenue    Price cut increases revenue if │ε P │> 1.

Revenue constant if │ε P │= 1.

Price cut decreases revenue if │ε P │< 1.

Uses of Price Elasticity Information

Price Elasticity and Marginal Revenue   How Elasticity Varies along a Demand Curve   As price rises, so does │ε P │.

As price falls, so does│ε P │.

Price Elasticity and Price Changes    MR > 0 if │ε P │> 1.

MR = 0 if │ε P │= 1.

MR < 0 if │ε P │< 1.

   Price Elasticity and Optimal Pricing Policy Optimal Price Formula    MR and ε P are directly related.

MR = P/[1+(1/ ε P )].

Optimal P* = MC/[1+(1/ ε P )].

Optimal Pricing Policy Example Determinants of Price Elasticity   Essential goods have low│ε P │.

Nonessential goods have high│ε P │.

Cross-price Elasticity of Demand   Substitutes and Complements  Cross-price elasticity shows demand sensitivity to changes in other prices.

 ε PX  = ∂Q Y /Q Y ÷ ∂P X /P X .

Substitutes have ε PX > 0.

  Complements have ε PX > 0.

Independent goods have ε PX > 0.

Cross-price Elasticity Example

Income Elasticity

  Normal Versus Inferior Goods  Income elasticity shows demand sensitivity to changes in income.

 ε I = ∂Q/Q ÷ ∂I/I.

  Normal goods have ε I Inferior goods have ε I > 0.

< 0.

Types of Normal Goods   Noncyclical goods have 0 < ε I Cyclical goods have ε I > 1.

< 1.