MANAGERIAL
th
ECONOMICS 11 Edition
By
Mark Hirschey
Demand Analysis
Chapter 5
Chapter 5
OVERVIEW
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Measuring Market Demand
Demand Sensitivity Analysis: Elasticity
Price Elasticity of Demand
Price Elasticity and Marginal Revenue
Price Elasticity and Optimal Pricing Policy
Cross-price Elasticity of Demand
Income Elasticity
Chapter 5
KEY CONCEPTS
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market demand curve
elasticity
endogenous variables
exogenous variables
point elasticity
arc elasticity
price elasticity of demand
elastic demand
unitary elasticity
inelastic demand
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optimal price formula
substitutes
complements
cross-price elasticity
income elasticity
normal goods
inferior goods.
counter-cyclical
noncyclical normal goods
cyclical normal goods
Measuring Market Demand
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Graphing the Market Demand Curve
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Market demand is total demand.
Evaluating Market Demand
Demand differs among market
segments.
 Add segment demand to get market
demand.
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Demand Sensitivity Analysis:
Elasticity
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Elasticity Concept
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Elasticity measures sensitivity.
Point and Arc Elasticity
Point elasticity reflects sensitivity of Y to
small changes in X, εX = ∂Y/Y ÷ ∂X/X.
 Arc elasticity reflects sensitivity of Y to
big changes in X, EX = (Y2–Y1)/(Y2+Y1)
÷ (X2-X1)/(X2+X1).
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Advertising Elasticity Example
Price Elasticity of Demand
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Price Elasticity Formula
Point price elasticity, εP = ∂Q/Q ÷ ∂P/P.
 In all cases, εP < 0 .
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Price Elasticity and Total Revenue
Price cut increases revenue if │εP│> 1.
 Revenue constant if │εP│= 1.
 Price cut decreases revenue if │εP│< 1.
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Uses of Price Elasticity Information
Price Elasticity and Marginal
Revenue
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How Elasticity Varies along a Demand
Curve
As price rises, so does │εP│.
 As price falls, so does│εP│.
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Price Elasticity and Price Changes
MR > 0 if │εP│> 1.
 MR = 0 if │εP│= 1.
 MR < 0 if │εP│< 1.
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Price Elasticity and Optimal
Pricing Policy
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Optimal Price Formula
MR and εP are directly related.
 MR = P/[1+(1/ εP)].
 Optimal P* = MC/[1+(1/ εP)].
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Optimal Pricing Policy Example
 Determinants of Price Elasticity
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Essential goods have low│εP│.
 Nonessential goods have high│εP│.
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Cross-price Elasticity of Demand
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Substitutes and Complements
Cross-price elasticity shows demand
sensitivity to changes in other prices.
 εPX = ∂QY/QY ÷ ∂PX/PX.
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 Substitutes
have εPX > 0.
 Complements have εPX > 0.
 Independent goods have εPX > 0.
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Cross-price Elasticity Example
Income Elasticity
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Normal Versus Inferior Goods
Income elasticity shows demand
sensitivity to changes in income.
 εI = ∂Q/Q ÷ ∂I/I.
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 Normal
goods have εI > 0.
 Inferior goods have εI < 0.
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Types of Normal Goods
Noncyclical goods have 0 < εI < 1.
 Cyclical goods have εI > 1.
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