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Demand Analysis (Cont.)

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.)

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  1. Demand Analysis (Cont.) • Managerial Economics Lect. In managerial economics

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

  7. Formula for elasticity of demand: • % change of quantity demanded divided %change of price = 1.5 Lect. In managerial economics

  8. Elasticity of demand • Formula for elasticity of demand: Lect. In managerial economics

  9. Calculation • Elastic demand = >0 • Inelastic demand = <0 • Elasticity = Unitary = 1 Lect. In managerial economics

  10. 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

  11. Arc elasticity Lect. In managerial economics

  12. 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

  13. 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

  14. Calculating elasticity from demand function • Suppose • Q = 100 – 5P • Change in Q/Change in P =-5 • Elasticity = -5(P/Q) Lect. In managerial economics

  15. 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

  16. 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

  17. 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

  18. Relationship between marginal revenue, and price elasticity Lect. In managerial economics

  19. 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

  20. Cross price elasticity • Substitutes and complements • Income elasticity • Normal, necessities , inferior • Advertising elasticity • Elasticity of price expectations Lect. In managerial economics

  21. 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

  22. Advertising elasticity • Determinants • The level of sales • Advertisement by other firms • Cumulative of past advertisement Lect. In managerial economics

  23. Elasticity of Price expectation Lect. In managerial economics

  24. 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

  25. 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

  26. 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

  27. 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

  28. 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

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