1. Managerial Economics Truett + Truett Eighth Edition
Chapter 2: Revenue of the Firm
John Wiley & Sons, Inc.
Slides by Jim Witsmeer
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2. Session 2 Outline Consumer/Firm Interactions Demand Function
Total and Average Revenue
Marginal Revenue
Elasticity of Demand
Price Elasticity of Demand
Other Elasticities of Demand
Summary
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3. Consumer Sovereignty and the Free Market
What power does the consumer exert?
What limits the suppliers ability to respond?
When does the supplier have the power?
Does Perfect Competition exist?
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4. Economic Discussion Economic Value Added Greater Than Normal Profit
Market Manipulation
Culture and the customer
Advertising
Market research
Creativity and consumer demand
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5. Demand Function
Qx = f(Px,Py,I…) where Qx is quantity demanded, is the Px price of X and Py, I, etc. are determinants of demand.
A demand function with more than two independent variables cannot be graphed. We don’t have the ability to do that because we can only see three dimensions.
However if Py, I, and the other independent variables remain constant while only Px varies we get a concept we can easily graph, the demand curve.
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6. Demand Curve
Qx = f(Px, ) where Qx is quantity demanded and Px, is the price of X.. The plot of how quantity demanded is related to prices is the demand curve.
This is by holding constant all the other relevant variables (determinants of demand).
Change in Demand
Change in Quantity Demanded
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7. Demand Function Properties
Demand functions are estimates.
Their accuracy depends on correctness of the function and available data.
Demand Functions are multivariable.
The firm may not have knowledge of all relevant variables.
Demand Functions are nonlinear.
In the region of interest they often can be approximated as linear.
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8. Revenue Total Revenue (TR) Average Revenue (AR) Marginal Revenue (MR)
P = price and Q = quantity
The rate of change of total revenue with respect to quantity
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9. Revenue under Linear Demand
Linear Demand Function MR
P or AR
Total Revenue
Marginal Revenue
ARC Marginal Revenue
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10. Determinants of Demand
SOME EXAMPLES
Consumer income
Prices of related goods or services
Consumer tastes
Number of consumers in market
Credit terms on loans
New housing starts
Fuel prices
Advertising
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11. Determinants of Demand
Product or Service
Cause
Effect
Normal Good
Incomes Increase
Demand Increases
Inferior Good
Income Increases
Demand Decreases
Substitute Good
Price of Related Product Increases
Demand for Substitute Increases
Complimentary Good
Demand for Second
Product Decreases
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12. Elasticity of Demand Relative Measure of Demand Response
Percent change in quantity of X demanded
Percent change in Z the
Determinant of Demand
Elasticity is the percent ratio of rate of change of QX with respect to Z
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13. ARC Elasticity of Demand
Percent change over an interval is the total change divided by the average value.
using algebra we find:
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14. Price Elasticity & RevenueEP MR
Classification
Impact of Price Change on Total Revenue
|EP| > 1
MR > 0
Elastic
Price , TR
|EP| < 1
MR < 0
Inelastic
|EP| = 1
MR = 0
Unitary Elastic
TR does not change
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15. Price Elasticity & Revenue
TR = Q•P and
Therefore:
But we know that:
So that:
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16. New Tricks of the Trade Yield Management Price Matching
Everyday Low Pricing
Value Pricing
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17. Other Elasticities of Demand
Income Elasticity of Demand
Cross Price Elasticity of Demand
Advertising Elasticity of Demand
Fuel Price Elasticity of Demand :
And many others
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18. How does this relate to profit?
Demand is only part of the picture.
Profit = Revenue – Cost
To understand profit we must learn something about cost.
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19. Summary Concepts
There are two concepts in this chapter that must be understood before proceeding:
One, is the invariable interrelationship between the demand, total revenue, and marginal revenue curves and elasticity of demand. ( Figure 2-8 in the textbook)
The other, is the difference between the actual or point value at a specific quantity and an approximate value called the average rate of change valid between two quantities.
NOTE: The first relationship assumes a linear demand curve and that all buyers are charged identical prices.
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20. End of Chapter 2
Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the United States copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for resale. The publisher assumes no responsibilities for errors, omissions, or damages, caused by the use of the information contained herein.
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