by: chichi <33
transactions of both parties (buyer and seller) either
MANAGERIAL ECONOMICS
INVESTMENT DECISIONS
To make an investment, the trade-off between
current costs and future gains is unavoidable which
should always be considered to determine if the future
gains are higher than the current costs.
DISCOUNTING
➢ A tool to determine the present value of possible
cash flow that will be generated by an investment
in the future. The formula for discounting is
To determine whether the investment is profitable or
not, discount the future value of an investment and
compare them with the current cost of the investment.
The general decision rule is NPV (net present
value).
“If the net present value of discounted cash flow
is larger than zero, then the investment earns
more than the cost of capital.”
BREAK EVEN ANALYSIS
➢ a way to determine investment profitability
through the breakeven quantity.
Breakeven quantity = Annual fixed cost / (price per
unit minus marginal cost (cost per unit)
Q=F/(P-MC)
BREAK EVEN QUANTITY
➢ The quantity wherein there is no loss and no gain
that means zero profit. But if you could sell more
than the breakeven quantity then it is now
profitable since the revenue exceeds the cost.
The individual’s value for a good or service is based
on the amount of money an individual is willing to
give up or acquire it. That means the value of good
lies on your willingness to pay for it so as to
acquire it or the price you are willing to sell it.
In a buyer-seller relationship, the buyer's value for a
certain product is how much he will pay for it (top
peso on buyers’ part) while the seller’s value of a
goods is the cost of goods (bottom peso on the part of
the seller). A buyer buys if the price is below his
value, top peso, and a seller sells if the price is
above his/her value, bottom peso. There will be
transactions if both parties gain in the exchange, if not
there will be no transaction, in that case, voluntary
create wealth or no wealth creation at all, or a very
minimal wealth creation.
SELLER SURPLUS
➢ The difference between the price agreed upon
and the seller's value.
BUYER SURPLUS
➢ the buyer's value less the agreed price.
TOTAL SURPLUS
➢ the gain in the transaction: buyer surplus plus
seller surplus.
SIMPLE PRICING
➢ the case of a single firm, a single product, single
price
Understanding consumer behavior is necessary in
determining the price of certain goods. The law of
demand and diminishing marginal utility are good
tools in economics in understanding how consumers
value certain goods.
LAW OF DEMAND
➢ Says that a consumer purchases more if price
decreases, purchase less if price increases.
DEMAND CURVES
➢ Show consumer behavior and say how much
consumers will buy at a given price.
THE PRINCIPLE OF DIMINISHING MARGINAL
UTILITY
➢ says that an added satisfaction decreases as a
consumer acquires or consume additional units
of a certain goods. That means subsequent or
succeeding consumption of certain goods per
unit yields less and less marginal value or utility
which makes consumers buy additional units only
if the price per unit of such goods is also
progressively decreasing.
If consumers behave optimally, they will consider the
difference between the value of the goods and the
price they pay for it to maximize consumer surplus. In
doing so, consumers think in marginal terms in
making purchase decisions.
The tradeoff between price and quantity is at the core
of pricing decisions. Raising prices will end up in
fewer units sold yet earn bigger on each unit sold
while reducing prices will increase units sold yet
earn smaller on each unit sold. This tradeoff can be
resolved using marginal analysis.
MR > MC, reduce price, sell more.
MR < MC, increase price, sell less.
 by: chichi <33
Consumer uses marginal analysis for maximization
of consumer surplus, while producer uses marginal
analysis for profit maximization.
PRICE ELASTICITY OF DEMAND
➢ The responsiveness of consumers to a price
change.
ed = percentage change in quantity demanded of
product X // Percentage change in price of product X
ed = change in quantity demanded of X / original
quantity demanded of X // change in price of X /
original price of X
ed = change in quantity demanded/ original quantity +
quantity after change / 2 // change in price / original
price + price after change/2
COEFFICIENT
➢ Must be treated as an absolute number since the
negative sign is construed as a relationship sign.
ELASTIC DEMAND
➢ Coefficient is greater than 1. A one percent
change in price results in more than one percent
change in quantity demanded.
➢ If there is a price increase then the decrease in
quantity is bigger than the increase in price, the
revenue decrease.
➢ If there is a price decrease then the increase in
quantity is bigger than the decrease in price, the
revenue increase.
INELASTIC DEMAND
➢ Coefficient is less than 1. A one percent change
in price results in less than one percent change in
quantity demanded.
➢ If there is a price increase then the decrease in
quantity is smaller than the increase in price, the
revenue increase.
➢ If there is a price decrease then the increase in
quantity is smaller than decrease in price, the
revenue decrease.
UNITARY DEMAND
➢ Coefficient is equal to 1. A one percent change in
price results in one percent change in quantity
demanded.
Factors that affect demand elasticity and optimal
pricing
1. More elastic demand of products happens if
the products have more close substitutes -
consumers respond to a price increase by
switching to substitute products.
2. Product brand individual demand is more
elastic than industry aggregate demand – As
a rough rule of thumb, brand elasticity is
approximately equal to industry price elasticity
divided by the brand name.
3. There is less elastic demand if the products
have many complements - products that are
consumed together with a large bundle of
complementary goods have less elastic.
4. Demand curves become more elastic in the
long run horizon – given more time to find
substitutes when price goes up and given more
time to find alternative uses for a good when
price goes down, consumers are more
responsive to price changes.
Demand becomes more elastic as price increases –
as price increases, consumers find more alternatives
to goods whose price increases.
PRICE ELASTICITY OF SUPPLY
➢ If the quantity supplied by producers is
responsive to the price changes supply is
elastic, if insensitive to price changes then it is
inelastic.
es = percentage change in quantity supplied of
product X // Percentage change in price of product X
es = change in quantity supplied of X / original
quantity supplied of x // change in price of X original
quantity supplied of X
es = change in quantity supplied / original quantity +
quantity after change / 2 // change in price / original
quantity + quantity after change / 2
ELASTIC SUPPLY
➢ Coefficient is greater than 1. A one percent
change in price results in more than one percent
change in quantity supplied.
INELASTIC SUPPLY
➢ Coefficient is less than 1. A one percent change
in price results in less than one percent change in
quantity supplied.
UNITARY SUPPLY
➢ Coefficient is equal to 1. A one percent change in
price results in one percent change in quantity
supplied.
The degree of price elasticity of supply depends on
how fast producers can shift resources between
alternative uses. The easier and faster producers can
shift resources between alternative uses, the greater
the price elasticity of supply.
MARKET PERIOD
➢ The period that occurs when time immediately
after a change in market price is too short for
producers to respond with a change in quantity.
Price elasticity of supply in the short run is the
period of time too short to change plant capacity but
long enough to use the fixed-sized plant more or less
intensively.
 by: chichi <33

Price elasticity of supply in the long run is the desired margin means that the MR>MC so
period of time long enough for firms to adjust plant reduces price, if the current margin is less
sizes and for new firms to enter or exit firms to leave than the desired margin then increases price
the industry. since MR<MC.

CROSS ELASTICITY OF DEMAND FORECASTING DEMAND AND ELASTICITY

➢ Measures how sensitive consumer demand of
one product (X) to a change in the price of some
other product (Y).
➢ If cross elasticity is negative the two goods are
complementary, if it is positive the goods are
substitutes. A zero cross elasticity connotes the
two goods are unrelated.
➢ To determine the effect of other factors besides
price that affects demand such as income, prices
of substitutes and complements, advertising, and
taste and preference, we define a factor of
elasticity demand:
➢ Factor elasticity of demand = (% change in
quantity) / (% change in factor)

Cross elasticity Formula: STAY-EVEN ANALYSIS AND ELASTICITY

Exy = Qx1 - Qx2 / Qx1 + Qx2 ➢ shows how many units you can lose before an
Py1 - Py2 / Py1 + Py2 increase in price becomes unprofitable. It is a
function of the magnitude or size of price
INCOME ELASTICITY OF DEMAND increases and the contribution margin:
➢ The responsiveness of consumer purchases ➢ Percentage change in quantity = percentage
relative to a change in income. change in Price / (percentage change in Price
➢ If income elasticity is positive the goods is a + margin), margin = (P-MC)/P.
normal goods, if they are negative the goods is ➢ If there is an increase in price and the expected
an inferior goods. decrease in quantity demanded is smaller than
the stay even quantity, the price increase is
ey = Q1 - Q2 / Q1 + Q2 profitable. The stay-even shows what changes in
Y1 - Y2 / Y1 + Y2 quantity demanded support a given change in
price. The elasticity estimates on the other hand
MARGINAL ANALYSIS shows what quantity changes will be.
➢ Points us to the right direction in pricing but how
are we going to determine the marginal revenue COST-BASED PRICING
requires information that price elasticity can ➢ cost plus desired fixed margin for each unit of
provide. product equal price per unit. The marginal
analysis, specifically optimal price which is MR =
MC or (P-MC)/P = 1/e do consider both cost
TOTAL REVENUE AND ELASTICITY OF DEMAND structure and consumer demand.

ELASTIC DEMAND
➢ a decrease in price will result in an increase in
total revenue.

INELASTIC DEMAND
➢ a decrease in price will result in a decrease in
total revenue.

UNITARY DEMAND
➢ either increase or decrease in price, total revenue
remain unchanged

MARGINAL REVENUE
➢ = P (1-1 / e)
➢ This expression is a numerical relationship
between marginal revenue and elasticity which
can be used in place of MR in the marginal
analysis rule MR > MC, and MR < MC. Such as
MR > MC implies that (P-MC)/P>1/e. (1/e is an
inverse of elasticity, P is price, MC is marginal
cost). The expression interpretation is that the left
side of the expression shows the current margin
of price over marginal cost, (P-MC)/P, and the
right side is desired margin, 1/e(inverse of
elasticity). If the current margin is greater than