Loading...

PPT – Demand The willingness and ability to buy How does marginal analysis inform simple pricing decisions? How can the concept of elasticity inform managerial decisions? How can managers learn about consumer demand? Professor Spry University of St. Thomas PowerPoint presentation | free to download - id: 487d9e-NmNkO

The Adobe Flash plugin is needed to view this content

Demand The willingness and ability to buy How

does marginal analysis inform simple pricing

decisions? How can the concept of elasticity

inform managerial decisions? How can managers

learn about consumer demand? Professor

Spry University of St. Thomas

- Economics 600
- 600pm-900pm

Todays agenda

- Demand functions
- Linear Demand Functions and Curves
- Players Theater Example
- Own-Price, Cross-Price, and Income Elasticities

of Demand - Applications of Demand Estimation
- Forecasting prices of FCC Licenses
- The Demand for Hoosier Lottery Tickets

Motivating Example Red Lobster

- All you can eat crab dinner
- For that 2nd and 3rd and helping,
- What is the marginal cost to customer?
- What is the marginal benefit to customer?
- What is the marginal benefit cost to Red

Lobster? - What if steak? Fish chips?

Demand Function for Indiana Lottery Games

- The relationship between the quantity demanded of

a good or service and all influencing factors - Qd f(X1, X2,X3,X4 Xn)
- where Qd is quantity demanded per period and the

Xis are the factors influencing demand - Example Demand for Indiana Lottery Tickets
- Q quantity of Lottery Tickets purchased per

period - X1 Price per ticket (expected loss)
- X2 Price of other goods
- X3 Average income per period
- X4 A binary variable for a state border
- Other variables such as advertising, proximity to

riverboat casinos, seasonal variables

Demand Curve

- Definition A demand curve shows the amount of a

good/service consumer(s) are willing and able to

buy per period at various prices all else

constant - Plug in values of other variables, such as

income, prices of substitutes, ect. into the

demand function to obtain the demand curve as a

function of the price of the good only - Pa-bQ or Q(P)

Modeling demand as a constrained choice problem

- The consumer has
- Desire to maximize satisfaction from a variety of

purchases - Tastes preferences affected by advertising and

other factors - A budget constraint for those purchases
- Affected by income, prices of goods services

under consideration

The Logic of Consumer Choice and Demand

- Change in a demand factor
- E.g. lower price of good gt change in budget

constraint gt reduces opportunity cost of

purchasing this good gt purchase more units - Movement along a single demand curve
- E.g. increase income gt expands budget constraint

gt buy more of many goods and services - Demand curve shifts
- E.g. persuasive advertising gt shapes tastes

preferences gt may sway consumer toward this

product without requiring a price decrease - Demand curve shifts

Market Demand Function for PTC Tickets

- Q 117 - 6.6P 1.66Ps - 3.3Pr 0.00661I
- where P is PTC ticket price, Ps is price of

symphony tickets, Pr is price of nearby

restaurant meals, and I is average per capita

income. - Suppose the variables have the following values
- Ps 50
- Pr 40
- I 50,000
- Substituting variable values (except for P) into

the equation and rounding - Q 400 6.6P demand curve or
- P 60 0.15Q (inverse) demand curve

Graphing the demand curve for PTC

PTC demand curve P 60 0.15Q Think of P as

the Y variable Think of Q as the X

variable 60 is the vertical Y intercept -0.15

is the slope (change in Y/change in X)

How Many Tickets Should PTC Sell Using Linear

Demand Curve Facts

- In general, if
- P a bQ (linear)
- TR aQ bQ2
- MR a 2bQ
- This is an application of the derivative formula.
- If f(x)axb then f(x)abxb-1.

Dont sell as much as possible, maximize your

profits!!!! If it is worth producing, produce

until Marginal Revenue Marginal Cost!!

Marginal Analysis and Pricing

- Q 400 6.6P demand curve or
- P 60 0.15Q (inverse) demand curve

Price elasticity of demand

- Measures the sensitivity of quantity demanded to

changes in demand factors - The price elasticity of demand is given by
- (all else constant)

Does a given (often a 1) change in the price of

the good lead to a small reduction or a huge,

titanic reduction in the QUANTIY DEMANDED??

Absolute Value

Determinants of price elasticity

- Availability of substitutes
- Size of good in consumer budget
- Time period for consumer adjustment
- Discuss a) Southwest Airlines estimates the

short-run price elasticity of business air travel

to be 2 and the long-run elasticity to be 5.

Does this seem reasonable? Explain. - b) Would the market demand for business air

travel be more or less elastic than Southwests?

Why?

Estimated Price Elasticities

- Prescription drugs (Baye, Maness, Wiggins in

Applied Economics 29 (1997)) - Cardiovascular 0.4
- Anti-infective 0.9
- Psychotherapeutic 0.3
- Anti-ulcer 0.7
- Recreation 1.1 (short term) 3.5 (long term)
- Clothing 0.9 (short term) 2.9 (long term)
- Alcohol tobacco0.3 (short term) 0.9 (long

term) - Baye, Jansen, Lee, in Applied Economics 24

(1992)

Calculating elasticity from a linear Demand

Curve point price elasticity

- ? Information requirements
- Demand curve equation
- Qa-ßP, ß ?Q/?P
- Initial price and quantity
- Q
- P

Calculating elasticity Using a linear demand Curve

- The demand curve facing the Como Park Golf Course

is Qd100 2P - The current price is 20.00 for a round of golf.
- 60 golfers play Como per day.
- What is the own-price elasticity of demand at

Como at a price of 20.00?

Calculating elasticity arc price elasticity

- ?Information requirements
- Quantity demanded before and after the price

change - Q1
- Q2
- Price before and after the price change
- P1
- P2

Calculating elasticity arc price elasticity

Example Housing Sales

- From March to April of 1998, the price of an

average single-family home decreased from

128,200 to 127,100. Interest rates and income

were unchanged. - Housing sales increase from 4,700,000 to

4,890,000. - Source WSJ, May 27, 1998

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

D

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

5

D

100

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

5

D

100

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

S2

5

D

100

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

S2

5

2

D

100

160

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

S2

5

2

D

100

160

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

S2

5

2

D

100

160

Q

Total Spending and the Shape of the Demand Curve

Inelastic Demand

P

S1

S2

5

A

2

C

B

D

100

160

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

D

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

5

D

100

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

5

D

100

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

S2

5

D

100

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

S2

5

4

D

100

240

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

S2

5

4

D

100

240

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

S2

5

4

D

100

240

Q

Total Spending and the Shape of the Demand Curve

Elastic Demand

P

S1

S2

5

A

4

D

C

B

100

240

Q

Cross-Price Elasticity

- Positive if substitutes negative if complements
- Cross-price elasticity of demand for new car

sales from a change in gas prices - 0.214 - (McCarthy, in Economic Inquiry 28 (July 1990),

pp. 530-43) - Interpretation?

Income Elasticity of Demand

- Inferior good lt0
- Normal good gt0
- Luxury good gt1
- Examples of income elasticities of demand
- Powerball 0.9
- Daily games 0.68
- Instant games 0.4

Log-Log Demand Functions Constant Elasticity of

Demand

- Assumption
- Constant own-price elasticity of elasticity of

demand and constant income elasticity of demand

Estimating Demand Multiple Regression Technique

- Information requirements
- Hypothetical demand relationship
- Q a bP cPsubst dI eAdvert.
- Data
- series for Q, P, Psubst , I, Advert.

Estimating Demand Multiple Regression Technique

- Use statistical program (e.g. Excel) to estimate

parameters using multiple regression techniques - a, b, c, d, e
- Assess summary statistics to judge reliability

Caution Demand Estimation Problems

- Omission of relevant variables
- Important demand variable
- Identification problem
- Price changes may not be exogenous
- Supply shifts muddy the water
- Critical issue because estimates of parameters

can be seriously biased

Demand Estimation in Telecom

- CEO of a regional tel. Co. was interested in

bidding on licenses for airwaves in the region

that the FCC was licensing off. Purpose was for

wireless communications networks. He read a New

York Times article that contained the following

data price paid per license in 10 different

regions (Millions of dollars), number of licenses

sold, quantity of licenses, and regional

population (millions). Given the three

logarithmic data series, he clicked the

regression tool button and found the following

relation - Ln P 2.23 1.2 ln Q 1.25 ln Pop
- The estimated equation should give him info on

how much he should expect to bid to buy a

license. You can show that with log-linear

demand functions such as this one, the estimated

coefficients equal elasticities. Since the

population in the region is 7 percent higher than

the average, this means - or the

change in P 8.75. - Thus, the CEO would expect to pay 8.75 higher

in his region. The data showed the average price

to be 70.7 million for a license. So he should

expect to pay 76.9 million. - What type of information would the CEO want to

know whether to place a high degree of confidence

in this estimate? Why?

(No Transcript)

Looking Forward

- Assignment 1 Due Sept. 30, Oct. 4 or 5
- Due at start of class!
- Read Managerial Economics Chapter 5
- Moneyball and the Oakland As