# Chapter 4 Demand Analysis

• Where does demand come from? How can managers have any predictive tools about how changes in certain variables will impact their demand? • Demand ultimate derives from the individual consumer or ﬁrm. Consumers demand products to satisfy their wants and needs. Firms demand products to produce other goods and services to sell in a market. • Consumers derive utility from their consumption of goods and services. • Firms derive proﬁt from their consumption of goods and services. • It is thought that consumers seek to maximize the utility they gain from consumption just as ﬁrms seek to maximize proﬁt. • Households are limited in their quest to maximize utility. They only have so much money to spend on consumption and they face a lot of diﬀerent wants/needs. • Ultimately, the income and the prices of the goods determine a household’s choice set. The income/prices combined with household preferences determine household consumption bundle. • The market demand curves are the aggregation of the individual household demand curves. • How much does quantity demanded change when there is a change in price (perhaps from a supply-side inﬂuence), a change in income, other prices, population, etc.? 49

50

CHAPTER 4. DEMAND ANALYSIS

4.1

Elasticity

• Discussing how much quantity demanded changes due to a supply shock or some other demand shock is diﬃcult to do across markets because prices and other inﬂuences on demand are measured in diﬀerent units and take on diﬀerent importance. • Economists developed the concept of elasticity to get around these problems of units and market diﬀerences. • An elasticity measures the percentage change in one variable due to a percentage change in another variable. Elasticity measures are unit-less and can be compared across markets and time. • Elasticity is mathematically deﬁned as %∆Y %∆X • A point elasticity is calculated at a particular point on the demand/supply curve and is written as ∂Y X %∆Y = X = %∆X ∂X Y • For example, if
X

= 3 then a 1% increase in X yields a 3% increase in Y (and vice-versa).

• Point elasticities are useful when analyzing a single point on a demand/supply curve. • At other times we will be working with two diﬀerent points on a demand/supply curve. In these cases we use the arc elasticity: ¯ %∆Y ∂Y X = ¯ %∆X ∂X Y ¯ ¯ where X is the average X of the two points and Y is the average Y of the two points.
X

=

4.1.1

Price Elasticity of Demand

• The most common elasticity used in microeconomics is the own-price elasticity of demand. • Own-price elasticity measures the percentage change in quantity demanded due to a percentage change in price:

and therefore ∆Q/∆P is negative. • How does the price elasticity help managers? Consider the following general results If | p | > 1 Raising price will lower total revenue d If | p | = 1 Raising price will not change TR (TR is maximized) d If | p | < 1 Raising price will increase total revenue d Perfectly inelastic demand and perfectly elastic demand . • Because the demand curve is downward sloping. Consider the following scenarios: P=8 P = 10 P=2 P=6 p d p d p d p d = −5000(8/20000) = −2 = −5000(10/10000) = −5 Relatively elastic Relatively elastic = −5000(2/50000) = −1/5 Relatively inelastic = −5000(6/30000) = −1 Unitary elastic • Generally. the more inelastic (less elastic) the demand. it is common to take the absolute value of the price elasticity of demand.4. The lower the price. the higher the price the more elastic the demand. = −1 or demand is unitary elastic.1. • An example: Assume Q = 60. • If ∆Q/∆P → −∞ or ∆P/∆Q → 0 then • If |∆Q/∆P | = |P/Q| then p d p d → 0 (from below) or demand is relatively → −∞ or demand is relatively elastic. 000 − 5. 000P . ELASTICITY %∆QD ∂QD P = %∆P ∂P QD p d 51 P d = • If ∆Q/∆P → 0 or ∆P/∆Q → −∞ then inelastic.

However.52 CHAPTER 4. T R is maximized and price elasticity of demand is one in absolute value . DEMAND ANALYSIS • Total revenue can be written as T R = P × Q which implies that MR = ∆P Q+P ∆Q • For most ﬁrms. if we consider the market for the product: ∆P ≤ 0 ⇒ MR ≤ P ∆Q ∆P If = 0 ⇒ MR = P ∆Q • When M R = 0 we have ∆P Q ∆Q ∆P Q 1 = − ∆Q P ∆Q P 1 = − ∆P Q P −1 = d P = − • When M R = 0. ∆P/∆Q = 0 because the individual ﬁrm is very small.

1.4. ELASTICITY 53 • Elasticity measures can help ﬁrms determine optimal pricing so to maximize proﬁt: Π = TR − TC mΠ = M R − M C ∆T R ∆P MR = =P +Q ∆Q ∆Q Q ∆P = P 1+ P ∆Q ∆Q P Recall: p = d ∆P Q .

10 on \$100 of cost. then price would fall slower than marginal cost.26 1 + −20 • What if P d = −1000 and M C = \$100? P∗ = \$100 = \$100. . the closer is price to marginal cost.2) • Example: Let a 2% drop in price yield a 4% increase in sales: p d = +4% = −2 −2% If M C = \$100 then P∗ = If M C = \$90 then P∗ = 100 1 = \$200 1 + −2 90 1 = \$180 1 + −2 • Price falls faster than marginal cost because demand is elastic. DEMAND ANALYSIS 1 ⇒ M R = P [1 + ] • From this. • If demand is inelastic. In this example proﬁt is \$0.10 1 1 + −1000 In other words. it is proﬁt enhancing for the ﬁrm to lower price and produce more. when the ﬁrm sets M R = M C it obtains 1 P [1 + ] = M C P∗ = MC 1+ 1 (4.54 CHAPTER 4. with very elastic demand there is very little proﬁt.1) (4. • The greater the demand elasticity. • As costs decline. • What if P d = −20 and M C = \$100? P∗ = \$100 1 = \$105.

1.4.945 ¯ ∆P Q +8 19561 • In essence.771. Fewer substitutes 2. the arc-elasticity between these two prices was negative one. the same two teams played again: average ticket price was \$9 and attendance was 4. • How to reduce price elasticity of demand? 1. • The next day.gov) . the Florida Marlins were \$1 and attendance was 34. ELASTICITY 55 • Why do ﬁrms want inelastic demand? Greater markups over marginal cost. Lower percentage of household budget 6. Expectations that prices will increase dramatically in the future 4.2 Examples from the real world Major League Baseball • Opening day 2002 for the Montreal Expos: All tickets to the Montreal Expos vs.351. Greater quality 3. • Montreal Expos might have been revenue maximizers in their tickets (consistent with price elasticity equal to one in absolute value).eia. Brand loyalty 4. the price elasticity for the Montreal Expos: P d = ¯ ∆Q P −29580 5 = = −0. for one thing.1. Infrequent purchases 5. • With these two games. • Question: Why not price at \$1 and make a lot of money on beer? Price of Oil • What is the short-run price elasticity of gasoline? • From the Energy Information Agency (www.

40 3.666.05 × 82.50 2.594.10 3. authors Jonathan Haughton and Soumodip Sarkar attempt to answer the question of what impact a \$1 gasoline tax increase would have on driving and accidents. this implies a longer-run price elasticity of P d ¯ 5.237.8 = −13. They submit that with a gas tax of \$1. DEMAND ANALYSIS • Sales to end users.112 45.041 -0.451 0.935. By June 2008.009 -0.027.068 -0.082 0.068 -0.833 45.070 0.171 1 mo P d 2 mo P d 45.815 47.103 -0.022 0.114 47.963.745 Averages -7.328 0.20 1.003 -0.044 %∆P -0.335.594.006 0.00 3. .099. Millions of gallons per day from 2008: Month Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Qty Price %∆Q 0. 808.256 0.092.658 45.035 -9.3 = −0.60 4.756 47.859.912. • In November 2010.859 ∆Q P 2 = ¯ = +0.028 0.80 3. the elasticity had jumped to -10.662.8 thousand gallons per day of gasoline were sold in the United states and the price was 2.028 -0.002 -0.30 3. or essentially zero.010 -0.507 48.329 0.105 46. miles driven would decrease by up to 12% and fatalities by up to 18%. 085.005 0.208+2.551 0.08.205 0.088 0.992 -0.5+36.004.009 -0.015 0.860 ∆P Q 2 • Could it be that today our response to changes in the price of gasoline are much more elastic and therefore do not elicit the same angst as similar price changes did in 2008? If price of gasoline goes back to \$4 do we anticipate that the quantity demanded would actually increase in equilibrium (in the short run)? Increasing the Gasoline Tax • In a 1996 article in the Energy Journal.275.680.00 3.11 but by November and December it was essentially zero again.049 0.293 47.076 0.040 -0.074 −9.021 0.192 0. Compared to November 2008. only 36.30 4.412 -0.001 -0.095 46.034 -0.00 3.210 0.680.290 -0.078 46.132 2.428 -0.56 CHAPTER 4.118 0.208 45.097 0.065 0.020 -0.7 2.046 -0.042 • The price elasticity of demand between Feb and March 2008 was -0.10 3.

Assuming that the entire tax increase is applied to the price.” Econometrica. 103-26. respectively. S. ELASTICITY 57 • How do they get to these results? By estimating and using the own-price elasticity of gasoline to calculate the impact on gasoline consumption. or 46%. Civics • Ford and Honda cater to the subcompact segment of the automobile market with their Escort and Civic models.4. both groups would reduce purchases by 3.23 × 46% = −10. For a 1% increase in price.4%.23 to -0. and Sarkar. Are Ford Escort buyers more or less price sensitive than buyers of Honda Civics? One way to answer this question is to estimate the change in quantity demanded from a \$100 increase in the price of each make.6% and 16. J. pp. 1970-1991.4. • Source: Pinelopi Koujianou-Goldberg (1995). of which 28% or \$0.23 %∆Q = −0. 17(2).32 was tax. Using this knowledge we can calculate the change in consumption: Low end: %∆Q/46% = −0. this means a price increase of \$0. • Source: Haughton. Automobile Industry.” Energy Journal.68.35 %∆Q = −0. . The long run own-price elasticity of demand for gasoline over a ten-year period was calculated to be in the range -0.35. pp.1. • A consistent way of comparing the price sensitivity of Escort and Civic buyers is to use the own-price elasticities of the demands.35 × 46% = −16.1% • Without going into the eﬀect on accidents. • The retail price of gasoline in 1991 was \$1. The own-price elasticities of the demands for Escorts and Civics have been estimated to be both −3.13. 891-951.1%. “Gasoline Tax as a Corrective Tax: Estimates for the United States.6% High end: %∆Q/46% = −0. But this does not compare like with like. 63(4). (1996). Escorts vs. “Product Diﬀerentiation and Oligopoly in International Markets: the Case of the U. we can still determine that a gas tax of \$1 would have been expected to decrease gas consumption by between 10.S.

000 × 25 = \$1. 000 58. 500 × 30 = \$1. 000 = −0.58 Higher Education CHAPTER 4.500 • Bezmen and Depken (1998. 4. 755.500 Total Revenue 60.139 • The elasticity in this example is then = 30+25 −1500 5 60. public colleges to be -0.1 Other Elasticity Measures Cross Price Elasticity • This elasticity measures the relative response to the quantity demanded for Good A due to a relative change in the price of Good X.2. • Mathematically this looks like: x d = %∆QD A \$∆PX .02. Consider the following table: Tuition Number Semester Price/ of Hours Hour Students \$25 \$30 4000 3900 15 15 Total Semester Hours 60.S. DEMAND ANALYSIS • From Eric Steger.000+58. Economics of Education Review): estimate the short-run tuition elasticity of enrollment in U.2 4. East Central University.000 58. 500.

This implies that Good A and Good X are not related to each other in consumption or are independent goods. 2008 provided the following data for select vehicles. This made a lot of people reconsider the type of vehicles they would purchase and drive.5%) . • If x > 0: The price of Good X increases and the quantity demand of Good A increases. d This implies that Good A and Good X are substitutes in consumption or are used in place of one another. Examples: Corn and telephones. cars and tires. • The April 2007 to April 2008 percentage change in the price of gasoline was (3.845 = 21. tennis balls and tennis rackets. There is a saying in America: “What does that have to do with the price of tea in China?” This would be used in a situation where two things were completely independent of each other.4. Examples: Hondas and Toyotas. OTHER ELASTICITY MEASURES 59 • If x < 0: The price of Good X increases and the quantity demand of Good A decreases. d This implies that Good A and Good X are complements in consumption or are used together. • If cross price elasticity is high (positive or negative) then the two goods are strong substitutes or complements.2. Samsung and Sony televisions. A New York Times article from May 2.458 − 2. then the two goods are weak substitutes or complements. Cross-price elasticity example: cars and gasoline • In 2008 the price of gasoline spiked above \$4 per gallon. Examples: iPhones and iPhone docking stations. X-box games and allergy medicine.845)/2. • If x = 0: The price of Good X increases and the quantity demand of Good A does d not change. • If cross price elasticity is close to zero. Dell and HP computers. computers and printers.

12 -1.757 -27.2.5 11. DEMAND ANALYSIS April 08 Sales %Change from Apr-07 44.80 x d -1.42 0. • Mathematically this looks like M d = %∆QD %∆M If If If If If M d M d M d M d M d >0⇒ <0⇒ >1⇒ =1⇒ <1⇒ Normal good Inferior good Luxury good Necessary good Vital good .25 -0.0 -2.016 37.2 Income Elasticity of Demand • The income elasticity of demand reﬂects the percentage change in the quantity demanded due to a percentage change in income.55 2.813 40.6 -30.075 21.231 35.50 Chevrolet Silverado Honda Accord Toyota Prius 4.60 Make Ford Toyota Model F-series Camry CHAPTER 4.9 53.

OTHER ELASTICITY MEASURES 61 • Firms are likely concerned about how the demand for their product will change with exogenous changes in household income. Walmart has experienced an increase in demand whereas Macy’s has experienced a decline in demand.2. • Here is the ﬁve year trend line of the stock price for Walmart (blue) and Macy’s (red): • We can see when times were good. In the current economic slowdown in the United States. holding technology ﬁxed. . • Population elasticity of demand P OP d = %∆QD %∆P OP • As population increases we might expect to see quantity demanded increase. Macy’s was doing much better than Walmart. in equilibrium. This suggests that Macy’s sells normal/luxury goods and Walmart sells inferior goods.4. Walmart outperformed Macy’s. 4. before the recession.2. less than one.3 Other elasticities • Can you think of other elasticities that might be useful to ﬁrms? • Advertising elasticity of demand: A d = %∆QD %∆Adv • We might expect advertising elasticity to be positive and. As times turned bad.

Therefore. .62 CHAPTER 4. • When analyzing multivariate relations such as these. or ∂Q/∂P . In this instance.. Optimization requires an analysis of how a change in each independent variable aﬀects the dependent variable. holding constant the eﬀect of all other independent variables.6A − 0 = 40 + P − 1. A is treated as a constant when the partial derivative of Q with respect to P is analyzed. it is possible to examine two partial derivatives: the partial of Q with respect to price. consider a hypothetical multivariate product demand function for CSI.2. where the demand Q is determined by the price charged. 4. The partial derivative concept is used in this type of marginal analysis.4 Advertising • To explore the concepts of multivariate optimization and the optimal level of advertising. • In light of the fact that the CSI demand function includes two independent variables. In determining partial derivatives. the partial derivative of Q with respect to P is: ∂Q/∂P = 0 − 10 + 0 + A − 0 − P = −10 + A − P The partial with respect to A is: ∂Q/∂A = 0 − 0 + 40 + P − 1. all variables except the one with respect to which the derivative is being taken remain unchanged.8A2 − 0. the price of the product itself and advertising. one is interested in the marginal eﬀect of each independent variable on the quantity sold.6A • Solving these two equations simultaneously yields the optimal price-output-advertising combination. or ∂Q/∂A. P . P is measured in price. and the level of advertising. A: Q = 5. DEMAND ANALYSIS • If population elasticity is greater than one this would imply network externalities or what are called relational goods/mob goods.5P 2 where Q is measured in units. P is treated as a constant when the partial derivative of Q with respect to A is evaluated. the dependent variable. Inc. 000 − 10P + 40A + P A − 0. A is measured in hundreds of dollars. and the partial of Q with respect to advertising expenditures.

The temperature elasticity of lemonade sales. A price reduction for personal computers will increase both the number of units demanded and the total revenue of sellers. D. Indicate whether each of the following statements is true or false. • Given this value. Name and describe three additional elasticities of your own. 800. C. • Inserting these values for P and A into the CSI demand function yields Q = 5. 5.6A = 0.000. which implies that 0. OTHER ELASTICITY MEASURES 63 • Because −10+A−P = 0. P = A−10.2. P = A − 10.2. B. and income elasticity = 2.5 The demand for personal computers can be characterized by the following point elasticities: price elasticity = 5. Demand for personal computers is price elastic and computers are cyclical normal goods. The snow elasticity of ski lift ticket sales. Falling software prices will increase revenues received by sellers of both computers and software. 10 = 50 − 10 = \$40. A 2% price reduction would be necessary to overcome the eﬀects of a 1% decline in income.4. 2. P4. E. 6. A. gives 40 + (A − 10) − 1. The cross-price elasticity indicates that a 5% reduction in the price of personal computers will cause a 20% increase in software demand. Substituting this value for P into 40+P −1.6A = 0. The condom elasticity of STDs. cross-price elasticity with software = 4.5 Problems and Questions Q4. Byrns: Describe in words and provide a predicted sign for the following elasticities 1. SOLUTION . 4.6A = 30 and A = 50 or \$5.1 From Ralph T. 3. and explain your answer. 4. The TV football game elasticity of divorce rates. The homerun elasticity of beer sales at a ballpark.5.

However. P4. Negative cross-price elasticity indicates that personal computers and software are compliments. True. A.500 and incurs marginal selling costs of \$350 per unit. Calculate the point price elasticity of demand for Harrison Ford 4WD Escape GasElectric Hybrid SUVs sold during the month of August. given a downward sloping demand curve. E. B. C. SOLUTION A. D. Customer response was wildly enthusiastic. B. there is no information concerning the price elasticity of demand for software. falling software prices will increase the demand for computers and resulting revenues for sellers. ∆Q/Q ∆P/P = 10%/ − 1% = = −10(Highly elastic) .64 CHAPTER 4. and therefore. True. Demand is price elastic (see part A). A 1% decline in income will cause a 2. These changes will not be mutually oﬀsetting. DEMAND ANALYSIS A. and that a price reduction will increase total revenues.6 In an eﬀort to reduce excess end-of-the-model-year inventory. since the income elasticity is greater than one. Since the income elasticity is positive. False. Calculate the proﬁt-maximizing price per unit if Harrison Ford has an average wholesale (invoice) cost of \$23. The negative sign on the price elasticity indicates that this is indeed the case here. False. A 2% reduction in price will cause a 10% increase in the quantity of personal computers demanded. personal computers are a normal good.5% fall in demand. Therefore. personal computer demand is also cyclical. with unit sales rising by 10% over the previous month’s level. one does not know the eﬀect of falling software prices on software revenues. Harrison Ford oﬀered a 1% discount oﬀ the average price of 4WD Escape Gas-Electric Hybrid SUVs sold during the month of August. False. The fact that price elasticity equals 5 indicates that demand is elastic with respect to price. A price reduction always increases units sold. The cross-price elasticity indicates that a 5% decrease in the price of software programs will have the eﬀect of increasing personal computer demand by 20%. Moreover.

67 < 0 indicates that beverages and appetizers are complements. SOLUTION A. Calculate the arc price elasticity of demand for appetizers. a further decrease in appetizer prices will cause a continued growth in beverage unit sales and revenues. to determine the proﬁt eﬀects of appetizer price changes it is necessary to consider revenue and cost implications of both appetizer and beverage sales. At P = \$8.4. Solving for the demand curve gives P = \$15 − \$0. In any case. OTHER ELASTICITY MEASURES B.75 > 1 calculated in part A implies an elastic demand for appetizers and that an additional price reduction will increase appetizer revenues. C. At P = \$12. 500 65 P4. Alternatively.033Q. If P = a + bQ. . total revenue is \$1. x = −3. 080(= \$1290). total revenue is \$1.67 ∆Px Q2 + Q1 10 − 12 600 + 300 C. Beverage sales also increased from 300 to 600 units per day. p = ∆Q P2 + P1 150 − 90 10 + 12 = = −2. Calculate the arc cross-price elasticity of demand between beverage sales and appetizer prices. total revenue is \$1. 500(= \$10150). If P = \$10. B. Holding all else equal. would you expect an additional appetizer price decrease to \$8 to cause both appetizer and beverage revenues to rise? Explain. Therefore.7 The South Beach Cafe recently reduced appetizer prices from \$12 to \$10 for afternoon ”early bird” customers and enjoyed a resulting increase in sales from 90 to 150 orders per day. x = ∆Q Px2 + Px1 600 − 300 10 + 12 = = −3. Yes. 500 + \$350)/[1 + 1/(−10)] = \$26. 680(= \$8210). The proﬁt-maximizing price can be found using the optimal price formula: P ∗ = M C/(1 + 1/ P ) = (\$23. A.2. the | p | = 2.75 ∆P Q2 + Q1 10 − 12 150 + 90 B. then \$12 = a + b(90) and \$10 = a + b(150).

000 to 4. A. On this basis. it is appropriate to estimate the arc price elasticity from a before-price-increase base of 50 million units: p = ∆Q 30 − 50 P2 + P1 Q1 + Q2 = 16.50 + 15. a competitor oﬀered a whopping \$52 oﬀ their regular \$137 price on deluxe garment bags.500 per year in a booming economic recovery. Lean’s \$140 deluxe garment bag declined from 10.66 CHAPTER 4. M = ∆Q M1 + M2 50 − 30 58. sales of B. an increase (decrease) in P4. Although the market response to the company’s spring catalog was generally good. Ironside sold 30 million square yards (units) of carpeting at an average wholesale price of \$15. sales this year would total 50 million units. Inc.50 − 15. 500 − 55.9 B. This year. B. During the past year. Calculate the implied income arc elasticity of demand. is highly sensitive to changes in national income. household income is expected to surge from \$55. calculate the implied arc price elasticity of demand. Without a price increase. Lower. so Ironside’s demand is also very price-sensitive.5 ∆M Q1 + Q2 58. Lean is a catalog retailer of a wide variety of sporting goods and recreational products. is a leading manufacturer of tufted carpeting under the Ironside brand. B. would a further increase in price result in higher or lower total revenue? SOLUTION A. the marketing director believes that a volume of 30 million units could be maintained despite an increase in price of \$1 per unit. 500 50 + 30 B.5030 + 50 = −8 ∆P 16. price will result in lower (higher) total revenues. Since carpet demand is in the elastic range. C.50 per unit.50 p C. = 8. 500 + 55. The carpet manufacturing industry is highly competitive. Demand for Ironside’s products is closely tied to the overall pace of building and remodeling activity and. DEMAND ANALYSIS P4. Given the projected rise in income. Holding all else equal. Ironside’s marketing director expects current-year sales to soar to 50 million units because of rising income. 500 = = 9.800 units. B.500 to \$58.8 Ironside Industries. therefore. . During this period. Without any price change. Therefore..

200 to 9. 560 = P2 + 130 13P2 = 1. 800 + 10.10 Enchantment Cosmetics. B. determine the further price reduction necessary for B. B. regain a volume of 10. SOLUTION A. 000 85 + 137 = 1. Lean’s arc price elasticity of demand for this product. Unfortunately. Lean to fully recover lost sales (i. p C. 000 B. C. Coupon printing and distribution costs totaled \$500 per month and represented a substantial increase over the typical . Enchantment ran a coupon promotion featuring \$5 oﬀ the new regular price. B. OTHER ELASTICITY MEASURES 67 A. Assuming the same arc price elasticity of demand calculated in Part B... 000 − 4.000 units per month.000 units). 800 − 10. Lean’s deluxe garment bag sales recovered from 4. Lean’s deluxe garment bag. 000 + 4. 430 P2 = \$110 This implies a further price reduction of \$20 because: ∆P = \$130 − \$110 = \$20 P4.800 units to 6.5 (Substitutes) 85 − 137 4.2. x = 4. p which implies that −12P2 + 1. 000 − 6. 000 + 6. Inc. Calculate B. B. sales dropped sharply from 16.4. In an eﬀort to regain lost sales. oﬀers a line of cosmetic and perfume products marketed through leading department stores. B. Calculate the arc cross-price elasticity of demand for B. 800 130 + 140 = −3 (Elastic) 130 − 140 6. 800 = −3 = P2 + 130 10.000 units following a price reduction to \$130 per unit.e. 000 P2 − 130 10. 000 = 6. Product Manager Erica Kane recently raised the suggested retail price on a popular line of mascara products from \$9 to \$12 following increases in the costs of labor and materials. B.

coupons were used on 40% of all purchases and monthly sales rose to 15. Despite these added costs.000. Calculate the arc price elasticity implied by the initial response to the Enchantment price increase. the quantity demanded would rise to 13. DEMAND ANALYSIS advertising budget of \$3. 000 . The eﬀective price reduction is \$2 since 40% of sales are accompanied by a coupon: ∆P = −\$5(0. Calculate the eﬀective price reduction resulting from the coupon promotion. 000 −2 = Q∗ + 9.000 units. the promotion was judged to be a success.4) = 10 ∆P = \$10 − \$12 = −\$2 C. 000 Q∗ = 13. 000 − 16. 000 ∗ −2(Q + 9. 200 B. 000 −11(Q∗ − 9. A. In the period prior to expiration. Why might the true arc advertising elasticity diﬀer from that calculated in part C? SOLUTION A. To calculate the arc advertising elasticity. the eﬀect of the \$2 price cut implicit in the coupon promotion must ﬁrst be reﬂected. B. D.68 CHAPTER 4. 000 + 16.250 per month. 000 10 + 12 −2 = 10 − 12 Q∗ + 9. In light of the price reduction associated with the coupon promotion and assuming no change in the price elasticity of demand. as it proved to be highly popular with consumers. C. because: Q∗ − Q1 P 2 + P 1 P2 − P1 Q∗ + Q1 Q∗ − 9. calculate Enchantment’s arc advertising elasticity. 000) p = 9Q∗ = 117. p = 12 + 9 ∆Q P1 + P2 9. With just a price cut. 000) = −11(Q∗ − 9. 200 = = −2 ∆P Q1 + Q2 12 − 9 9.4) = −2 or P2 = \$12 − \$5(0.

000 + 13. 750 + 3. as seems likely. Synergy between advertising and the implicit price reduction that accompanies a coupon promotion can cause the estimate in Part C to overstate the true advertising elasticity. In addition. the arc advertising elasticity can be calculated as: 69 A Q1 − Q∗ A1 + A2 A2 − A1 Q2 + Q∗ 15. Similarly. . OTHER ELASTICITY MEASURES Then. 000 = D. 000 3. Synergistic or interactive eﬀects may increase advertising eﬀectiveness when the promotion is accompanied by a price cut.4. 250 = =1 3. and may spur sales by much more than a dollar equivalent across-the-board price cut. 250 15.2. a coupon is a price cut for only the most price sensitive (coupon-using) customers. 000 − 13. It is important to recognize that a coupon promotion can involve more than just the independent eﬀects of a price cut plus an increase in advertising as is implied in Part C. this advertising elasticity will be overstated to the extent that targeted price cuts have a bigger inﬂuence on the quantity demanded than similar across-the-board price reductions. 750 − 3. Similarly. price reductions can have a much larger impact when advertised.