Managerial Economics & Business

Strategy
Quantitative Demand Analysis

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Overview
I. The Elasticity Concept

Own Price Elasticity

Elasticity and Total Revenue
Cross-Price Elasticity
Income Elasticity

II. Demand Functions

Linear
Log-Linear

III. Regression Analysis

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The Elasticity Concept

How responsive is a change of variable G to a
change in variable S

EG , S

%G

%S

If EG,S > 0, then S and G are directly related.

If EG,S < 0, then S and G are inversely related.
If EG,S = 0, then S and G are unrelated.

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Own Price Elasticity of Demand

EQ X , PX

%QX

%PX

Negative according to the law of demand.

Elastic:

EQX , PX 1

Inelastic: EQX , PX 1
Unitary:

EQX , PX 1

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Perfectly Elastic &

Inelastic Demand
Price

Price
D
D

Quantity
Perfectly Elastic ( EQX , PX )

Quantity
Perfectly Inelastic ( EQX , PX 0)

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Own-Price Elasticity
and Total Revenue
Elastic
Increase (a decrease) in price leads to a decrease
(an increase) in total revenue.

Inelastic
Increase (a decrease) in price leads to an increase
(a decrease) in total revenue.

Unitary
Total revenue is maximized at the point where
demand is unitary elastic.

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Elasticity, Total Revenue and Linear Demand

P
100

TR

10

20

30

40

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR

80

800

10

20

30

40

50

10

20

30

40

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR

80
1200

60

800

10

20

30

40

50

10

20

30

40

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR

80
1200

60
40

800

10

20

30

40

50

10

20

30

40

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR

80
1200

60
40

800

20

10

20

30

40

50

10

20

30

40

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR
Elastic

80
1200

60
40

800

20

10

20

30

40

50

10

20

Elastic

30

40

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR
Elastic

80
1200

60
Inelastic

40

800

20

10

20

30

40

50

10
Elastic

20

30

40
Inelastic

50

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Elasticity, Total Revenue and Linear Demand

P
100

TR
Elastic

80

Unit elastic
Unit elastic
1200

60
Inelastic

40

800

20

10

20

30

40

50

10
Elastic

20

30

40
Inelastic

50

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Demand, Marginal Revenue (MR) and

Elasticity
When

P
100

Elastic

80

MR > 0, demand is
elastic;
MR = 0, demand is
unit elastic;
MR < 0, demand is
inelastic.

Unit elastic

60
Inelastic

40
20

10

20

40
MR

50

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EP

TR=PQ

MR=P(1+1/Ep)

100

-5

500

200

-2

800

300

-1

900

400

-1/2

800

-2

500

1/5

500

-4

600

600

-6

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Factors Affecting
Own Price Elasticity
Available Substitutes
The more substitutes available for the good, the
more elastic the demand.

Time
Demand tends to be more inelastic in the short term
than in the long term.
Time allows consumers to seek out available
substitutes.

Expenditure Share
Goods that comprise a small share of consumers
budgets tend to be more inelastic than goods for
which consumers spend a large portion of their
incomes.

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Cross Price Elasticity of Demand

A measure of responsiveness of the demand for a
good to changes in the price of a related good.

EQX , PY

%QX

%PY

If EQX,PY > 0, then X and Y are substitutes.

If EQ

X,PY

< 0, then X and Y are complements.

 Whenever goods X & Y are substitutes, increase

in the price of Y leads an increase in the demand
of X EQX,P Y > 0
Whenever goods X & Y are complements, an
increase in the price of Y leads to a decrease in
the demand of X EQX,P Y < 0

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Predicting Revenue Changes from Two

Products
Suppose that a firm sells to related goods. If the price of X
changes, then total revenue will change by:

R R X 1 EQX , PX RY EQY , PX %PX

(Baye, 2010:87)

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Jika restoran mendapatkan $4000 tiap minggu untuk

penjualan hamburger (produk X) dan $2000 dari
penjualan soda. Jika nilai dan elastisitas permintaan
silang antara soda dan hamburger adalah 4.0. Apa
yang terjadi dengan total pendapatan jika harga
hamburger berkurang 1%?

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Interpreting Demand Functions

Mathematical representations of demand curves.
Example:
d

QX 10 2 PX 3PY 2 M
Law of demand holds (coefficient of PX is negative).
X and Y are substitutes (coefficient of PY is positive).
X is an inferior good (coefficient of M is negative).

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Income Elasticity
EQX , M

%QX

%M

A measure of the responsiveness of the demand for a

good to changes in consumer income.
If EQX,M > 0, then X is a normal good. An increase in income leads to
an increase in the consumption of X
If EQX,M < 0, then X is a inferior good. An increase in income leads
to decrease in the consumption of X.

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Linear Demand Functions and

Elasticities
General Linear Demand Function and Elasticities:

QX 0 X PX Y PY M M H H
d

P
EQ X , PX X X
QX
Own Price
Elasticity

EQX , PY

PY
Y
QX

Cross Price
Elasticity

EQX , M M

M
QX

Income
Elasticity

Thus the linear demand curve, the elasticity of

demand with respect to a given variable is simply
the coefficient of the variable multiplied by the ratio
of the variable to the quantity demand.

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Log-Linear Demand
General Log-Linear Demand Function:
Demand is log-linear if the logarithm of demand is a linear
function of the logarithms of prices, income, & other variables.

ln Q X d 0 X ln PX Y ln PY M ln M H ln H

Own Price Elasticity :

Cross Price Elasticity :
Income Elasticity :

X
Y
M

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Example of Log-Linear Demand

ln(Qd) = 10 - 2 ln(P).
Own Price Elasticity: -2.

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Graphical Representation of Linear

and Log-Linear Demand
P

D
Linear

D
Q

Log Linear

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Regression Analysis
One use is for estimating demand functions.
Important terminology and concepts:

Least Squares Regression model: Y = a + bX + e.

Least Squares Regression line: Y a bX
Confidence Intervals.
t-statistic.
R-square or Coefficient of Determination.
F-statistic.

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An Example
Use a spreadsheet to estimate the following
log-linear demand function.

ln Qx 0 x ln Px e

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Summary Output

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Interpreting the Regression Output

The estimated log-linear demand function is:
ln(Qx) = 7.58 - 0.84 ln(Px).
Own price elasticity: -0.84 (inelastic).

How good is our estimate?

t-statistics of 5.29 and -2.80 indicate that the
estimated coefficients are statistically different from
zero.
R-square of 0.17 indicates the ln(PX) variable explains
only 17 percent of the variation in ln(Qx).
F-statistic significant at the 1 percent level.

Conclusion
Elasticities are tools you can use to quantify
the impact of changes in prices, income, and
advertising on sales and revenues.
Given market or survey data, regression
analysis can be used to estimate:
Demand functions.
Elasticities.
A host of other things, including cost functions.

Managers can quantify the impact of changes

in prices, income, advertising, etc.

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