SEU Estimate the Demand for Orange Juice Using Multiple Linear Regression Questions
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MANAGERIAL ECONOMICS:
THEORY, APPLICATIONS, AND CASES
W. Bruce Allen | Neil A. Doherty | Keith Weigelt | Edwin Mansfield
Chapter 1
INTRODUCTION
OBJECTIVES
Provide a guide to making good managerial decisions.
Use formal models to analyze the effects of managerial
decisions on measures of a firms success.
MANAGERIAL ECONOMICS
Differs from microeconomics
Microeconomics focuses on description.
Managerial economics is prescriptive.
Is an integrative course
Brings the various functional areas of business together
in a single analytical framework
Exhibits economies of scope
Integrates material from other disciplines
Reinforces and enhances understanding of those
subjects
THE THEORY OF THE FIRM
Managerial Objective
Make choices that increase the value of the firm.
The value of the firm is defined as the present value of
future profits.
THE THEORY OF THE FIRM
Managerial Choices
Influence total revenue by managing demand
Influence total cost by managing production
Influence the relevant interest rate by managing
finances and risk
Managerial Constraints
Available technologies
Resource scarcity
Legal or contractual limitations
WHAT IS PROFIT?
Two Measures of Profit
Accounting Profit
Historical costs
Legal compliance
Reporting requirements
Economic Profit
Market value
Opportunity, or implicit cost
More useful measure for managerial decision making
PROFIT
Measures the quality of managers decision-making skills
Encourages good management decisions by linkage with
incentives
SOURCES OF PROFIT
Innovation
Producing products that are better than existing
products in terms of functionality, technology, and style
Risk Taking
Future outcomes and their likelihoods are unknown, as
are the reactions of rivals.
Exploiting Market Inefficiencies
Building barriers to entry, employing sophisticated
pricing strategies, diversifying, and making good
strategic production decisions
THE PRINCIPALAGENT PROBLEM
Managerial Interests and the PrincipalAgent
Problem
The interests of a firms owners and those of its
managers may differ, unless the manager is the owner.
THE PRINCIPALAGENT PROBLEM
Separation of ownership and control
The principals are the owners.
They want managers to maximize the value of the firm.
The agents are the managers.
They want more compensation and less accountability.
The divergence in goals is the principalagent problem.
MORAL HAZARD
Moral hazard exists when people behave
differently when they are not subject to the risks
associated with their behavior.
Managers who do not maximize the value of the
firm may do so because they do not suffer as a
result of their behavior.
SOLUTION: MORAL HAZARD
Devise methods that lead to convergence of the
interests of the firms owners and its managers
Examples: stock option plans or bonuses linked to
profits
DEMAND AND SUPPLY: A FIRST LOOK
Market
A group of firms and individuals that interact with each
other to buy or sell a good
Part of an economys infrastructure
A social institution that exists to facilitate economic
exchange
Relies on binding, enforceable contracts
THE DEMAND SIDE OF THE MARKET
Demand Function
Quantity demanded relative to price, holding other
possible influences constant
Negative slope
Period of time
Shifts in demand
THE DEMAND SIDE OF THE MARKET
Other Influences (held constant)
Income
Prices of substitutes and complements
Advertising expenditures
Product quality
Government fiat
THE DEMAND SIDE OF THE MARKET
Total Revenue Function
A firms total revenue (TR) for a given time period is
equal to the price charged (P) times the quantity sold
(Q) during that time period.
TR = P x Q
The demand function reflects the effect of changes in P
on quantity demanded (Q) per time period and, hence,
the effect of changes in P on TR.
THE MARKET DEMAND CURVE FOR COPPER,
WORLD MARKET
Managerial Economics, 8e
Copyright @ W.W. & Company 2013
THE SUPPLY SIDE OF A MARKET
Supply Function
Quantity supplied relative to price, holding other
possible influences constant
Positive slope
Period of time
Shifts in supply
Other influences (held constant)
Technology
Cost of production inputs (Land, Labor, Capital)
THE MARKET SUPPLY CURVE FOR COPPER,
WORLD MARKET
Managerial Economics, 8e
Copyright @ W.W. & Company 2013
EQUILIBRIUM PRICE
Disequilibrium
Price is too high
Excess supply
Surplus
Causes price to fall
Price is too low
Excess demand
Shortage
Causes price to rise
EQUILIBRIUM PRICE
Equilibrium Price
Quantity demanded is equal to quantity supplied.
Price is stable.
The market is in balance because everyone who wants
to purchase the good can, and every seller who wants
to sell the good can.
EQUILIBRIUM PRICE OF COPPER, WORLD
MARKET
Managerial Economics, 8e
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ACTUAL PRICE
Invisible Hand
No governmental agency is needed to induce producers
to drop or increase their prices.
If actual price is above equilibrium price, there will be
a surplus that puts downward pressure on the actual
price.
ACTUAL PRICE
If actual price is below equilibrium price, there will be a
shortage that puts upward pressure on the actual price.
If actual price is equal to equilibrium price, then there will
be neither a shortage nor a surplus and price will be stable.
WHAT IF THE DEMAND CURVE SHIFTS?
Increase in Demand
Represented by a rightward or upward shift in the
demand curve
Result of a change that makes buyers willing to
purchase a larger quantity of a good at the current price
and/or to pay a higher price for the current quantity
Will create a shortage and cause the equilibrium price to
increase
WHAT IF THE DEMAND CURVE SHIFTS?
Decrease in Demand
Represented by a leftward or downward shift in the
demand curve
Result of a change that makes buyers purchase a
smaller quantity of a good at the current price and/or
continue to buy the current quantity only if the price is
reduced
Will create a surplus and cause the equilibrium price to
decrease
EFFECTS OF LEFTWARD AND RIGHTWARD SHIFTS OF THE
DEMAND CURVE ON THE EQUILIBRIUM PRICE OF COPPER
Managerial Economics, 8e
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WHAT IF THE DEMAND CURVE SHIFTS
Increase in Supply
Represented by a rightward or downward shift in the
supply curve
Result of a change that makes sellers willing to offer a
larger quantity of a good at the current price and/or to
offer the current quantity at a lower price
Will create a surplus and cause the equilibrium price to
decrease
WHAT IF THE DEMAND CURVE SHIFTS
Decrease in Supply
Represented by a leftward or upward shift in the supply
curve
Result of a change that makes sellers willing to offer a
smaller quantity of a good at the current price and/or to
offer the current quantity at a higher price
Will create a shortage and cause the equilibrium price to
increase
EFFECTS OF LEFTWARD AND RIGHTWARD SHIFTS OF THE
SUPPLY CURVE ON THE EQUILIBRIUM PRICE OF COPPER
Managerial Economics, 8e
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LIFE DURING A MARKET MOVEMENT
Managerial Economics, 8e
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Chapter 1: INTRODUCTION
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MANAGERIAL ECONOMICS:
THEORY, APPLICATIONS, AND CASES
W. Bruce Allen | Neil A. Doherty | Keith Weigelt | Edwin Mansfield
Chapter 2
DEMAND THEORY
OBJECTIVES
Explain the importance of market demand in the
determination of profit.
Understand the many factors that influence
demand.
Elasticity: Measures the percentage change in one
factor given a small (marginal) percentage change in
another factor
Demand elasticity: Measures the percentage change
in quantity demanded given a small (marginal)
percentage change in another factor that is related to
demand
OBJECTIVES
Explain the role of managers in controlling and
predicting market demand.
Managers can influence demand by
controlling, price, advertising, product quality,
and distribution strategies.
OBJECTIVES
Role of managers (contd)
Managers cannot control, but need to understand,
elements of the competitive environment that
influence demand.
This includes the availability of substitute goods, their pricing,
and advertising strategies employed by sellers.
Managers cannot control, but need to understand
how the macroeconomic environment influences
demand.
This includes interest rates, taxes, and both local and global
levels of economic activity.
THE MARKET DEMAND CURVE
Market demand schedule: Table showing the
total quantity of the good purchased at each
price
Market demand curve: Plot of the market
demand schedule on a graph
Price (the X variable) is on the vertical and quantity
demanded (the Y variable) is on the horizontal axis.
© 2013 W. W. Norton Co., Inc.
DEMAND CURVE FOR TABLETS
Managerial Economics, 8e
Copyright @ W.W. & Company 2013
THE MARKET DEMAND CURVE
Characteristics of the market demand curve
Quantity demanded is for output of the entire market,
not of a single firm.
For most products and services, the market demand
curve slopes downward and to the right.
Quantity demanded is defined with regard to a
particular time period.
THE MARKET DEMAND CURVE
Determinants of the position and shape of the
market demand curve
Consumer tastes
Example: Increase in preference for tablets causes
an increase in demand for tablets.
EFFECT OF AN INCREASED PREFERENCE ON THE
MARKET DEMAND CURVE FOR TABLETS
Managerial Economics, 8e
Copyright @ W.W. & Company 2013
THE MARKET DEMAND CURVE
Consumer income
Normal and inferior goods
Example: Increase in income causes an increase in
demand for tablets.
Population size in the market
EFFECT OF AN INCREASE IN PER CAPITA INCOME
ON THE MARKET DEMAND CURVE FOR TABLETS
Managerial Economics, 8e
Copyright @ W.W. & Company 2013
INDUSTRY AND FIRM DEMAND FUNCTIONS
Market demand function: the relationship
between the quantity demanded and the various
factors that influence this quantity
Quantity of X (Q) = f (factors)
Factors include
price of X
incomes of consumers
tastes of consumers
prices of other goods
population
advertising expenditures
INDUSTRY AND FIRM DEMAND FUNCTIONS
Example: Q = b1P + b2I + b3S + b4A
Assumes that population is constant and that the
demand function is linear
P = price of tablets
I = per capita disposable income
S = average price of software
A = amount spent on advertising
b1, b2, b3 , and b4 are parameters that are estimated
using statistical methods
INDUSTRY AND FIRM DEMAND FUNCTIONS
Parameters: Constant or variable terms used in
the function that helps managers determine the
specific form of the function but not its general
nature
Example: Q = -700P + 200I – 500S + 0.01A
INDUSTRY AND FIRM DEMAND FUNCTIONS
Relationship between the market demand
function and market demand curve
Market demand curve shows the relationship between
Q and P when all other variables are held constant at
specific values.
Market demand function does not explicitly hold any
values constant.
INDUSTRY AND FIRM DEMAND FUNCTIONS
Example: Q = 700P + 200(13,000) 500(400)
+ 0.01(50,000,000)
Example: Q = 2,900,000 700P
Example: P = 4,143 0.001429Q
Example: Q = 700P + 200(13,000) 500(200)
+ 0.01(50,000,000)
Shift in demand due to a change in the average price
of software from 400 to 200
Example: Q = 3,000,000 700P
Example: P = 4,286 0.001429P
DEMAND CURVE FOR TABLETS
Managerial Economics, 8e
Copyright @ W.W. & Company 2013
INDUSTRY AND FIRM DEMAND FUNCTIONS
The firms demand curve
Negative slope with regard to price
Slope may not be the same as that of the market
demand curve
Represents a portion of market demand
Market share
Responds to same market and macroeconomic
factors as the market demand curve
INDUSTRY AND FIRM DEMAND FUNCTIONS
Directly related to the prices of substitute goods
provided by competitors
Increase in competitors price will cause an increase
in a firms demand.
Decrease in competitors price will cause a decrease
in a firms demand.
INDUSTRY AND FIRM DEMAND FUNCTIONS
Inversely related to the prices of substitute
goods provided by competitors
Increase in competitors price will cause a decrease in
a firms demand.
Decrease in competitors price will cause an increase
in a firms demand.
THE OWN-PRICE ELASTICITY OF DEMAND
Own-price elasticity of demand
The elasticity of a function is the percentage change
in the dependent (Y) variable in response to a 1
percent increase in the independent (X) variable.
The price elasticity of a demand function is the
percentage change in quantity demanded in response
to a 1 percent increase in price.
THE OWN-PRICE ELASTICITY OF DEMAND
Own-price elasticity of demand (contd)
Equation:
Price elasticity generally is different at different prices
and in different markets.
THE OWN-PRICE ELASTICITY OF DEMAND
Own-price elasticity of demand (contd)
Price elasticity of demand is symbolized by ?.
0 ? ? ? ?
When |?| > 1, demand is elastic.
When |?| < 1, demand is inelastic.
When |?| = 1, demand is unitary.
THE OWN-PRICE ELASTICITY OF DEMAND
Own-price elasticity of demand (contd)
Price elasticity demand is symbolized by ?.
When ? = 0, demand is perfectly inelastic and the demand
curve is vertical.
Quantity demanded is the same at all prices.
When ? = ?, demand is perfectly elastic and the demand
curve is horizontal.
Price is the same for all quantities demanded.
If price rises, quantity demanded falls to zero.
If price falls, quantity demanded increases without limit.
DEMAND CURVES WITH ZERO AND
INFINITE PRICE ELASTICITIES OF DEMAND
Managerial Economics, 8e
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THE OWN-PRICE ELASTICITY OF DEMAND
Linear demand curves
The slope of a linear demand curve is constant.
If the demand curve is neither vertical nor horizontal,
the price elasticity will differ depending on price.
At the midpoint of a linear demand curve, ? = 1, with ?
approaching zero as price approaches zero.
At prices above the midpoint, demand is elastic, with ?
approaching negative infinity as quantity approaches zero.
At prices below the midpoint, demand is inelastic.
VALUES OF THE PRICE ELASTICITY OF DEMAND AT
VARIOUS POINTS ALONG A LINEAR DEMAND CURVE
Managerial Economics, 8e
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POINT AND ARC ELASTICITY
The point price elasticity formula should be used
working with an estimated demand curve or
when the change in price is very small.
POINT AND ARC ELASTICITY
Point price elasticity (contd)
Calculated value for small changes will differ
depending on whether P and Q are the starting values
or the ending values after the price change. The
difference will be small if the change is small.
Example: P1 = 99.95, P2 = 100.00, Q1 = 20,002, and Q2 =
20,000
? = [(20002 20000)/(99.95 100)][99.95/20002] = 0.1999
? = [(20000 20002)/(100 99.95][100/200000] = 0.22
POINT AND ARC ELASTICITY
Point price elasticity (contd)
If the price change is large, then the direction of
change will influence the calculated elasticity.
Example: P1 = 5, P2 = 4, Q1 = 3, and Q2 = 40
? = [(40 3)/(4 5)][5/3] = 61.67
? = [(3 40)/(5 4)][4/40] = 3.70
This problem is corrected by using the arc
midpoints formula.
© 2013 W. W. Norton Co., Inc.
POINT AND ARC ELASTICITY
The midpoints arc elasticity formula should be
used to estimate the price elasticity of demand
from a demand schedule where price differences
are not very small.
Example: P1 = 5, P2 = 4, Q1 = 3, and Q2 = 40
? = [(40 3)/(4 5)][(5 + 4)/(3 + 40)] = 7.74
© 2013 W. W. Norton Co., Inc.
USING THE DEMAND FUNCTION TO
CALCULATE THE PRICE ELASTICITY
Given
Q = 700P + 200I 500S + 0.01A
Q = Quantity demanded of computers
Price = P = 3,000
Income = I = 13,000
Software = S = 400
Advertising = A = 50,000,000
USING THE DEMAND FUNCTION TO
CALCULATE THE PRICE ELASTICITY
Derive the demand curve
Q = 700P + (200)(13000) (500)(400) +
(0.01)(50000000)
Q = 2900000 700P
Determine Q
Q = 2900000 (700)(3000) = 800000
? = (700)(3000/800000) = 2.62
For P = 2000, Q = 2900000 (700)(2000) =
1500000,
so ? = (700)(2000/1500000) = 0.93
THE EFFECT OF PRICE ELASTICITY ON
THE FIRMS REVENUE
Derivation of relationship between marginal
revenue (?TR/?Q or dTR/dQ) and the price
elasticity of demand
TR = PQ
dTR/dQ = Q(dP/dP) + P(dQ/dP)
(1/Q)(dTR/dQ) = (dP/dP) + (P/Q)(dQ/dP) = 1 + ?
THE EFFECT OF PRICE ELASTICITY ON
THE FIRMS REVENUE
1/Q is positive. Implications:
If ? = 1, dTR/dQ = 0, so total revenue is at a
maximum and a change in P will have no effect on
total revenue.
If ? > 1 (inelastic), dTR/dQ < 0, so an increase in P
(and consequent decrease in Q) will increase total
revenue.
If ? < 1 (elastic), dTR/dQ > 0, so an increase in P
(and consequent decrease in Q) will decrease total
revenue.
THE EFFECT OF PRICE ELASTICITY ON
THE FIRMS REVENUE
If the price elasticity is unitary, any price change
will cause an equal and opposite percentage
change in quantity. Total revenue will remain
constant.
If the price elasticity is in the inelastic range,
then a 1% change in P will cause less than a 1%
change in quantity in the opposite direction.
Therefore, total revenue will change in the same
direction as price.
THE EFFECT OF PRICE ELASTICITY ON
THE FIRMS REVENUE
If the price elasticity is in the elastic range, then
a 1% change in P will cause more than a 1%
change in quantity in the opposite direction. Total
revenue will change in the opposite direction
from price.
FUNDING PUBLIC TRANSIT
Given
Price (fare) elasticity of demand for public transit in
the United States is about 0.3.
All public transit systems in the United States lose
money.
Public transit systems are funded by federal, state,
and local governments, all of which have budget
issues.
FUNDING PUBLIC TRANSIT
Which transit systems have the most difficult
time getting public funding?
Revenue from sales will increase if fares are
increased, because demand is inelastic.
Costs will likely decrease if fares are increased,
because quantity demanded (ridership) will fall.
Managers of public transit will therefore increase
fares if they do not receive enough public funds to
balance their budgets.
DETERMINANTS OF OWN-PRICE
ELASTICITY OF DEMAND
Number and similarity of available substitutes
Product price relative to a consumers total
budget
Time period available for adjustment to a price
change
© 2013 W. W. Norton Co., Inc.
THE STRATEGIC USE OF THE PRICE
ELASTICITY OF DEMAND
Example: Strategic pricing of first class (? =
0.45), regular economy (? = 1.30) and
excursion (? = 1.83) airline tickets between the
United States and Europe
First class prices should be relatively high because
demand is inelastic.
Regular economy and excursion prices should be
relatively low because demand is elastic.
© 2013 W. W. Norton Co., Inc.
THE STRATEGIC USE OF PRICE
ELASTICITY OF DEMAND
Example: Using differentiation strategies to
change the price elasticity of demand for a
product
Differentiation strategies convince consumers that a
product is unique, and therefore has fewer
substitutes.
THE STRATEGIC USE OF PRICE
ELASTICITY OF DEMAND
Example (contd)
If consumers perceive that a product has fewer
substitutes, then their price elasticity of demand for
the product will decrease (become less elastic) in
absolute value.
Differentiation strategies do not require actual
differences in products, only a perceived difference.
TOTAL REVENUE, MARGINAL REVENUE,
AND PRICE ELASTICITY
A firms total revenue (TR) is equal to the total
amount of money consumers spend on the
product in a given time period.
Linear demand curve: P = a bQ
Corresponding total revenue curve: TR = PQ = aQ
bQ2
TOTAL REVENUE, MARGINAL REVENUE,
AND PRICE ELASTICITY
Marginal revenue: the incremental revenue
earned from selling the nth unit of output
MR = ?TR/?Q = ?( aQ bQ2)/?Q = a 2bQ
? = (1/b)[(a bQ)/Q]
If Q = a/2b, then ? = -1
If Q > a/2b, then ? is inelastic
If Q < a/2b, then ? is elastic
TOTAL REVENUE, MARGINAL REVENUE,
AND PRICE ELASTICITY
Marginal revenue (contd)
MR = ?TR/?Q = ?(PQ)/?Q = P(?Q/?Q) + Q(?P/?Q) =
P[1 + (Q/P)(?P/?Q) so MR = P(1 + 1/?)
|?| >1 (elastic) implies MR > 0
|?| 1 => increasing returns
b + c = 1 => constant returns
b + c < 1 => decreasing returns
ISOQUANT FOR A ONE-POUND WEIGHT GAIN FOR A BROILER AND
ISOCOST CURVE IF CORN PRICE IS ¾ OF SOYBEAN OILMEAL PRICE
Managerial Economics, 8e
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This concludes the Lecture
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Chapter 5: PRODUCTION THEORY
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