Chaoter 3 Demand Theory 727

to estimate dre effect of reducing the price of a conrrnodiry on dre clernancl of othe r
related conr.nodiries that dre firnr sells. ,\ irigh cross-price elrsticin' oI dcrn rrrd is
also used to define an industry.
5. For the analysis of demand, the firm should first identify all the irnportant variables
.that affect the demand for the product it sells. Bv using regression analysis (dis-
cussed in Chapter 4), the fimr could obtain reliable esdmates of the effect of a
change in each ofthese variables on demand for the product.
There is an increasing trend ofconverqing tastes around the s'orld.'Lrstes in the
Un.ited States affect tastes around the *'orld, and tastes abroad stronglv influence
tastes in the United States, \\rl.rile sorne national differences s'ill surely reurain,
the information revolution and cross-fertiliz',rtion oI cr.rlrurcs c..rn be erpe cted to
accelerate the global convergence of tastes. This has irnportant implications for
all firms.
7. Since t}le rnid-1990s, the Internet has given rise to electronic commerce, u'hich is
revolutioniz-ing traditional business relationships. E-cornrlcrce refcrs to the pro-
ducdon, advertising, slle, nncl distribr.rtion of products trrrcl scrvices fronr business
to business and fronr business to consumers thror.rgh tl're Internet. Thc bigeest
hrres oIe-commerce for consunrers ire tl)c convenience of har.ing roun(l-the-clock
acccss to the virrual storc and the,rbilin'to cng',rge irr corrrprirtivt shopping:rt
minimrl cost and effort. Through e-cornmerce, sellers can sharply reduce their
cost of executing sales and procuring inputs, reformulate supply chains and logis-
rics, and redefine custoner relationship managenlent.

(a) If our main interest in managerial economics is the demand that a firm faces Discussion
for is product, why do \r'e srudy consumer demand dreorv? (&) \Mrat is the dis-
tinction beween inferior goods and normal goods? Benveen the substirution ef-
Questions
fect and the income effect? Benveen a change in the quantiw dernlrndecl and a
change in demand?
2. (a) Iiorv many ty?es of demand functions are drere? (&) In which tlpe cf demrnd
are we most interested in rnrnaeerial economics? \\hy? (r) \4hy do 1ve then srudl'
thc other r)?es of denlend?
(a)What are d1e most important deterrninants of the dernand function that a finn
faces for the con.rrnodin' it sells? (/l) \\hat is nreant b1' producers' goodsi Bt' de-
rived demand? (r) \\hy is the demand for durable goods (bodr consunrers' and
producers') less stable than the demand for nondurable goods?

@V>What is the advantage of using the price elasticiry rather than the slope of the
v i.-".ra curve or is inverse to measure the resoonsiveness in the ouanriw de-
rnanded of a commodiry- to a change in it-s price? (l') \afty and horv is the formula
for arc price elasticiq'of dernancl diffcrcnt frorn rhe forrnula for point pricc clas-
ticity of dcrnand?
(! (r) State the rcledonship benveen the total revcnue of a firnr and the price el'.rstic-
ity of dernand for a price ino'ense alonq a linear derran<l curvc. (l) Explain tlre rcr-
son for the relationship tl'rrt vou stlted in part (a).
6. (a) Explain rvhy a firm facing a negatively slopeC demand curve rvould never pro-
duce in the inelasric pordon of the demand cun'e. (l') \\''l-ren ri'ould the firm u'ant
to operate at the point rvhere its demand cun,e is unitan'elrsdc?

5o+l lt j, r/
Part 2 Demand Anatysis

Pe=
7. (a) \\buld you erpect the price elasticiry of demrnd to be higher for Chewolet
A=
tomobiles or for automobiles in general? \\hv? (l) \\rould )'ou expect the pd P,=
elasticirl'ofdernand for electricir)"for residential ttse to be higher or lorver
indusrial use? \\/try? (c) Would you er?ect *re price elasticity of demand for
triciry to be higher er lorverin the shon run as compared u"ith the long mn?
(a) Indicate
8. If there hasbeen a I0 percentinbrease in consumers'income berrveen nvoperi
unit cl
each
rvhat rvas the percentage change in the demand for foreigJn travel? For
of Q" if tne
products? For flour? (Hirrt: Use the inconre-el';lsticin'r"llues iu Thble 3-4.)
s8,0oo, Pc
9. Agriculrural commodities arc kno*'n to ha';e a price-inelastic clemand and to the demant
necessities. Florr can this inforrn:rtion lllorv us to ernhin rvlrl thc incorne of
3. Starting wi
ers falls (a) after a good han-est? (l') In relation to the inconres in other
assume dra
the economv?
million, I :
10. Suppose that the cross-price elasriciry of demand becween Mclntosh and (i.e., the ir
Delicious apples is 0.8, ber*'een apples and apple juice is 0.5, benveen apples curve for (
cheesc is 0.4, and benveen apples and beer is 0.1. \\Ihat crn )'ou sly rrboutthe graPh, Plo
lationship benvecn each set of comrnoditics? \d4rat is th
^
ll (r) !\/hat othcr elrsticities of dcrnanrl ilrc thcre lrcsirlcs pricc, irrcornc, and G.)rn" t"" c
price? (D) l\h:rt is the usefulness to the firm of the clasticio' of dcmand for V son of the
variables over rvhich the firm has some control? (c) Of the clasticiw of administrt
over rvhich the firm has no conrrol? (d) \\thy is it essential for the firm to use demand a:
elasciciry of all the variables included in the dernancl ftrnction? mand for
t2. (,2) \\ftv are txstes converqingl around the u'orld? (l) \\rhat is the gression a

this for U.S. finns?

lJ. Horv is e-commerce revolutionizine tie brrsiness rvorld? where th,
parlor, ar
schedule
each doll
PfOb[gmS L John Smith, che research manager for rnarkering ar the Cherrolet Dir.isionof thc der.'rand I

General Motors Corporation, has specified the foilorving general demand firnc. $5 and P
tion for Cherrolets in the United States: i. Showhc
cream gl
Qc -- f(Pc, N, 1, Pr, PG,,,1, Pr)
Also sho
rvhere Q6. is the quantiw demanded of Chevrolets per I'exr, P6. is the price for ice cr
Chevrolets, N is population, 1is disposabie incorne, P, is the price o[Ford 6. For the
mobiles, P6 is the price of gasoline, I is the amounr of advercising for Che similar I
and P1 is credit incentives to purchase Chevrolets. Indicare rvhether you expect enuer aI
each independent or explanatoryr vx.ir61. to be directly or inversely related totie demand

6o
quandry demanded ofChevrolets and the reason for vour cxpectarion. figure sr

Suppose that Gtr'l's Smith estimated rhe follorving resression equation for ,mand is
Chewolet autonrobiles: andMI
+ 2,000N + 501 + 7. The tot
Qr..= 100,000 - 100/'}r- .101)/,
iion wh
1,000P6 +,i.4 + 40,0001,/
the Pri'
rvhere Q6 : quantit)' clernandcd per vear of Chcvrolet arrtorncrbiles --0.4.I
:
P6 price of Cherrolet atrtomobiles, in dollars operatr
N: popularion of the United States, in rnillions adoPt?
1 = per crpitrr disposrrble income, in dollrrs
clurge
Pp : price of Ford nrtornobiles, in doll..rrs

1,t( L
 Chapter 3 Demand Theory 129

Pc : real price of gasoline, in cents per gallon

I : adverrising expendirures br. Cl'revrolet; in dollars per vear
Pr : credit incentives to purchasc Chevrolets, in percentrge poirtts
belorv the rate of interes! on borro*'ins in the absence of
incentives
(,e)Indicate the change in the number of Chevrolets purchased peryear (Q6) for
each unit change in the independent or explanatory variables. (D) Find dre value
of Q6if the averase value of P6: 59,000, N: 200 nrillion, I: S10,000, Pp=
58,000, Pc : 80 cents,.'1 : 5200,000, and iiP, : l. (r) Dcrive the cqu:rtion for
the clcnranrl cun'c for Chcr'r'olets; and (r/) plot it. | : Q*:, td . u>,, $auu
Strrting rvith dre cstiuratcd clcrlancl function fi-rr (ihcvrolcts grven in [)roblern 2,
assunle that the average value of the independent vlriables changes to N : 225
million, /: $12,000, Pp: $10,000, Pc: 100 cents, l : 5250,000, and P, = g
(i.e., the incentives are phased out). (r) Find the equation of the new demand
curve for Chewolets and (&) plot this ne*'demand curve, Di, and on the same
graph, plot the demand cun'e for Chevrolets, D6, found in Problem 2(d). fcl
!\trat is the relacionsl'rip benveen D6 and Dy' ? \\that explains this relationshipi
Thc Ice Crcam Parlor is the onlf ice creirnr p',rrlor in Smit.htorrn. r\lichlcl, thc
son of the orvner, hrs just ccrnre back frorn college, rvhcre he majors in br-rsiness
administration. In his course in rnanagerial econornics, Nlichael has just snrdied
demand analysis, and he decides to applv rvhat he has learned to estimate rhe de-
mand for ice cream in his fathcr's parlor during his surnrner vac'.rtion. Llsins re-
gression anall'sis, i\licheel estimxtes the follou,ing demand function:

Qr=120-20P1
rvhere the subscript 1 refers to ice cream portions sen'ed per day in his fatl'rer's
parlor, and P1 is the dollar price. Ilichael then sets out to (a) derive the demand
schedule for ice cream and plot it, (1') find the.point price elasticih'of dernancl at
each dollar price, frorn P : 56 to P : $0, ancl (c)-frxl tfie-i-price elasticin'of
dernrnd benveen consecutive doll':rr prices (i.c., bcnveen 1) = $6:rnd P: S5,1'=
$5 and P = 54, and so on). Shorv hos'r\{ichrel rvould gct his results.
Shorv irou,ilichael could havc for.rncl the price elastici$ of dernand (Ip) for rcc
crearn graphicall)'at, sx)., Pr : 54 for the dern,rnd function giycn in Probleni 4.
Also shorv graphicalll' that at Py = $4, 8p rvould be the same if the denrand cun'e
for ice cream s.ere cun'ilincar but tlngent to the linelr denrrnd cun c 3t Pr = S,1.
For the dernand frinction for ice crearn given in Problem 4, (a) construct a table
similar to Thble l-2 in the text, shorving the quantirv- clernanded, the total rer'-
enue, and the marginal revenue schedules of the Ice Cream Parlor. (l;) Plot the
demand, the total revenue, and the rnarginal revenue scheclules from part (a) in e
figure similar to Figure l-5 in the text and indicate on it thc range over rvhich de-
mand is elastic, inelastic, and unitarv elastic. (c) Derive the equiltion for the 'IR
and ,LIR schedules for the parlor.
The total operating revenues of a public transportation:rr.rthoriq, are $100 rr-ril-
lion l,hile its total operxting costs rrre S120 nrillion. The price of a ride is S1, rnd
t1.re price elasticiq' ofdenrand for public transPortation has been esdrnrted to be
--0.4. By larv, the public transportation audroriw must take steps to eliminate its
operating deficit. (a) \\4-rat pricing policy should the transportarion authorin'
adopt? \\rhv? (1.') \\hat price per ride must the public transportation ,rr.rthorit\'
charge to elirnin:rte the deficit if it c:rnnot rednce costs?

9o r
\
I
Part 2 Demand Anatysis

n
<-<'
/-\) '8/ The coefficient of income in a regression of the quxntio dernancled of a com-
\,/
\
/\9'/ .7 rnodiq'on price, incorne, and otlier variables is 10. (a) Cirlculatc thc incorne elrrs-
dciq'of dernand for tliis cornnrodin'at incornc of S10,000 and salcs of 80,000
units. (/') \4/hat rvould be the income elasticirv of dcmand if sales increased from
80,000 to 90,000 units and income rose from $10,000 to $11,000? Whatqpe of
good is this commodirl'?
9. A researcher esdmated th:rt the price elasticin'of demand for automobiles in the
United States is - 1.2, s'hile thc irrconre el.rsticin' r-.,f de nr'rntl is i,0. Ncrt t'c.rr,
U.S. autornakers intend to increase the average price of autornobiles br' 5 per-
cent, and thel expect consurners' disposable incorne to rise lrr' 3 percent. (rf If
s:rles of domesdcallr- producecl autornobiles are 8 rnillion this velr, hos' nrtnv lu-
tornobiles do vou expect U.S. iutonrikers to sell next verr? (l) Bv horv much
should domestic automakers increase the price of autonrobiles if dre1. rvish to rn-
crease sales by 5 percent next year?
10. The coefficient of the price of gasoline in the resressic.rn of the quantit)'de-
nranded of autonrobiles (in rrrilliorrs of units) on the price of g';rsoline (in doll'rrrs)
and othervarirbles is -14. (rz) Crlculate the cross-price elrsticin'of demrnd be-
r\r'ecn autornobiles nnd grsolinc at tlrc gasolirrc price of $l pcr grllon and salcs of
autonrobiles of 8 (rnillion unim). (l) \Vhrt would be the cross-price elasticiw of
demand benveen automobiles and grsoline if sales of autornobiles declined from
8 to 6 with an increase in the gasoline pricc from $l to $1.20 per gallon?
I l. The rnanage ment of the Mini ,\'till Steel Cornpau' cstirnated thc follorving ehs-
dciries for a special qpe of steel: Er, = 2, E r = l, and .Eyy = l.5, rvhere X refers to
steel and f to alun'rinunr. Next vear, the firm rvould like to incre:rse the p{ce of
the steel it sells by 6 percent. The managernent forecasted that income *'ill rise
by 4 percent next year and that dre price of alr.rminurn will fall by 2 percent. (a) If
the sales this year are 1,200 tons of the steel, horv lnrny tolls can the firm expect
to sell next 1'ear? (&) Bv rvhat percentase nrust the firm changc tl-re price of steel
to keep its sales at 1,200 tons ncxt 1'ear?
t2. Integrating Problem
T'he research department of the Corn Flakes Corporation (CFC) cstimated the
following regression for the demand of the cornflakes it sellsr
Q..-: 1.0 - 2.0P.y + 1.51 + 0.8P)-- 3.OP,\r + i.0rl
rvhere Q.1'= sales of CFC cornflakes, in millions of l0-ounce boxes perl'ear
Px: th. price of CFC corrrflakes, in dollars per 10-ourrce box
1 = personal disposable income, in trillions of dollars per year
Py : price of competitive brand of cornflakes, in dollars per I 0-ounce
box
P,11 : price of milk, in dollars per quart
I : advertising expendirurcs ofCFC cornflakes, in hundreds of
thousands of dollars per )'ear
Tlrisl'ear,Px: $2,1: 54, Pr = $2.50, Itr: $1, andA = $2. (a) Calculate the sales
ofCFC cornflakes this year; (l) calculate the elasdciry ofsales s'ith rcspecr to crch
variable in drc dernand frrnction; (r) estirnatc dre levcl of sales lrcxr year if CFC rc-
duces P1, b.v l0 percent, increases advercising by 20 percent, / rises by 5 percent, Py
is reduced bv 10 percent, and P;q1 remains unchanged. (d) By how nruch should CFC
change its advertising ifit rvants its sales to be 30 percenr higher dran rhis veari

5 o.rl 8 4tr{A )iA