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Managerial Economics and Organizational Architecture, Chapter 4 Demand The willingness and ability to buy McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Demand learning objectives Students should be able to Describe and apply demand function and demand curve Distinguish between change in quantity demanded and change in demand Calculate and interpret demand elasticity McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Demand Function A mathematical representation of the relationship between the quantity demanded and all factors influencing demand: Q = f(X 1, X 2,… X n ) where Q is quantity demanded and the X i s are the factors influencing demand McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Demand for PTC Tickets Q = 117 - 6.6P + 1.66P s - 3.3P r + 0.00661I where P is PTC ticket price, P s is price of symphony tickets, P r is price of nearby restaurant meals, and I is average per capita income. (Interpret each term of the above equation.) McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Variable values Suppose the variables have the following values: P = $30 P s = $50 P r = $40 I = $50,000 How many tickets will PTC sell? McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 The demand curve Substitute variable values (except for P) into the equation and simplify: P = 60 - 0.15Q This is the equation for the demand curve. McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Graphing the demand curve McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Demand elasticity The price elasticity of demand is given by [Note: the convention used here is to express the elasticity as a negative quantity so that, when calculated, the result is a positive number] McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Calculating elasticity arc price elasticity Information requirements: Quantity demanded before and after the price change Q 1 Q 2 Price before and after the price change P 1 P 2 McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Calculating elasticity arc price elasticity McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Arc price elasticity example McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Calculating elasticity point price elasticity Information requirements Demand curve equation: Q=a+bP, b= Q/ P, b<0 Current price and quantity P Q McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Calculating elasticity point price elasticity McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Point price elasticity example If the demand equation is Q=400-6.67P, P=35*, and Q=167, then elasticity is *This price is midway between the two prices in the arc elasticity calculation. McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Range of price elasticities McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Determinants of price elasticity Availability of substitutes –few substitutes for milk –many substitutes for milk at the supermarket Size of good in consumer budget –consider salt versus a Lexus Time period for consumer adjustment –given enough time, how do we adjust to higher fuel prices? McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Price changes and total revenue PTCs total revenue is TR=P Q The inverse demand curve is P=60-.15Q Substituting, TR=(60-.15Q) Q=60Q-.15Q 2 From this we can derive marginal revenue (MR= TR/ Q=60-.30Q) (Well, OK, we did use a little calculus for that last step. Trust us.) McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Elasticity, prices, and total revenue McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Demand, total revenue, & marginal revenue linear demand curve McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Other demand influences Complements versus substitutes –Cross price elasticity of demand McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Other demand influences Income –Normal goods –Inferior goods Income elasticity McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Product life cycle McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Omitted variables problem 199819992000 Income (I)$3,000$4,000$3,500 Advertising (A)232.5 Price (P)10 Sales (S)236284260 True demandS=120-2P+8A+0.04I Estimated demand S=140+48A McGraw-Hill/Irwin

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Managerial Economics and Organizational Architecture, Chapter 4 Estimating demand the identification problem McGraw-Hill/Irwin

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