Managerial Economics

Applications, Strategies and Tactics, 14e

James R. McGuigan
R. Charles Moyer
Frederick H. deB. Harris

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
1
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 PART II – DEMAND AND FORECASTING

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
2
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Analysis
Overview
• DEMAND RELATIONSHIPS
• THE PRICE ELASTICITY OF DEMAND
• THE INCOME ELASTICITY OF DEMAND
• CROSS ELASTICITY OF DEMAND
• THE COMBINED EFFECT OF DEMAND ELASTICITIES

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
3
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
The Demand Schedule Defined (1 of 2)
• The demand schedule is the simplest form of the
demand relationship
• It is merely a list of prices and corresponding quantities of a
product or service that would be demanded over a particular
time period by some individual or group of individuals at
uniform prices
• Table 3.1 shows the demand schedule for gasoline
• Note the inverse relationship between price and quantity
demanded; this is referred to as the law of demand
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
4
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.1 – U.S. Household Demand for
Gasoline

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
5
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
The Demand Schedule Defined (2 of 2)
• Demand schedules shift when one determinant of
demand changes
• Example: the demand schedule for gas-guzzling SUVs in 1999
reflected low gasoline prices ($2.00/gal); Ford sold 428,000 Ford
Explorers
• By 2007, with gas at $3.50/gal, Ford sold 127,000 Explorers
despite deep discounts
• By 2008, with gas prices over $4.00/gal, the Ford Explorer sold
fewer than 30,000 units, and was withdrawn from the market
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
6
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.1 – Demand for SUV (Ford Explorer)
as Gasoline Price Doubled

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
7
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Constrained Utility Maximization & Consumer Behavior (1 of 4)

• Demand is based on the theory of consumer choice

• Each consumer must choose among combinations of goods &
services that maximize satisfaction or utility, subject to a
constraint on the amount of funds available
• Economists have identified two basic reasons for the increase in
quantity demanded as the result of a price reduction:
• Purchasing power
• Substitution effects

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
8
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Constrained Utility Maximization & Consumer Behavior (2 of 4)
• Purchasing Power Effect
• When the price of a good declines, the purchasing power of the
consumer has increased
• Sometimes the effect is small because little of the household
budget is expanded on that good
• Substitution Effect
• When the price of a good such as movies declines, it is less
expensive than other forms of entertainment; a consumer can
purchase more of the good whose price has declined, and less of
the substitute
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
9
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.2 – Consumption Choice on a Business
Trip

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
10
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Constrained Utility Maximization & Consumer Behavior (3 of 4)

• Targeting, Switching Costs, and Positioning

• The consumer’s desired rate of purchase can also be affected by
several other marketing decisions, such as:
• Targeting the most likely customers
• Establishing loyalty programs
• Carefully positioning the product
• Expanding Equation 2.1 to include these marketing decisions,
we have an implicit demand function such as:

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
11
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Constrained Utility Maximization & Consumer Behavior (4 of 4)

• Targeting, Switching Costs, and Positioning

• Targeting is often the subject of extensive marketing research
• Knowing the customer well enough to prick the right target customer is
a priority in marketing, since it costs 5 times as much to attract a new
customer as to sell to a regular customer
• Switching costs can reduce the number of substitutes under
consideration
• The correct positioning of a product in the customer’s
perception from upscale to down market is important
• As purchasing power rises, goods perceived as inferior will lose sales
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
12
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 What Went Right? ● What Went Wrong?
Chevy Volt
• The hybrid gasoline-electric Toyota Prius at $24,000 proved to be a
good aspirant good for 20-somethings
• Chevy hoped to capture green-conscious young professionals with
the Volt at a planned price point of $33,000, but the batteries
needed to power the Volt were $8, 000 more expensive than
anticipated
• The Volt’s target market will likely not have sufficient disposal
income to purchase at $41,000, and consumers with more money
will likely prefer the Tesla for $52,000 that out-accelerates a Ferrari
• The positioning of the Chevy Volt appears problematic
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
13
 Chapter 3 – Demand Relationships
Price Elasticity Defined (1 of 3)
• The most commonly used measure of the
responsiveness of quantity demanded or supplied to
changes in any of the variables that influence supply
and demand functions is elasticity
• Elasticity is a ratio of the percentage change in quantity
to the percentage change in a determinant, ceteris
paribus (all other things remaining unchanged)

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
14
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Price Elasticity Defined (2 of 3)
• Price elasticity of demand (ED) is the ratio of the
percentage change in quantity demanded to the
percentage change in price, assuming all other
factors remain unchanged

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
15
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Price Elasticity Defined (3 of 3)

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
16
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.3 – Two-person Urban Household
Demand for Gasoline

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
17
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.4 – Two-person Urban Household Gasoline
Demand, Worldwide 2010 (Fuel tax per gallon)

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
18
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Interpreting Price Elasticity: … Price Elasticity and Sales (1 of 3)

• Price elasticity may take on values over the range

from 0 to infinity (See Table 3.2)
• When demand is unit elastic, a percentage change in
price P is matched by an equal change in QD
• When demand is elastic, a percentage change in P is
exceeded by the percentage change in QD.
• For inelastic demand, a percentage change in P results in
a smaller percentage change in QD
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
19
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.2 –
Price Elasticity of Demand in Absolute Values

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
20
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.5 –
Perfectly Elastic and Inelastic Demand Curves

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
21
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.3 –
Partial List of Factors Affecting Supply

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
22
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.6 –
Price Elasticity over Demand Function

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
23
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Interpreting Price Elasticity: … Price Elasticity and Sales (2 of 3)

• Marginal revenue is the change in total revenue that

results from a one-unit change in quantity
demanded

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
24
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Interpreting Price Elasticity: … Price Elasticity and Sales (3 of 3)

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
25
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
The Importance of Elasticity-Revenue Relationships (1 of 1)

• Elasticity is often key to marketing plans

• A manager will try to increase sales revenue by
allocating budget among price promotions, advertising,
retail displays, trade allowances, etc
• Firms should seek to raise prices for products discovered
occupying the inelastic range of their demand
• To lower prices in such a range would be “double-dumb”
increasing costs and decreasing revenue

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
26
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Figure 3.7 – Raising Price with Demand in the
Inelastic Range for the VW Beetle

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
27
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Factors Affecting the Price Elasticity of Demand (1 of 1)
• Price inelasticities vary greatly among products
• Some factors that account for the differing
responsiveness of consumers to price changes are:
• The availability and Closeness of Substitutes
• Percentage of the Consumer’s Budget
• Positioning as Income Superior
• Time Period of Adjustment

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
28
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.4 –
Empirical Price Elasticities (1 of 2)

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
29
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.4 –
Empirical Price Elasticities (2 of 2)

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
30
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
The Income Elasticity of Demand (1 of 2)
• Income Elasticity is the ratio of the percentage
change in quantity demanded to the percentage
change in income, assuming all other factors
influencing demand remain unchanged

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
31
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
The Income Elasticity of Demand (2 of 2)
• Interpreting the Income Elasticity
• For most goods, income elasticity is expected to be positive,
Ey>0 (income-superior goods)
• Those that are negative are called inferior goods
• Advertising Elasticity
• Measures the responsiveness of sales to changes in
advertising expenditures as measured by the ratio of the
percentage change in sales to the percentage change in
advertising expenditures
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
32
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Cross Elasticity of Demand (1 of 3)
• Cross Price Elasticity Defined
• The ratio of the percentage change in the quantity
demanded of Good A to the percentage change in the
price of Good B, assuming that all other factors
influencing demand remain unchanged

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
33
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Cross Elasticity of Demand (2 of 3)
• Interpreting Cross Price Elasticity
• If the cross price elasticity between products A and B is
positive, the products are referred to as substitutes for
each other
• A negative cross price elasticity indicates that the
products are complementary

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
34
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.5 – Empirical Income Elasticities

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
35
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Cross Elasticity of Demand (3 of 3)
• Antitrust and Cross Price Elasticities
• The number of close substitutes may be an important
determinant of the degree of competition in a market
• The fewer the number of close substitutes that exist for a
product, the greater the amount of market power possessed by
the selling firm
• An important issue in antitrust cases involves the appropriate
definition of the relevant product market to be used in
computing statistics of market control (Example: cellophane
only, or all flexible packaging materials?)
© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
36
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
Empirical Illustration of Price, Income, & Cross Elasticities (1 of 1)

• A study examined the elasticity of energy use by

residential, commercial & industrial users
• The authors hypothesized that the demand for
electricity was determined by the price of electricity,
income levels, and the price of a substitute good-
natural gas
• Table 3.6 summarizes these elasticities

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
37
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Table 3.6 – Electricity-Use Elasticities

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
38
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Chapter 3 – Demand Relationships
The Combined Effect of Demand Elasticities (1 of 1)
• When two or more factors that affect demand
change simultaneously, one may be interested in
determining their combined impact on quantity
demanded
• The combined use of income and price elasticities
can be generalized to include any of the elasticity
concepts developed earlier in this chapter

© 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
39
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.