Economic for

Manager
Quantitative Demand Analysis
The economic concept of
elasticity
 Elasticity: is the general concept used to quantify
the percentage change in one variable relative to
a percentage change in another.
 It’s the general responsiveness or sensitivity of a
percentage change in one variable when other
variable changes.
 Slope is a poor measure of responsiveness, slope
tells only the direction of relationship.

percent change in A
Coefficient of Elasticity 
percent change in B
Price elasticity of demand
 Price elasticity of demand: The ratio of
the percentage of change in quantity
demanded to the percentage of change in
price; measures the responsiveness of
quantity demanded to changes in price.
% change in quantity demanded
Price elasticity of demand 
% change in price

%  Quantity
Ep 
%  Price
Types of price elasticity of
demand
 There are five types of price elasticity of
demand. (Degree of elasticity of demand) Such
as

 Perfectly elastic demand

 Perfectly inelastic demand

 Relatively elastic demand

 Relatively inelastic demand and

 Unitary elastic demand.

Types of price elasticity of
demand
1. Perfectly elastic demand (infinitely
elastic)
When a small change in price leads to infinite
change in quantity demanded, it is called
perfectly elastic demand. In this case the
demand curve is a
horizontal straight
line as given below.
(Here ep= ∞)
Types of price elasticity of
demand
2. Perfectly inelastic demand:
when large change in price fails to bring
about
a change in quantity demanded. I.e. the
change
in price will not affect the quantity demanded
and quantity remains the same whatever the
change in price. Here demand curve will be
vertical line as follows and ep= 0
Types of price elasticity of
demand
3. Relatively elastic demand
Here a small change in price leads to very big change in quantity
demanded. In this case demand curve will be flatter one and
ep=>1

4. Relatively inelastic demand

Here quantity demanded changes less than proportionate to
changes in price. A large change in price leads to small change in
demand. In this case demand curve will be steeper and ep=<1

5. Unit elasticity of demand ( unitary elastic)

Here the change in demand is exactly equal to the
change in price. When both are equal, ep= 1, the
elasticity is said to be unitary.
Types of price elasticity of
demand
The above five types of price elasticity of
demand can be summarized as follows:
Types of price elasticity of
demand
Price elasticity of demand
 Arc elasticity: elasticity which is measured
over a discrete interval of a curve
Q 2  Q1 P  P1
Ep   2
(Q1  Q 2 )/2 (P1  P2 )/2

Ep = coefficient of arc price elasticity

Q1 = original quantity demanded
Q2 = new quantity demanded
P1 = original price
P2 = new price
Price elasticity of demand
Price elasticity of demand
 For example, suppose that a firm increases the
price of its product by 2% and quantity
demanded subsequently decreases by 3%. The
price elasticity would be:
 3%
E p

2%
 1.5

 Ep is negative because of the law of demand,

which states that price and quantity demanded
are inversely related. Thus, when the price
change is positive, the change in quantity
demanded is negative, and vice versa.
Price elasticity of demand
 Point elasticity: elasticity measured at a
given point of a demand

dQ P1
εP = x
dP Q1
Price elasticity of demand
 For example
If Q = 18 –P, if the price is assumed to be
$12.
find price elasticity of demand using point
method.
 The derivative of Q with respect to P is -1.

thus, the point elasticity of demand at $12

and 6units 12 is :
 p
 1 
6
2
The determinants of
elasticity
Factors affecting demand elasticity

 Availability of substitutes
 Necessities verses Luxuries
 Proportion of income spent
 Durability of product
 Possibility of postponing purchase
 Possibility of repair
Length of time period
What do Substitutes have to do
with a price change?
 The more substitutes a product has, the
more sensitive consumers are to a price
change, and the more elastic the demand
curve.
 A necessity has poor substitutes, so the
demand for a necessity is inelastic. Food,
medicine are a necessity.
 A luxury has many substitutes, so the demand
for a luxury is elastic. Exotic vacations are
luxuries.
Proportion of Income Spent

◦ A price rise, like a decrease in income, means

that people cannot afford to buy the same
quantities.
◦ The greater the proportion of income spent on a
good, the more elastic is the demand for the
good
◦ The larger the purchase is to one’s budget, the
more sensitive consumers are to a price
change, and the more elastic the demand curve
Length of time to the Price
Changes
◦ The longer the time elapsed since the
price change, the more elastic is the
demand for the good.
◦ The shorter the time elapsed since the
price change the more inelastic is the
demand for the good.
Total Revenue and the Price
Elasticity of Demand
 Total revenue is the amount spent on a
good and received by its sellers and equals
the price of the good multiplied by the
quantity of the good sold.
TR = P x Q
total revenue = price x quantity

effects of price changes P  QD 

on quantity demanded:
and
P  QD 
Total Revenue and the Price
Elasticity of Demand
If demand is elastic:
 A given percentage rise in price brings a larger
percentage decrease in the quantity demanded.
 Total revenue decreases. And vice versa.
effect of price increase on
a product with elastic demand: P x QD  TR 

If demand is inelastic:
 A given percentage rise in price brings a smaller
percentage decrease in the quantity demanded.
 Total revenue increases. And vice versa.
effect of price increase on
a product with inelastic demand: P x QD  TR 
Total Revenue and the Price
Elasticity of Demand
 If price and total revenue change in the opposite

directions, demand is elastic.

 If a price change leaves total revenue unchanged,

demand is unit elastic.

 If price and total revenue change in the same direction,

demand is inelastic.
 Total Revenue and the Price
Elasticity of Demand
 Revenue reaches its peak
if elasticity =1
P Q TR(PQ) MR
18 0 0 -
16 2 32 16
14 4 56 12
12 6 72 8
10 8 80 4
8 10 80 0
6 12 72 -4
4 14 56 -8
2 16 32 -12
0 18 0 0
Total Revenue and the Price
Elasticity of Demand
 The mathematics of elasticity
Suppose that the inverse demand function is given by:
P = 18 – Q 2
TR PQ 18Q - Q
Marginal revenue: dTR/dQ = 18 -2Q
If we want to find the point where revenue is
maximised, we look at the point at which MR=0. thus
18 – 2Q=0
18 = 2Q
9=Q
 If Q=80-2P, find level of output that gives maximum

revenue.
Other types of elasticity of
demand
 Cross-elasticity of demand: the
percentage change in quantity consumed of
one product as a result of a 1 percent
change in the price of a related
% product.
QA
Ex 
% PB
 Arc cross-elasticity
Q2 A  Q1 A P2 B  P1B
EX  
(Q1 A  Q2 A ) / 2 ( P1B  P2 B ) / 2

Q A PB
 Point cross-elasticity EX 
QA

PB
 Other type of elasticity of
demand
 if %ΔQx ÷ %ΔPy >0, then X & Y are
substitutes
 If %ΔQ ÷ %Δp <0, then X & Y are
x y
complements

 The sign of cross-elasticity for substitutes is

positive

 The sign of cross-elasticity for complements

is negative
Other types of elasticity
 Income elasticity of demand: the
percentage change in quantity demanded
caused by a 1 percent change in income
%Q
EY 
%Y
 Arc income elasticity
Q2  Q1 Y2  Y1
EY  
(Q1  Q2 ) / 2 (Y1  Y2 ) / 2
Uses of Elasticities
 Pricing.
 Managing cash flows.
 Impact of changes in competitors’

prices.
 Impact of economic booms and

recessions.
 Impact of advertising campaigns.
 And lots more!
Why Should business
Managers Study Elasticity?
 Own-price elasticity helps managers
understand the impact that price changes
will have on their revenue.
 Income elasticity can help managers

understand what income groups to target

their product to.
 Cross-price elasticity can help managers

understand who their closest competitors

are.
Some questions
 Supposing a university’s enrollment
drops by 20% because tuition rises
by 10%, what is the Price Elasticity of
Demand?
 Answer
 -2, elastic
Home Work.
 Assuming price elasticity of demand for international calls
by Hormud telecom is -8.64. if Hormud lower price by
3%. What will happen the volume of telephone calls by
Hormud?
 Answer
 25.92%
 Cross price elasticity of demand for telecommunication
industry is given by 9.06. What happens the demand for
Hormud, if its competitors reduces their prices by 4%?
 Answer
 -36.24%
Specific Demand
Functions
 Linear Demand

d
QX  0   X PX   Y PY   M M   H H

P PY M
EQX , PX  X X E QX ,PY  Y E QX ,M  M
QX QX QX
Own Price Cross Price Income
Elasticity Elasticity Elasticity
Some computational questions
The daily demand for Invigorated PED shoes is estimated to be
Qx d =100 -3Px+ 4Py -0.01M +2Ax
where Ax represents the amount of advertising spent on shoes
(X), Px is the price of good X, Py is the price of good Y, and M
is average income. Suppose good X sells at $25 a pair, good Y
sells at $35, the company utilizes 50 units of advertising, and
average consumer income is $20,000. Calculate and interpret
the own price, cross-price, and income elasticity of demand.
 Answer:
 To calculate the own price elasticity for
linear demand, we use the formula
PX
EQ X , PX  X
QX

Here 3, and Px =25. The only other information we need to

calculate
 x the elasticity is the quantity consumed of X. To find Qx, we
substitute the given values of prices, income, and advertising into
the demand equation to get

Qx =100 -3(25) +4(35) -.01(20,000) +2(50) = 65 units

33
 Answer:

 Hence the own price elasticity of demand

is given by
25
E QX ,PX  3( )  1.15
65
demand is elastic: Total revenues will fall if it raises shoe prices.

the cross-price elasticity of demand is

35
E QX ,PY 4( ) 2.15
65
Since this is positive, good Y is a substitute for Invigorated PED
shoes
34
 Answer:

 The income elasticity of demand for

Invigorated PED’s shoes is

20,000
E QX ,M  0.01( )  3.08
65
Invigorated PED’s shoes are inferior goods, since this is a
negative number.

35
HOME WORK
 Suppose the demand curve for a product is given
by Qdx=1,000-2Px+0.2Pz, Pz= 400

a) What is the own price elasticity of demand

when Px=154? Is demand elastic or inelastic at
this price? What would happen to the firm’s
revenue if it decides to charge price below
$154.
b) What is cross price elasticity of demand
between good X and good Z when Px=154?
Are good X and Z substitutes or complements?
HOME WORK
 Suppose some statistics made high
education industry show that
Hormud’s own tuition elasticity of
demand for its postgraduate
programs is given by -6.01.
 Another statistics show that

Hormud’s own tuition elasticity of

demand for its undergraduate
programmes-0.32.
HOME WORK
 Therefore Hormud needs to boost
revenue in order to maximize profits.
a) Should Hormud lower or raise its
tuition for postgraduate programs?
Show how with example?
b) Should Hormud lower or raise its
price for undergraduate
programmes? Show how with
example?
HOME WORK

Suppose Horumud’s cross price elasticity of

demand for local calls is 7.05

 a) If competitors reduced their prices by 6

percent, what would happen to the demand
for Hormud’s local calls ?
 b) What will happen to the demand for

Hormud’s local calls if its competitors raise

their prices by 3 percent?