Price Quantity Total Marginal

Revenue Revenue
10 1 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
2 9 18 -6
1 10 10 -8
Price Quantity Total Marginal
Revenue Revenue
10 1 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
2 9 18 -6
1 10 10 -8
Total and Marginal Revenue
Quantity Demanded
M
R
/
P
r
i
c
e

-10
-5
0
5
10
Total Revenue
0
5
10
15
20
25
30
35
0
2 4 6 8 10 12
Quantity per period
T
o
t
a
l

R
e
v
e
n
u
e

15
0
2 4 6 8 10 12
Marginal Revenue
Average Revenue
Marginal Revenue Equation
Demand Equation Q = B + a
p
P
P = -B/a
p
+ Q/a
p
TR = PQ = -B/a
p
*Q

+ Q
2
/a
p
MR = d(PQ)/dQ = -B/a
p
+ 2Q/a
p
MR = 0 , Q = B/2
For Q < B/2 , MR = +ve Q > B/2 , MR = -ve
Relation of Demand & Marginal
Revenue Curve

The curves intercept y-axis at same point
Intercept of MR & Demand (DD) curve = -B/a
p

Slope of (DD) curve = 1/ a
p

Slope of MR curve = 2/ a
p
= 2 DD curve

ELASTICITY
A general concept used to quantify the
response in one variable when another
variable changes
elasticity of A with respect to B =
% AA/ %AB
Calculating Elasticities
P
1
= 3
P
2
= 2
Q
1
= 5
Q
2
= 10
D
Price per
Pound
Pounds of X per week
Pounds of X per month
Slope: AY = P
2
P
1
AX = Q
2
Q
1

= 2 3 = -1
10 5 = 5

Ounces of X per month
Slope: AY = P
2
P
1
AX = Q
2
Q
1

= 2 3 = -1
160 80 = 80

P
P
P
1
= 3
P
2
= 2
Q
1
= 80
Q
2
= 160
D
Price per
Pound
Ounces of X per week
Q Q
0 0
Point Price Elasticity of Demand
/
/
P
Q Q Q P
E
P P P Q
A A
= =
A A
Point Definition
Ratio of the percentage of change in quantity
demanded to the percentage change in price.
% AQ
Ep =
% AP
For AP approaching 0

AQ/AP = dQ/dP


Linear equation = dQ/dP = constant

dQ/dP = a
p

Q
d
= B + a
p
P = B + dQ/dP P

Point Price Elasticity of Demand
Point Price Elasticity of demand
0
1
2
3
4
5
6
7
0 100 200 300 400 500 600 700
Qx
P
x

A
F
G
H
J
B
C
Dx
B = -5
C = -2
F = -1
G = -0.5
H = -0.2
Arc Price Elasticity of Demand
2 1 2 1
2 1 2 1
P
Q Q P P
E
P P Q Q
+
=
+
E
p
= Q
2
- Q
1
P
2
- P
1

(Q
2
+ Q
1
)/2 (P
2
+ P
1
)/2
Example
Calculate the arc price elasticity from point C
to point F.


= (300 200)/ (3-4) * ((3+4)/ (300+200))
= -1.4

Price Quantity Total Marginal
Revenue Revenue
10 1 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
2 9 18 -6
1 10 10 -8
Calculate Elasticity
Price Quantity Total Marginal Price
Revenue Revenue Elasticity
10 1 10 -10.00
9 2 18 8 -4.50
8 3 24 6 -2.67
7 4 28 4 -1.75
6 5 30 2 -1.20
5 6 30 0 -0.83
4 7 28 -2 -0.57
3 8 24 -4 -0.38
2 9 18 -6 -0.22
1 10 10 -8 -0.10
Total Marginal Elasticity
Quantity Demanded
M
R
/
P
r
i
c
e

-10
-5
0
5
10
Total Revenue
0
5
10
15
20
25
30
35
0
2 4 6 8 10 12
Quantity per period
T
o
t
a
l

R
e
v
e
n
u
e

15
0
2 4 6 8 10 12
Marginal Revenue
Elastic
Ep < - 1
Unitary elastic
Ep = - 1
Inelastic
-1 < Ep < 0
Price
Qty Demanded
0
Q
P
Price
Qty Demanded
0
Q
P
D
D
Perfectly Inelastic Demand Perfectly Elastic Demand
Perfectly inelastic demand
Q
d
does not change at all when price changes
Inelastic demand
-1 < E s 0
Unitary elastic demand
E = -1
Elastic demand
E < -1
Perfectly elastic demand
Q
d
drops to zero at the slightest increase in price
Exercise
For each of the following equations, determine
whether the demand is elastic, inelastic or unitary
elastic at the given price.
a) Q =100 4P and P = $20
b) Q =1500 20 P and P = $5
c) P = 50 0.1Q and P = $20

a) -4, elastic
b) -0.07, Inelastic
c) -0.67, Inelastic
Marginal Revenue and Price Elasticity
of Demand
1
1
P
MR P
E
| |
= +
|
\ .
MR = d(PQ) = dQ*P + dP*Q
dQ dQ dQ

= P + QdP = P 1 + dP.Q
dQ dQ P
P * Q
d
= TR Elastic Demand

P * Q
d
= TR Elastic Demand

P * Q
d
= TR Inelastic Demand

P * Q
d
= TR Inelastic Demand



Present Loss : $ 7.5 million
Present fee per student : $3,000
Suggested increase : 25%
Total number of students : 10000
Elasticity for enrollment at state universities is -1.3 with respect to tuition changes

1% increase in tuition = 1.3% decrease in enrollment
Increase of 25% decline in enrollment by 32.5%
3000 * 10000 = $30,000,000
3750 * 6750 = $25,312,500

Problem
Determinants of Price Elasticity of
Demand
Demand for a commodity will be less elastic if:
It has few substitutes
Requires small proportion of total expenditure
Less time is available to adjust to a price change
Determinants of Price Elasticity of
Demand
Demand for a commodity will be more elastic if:
It has many close substitutes
Requires substantial proportion of total
expenditure
More time is available to adjust to a price change
Income Elasticity of Demand
Point Definition
/
/
I
Q Q Q I
E
I I I Q
A A
= =
A A
The responsiveness of demand to changes in income.
Other factors held constant, income elasticity of a
good is the percentage change in demand associated
with a 1% change in income
Income Elasticity of Demand
Arc Definition
2 1 2 1
2 1 2 1
I
Q Q I I
E
I I Q Q
+
=
+
Demand of automobiles as a function of income is
Q = 50,000 + 5(I)
Present Income = $10,000
Changed Income = $11,000

I
1
= $10,000, Q = 100,000
I
2
= $11,000, Q = 105,000
E
I
= 0.512
Normal Goods Q/I = +ve, E
I
= +ve
Necessities 0 < E
I
s 1
Luxuries E
I
> 1

Inferior Goods Q/I = -ve, E
I
= -ve
Cross-Price Elasticity of Demand
Point Definition
/
/
X X X Y
XY
Y Y Y X
Q Q Q P
E
P P P Q
A A
= =
A A
Responsiveness in the demand for commodity X
to a change in the price of commodity Y. Other
factors held constant, cross price elasticity of a
good is the % change in demand for commodity
X divided by the % change in the price of
commodity Y
Cross-Price Elasticity of Demand
Arc Definition
2 1 2 1
2 1 2 1
X X Y Y
XY
Y Y X X
Q Q P P
E
P P Q Q
+
=
+
Substitutes
0
XY
E >
Complements
0
XY
E <
Importance of Elasticity in Decision
making
To determine the optimal operational policies
To determine the most effective way to respond to
policies of competing firms
To plan growth strategy
Importance of Income Elasticity

Forecasting demand under different economic
conditions
To identify market for the product
To identify most suitable promotional
campaign

Importance of Cross price Elasticity
Measures the effect of changing the price of a
product on demand of other related products
that the firm sells

High positive cross price elasticity of demand is
used to define an industry
Exercise
A consultant estimates the price-quantity
relationship for New World Pizza to be at
P = 50 5Q.
At what output rate is demand unitary elastic?
Over what range of output is demand elastic?
At the current price, eight units are demanded
each period. If the objective is to increase total
revenue, should the price be increased or
decreased? Explain.


P =50 -5Q
MR = 50-10Q
For unitary elastic MR = 0 so Q =5
MR will be +ve when Q<5, so demand will be
elastic when 0<=Q<5.
P for Q=8 is P=50-5*8 = 50-40 = 10

Ep= -1/5*10/8 = -0.25. As demand is inelastic,
when we increase price, TR increases.
5 / 1 / = A A P Q
Question: Demand for a firms product has been estimated to
be
Qd = 1000-200P
If the price of the product is Rs 3 per unit, find out the
price elasticity of demand at this price.
Solutuion: Price elasticity of demand is
ep= dQ/dP*P/Q
in the given demand function 200 is the coefficient of price
which measures dQ/dP. In order to find out price elasticity
of demand at price Rs3, we have first to find out the
quantitydemanded at this price by using the given demand
equation. Thus,
Q=1000-200*3=400
Thus, P=Rs3 and quantity demanded at the price is 400
units. Substituting the values of dQ/dP, P and Q in the
price elasticity formula, we have
ep= dq/dp*P/Q=200*3/400=3/2=1.5
Q. The price elasticity of demand for colour
TVs is estimated to be -2.5. if the price of
colour TVs is reduced by 20 percent, how
much percentage increase in the quantity of
colour TVs sold do you expect?
Solu. Price elasticity of demand being equal
to -2.5 means that one pwercent change in
price causes 2.5 percent change in quantity
demanded or sold. 20 percent reduction in
price of colour will cause increase in
quantity sold by 2.5*20=50 percent.