QUANTITATIVE DEMAND

ANALYSIS
WEEK5
 INTRODUCTION

• IN week 5, we saw demand for a firm’s product (Qxd) depends on its price
(Px), the prices of substitutes or complements (Py), consumer incomes (M),
and other variables (H) such as advertising, the size of the population, or
consumer expectations:
How much do we have to cut our price to achieve 3.2 percent sales growth ?

If we cut prices by 6.5 percent, how many more units will we sell? Do we have
sufficient inventories on hand to accommodate this increase in sales? If not, do we
have enough personnel to increase production? How much will our revenues and
cash flows change as a result of this price cut?

 How much will our sales change if rivals cut their prices by 2 percent or a
recession hits and household incomes decline by 2.5 percent?
 THE ELASTICITY CONCEPT

measures the responsiveness of one

variable to changes in another variable.
measure of the responsiveness of one
variable to changes in another variable;
the percentage change in one variable
that arises due to a given percentage
change in another variable.
 OWN PRICE ELASTICITY OF DEMAND,

which measures the responsiveness of

quantity demanded to a change in price.
A measure of the responsiveness of the
quantity demanded of a good to a chang in Example : Say that a 10 percent
the price of that good; the percentage increase in the product’s price leads to a 20 percent
change in quantity demanded divided by the decline in the quantity demanded of the
good since −20%/10% = −2.
percentage change in the price of the good.
NEGATIVE : LAW OF DEMAND
 A ALTERNATIVE CALCULUS

• Since demand function is :

 HOW ABOUT LINE EQUATION ?

Q= a-bP
Take the partial derivative according to P.
Change of Q/Change in P= -b remember P/Q therefore
Own price elasticity= -b x P/Q
ELASTICITY AND TOTAL REVENUE

We have linear demand function, Qxd  = 80 − 2 Px .

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
 EXAMPLE 1

According to an FTC Report by Michael Ward, AT&T’s own price elasticity of

demand for long distance services is -8.64. AT&T needs to boost revenues in
order to meet it’s marketing goals. To accomplish this goal, should AT&T raise
or lower it’s price?
Lower , to increase its revenues
 EXAMPLE 2

Suppose the research department of a computer company estimates that the

own price elasticity of demand for a particular desktop computer is −1.7. If the
company cuts prices by 5 percent, will computer sales increase enough to
increase overall revenues?
 EXAMPLE 3

• Suppose instead that EQx ,Px = −∞ or EQx ,Px = 0. How would the quantity
demanded respond to a change in price?
PERFECTLY ELASTIC
PERFECT INELASTIC
 FACTORS AFFECTING THE
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 consumer’s budgets tend to be more inelastic than goods for
which consumers spend a large portion of their incomes.
 CROSS-PRICE ELASTICITY

• which reveals the responsiveness of the

demand for a good to changes in the price
of a related good.
• A measure of the responsiveness of the
demand for a good to Changes in the price
of a related good; the percentage change in
the quantity demanded of one good divided
by the percentage change in the price of a
related good.
ALTERNATIVE

• If EQxPy > 0, then X and Y are

substitutes.
• If EQxPy < 0, then X and Y are
complements.
 EXAMPLE:

For example, clothing and food have a cross-price elasticity of –0.18. This
means that if the price of food increases by 10 percent, the demand for clothing
will decrease by 1.8 percent; food and clothing are complements.
 EXAMPLE 4

You have just opened a new grocery store. Every item you carry is generic
(generic beer, generic bread, generic chicken, etc.). You recently read an article
in the Wall Street Journal reporting that the price of recreation is expected to
increase by 15 percent. How will this affect your store’s sales of generic food
products? ( Food and recreation elasticity 0.15)
 EXAMPLE 4

Given in the market demand for good X; Qx= 3000-4Px+ 0.80Py

Qx is the quantity demanded of good X
Px price of good X
Py price of good Y
- Calculate the price elasticity of demand when , Py= 200, Px= 300. is Good X
and Y complement or substitute?
 PREDICTING REVENUE CHANGES FROM
TWO PRODUCTS

• Suppose that a firm sells to related goods, say, hamburger and soda. Then,
lowering the price of hamburgers aects its revenues from both hamburgers
and soda. The price ect depends on both own-price elasticity and cross-price
elasticities.
If the price of X changes, then total revenue will change by:
revenues as R = Rx + Ry, Rx = PxQx denotes revenues from
the sale of product X and Ry = PyQy represents revenues from product Y. The
impact of a small percentage change in the price of product X (%ΔPx =
ΔPx/Px)
 EXAMPLE 5

Suppose a restaurant earns Php 4,000 per week in revenues from hamburger
sales (product X) and Php 2,000 per week from soda sales (product Y). Thus,
Rx = Php 4,000 and Ry = Php 2,000. If the own price elasticity of demand for
burgers is EQx, Px = −1.5 and the cross-price elasticity of demand between
sodas and hamburgers is EQx, Px = −4.0, what would happen to the firm’s total
revenues if it reduced the price of hamburgers by 1 percent?
 INCOME ELASTICITY

• is a measure of the responsiveness of

consumer demand to changes in
income.
• A measure of the responsiveness of the
demand for a good to changes in
consumer income; the percentage
change in quantity demanded divided
by the percentage change in income.
 A CALCULUS ALTERNATIVE

The income elasticity for a good with • If EQx ;M > 0, then X is a normal
a demand function Q x d  =  f( Px , Py good.
, M, H ) may be found using calculus: • If EQx ;M < 0, then X is an inferior
good.
 EXAMPLE 6

• Your firm’s research department has estimated the income elasticity of

demand for nonfed ground beef to be −1.94. You have just read in The Wall
Street Journal that due to an upturn in the economy, consumer incomes are
expected to rise by 10 percent over the next three years. As a manager of a
meat-processing plant, how will this forecast affect your purchases of nonfed
cattle?
OBTAINING ELASTICITIES FROM
DEMAND FUNCTIONS
 A CALCULUS ALTERNATIVE

• The elasticities for a linear demand curve may be found using calculus.
Specifically,

and similarly for the cross-price and income elasticities.

 EXAMPLE 7

The daily demand for Invigorated PED shoes is estimated to be Qx d  = 100 − 3

Px + 4 Py − .01M + 2 Ax where Ax represents the amount of advertising spent
on shoes (X), Px is the price of good X, Py is the price of good Y, and M is
average income. Suppose good X sells at Php 25 a pair, good Y sells at Php 35,
the company utilizes 50 units of advertising, and average consumer income is
Php 20,000. Calculate and interpret the own price, cross-price, and income
elasticities of demand.
 USES OF ELASTICITIES

• Pricing.
• Managing cash ows.
• Impact of changes in competitors' prices.
• Impact of economic booms and recessions.
• Impact of advertising campaigns.
• And lots more!