MANAGERIAL ECONOMICS

Module 3
Demand and Pricing
Learning Objectives:
At the end of the module, you are expected to:
1. Define Marketing
2. Define consumer
3. Define demand
4. State the theory of consumer
5. Identify the determinants of demand
6. Know the meaning of forecasting demand
7. Define and compute elasticity of demand
8. Define price discrimination

Introduction:
Decision related to demand and pricing are usually called Marketing decision.
Marketing an established profession and an applied academic discipline with a large body of
literature. However, economic reasoning and concepts provide much of the theoretical foundation for
marketing decision.

Theory of Consumer:
Consumer is someone who makes consumption decision s for herself or for her household unit
in a modern society. Consumption is largely facilitated by purchased for goods and services. Some of
these goods and services are essentials to the consumer's livelihood, but others are discretionary
perhaps even a luxury.
Consumers are limited in how much to they can consume by their wealth. A consumer's wealth
will change overtime to income and expenditures. She might be able to borrow against future income so
as to increase her capacity to purchased new in exchange for diminished wealth and consumption later.
Similarly, she may retain some of her current wealth to savings towards increase future
consumption.
The theory of consumer posits that a consumer plan her purchased as the timing of those
purchases and borrowing and savings as maximize the satisfaction she to her household unit with
experience from consumption of goods and services.
In this theory of consumer are able to compare any two patterns of consumption, borrowings
and savings and that either one is preferred with the second, or they are different between the two
patterns.
Based on the ability to do that comparison, consumers look at the prices charge for various
services in the future and what they expect in the future and select pattern of consumption, borrowing
and savings that generated the greatest satisfaction over their lifetime within the constraint of their
wealth and expect future income.
Theory of consumer states that they will adjust their consumption, borrowing and savings to
restore the optimality from the newly revealed prices.
 Two Effects of Prices Changes
1. Substitution effect - The consumer responses to a changing prices to restore balance in the ratios of
marginal utility to price.
2. Income effect - The potential increase in the consumption of two commodities.

Determinants of Demand
1. Price itself
2. Income
3. Prices of related goods
4. Taste and preference
5. Size of the population
6. Expectation on future prices

Elasticity of Demand
Elasticity of Demand- it explains the relationship between a change in price and change in amount
demanded.
%∆ Q
Elasticity=
%∆ P

Types of Elasticity of demand

1. Price elasticity of demand - measures the changes in quantity demand to a change in price.
∆Q Q 2−Q 1
% ∆ Qd Q Q1
ε d= ∨ ∨
%∆ P ∆ P P2−P 1
P P1

2. Income elasticity of demand - shows the change in quantity demanded as a result of a change in
income.
∆Qd
Qd
ε y=
∆M
M

3. Cross elasticity of demand - A change in the price of one commodity leads to a change in
quantity demanded of another commodity.

Cross elasticity of demand for substitute goods

∆ Qx
Qx
ε xy =
∆ Py
Py
 Cross elasticity of demand for complementing goods

∆ Qx
Qx
ε xy =
∆ Py
Py

∑ ¿ greek letter epsilon which means change

∆=greek letter delta which means change

% ∆= percentage change

Forecasting Demand
The trade can estimate the quantity of goods to be sold at the different level of income to raise
the targeted revenue. The impact of changing income levels on the demand of the product can be
assessed with the help of income elasticity.

Price Discrimination
The strategy of a business or seller charging a different prices to various customers for the same product
or services.

Other Formulas

Ɛ ARC ∨ARC Elasticity :

( P1 + P2 )
Q 2 −Q 1 2
Ɛ ARC = ×
P2 −P 1 ( Q 1 +Q 2 )
2
Point Elasticity:

Q2−Q1
Q1
Ɛ D=
P2−P1
P1