DETERMINANTS OF DEMAND

A firms quantity of sales depends

on multiple economic factors.
For instance, an airlines seat demand
might be described by the equation:
Q = 25 + 3Y + P 2P.
Here, demand depends on:
customer income (Y),
the rivals price (P),
and the airlines price (P).

Chapter 3
slide 1

3.2

SHIFTS IN DEMAND
Any change in the firms own price
shows up as a movement along the
firms demand curve.
A change in any other variable
constitutes a shift in the position
of the demand curve

For instance, an increase in a

competitors price would cause
a favorable demand shift as shown.

ELASTICITY OF DEMAND
How Responsive are Sales to Changes in Price?
The Concept of Elasticity Supplies the Answer.
EP = [% Change Q]/[% Change P] = [Q/Q]/[P/P].
Example: P0 = 100 & Q0 = 1200
P1 = 110 & Q1 = 1160
EP = [(1160 1200)/1200]/[(110 100)/100]
= -3.33%/10%
= -.333.

3.3

PROPERTIES OF ELASTICITY

3.4

Elasticity Varies along

a Linear Demand Curve.

Unitary Elastic: EP = -1
Inelastic: -1 < EP < 0
Elastic: - < EP < -1
400
300

= (-4)(100/1200) = -.333 B

Demand is
Elastic
A

= (-4)(300/400) =

-3

B Demand is
Inelastic

MR
MR = 0
400

800

Q = 1600 - 4P

EP = -1

200
100

EP = (Q/P)(P/Q)

1200

1600

3.5

USING ELASTICITY
Other Elasticities:
Income Elasticity:
EY = (% change Q)/(% change Y)

Cross Price Elasticity:

EP = (% change Q)/(% change P)

Necessities: 0 < EY < 1

Discretionary: EY > 1
Predicting Sales:
Q/Q = (EP)(P/P) + (EY)(Y/Y) + (EP)(P/P) .

3.6

USING ELASTICITY
Maximizing Profit and Revenue in
Pure Selling Problems (MC = 0).

Optimal Solution: MR = 0
or equivalently: EP = -1.

Examples:
Selling Software
Selling a CD
Revenue

Utilizing a Sports Stadium

With high demand, price to fill stadium.
With low demand, do not cut price
to fill stadium.

Capacity

3.7

OPTIMAL PRICING
1. The Markup Rule
[P - MC]/P = -1/EP
or P = [EP /(1+ EP )] MC
2. Price Discrimination

MC = 100

EP

-2
-3
-4
-6

200
150
133
120

Apply Markup rule to separate

segments. More inelastic segments
get the higher markups (over common MC).
Equivalently, Set MR1 = MR2 = MC.

MAXIMIZING REVENUE W/
LIMITED CAPACITY
Airline Yield Management:
Maximizing Revenue utilizing
Business Class and Economy Class seats.
The key is to set: MRB = MRE.
Example: Airline has 180 seats and faces demand:
PB = 330 QB and PE = 250 QE. Therefore,
MRB = 330 - 2QB = MRE = 250 2QE.
We also know that: QB + QE = 180.
The solution to these simultaneous equations is:
QB = 110 seats and QE = 70 seats.
In turn, PB = $220 and PE = $180.

3.8