Review of Chapter 3: Demand Analysis and Optimal Pricing

Economic reasoning

1. Recognize complement, substitute, normal, and inferior goods.

2. What do the coefficients on the explanatory variables in the demand function tell
us?
3. What does Ep (or other types of elasticity) = - 2 mean?
4. How does total revenue change when P changes, depending on Ep?
5. Why does inelastic demand imply MR<0, elastic demand MR>0 and unit elastic
demand MR=0?
6. Profit maximization is equivalent to revenue maximization for pure selling
problems.
7. Why profit is not maximized when demand is inelastic?
8. The relationship between the size of the firm’s markup above marginal cost and
Ep.
9. When the firm faces different demand in different markets (with same marginal
costs), why uniform pricing generates lower profit for each market and hence
lower total profit compared with price discrimination?
10. When a firm faces a binding output constraint, the firm should equalize marginal
profits across different markets to maximize total profit. How should the firm
allocate the fixed amount of output between the markets to maximize total profit
if Mπ1>Mπ2?

Graphical Skill:

1. Identify elastic, inelastic, and unit elastic demand on a linear demand curve.
2. Learn to find out revenue maximizing Q and P from a linear demand curve. Draw
the MR curve.

Problem Solving Skill:

1. Compute price elasticity, income elasticity, cross-price elasticity, and other types
of elasticity of demand.
2. Predict ∆Q or %∆Q given changes in explanatory variables. To keep Q constant,
how a firm should adjust its price (or advertising expenditure)?
3. Demonstrate generally Ep= -1 at the midpoint of a linear demand curve.
4. Optimal markup rule: P=(Ep/1+Ep)MC.
5. Uniform pricing: determine total demand at the uniform price, then inverse
demand, then MR=MC.
6. Third degree price discrimination: MR=MC for each market.
7. Compare the solution for uniform pricing and for third degree price
discrimination. Demonstrate why at the solution of uniform pricing, profit in each

1
 market is not maximized, and whether the firm should increase or decrease Q to
raise profit in each market (You can compare MR and MC as we did in class, or
you can look at Mπ).
8. Profit maximization with a fixed amount of output: differentiating between
binding and non-binding constraint; for a binding constraint, use Lagrange
multiplier or equalization of marginal profits.