1. Instructor Sandeep Basnyat Sandeep_basnyat@yahoo.com 9841 892281
Managerial Economics Ace Institute of Management Executive MBA Program Remainings from Objectives of the Firm
Instructor
Sandeep Basnyat

2. Profit Maximization
If increase Q by one unit, revenue rises by MR, cost rises by MC.
If MR > MC, then increase Q to raise profit.
If MR < MC, then reduce Q to raise profit.
What Q maximizes the firm’s profit?

3. Firms maximize profit by producing the Quantity until
Profit Maximization Q TR TC
Profit MR MC
Profit = MR – MC
At any Q with MR > MC, increasing Q raises profit. $0 45 33 23 15 9 $5 5 7 1
–$5
$10 12 10 8 6 $4 –2 2 4 $6 1 10 10 2 20
At any Q with MR < MC, reducing Q raises profit. 10 3 30 10 4 40
(The table on this slide is similar to Table 2 in the textbook.)
For most students, seeing the complete table all at once is too much information. So, the table is animated as follows:
Initially, the only columns displayed are the ones students saw at the end of the exercise in Active Learning 1: Q, TR, and MR.
Then, TC appears, followed by MC. It might be useful to remind students of the relationship between MC and TC.
Then, the Profit column appears. Students should be able to see that, at each value of Q, profit equals TR minus TC.
The last column to appear is the change in profit.
When the table is complete, we use it to show
it is profitable to increase production whenever MR > MC, such as at Q = 0 , 1, or 2.
it is profitable to reduce production whenever MC > MR, such as at Q = 5. 10 5 50
Firms maximize profit by producing the Quantity until
MR = MC

4. Exercise Calculate the profit maximizing output (Q); and
Assume a cost function: TC = Q Q2 and a constant marginal revenue $10 per unit for a firm.
Calculate the profit maximizing output (Q); and
Total profit if the selling price per unit (P) = MR.
Solution:
a) MC = dTC /dQ = Q
Profit maximizing output is at where
MR = MC
10 = Q
Therefore, Profit Maximizing Quantity (Q) = 400 units.
b) Profit = TR –TC = [(PxQ) – TC]
= [(10x400) – ( (400) (4002)] = $600

5. Exercise
Assume the following functions for a firm Demand : Q = 90 – 2P Total Revenue: TC = Q3 - 8Q2 + 57Q + 2 Find the followings for this firm.
Profit maximizing Quantity
Price per unit
Total Profit
Q = 4
P = 43
π = 6

6. Sales Revenue or Revenue MaximizationQ P TR AR MR
Sales Revenue Maximization Condition
MR = 0
$4.50 9 10 7 4
$ 0
n.a. 1
4.00
1.50
2.00
2.50
3.00
3.50
$4.00 –1 1 2 3 $4 2
3.50 3
3.00 4
2.50
When the AR column appears, note that AR = P at every quantity. This, of course, is a tautology.
When the MR column appears, note that MR is less than P. This is not as easy to see, because the MR numbers are offset from the rows of the table, just as if you were in an elevator stuck between two floors. But students can still see that MR < P.
For example, in the range of output of Q=2 to Q=3, the price ranges from $3.50 to $3.00, but MR is only $2. 5
2.00 6
1.50

7. Exercise
Assume the following functions for a firm Demand : P = 7,500 – 3.75Q Total Cost: TC = 1,012, ,500Q Q2 Find the followings for this firm.
Revenue maximizing Quantity
Price per unit
Total Revenue
Total Profit / Loss
Q = 1000 units.
P = 3,750
TR = 3,750,000
π = - 12,500

8. Exercise Profit Revenue 90 100 i) Maximizing Quantity 2200 2000
Assume the following functions for a firm
Demand : P = 4,000 – 20Q
Total Cost: TC = Q
Find the followings for this firm under
Profit maximization objective
Revenue Maximization objective.
Profit Revenue
1,60,000 1,58,000
i) Maximizing Quantity
ii) Price per unit
iii) Total Profit / Loss

9. Numerical Exercise Assume the following functions for a firm:
Demand : P = 20 – Q
Total Cost: TC = Q2 + 8Q + 2
a) Find Price (P), Quantity (Q) and Total Profit (or Loss) for each of the following conditions:
Profit maximization
Revenue Maximization
b) Find Price (P), Quantity (Q), Total Revenue (TR) and Total cost (TC) for sales maximization with profit constraint or profit constraint of 8 or higher.
P = 17, Q = 3, π = 16
P = 10, Q = 10, π = 82 (loss)
When Q = 1; P = 19, TR = 19, TC = 11
When Q = 5; P = 15, TR = 75, TC = 67
Firm should produce Q = 5.

10. Average Total Cost or Average Cost Minimization
Related to two important costs: MC and ATC
Recall:
ATC = AFC + AVC or TC / Q
MC =
∆TC ∆Q

11. Marginal Cost ∆TC MC = ∆Q
Marginal Cost (MC) is the change in total cost from producing one more unit:
$100
$70 1
170
∆TC ∆Q
MC = 50 2
220 40 3
260 50 4
310 70 5
380
100 6
480
140 7
620

12. Average Total Cost Curves$0
$25
$50
$75
$100
$125
$150
$175
$200 1 2 3 4 5 6 7 Q
Costs Q TC
ATC
$100
n.a. 1
170
$170 2
220
110 3
260
86.67 4
310
77.50 5
380 76 6
480 80 7
620
88.57

13. Important Economic Relation: ATC and MC
When MC < ATC,
ATC is falling.
When MC > ATC,
ATC is rising.
The MC curve crosses the ATC curve at the ATC curve’s minimum. $0
$25
$50
$75
$100
$125
$150
$175
$200 1 2 3 4 5 6 7 Q
Costs
ATC MC
The textbook gives a nice analogy to help students understand this. A student’s GPA is like ATC. The grade she earns in her next course is like MC. If her next grade (MC) is less than her GPA (ATC), then her GPA will fall. If her next grade (MC) is greater than her GPA (ATC), then her GPA will rise.
I suggest letting students read the GPA example in the book, and giving them the following example in class:
You run a pizza joint. You’re producing 100 pizzas per night, and your cost per pizza (ATC) is $3. The cost of producing one more pizza (MC) is $2. If you produce this pizza, what happens to ATC? Most students will understand immediately that ATC falls (albeit by a small amount). Instead, suppose the cost of producing one more pizza (MC) is $4. Then, producing this additional pizza causes ATC to rise.
ATC is minimum where,
ATC = MC
AVC is minimum where,
AVC = MC

14. Exercise Given the cost function: TC = 1000 + 10Q - 0.9Q2 + 0.04Q3
Find Q when AVC is minimum.
Solution
When AVC is minimum:
AVC = MC
Q Q2 = Q+ 0.12Q2
Or, Q Q = 0
Or, Q(- 0.08Q+ 0.9) = 0
Or, Q =0 and Q+ 0.9 = 0 i.e, Q = (Minimum AVC)

15. Exercise
Assume the following functions for a firm Demand : P = 7,500 – 3.75Q Total Cost: TC = 1,012, ,500Q Q2 Find the followings for this firm if your objective is to minimize average cost.
a) Q
b) Price per unit
c) Total Revenue
d) Total Profit
Q = 900
P = 4,125
TR = 3,712,500
π = 337,500

16. Instructor Sandeep Basnyat Sandeep_basnyat@yahoo.com 9841 892281
Managerial Economics Ace Institute of Management Executive MBA Program Session 2: Supply, Demand and Elasticity
Instructor
Sandeep Basnyat

17. Demand Demand comes from the behavior of buyers.
Demand comes from the behavior of buyers.
The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.
Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal.

18. The Market Demand Curve for OrangeP
Qd (Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6 P Q

19. Demand Curve Shifters: Non-price Determinants of Demand
Price
Number of buyers
Income level
Effect on normal goods
Effect on inferior good
Prices of other goods
Substitute goods
Complement goods
Taste or Preference
Expectation
Qty
Price
Qty

20. Q = 10,000 – 200 P + 0.03POp + 0.6I + 0.2 A Numerical exercise
The ABC Marketing consulting firm found that a particular brand of portable stereo has the following demand curve for a certain region:
Q = 10,000 – 200 P POp + 0.6I A
Where,
Q = quantity per month
P = Price in $
Pop = Population
I = Disposable income
A = Advertising expenditure in $
Determine the demand curve for the company in a market in which P = 300, Pop = 1,000,000, I = 30,000, and A = 15000
b) Calculate the quantity demanded at prices of $200
c) Calculate the price necessary to sell 45,000 units.
(Ans.: Q = 61,000 – 200P)
(Ans.: 21000)
(Ans.: $80)

21. Supply Supply comes from the behavior of sellers.
Supply comes from the behavior of sellers.
The quantity supplied of any good is the amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal

22. Market Supply Schedule & Curve
Market Supply Schedule & Curve
Price of lattes
Quantity of lattes supplied
$0.00
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18 P Q

23. Shift supply curve left or right
Supply Curve Shifters
Shift supply curve left or right
Number of sellers
Input prices
Technology
Expectation
Again, the animation here is carefully designed to help make clear that a shift in the supply curve means that there is a change in the quantity supplied at each possible price. If it seems tedious, you can turn it off. In any case, be assured that, by the end of this chapter, the animation of curve shifts will be streamlined and simplified.

24. Supply and Demand Together
Supply and Demand Together P Q
Equilibrium Price and Quantity S D
We now return to the latte example to illustrate the concepts of equilibrium, shortage and surplus.

25. Numerical Problem on Demand and Supply
1) Suppose:
Demand eqn. for a product: Qd = 286 − 20p
Supply eqn. For a product: Qs = p
Find Equilibrium Quantity and Price:
Solution:
Qd = Qs
286 − 20p = p
60p = 198
P = $3.30
Q = 286 – 20(3.3) = 220

26. Comparative Static Analysis
Sensitivity analysis or “what-if” analysis.
The role of factors influencing demand is analyzed while holding supply conditions constant.
Or, the role of factors influencing supply is analyzed by studying changes in supply while holding demand conditions constant
Short and Long run analyses
Short: Price adjustment to stabilize equilibrium
Long: Reallocation of resources

27. when quantity supplied is greater than quantity demanded
Surplus:
when quantity supplied is greater than quantity demanded P Q
Example: If P = $5, S D
Surplus
then QD = 9
and QS = 25
resulting in a surplus of 16 units

28. Short-run market change: Rationing Mechanism of Price: Surplus caseP Q
Facing a surplus, sellers try to increase sales by cutting the price. S D
Surplus
This causes QD to rise
and QS to fall…
…which reduces the surplus.

29. Short-run market change: Rationing Mechanism of Price: Surplus caseP Q
Facing a surplus, sellers try to increase sales by cutting the price. S D
Surplus
Falling prices cause QD to rise and QS to fall.
Prices continue to fall until market reaches equilibrium.

30. What happens if the market price is lower than equilibrium price?
Shortage
What happens if the market price is lower than equilibrium price? P Q
Example: If P = $1, S D
then QD = 21 lattes
and QS = 5 lattes
resulting in a shortage of 16 lattes
Shortage

31. Short-run market change: Rationing Mechanism of Price: Shortage caseP Q
Facing a shortage, sellers raise the price, S D
causing QD to fall
and QS to rise,
…which reduces the shortage.
Shortage

32. Short-run market change: Rationing Mechanism of Price: Shortage case
Facing a shortage, sellers raise the price, P Q
causing QD to fall S D
and QS to rise.
Prices continue to rise until market reaches equilibrium.
Rationing Mechanism: Price adjustment to balance demand and supply in market
Shortage

33. Long run analysis: Guiding or Allocating Mechanism: Market for Hybrid Cars
EVENTS: 1. Price of gas rises
2.New technology reduces production costs P Q S1 S2 D2 D1 P2 P3 Q3
Short-run Analysis P1 Q1
Long-run Analysis Q2

34. Increase in D> Increase in S. What about others?P Q P Q S1 S2 S1 S2 D2 D2 D1 D1 P2 P3 Q3 P1 Q1 P1 Q1 P2 Q2 Q2

35. Elasticity and its application

36. Price Elasticity of Demand
Price elasticity of demand =
Percentage change in Qd
Percentage change in P
Price elasticity of demand measures how much Qd responds to a change in P.

37. Price Elasticity of Demand
Price elasticity of demand =
Percentage change in Qd
Percentage change in P P Q
Example: D
P rises by 10%
Price elasticity of demand equals P2 Q2 P1 Q1
15%
10%
= 1.5
Q falls by 15%
What does elasticity = 1.5 mean?

38. Calculating Percentage Changes
Standard method of computing the percentage (%) change:
Calculate Price Elasticity of Demand
end value – start value
start value
x 100% P Q
2500 10 B D
2000 15 A

39. Calculating Percentage Changes
Demand for your guiding
Problem:
From A to B, P rises 25%, Q falls 33.33%, elasticity = 33.33/25 = -1.33
From B to A, P falls 20%, Q rises 50%, elasticity = 50/20 = P Q
2500 10 B D
2000 15 A
How to solve this confusion?

40. Calculating Percentage Changes
So, we instead use the midpoint method:
end value – start value
midpoint
x 100%
The midpoint is the number halfway between the start & end values, also the average of those values.
It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!
What is PED using midpoint method?

41. Calculating Percentage Changes
Using the midpoint method, the % change in P equals
2500 – 2000
2250
x 100%
= 22.2%
The % change in Q equals
10 – 15
12.5
x 100%
= %
These calculations are based on the example shown a few slides back: points A and B on the website demand curve.
The price elasticity of demand equals
40/22.2 =

42. A C T I V E L E A R N I N G 1: Calculate an elasticity
Use the following information to calculate the price elasticity of demand for hotel rooms using midpoint method:
if P = $70, Qd = 5000
if P = $90, Qd = 3000 42

43. A C T I V E L E A R N I N G 1: Answers
Use midpoint method to calculate % change in Qd
(5000 – 3000)/4000 = 50%
% change in P
($70 – $90)/$80 = - 25%
The price elasticity of demand equals
50%
25% = 43

44. Calculating Price Elasticity of Demand

45. Numerical example
Consider a competitive market for which the quantities demanded and supplied (per year) at various prices are given as follows:
Price($) Demand (millions)
60 22
80 20
Calculate the price elasticity of demand when the price is $80.

46. Solution to Numerical example
From the above question, with each price increase of $20, the quantity demanded decreases by 2. Therefore,
At P = 80, quantity demanded equals 20 and

47. Calculating Price Elasticity of Demand
The estimated linear demand function for pork is:
Q = p
where Q is the quantity of pork demanded in million kg per year and p is the price of pork in $ per year.
At the equilibrium point of p = $3.30 and Q = 220 Find the elasticity of demand for pork:

48. Calculating Price Elasticity of Demand
The estimated linear demand function for pork is:
Q = p
where Q is the quantity of pork demanded in million kg per year and p is the price of pork in $ per year.
At the equilibrium point of p = $3.30 and Q = 220 the elasticity of demand for pork:

49. Numerical Example Demand for a publisher’s book is given as:
Qx = 12,000 – 5,000Px + 5I + 500Pc
Px = Price of the book = $5
I = Income per capita = $10,000
Pc = Price of the books from competing publishers = $6
Find Price elasticity of demand for the book.

50. Solution to Numerical Example
Substituting the values of I and Pc
Qx = 12,000 – 5,000Px + 5(10000) + 500(6)
Or, Qx = 65,000 – 5,000Px
When Px = $5 (given), Qx = 40,000
Now, dQx/dPx =
Therefore, E p = x (5 / 40000) =

51. The Determinants of Price Elasticity
The price elasticity of demand depends on:
the extent to which close substitutes are available
whether the good is a necessity or a luxury
how broadly or narrowly the good is defined
the time horizon: elasticity is higher in the long run than the short run.
This slide is a convenience for your students, and replicates a similar table from the text.
If you’re pressed for time, it is probably safe to omit this slide from your presentation.

52. The Variety of Demand Curves
Economists classify demand curves according to their elasticity.
The price elasticity of demand is closely related to the slope of the demand curve.
Rule of thumb: The flatter the curve, the bigger the elasticity. The steeper the curve, the smaller the elasticity.
The next 5 slides present the different classifications, from least to most elastic.

53. “Perfectly inelastic demand” (one extreme case)
Price elasticity of demand =
% change in Q
% change in P 0%
= 0
10%
D curve: P Q D
vertical Q1 P1
Consumers’ price sensitivity: P2
If Q doesn’t change, then the percentage change in Q equals zero, and thus elasticity equals zero.
It is hard to think of a good for which the price elasticity of demand is literally zero. Take insulin, for example. A sufficiently large price increase would probably reduce demand for insulin a little, particularly among people with very low incomes and no health insurance.
However, if elasticity is very close to zero, then the demand curve is almost vertical. In such cases, the convenience of modeling demand as perfectly inelastic probably outweighs the cost of being slightly inaccurate.
P falls by 10%
Elasticity:
Q changes by 0%

54. Price elasticity of demand
“Inelastic demand”
Price elasticity of demand =
% change in Q
% change in P
< 10%
< 1
10% D
D curve: P Q
relatively steep Q1 P1
Consumers’ price sensitivity: P2 Q2
relatively low
An example: student demand for textbooks that their professors have required for their courses.
Here, it’s a little more clear that elasticity would be small, but not zero. At a high enough price, some students will not buy their books, but instead will share with a friend, or try to find them in the library, or just take copious notes in class.
Another example: gasoline in the short run.
P falls by 10%
Elasticity:
< 1
Q rises less than 10%

55. Price elasticity of demand
“Unit elastic demand”
Price elasticity of demand =
% change in Q
% change in P
10%
= 1
10% D
D curve: P Q
intermediate slope Q1 P1
Consumers’ price sensitivity: P2 Q2
intermediate
This is the intermediate case: the demand curve is neither relatively steep nor relatively flat. Buyers are neither relatively price-sensitive nor relatively insensitive to price.
This is also the case where price changes have no effect on revenue.
P falls by 10%
Elasticity: 1
Q rises by 10%

56. Price elasticity of demand
“Elastic demand”
Price elasticity of demand =
% change in Q
% change in P
> 10%
> 1
10% D
D curve: P Q
relatively flat Q1 P1
Consumers’ price sensitivity: P2 Q2
relatively high
A good example here would be Rice Krispies, or nearly anything with readily available substitutes.
An elastic demand curve is flatter than a unit elastic demand curve (which itself is flatter than an inelastic demand curve).
P falls by 10%
Elasticity:
> 1
Q rises more than 10%

57. “Perfectly elastic demand” (the other extreme)
Price elasticity of demand =
% change in Q
% change in P
any %
= infinity 0%
D curve: P Q
horizontal
P2 = P1 D
Consumers’ price sensitivity: Q1 Q2
extreme
“Extreme price sensitivity” means the tiniest price increase causes demand to fall to zero.
“Q changes by any %” – when the D curve is horizontal, the quantity is indeterminant. Consumers might demand Q1 units one month, Q2 units another month, and some other quantity later. Q can change by any amount, but P always “changes by 0%” (i.e. doesn’t change).
If perfectly inelastic is one extreme, this (perfectly elastic) is the other.
Here’s a good real-world example of a perfectly elastic demand curve, which foreshadows an upcoming chapter on firms in competitive markets. Suppose you run a small family farm in Iowa. Your main crop is wheat. The demand curve in this market is downward-sloping, and the market demand and supply curves determine the price of wheat. Suppose that price is $5/bushel.
Now consider the demand curve facing you, the individual wheat farmer. If you charge a price of $5, you can sell as much or as little as you want. If you charge a price even just a little higher than $5, demand for YOUR wheat will fall to zero: Buyers would not be willing to pay you more than $5 when they could get the same wheat elsewhere for $5. Similarly, if you drop your price below $5, then demand for YOUR wheat will become enormous (not literally infinite, but “almost infinite”): if other wheat farmers are charging $5 and you charge less, then EVERY buyer will want to buy wheat from you.
Why is the demand curve facing an individual producer perfectly elastic? Recall that elasticity is greater when lots of close substitutes are available. In this case, you are selling a product that has many perfect substitutes: the wheat sold by every other farmer is a perfect substitute for the wheat you sell.
P changes by 0%
Elasticity:
infinity
Q changes by any %

58. Thank You