1. Managerial Economics & Business Strategy
Chapter 3
Quantitative Demand Analysis

2. Could we do it??
You are the owner of a bookstore, and earn revenues primarily from selling coffee and books. For the past two years you have consistently earned, on average, revenues of $500 per week from selling coffee and $1000 per week from selling books. If the own price elasticity of demand for coffee is -1.0 and the cross price elasticity of demand between books and coffee is -1.8, what would happen to your revenues if you lowered the price of coffee (if coffee is good X) by 10%?

3. Income Elasticity If EQX,M > 0, then X is a normal good.
If EQX,M < 0, then X is a inferior good.

4. Example 1: Pricing and Cash Flows
According to an FTC Report by Michael Ward, AT&T’s own price elasticity of demand for long distance services is
AT&T needs to boost revenues in order to meet it’s marketing goals.
To accomplish this goal, should AT&T raise or lower it’s price?

5. Answer: Lower price!
Since demand is elastic, a reduction in price will increase quantity demanded by a greater percentage than the price decline, resulting in more revenues for AT&T.

6. Example 2: Quantifying the Change
If AT&T lowered price by 3 percent, what would happen to the volume of long distance telephone calls routed through AT&T?
Remember AT&T’s own price elasticity of demand for long distance services is -8.64

7. Answer
Calls would increase by percent!

8. Example 3: Impact of a change in a competitor’s price
According to an FTC Report by Michael Ward, AT&T’s cross price elasticity of demand for long distance services is 9.06.
If competitors reduced their prices by 4 percent, what would happen to the demand for AT&T services?

9. Answer
AT&T’s demand would fall by percent!

10. We can use elasticities to find the supply and demand functions
Midcontinent Plastics makes 80 fiberglass truck hoods per day for large truck manufacturers. Each hood sells for $ Midcontinent sells all of its product to the large truck manufacturers. If the own price elasticity of demand for hoods is ‑0.4 and the price elasticity of supply is 1.5.
Compute the supply and demand for truck hoods.

11. Interpreting Demand Functions
Mathematical representations of demand curves.
Example:
X and Y are substitutes (coefficient of PY is positive).
X is an inferior good (coefficient of M is negative).

12. Linear Demand Functions
General Linear Demand Function:
Own Price
Elasticity
Cross Price
Elasticity
Income
Elasticity

13. Example of Linear Demand
Qd = P.
Own-Price Elasticity
(-2){P/Q}.
If P=1 what does Q equal?
Q=8 (since = 8).
Own price elasticity at P=1, Q=8
(-2){1/8}=

14. Log-Linear Demand
Take Natural Log of both sides to get general Log-Linear Demand Function:

15. Example of Log-Linear Demand
ln(Qd) = ln(P).
Own Price Elasticity: -2.