CHAPTER 3 Quantitative Demand Analysis Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter Outline The elasticity concept Own price elasticity of demand – Elasticity and total revenue – Factors affecting the own price elasticity of demand – Marginal revenue and the own price elasticity of demand Cross-price elasticity – Revenue changes with multiple products Income elasticity Other Elasticities – Linear demand functions – Nonlinear demand functions Obtaining elasticities from demand functions – Elasticities for linear demand functions – Elasticities for nonlinear demand functions Regression Analysis – Statistical significance of estimated coefficients – Overall fit of regression line – Regression for nonlinear functions and multiple regression 3-2 Chapter Overview

Introduction Chapter 2 focused on interpreting demand functions in qualitative terms: – An increase in the price of a good leads quantity demanded for that good to decline. – A decrease in income leads demand for a normal good to decline. This chapter examines the magnitude of changes using the elasticity concept, and introduces basic analysis to measure different elasticities. 3-3 Chapter Overview

Own Price Elasticity 3-4 Own Price Elasticity of Demand

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Total Revenue Test When demand is elastic: – A price increase (decrease) leads to a decrease (increase) in total revenue. When demand is inelastic: – A price increase (decrease) leads to an increase (decrease) in total revenue. When demand is unitary elastic: – Total revenue is maximized. 3-6 Own Price Elasticity of Demand

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Extreme Elasticities 3-8 Quantity Demand Price Perfectly Inelastic Demand Perfectly elastic Own Price Elasticity of Demand

Factors Affecting the Own Price Elasticity Three factors can impact the own price elasticity of demand: – Availability of consumption substitutes. – Time/Duration of purchase horizon. – Expenditure share of consumers’ budgets. 3-9 Own Price Elasticity of Demand

Elasticity and Marginal Revenue 3-10 Own Price Elasticity of Demand

Demand and Marginal Revenue 3-11 Quantity 0 MR 3 Price 6 Elastic Demand Own Price Elasticity of Demand 1 6 Inelastic Unitary Marginal Revenue (MR)

Cross-Price Elasticity 3-12 Cross-Price Elasticity

Cross-Price Elasticity in Action 3-13 Cross-Price Elasticity

3-14 Cross-Price Elasticity

Cross-Price Elasticity in Action 3-15 Cross-Price Elasticity

Income Elasticity 3-16 Income Elasticity

Income Elasticity in Action 3-17 Income Elasticity

Other Elasticities Own advertising elasticity of demand for good X is the ratio of the percentage change in the consumption of X to the percentage change in advertising spent on X. Cross-advertising elasticity between goods X and Y would measure the percentage change in the consumption of X that results from a 1 percent change in advertising toward Y Other Elasticities

Elasticities for Linear Demand Functions 3-19 Obtaining Elasticities From Demand Functions

Elasticities for Linear Demand Functions In Action 3-20 Obtaining Elasticities From Demand Functions

Elasticities for Nonlinear Demand Functions 3-21 Obtaining Elasticities From Demand Functions

Elasticities for Nonlinear Demand Functions In Action 3-22 Obtaining Elasticities From Demand Functions

Regression for Nonlinear Functions and Multiple Regression 3-23 Regression Analysis

Conclusion Elasticities are tools you can use to quantify the impact of changes in prices, income, and advertising on sales and revenues. Given market or survey data, regression analysis can be used to estimate: – Demand functions. – Elasticities. – A host of other things, including cost functions. Managers can quantify the impact of changes in prices, income, advertising, etc. 3-24