BUS-525 [SEC 4 & 5]

MANAGERIAL ECONOMICS
COURSE CONVENER:
DR. K.M. ZAHIDUL ISLAM
PROFESSOR, IBA, JAHANGIRNAGAR UNIVERSITY
& ADJUNCT FACULTY, NSU, SBE
GENERAL ADMINISTRATION

 About the course

 Class schedule and attendance

Managerial Economics
 Required text and materials: Pindyck
R. S., Rubinfeld D. L. and Mehta, P.
L. (2011) Microeconomics (8th Ed),
Pearson Publications.
 Syllabus

 Assessment

2
BASICS OF DRAWING GRAPHS IN
ECONOMICS
 Following are the issues you need to know:
1. Label horizontal and vertical axis with appropriate
variable name

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2. Find/assume the relationship between the variables with
logic. [ P goes up demand goes down, [-: Normal product;
Income goes up, demand goes up, normal product]
3. Prepare a table to show the relationship between the
variables
4. Plot the values (for both the variables) in the diagram and
connect the points to get a continuous line. Remember, if
you are given a coordinate point such as (5, 7), first
number (in our case 5) is for the X-axis variable and
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second number (in our case 7) for the Y-axis variable.
BASICS OF DRAWING GRAPHS IN
ECONOMICS
 You may have any of the following relations between
two variables under consideration:
Positive (the line should be upward slopping)

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1.

2. Negative (line is downward slopping)

3. One variable has constant/fixed impact on another .
That is, when one variable changes the other one
experiences no change(either a perfectly horizontal or
perfectly vertical line)

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WHAT TO BEGIN WITH:
FUNDAMENTALS
 Economics: It is the study of how societies use scarce
resources to produce and deliver the valuable goods in
order to fulfill the unlimited needs of the people.

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 Economics divides into two main parts

 Microeconomics – study of choices that individuals and

businesses make, the way those choices interact in
markets, and the influence of governments.
 Macroeconomics – study of the performance of the
national and global economies

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What is Microeconomics and Macroeconomics ? Micro means “
Small” and Macro means “Large”

Microeconomics deals with the study of individual behavior.

• It deals with the equilibrium [ D = S] of an individual consumer,
producer, firm or industry.

Macroeconomics on the other hand, deals with economy wide

aggregates.

• Determination of National Income Output, Employment

• Changes in Aggregate economic activity, known as Business
Cycles
• Changes in general price level , known as inflation, deflation
• Policy measures to correct disequilibrium in the economy,
Monetary policy and Fiscal policy
FATHER OF ECONOMICS
 Adam Smith (1723 – 1790) was a Scottish
Economist.
 He is said FATHER OF ECONOMICS
 He is also FATHER OF CAPITALISM
 His Book: WEALTH OF NATIONS [ An
inquiry into the causes and nature of wealth
of nation]
 We want to talk about POVERTY not wealth.
 His main theory is “There is an invisible
hand [ Laissez Faire] that determine
everything – Don’t disturb it”[ Laissez faire]
 What is the invisible hand?
INVISIBLE HAND
 P Invisible hands – demand and
supply – determines quantity
and price.
D: Price goes up, demand
goes down [ Inverse
relationship; Law of demand]
S: Price goes up, supply goes
S D up [ Positive relationship; Law
of supply]

Q
TERMS
Explicit Cost [EC]: Direct Monterey for market supplied resources.
Implicit Cost [IC]: Non-monetary opportunity cost [ Next best option scarified
for selecting one option] of using own resources.
Economic Profit (EP) = Total revenue (P*Q) – EC –IC
Accounting Profit (AP) = TR – EC

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AP> EP, but if resources have no alternative use then EP = AP.

Positive Economics: Description of something as it is.

Normative Economics: What should be [ Recommendation]
Production Possibility Frontier (PPF): Using a technology how two good may be
produced.

Example: Taka 500,000@12%, Start a small business: TR = 180,000; labor+

Material cost +FOH ( Factory overheard) = Taka 50, 000
EP = 180000 – 50,000 – 60000 = Taka 70000
AP = 180000 – 50,000 = 130000 9
WHAT IS MANAGERIAL ECONOMICS
 Douglas - “Managerial economics is .. the application of
economic principles and methodologies to the decision-
making process within the firm or organization.”

 Salvatore - “Managerial economics refers to the application

of economic theory and the tools of analysis of decision
science to examine how an organisation can achieve its
objectives most effectively.”
 Managerial Decision Problems [ P?]

Economic theory Decision Sciences

Microeconomics Mathematical Economics
Macroeconomics Econometrics

MANAGERIAL ECONOMICS
Application of economic theory
and decision science tools to solve
managerial decision problems

OPTIMAL SOLUTIONS TO
MANAGERIAL DECISION PROBLEMS [ ACmin = Average
cost minimum = Taka 40, P = Taka 35, 45, 50]
FIGURE 1 THE CIRCULAR FLOW

MARKETS
Revenue FOR Spending
GOODS AND SERVICES
•Firms sell
Goods Goods and
•Households buy
and services services
sold bought

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of Taka

Copyright © 2004 South-Western

THE BASICS OF SUPPLY AND DEMAND
 Supply : Amount of goods and services
that a producer is willing to supply at
different market prices.

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 The curve: Relationship between the

quantity of a good that producers are

willing to sell and the price of the good.
 A positive relationship. Why??

 Because it follows:

QS = QS(P) (Movement along the supply

curve/ Change of quantity supplied)
Movement along the supply curve [ Change
of quantity supplied; Price of the goods
is changing but other factors are
constant]
Shift of the curve [ Change of the supply]:
Other factors other than goods own
price may change. 13
OTHER VARIABLES THAT AFFECT
SUPPLY: SHIFTING OF THE CURVE

 The quantity that producers are willing to sell depends not

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only on the price they receive but also on their production
costs, including wages, interest charges, and the costs of
raw materials.
 When production costs decrease, output increases no
matter what the market price happens to be. The entire
supply curve thus shifts to the right.
 Economists often use the phrase change in supply to refer
to shifts in the supply curve, while reserving the phrase
change in the quantity supplied to apply to movements
along the supply curve. 14
DETERMINANTS OF SUPPLY
Qx = f( Px, input price, Py, Pe, Tax, Subsidy, quota…)

Where Py = Price of related goods [Pepsi and coke; Pepsi price goes
up, coke price is at is . What will happen to the supply of coke? Supply

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of coke should go down. The products are substitute]
If price of Camera goes up what will happen tot the supply of film?
Supply of film should go up. The [products are Complements]
Pe = expected future price [ Pe goes up, supply goes down]
Tax goes up, supply goes down
Subsidy : subsidy goes up, supply goes up.

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 THE DEMAND CURVE
 Demand: The amount of goods and services that
an individual is willing and able to buy at given
market prices.
 Flow is: Need ( a felt deprivation) then Want and
then Demand

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 If food is need, fish, vegetable and meat can be
want. But the one you can effort (ability factor) is
demand. Try other examples.
 Demand curve shows the relationship between
quantity demand at different prices. (Movement
along the demand curve / Change of quantity
demanded; goods own price changes but other
factors are held constant]
 Shift of the demand curve ( Change of the
demand): Price is constant but any factor
influencing demand may change
 QD = f(P) [ Direct demand function]

P = f(Qd) [ Indirect demand function] 16

HOW TO IDENTIFY PRODUCT?
 P goes up; demand goes down; Normal product [ -; price and quantity negatively related]
 P goes up; demand goes up; Giffen product [ +]; violation of law of demand ( price goes
up, demand goes up; Potato).
 M (money / income) goes up, demand goes up, Normal product [+]
 M (income) goes up , demand goes down, inferior product [-]

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Price of related product [; Main product is X; Py = Price of related product]
 If Py [ coffee ] goes up, demand of related product goes up (Qx= tea; Price of tea is
constant); Substitute product (one for another)
 If Py [leather ] goes up, demand of related product goes down (Qx= shoe; Price of shoe is
constant); complement product [ two products are required at the same time].
…………………………………..
Em = Income elasticity of demand; m= money = budget= Income
= % change in Qd/% Change in income = 15%/10% = + 1.5
Income elasticity [ Em> 1( + and>1) ] is positive and greater than 1, it is luxury product.
Income elasticity [ Em> 0( + and<1) ] is positive and less than 1, it is necessity product.
[ Em = 8%/ 10% = + 0.8
Em = -5%/ 10% = - 0.5 [ look at the sign and comment on the type of the product, in this case 17
it is negative, Inferior; take the absolute value, Absolute value is less than 1, demand is
inelastic]
DIRECT AND INDIRECT DEMAND
FUNCTION
Qd = f(P) = a + bP [ like Y = c+ mx]
Qd = 8 – 2P [ Direct demand] ; If price is Taka 2, Qd = 8

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– 2*2 = 4

m = (y2 –y1) / (x2 –x1)

…………………………..
2P = 8 – Q
P = 4 – 0.5Q [ indirect demand] ; If Q = 1, P = 4 -0.5*1 =
3.5

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 Giffen Product:
M = Money/ Income = Taka 10,000 = Nominal income

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Potato [ Taka 20 ; Meat [ Taka 500]
If potato price goes up, real income [ income expressed by the
number of goods] should go down. Consumer should be buying
potato more rather than starving.

Potato = M/Pp= Taka 10000/20 = 500 = Real income

Meat = M/meat Price = 10,000/ Taka 500 = 20= real income.

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HORIZONTAL SUMMATION OF
INDIVIDUAL DEMAND: FROM
INDIVIDUAL TO MARKET DEMAND
 Determinants of demand
QDX = f(PX, M, N, , PY, T, Pe)

QDX = quantity demanded of commodity X

PX = price per unit of commodity X [ -, +]
M = Income of the consumers [ +, -]
Number of buyers [+]
N=
price of related (substitute or
Py = complementary) commodity [ +, -]
T = Taste [ +]
Pe = Expected Future price [ +]
OTHER FACTORS INFLUENCING
DEMAND (SHIFTING THE LINE)
 Substitutes: Two goods for which an increase in the

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price of one leads to an increase in the quantity
demanded of the other. Example: Tea/Coffee,
Coke/Pepsi, Private/Public Uni??
 Complements: Two goods for which an increase in the
price of one leads to a decrease in the quantity demanded
f the other. Example: Blade/Razor, Pair of shoes,
Tea/Sugar etc.
 How do they affect the position of the demand curve?
Try with the stated examples.
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MARKET MECHANISM
 Equilibrium is the most efficient
point in a market as it is found
with the interactions of DD )

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deand curve) and SS ( supply
curve) curve. Why not other
points ?? Surplus and shortage
and equilibrium distortion?
 Equilibrium price is the one that
equates demand and supply of a
product. [ P2 = Maximum price
= Ceiling price ---Shortage; P1 =
Minimum price = Floor Price;]
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APPLICATIONS OF MARKET
MECHANISM: MANAGERIAL
IMPLICATIONS
Explain different cases of shift in demand and supply curve (Hint:
Market is already in Equilibrium: D = S).
What if demand for private schooling increases because of population

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
growth
 What if cost of production increases because of an increment in price
of an ingredient (fertilizer)
 What if per/hour labor charge increases to harvest rice?
 What happens to the market equilibrium of Coke if the price of Pepsi
decreases
 What happens to the market of Keyboard if the price of processor
increases
 What happens to Rice market if cost of producing Noodles declines?
 Cattle disease is discovered: 24
 Medical research says that the product is cholesterol free
MANAGERIAL APPLICATIONS

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 Assume, Qd = 80 – P and Qs = -10 + 0.5P. Find the
equilibrium quantity and price. Show the equilibrium in a
diagram.

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MANAGERIAL APPLICATIONS

 Deriving demand and supply equations from a set of data

Price QD QS

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12 (p1) 140(q1) 20 [ d>s; shortage]
20 (p2) 100 (q2) 100 [ equilibrium; d = s]
28 60 180 [ d<s ; surplus]
36 20 260
Find the demand and supply equations and then find the equilibrium.
Draw the diagram for the problem
m= slope = (y2 –y1)/ (x2 –x1) [ y = mx+c ]

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FINDING DEMAND AND SUPPLY
EQUATIONS
For Demand equation
P1 = Taka 12, Q1 = 140
P2 = 20; Q2 = 100
Qd = f( P)= a+ bP [ like y = mx + c]

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b = QX/PX = slope ;  = delta = small change
= (Q2 –Q1)/(P2-P1) = (100 – 140)/ (20-12)
= - 40/8 = - 5
Qd = a - 5P [ if price goes up by Taka 1, demand goes down by 5]
How to find constant = a; say P = Taka 12
Qd = a -5*12; Qd = a – 60
140 = a – 60; a = 200
Qd = 200 – 5P (1) Demand equation
Drawing the graph: P = 0; Qd = 200; 27
Qd = 0; 0 = 200-5P; P = Taka40
 SUPPLY EQUATION
P1 = Taka 12, Q1 = 20
P2 = 20; Q2 = 100
Qs = f(P) = a+ bp
b = QX/PX
= 100-20/20-12 = 80/8 = 10
Qs = a+ 10P [ if price goes up by Taka 1, supply goes up 10 units]

Managerial Economics
Let us say P = Taka 12
Qs = a+ b*12; 20 = a+10*12 = a+ 120
a = -100
Qs = -100+ 10P [2] supply equation
For equilibrium; solve D = S
200 – 5P = -100+ 10P
-5P -10P = -100 – 200
15P = 300
P = Taka 20; put equilibrium price in demand or supply;
d = 100; [Qd = 200 – 5P = 200 -5*20 = 100
S = 100 [Qs = -100+ 10P = -100 +10*20 = 100]
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DEMAND EQUATION[ ANOTHER
EXAMPLE]
Qd = f(P) = a+ bP = 8 – 2P [ like y = mx +c]
b = slope = QX/PX = (Q2 –Q1) /(P2-P1)
Say P is 0; Qd = 8; qd = 0; 0 = 8 - 2P ; 2P = 8; P = 4
Ed = PED = Slope*P/Q = -2*P/Q = -2*2/4 = -1 [ Unit elastic
demand]

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 MANAGERIAL APPLICATIONS
 At a price of $5, 1,000 movie tickets would be demanded in a small town, but only 200
would be supplied, while, At a price of $15, 300 movie tickets would be demanded and
1,200 would be supplied.
Derive the demand and supply equation and calculate equilibrium price and quantity.
Ans: P1 = Taka 5, P2 = Taka 15
DEMAND

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Q1 = 1000; Q2 = 300 [ SUPLLY , Q1 = 200, Q2 = 1200]
Qd =f(P) = a + bP ; b = Change of Q/Change of P = (300 -1000)/ (15-5) = -700/10 = -70
Write the demand equation = a- 70P; Qd = 1000 = a- 70*5
a = 1350
Qd = 1350 – 70P [ 1]
Similarly derive the supply equation
 Solve Qd = Qs
 Put the equilibrium Price in Qd and Qs
….
Elasticity (=PED ( Price elasticity of demand =Ed) = % change in Qd/% change in P = (300 -1000)/1000/
[(15 -5)/5 = -70%/200% = - 0.35 [absolute value of Ed is less than1,so demand is inelastic; Inelastic
30
demand]
Another example, Ed = - 2 ; Absolute value is greater than 1, demand is elastic
PREDICTING CHANGE IN THE MARKET:
CONCEPTS OF ELASTICITY

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 Why applying elasticity:
- It measures the responsiveness of one variable with respect
to a change in another (such as price and quantity demand).
- Provides exact measure of change.
- Types of product and demand can be identified
- Appropriate for competitor’s strategic analysis

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ELASTICITY EXAMINED
 Price Elasticity of Demand [=PED =Ed = Ep]
Price elasticity of demand measures percentage change in quantity
demanded of a good resulting from a 1-percent change in its price. [ q1 =
10, q2 = 12, p1 = Taka 5, P2 = Taka 3]

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Question: Are PED and slope of the demand curve same??? [ No]

[ % change of Price = (3 -5)/5 = -40%

% Change of Qd = (12 -10)/ 10 = 20%
ED = 20%/-40% = -0.5 ;Look at the sign: - [ Normal product]; Take
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absolute value of PED, it is Less than 1, so demand is inelastcic.
EXPLANATION: ED = EP = PED AND SLOPE

 Elasticity and slope is not the same thing.

 Slope is same every where along a linear demand curve
but elasticity is not same every where along the linear
demand curve.

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33
 ELASTICITY AT DIFFERENT POINTS OF DD CURVE
 The price elasticity of demand depends not only on
the slope of the demand curve but also on the price
and quantity.
 The elasticity, therefore, varies along the curve as
price and quantity change. Slope is constant for this
linear demand curve.

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 At the top portion of the demand curve, as price is
high and quantity is small , elasticity is large.
 The elasticity becomes smaller as we move down
the curve.
PED= QX/Px*P/Q = -2 *1/6 = - 0.33 [ inelastic]
PEd = QX/Px*P/Q = -2*2/4 = -1 [ Unit elastic]
PED = QX/Px*P/Q = - 2*3/2= -3 [ elastic]

Elasticity of demand is negative, Product is

normal.
Absolute value of Ed>1; the demand is elastic, if it
is <1, it is inelastic, If it is 1, it Unit elastic.
But if Ed is positive, the product is giffen.
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TYPES OF ELASTICITY
 Types of price elasticity :
 1. Perfectly elastic demand Ep = ∞
 2. Elastic demand Ep > 1 [ absolute value greater

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than 1, Ep = - 3 ; absolute value is 3]
 3. Inelastic demand Ep < 1
 4. Unit elastic demand Ep = 1[ ep = -1; take
absolute value]
 5. Perfectly inelastic demand Ep = 0

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EXTREME CASES OF
ELASTICITY

 (a) For a horizontal demand

curve, ∆Q/∆P is infinite.
Because a tiny change in price

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leads to an enormous change
(too much responsive) in
demand, the elasticity of demand
is infinite. [ Perfectly elastic
demand; Ep = ∞ ]
 For a vertical demand curve,
∆Q/∆P is zero. Because the
quantity demanded is the same
(thus non-responsive) no matter
what the price, the elasticity of 36

demand is zero.
HOW TO FIND SLOPE, IF EQUATION IS NOT GIVEN

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37
CONT. .
 Slope = rise/run = 4/8 = ½
 Take inverse of ½ = 2 [ then take a negative sign, as
Price and quality is inversely related]
Slope = -2 [ According to law of demand]

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38
A NUMERICAL EXAMPLE

Quantity Q2-Q1 Price P2-P1 PED

1 125 Slope = (q2-q1)/(p2 –p1) =(2-1)/(100-125)

=1/-25

(1/-25)* (125/1) = - 0.04x125 = - 5; point

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elasticity
Ed= QX/Px*P/Q

2 1 100 -25

4 2 50 -50 (2/-50)x(100/2) = - 0.04x50 = - 2

5 1 10 -40 (1/-40)x(50/4) = - 0.025x12.5 = - 0.3

 How to interpret the results

 Two interpretations to make:
1) Look at the sign and say whether the good is normal or giffen
2) Now look at the absolute value and say whether it is demand 39
elastic or inelastic or unit elastic.
CONT…[ARC/ INTERVAL ELASTICITY]
Q1= 1, p1 = 125
q2 = 2; p2 = 100
Slope = 1/-25 [ slope = (q2 – q1)/(p2 –p1)]
Elasticity ( Arc/Interval elasticity]

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= Slope*(p1+p2)/2/( q1+q2)/2 = slope* Average P/Average Q
=1/-25*112.5/1.5 = -0.04 * 75 = -3

 Point Elasticity at price 125, elasticity at price 100

Ed= QX/Px *P/Q
 Elasticity in between prices of Taka 125 and 100 [ ARC elasticity].
Arc elasticity= QX/Px *(p1+p2)/2/( q1+q2)/2
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RELATION BETWEEN ELASTICITY AND
REVENUE: MANAGERIAL APPLICATION

 If ED>1 (elastic demand) that means ∆Q>∆P thus this product is price sensitive. A small
reduction of price will significantly increase the quantity demand.

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 Decision: Reduce price and maximize revenue. Example, Example , luxury and addictive goods
such as automobiles, cigarette, perfume etc.
 Summary: Ed>1; decrease price, revenue goes up

 In case of ED<1 (inelastic demand) do the opposite. Example: daily necessary

 Decision: Increase price and thus revenue. [ Ed<1]
 If ED = -1 (unit-elastic demand), wait and observe. [ revenue should not change if we increase
or decrease price]
Ed<1 , increase price, revenue goes up[ decrease price, revenue goes down]
Ed>1, if price is increased, revenue is decreased.
TR = Total Revenue = P*Q [ Rice price is increased by 20%, demand decrease by 5%, Price
is increase, revenue is increased, Price has more powerful impact on Total revenue, Ed<1, for
product with inelastic demand]

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 CRITICAL DECISION MAKING: A
NUMERICAL EXAMPLE
 Your supermarket is selling 1000 containers of butter a week at $ 1.50 each. You
know that the own price elasticity for butter is –0.8. If you decide to reduce the price
by 10%, how many more butter containers would you be selling that week?

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ANS:
Ed = % change in Qd/% change in Price = % change in Q/-10%
-0.8 = % change in Q/-10%
% change in Qd = -0.8* (-10%) = + 8% = 1000* 8% = 80; new demand =
1000+ 80 =1080
New Revenue = P*Q = 1.35* 1080 = 1458 [ new price = Taka 1.5*90% =
Taka 1.35
Initial Revenue = P*Q = Taka 1.5* 1000 = Taka 1500
Decision: Do not decrease price as the product demand is inelastic
[ Ed<1].
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FINDING THE SOLUTION
Since E= Q/Q / P/P = -0.8, and
P/P = - 0.10 [ decrease price by 10%]
Q/Q= -0.8 *(- 0.10)
Q= -0.8*(-0.10) * 1000 = 80 more units should be sold

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What would be the total revenue gain?
Revenue without price reduction= 1000*1.50 = 1500
New revenue= 1080 *1.35 = 1458
Was it a good decision?
 What if you increase the price by 10%??

New revenue = P*Q = 1.65*920 = 1518

Now you are a good manager!!!!
New price = Taka1.5*1.1 = Taka 1.65
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New Q = 1000 - 80 = 920
 Elasticity and Revenue : If demand is elastic a given fall in price causes a relatively
larger increase in the total revenue.

 P↓ - TR↑ when demand is elastic. [ Increase price, revenue decreases.

 P↓ - TR↓ when demand is inelastic. [ Increase price, revenue should go up]
 P↓ ↑ - TR remains same when demand is Unit elastic. [ Rule of revenue
maximization]

Let us Consider The equations: Q = 120 – 6P to explain the relationship between elasticity
and revenue.

Measurement of elasticity :
 Point and Arc elasticity

 Elasticity when demand is linear [ everywhere slope is same]

 Determinants of elasticity :
 (1) Number substitutes, [ black jeans and blue jeans; elasticity should be higher,

Ed>1]
 (2) the buyers’ budgets, [banana, family dinner in a restaurant; expensive item’s

elasticity should be higher]

 (3) Time dimension [short-run ( elasticity is less), long-run ( elasticity should be

high]
 (4) Necessity vs luxury product [ water (elasticity is inelastic), diamond (elastic

demand]
 Other Elasticity Concepts
 Income elasticity

 Cross elasticity
ELASTICITY AND REVENUE RELATIONSHIP
 P↓ ↑ - TR remains same when demand is Unit elastic.

TR = Total revenue = P*Q

dTR/dQ = MR (= Marginal revenue) = P. 1+ Q. dP/dQ [ apply uv rule
of derivation]
= P(1+ Q/P* dP/dQ) = P(1+1/Ed)
[Q/P* dP/dQ it is opposite of

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elasticity]
MR = P(1+1/Ed)
Let us check
P = Taka 10, E = -1, - 0.5, -2
MR = P(1+1/Ed)
MR = 10( 1+1/-1) = 0 [ Maximized]
MR = 10(1+1/-0.5) = -10
MR = 10(1+1/-2) = 5
Findings: Revenue is maximized when Ed = -1 [ Unit
elastic]

45
AN EXAMPLE:

Q = 120 – 6P [ Direct demand function]

6P = 120 – Q
P = 20 -1/6Q [ Inverse demand function]
P*Q = TR = 20Q -1/6Q^2 [ Multiply both sides by Q]
dTR/dQ = MR = 20 – 1/6*2*Q = 0 [ F.O.C; First order condition]
20 – Q/3 = 0

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60 – Q = 0
Q* = 60; P* = 20 -1/6 *Q = Taka 10 [ Ed = -6*P/Q = -6*10/60 = -1]
TR* =P*Q* = Taka 600
Decision: If we sell 60 units revenue should be optimum; At Q = 60, MR = 0 and Ed = -1;
any Q below 60, MR>0 and Ed>1, at any Q> 60, MR<0 and Ed <1
Y = ax^n
dy/dx = a. n.x^n-1 [ derivation: The rate of change of a function with respect to a change a variable]
Y = 6x^2
dy/dX = 6.2.x^2-1 = 12X
TR = P*Q
dTR/dQ = MR = P.1.Q^1-1 = P + Q.dP/dQ = P(1+ Q/P. dP/dQ) = P(1 +1/Ed)

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 LET’S WORKOUT ONE MORE

 Assume that you are in an interview session and the panel asks you
to give a pricing decision that will maximize company’s interest
(that’s revenue) based on the following functions:
Demand: QD = 3550 – 266P

Managerial Economics
Supply: QS = 1800 + 240P
Decision: As Ed ( elasticity of demand) is less than 1 (Ed = -0.35, see
in the next page), the demand is inelastic, if we increase price,
revenue should go up.

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2.4 ELASTICITIES OF SUPPLY AND DEMAND

For a few decades, changes in the wheat market had major

implications for both American farmers and U.S. agricultural
policy.

To understand what happened, let’s examine the behavior of supply and demand
beginning in 1981.

By setting the quantity supplied equal to the quantity demanded, we can determine
the market-clearing price of wheat for 1981:
2.4 ELASTICITIES OF SUPPLY AND DEMAND

Substituting into the supply curve equation, we get

We use the demand curve to find the price elasticity of demand:

Thus demand is inelastic.

We can likewise calculate the price elasticity of supply:

Because these supply and demand curves are linear, the price elasticities will
vary as we move along the curves.
CROSS PRICE ELASTICITY OF DEMAND: EXPLORING
THE RELATION WITH SUBSTITUTE AND COMPLEMENTS
 Shows the percentage change in the quantity demanded of
good Y in response to a change in the price of good X.

Managerial Economics
 EDYX = % Change in QDY / % change in PX
 Algebraically: Qy Px Qy Px
EdYX    
Qy Px Px Qy
Read as the cross-price elasticity of demand for commodity
Y with respect to commodity X.
Units of Y demanded Price of X EDYX___________
60 $10
40 $12 (-20/2)x(10/60) = - 1.66
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EdYX = -20/2* 12/40 [ At pX = Taka 12, Qy = 40; Product is complement and
demand is elastic as the absolute value of EYX is more than 1]
INTERPRETING RESULTS

 If CED [ cross elasticity of demand] is (+) ve, goods are substitute

to each other

Managerial Economics
 If CED is (-) negative, goods are complements which is the
case here [ -1.66]

 Our value of Eyx = -1.66 can be interpreted as: Goods are

complements and 1% increase in price of X will have
more than 1% (1.66%) reduction in demand for Y.

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INCOME ELASTICITY OF DEMAND
 Shows the percentage change in the quantity demanded of good Y in response to
a percentage change in Income.
EI = Em = % Change in QY / % change in I

Managerial Economics
 Algebraically:

Qy I Qy I
EI    
Qy I I Qy
Units of Y demanded Income EI
100 $1200
150 $1600 (50/400)x(1200/100) = 1.5

Luxury ( EI is positive and greater than 1) and demand is elastic

If we get EI = -5; product is inferior, EI is elastic [ Absolute value of EI>1, so it is elastic demand]
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INTERPRETING RESULTS
 If IED is Positive (but less than one), good is normal; necessity
 If IED is negative good is inferior

Managerial Economics
 If IED is Positive (but greater than one), good is Luxury.

 Our value of 1.5 can be interpreted as: Good is luxury and 1%

increase in income will have more than 1% (1.5%) increase in
demand for this goods.

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 MANAGERIAL APPLICATION
 Advertising elasticity: It shows the responsiveness of the
quantity demanded of a particular product with respect to a
change in advertising expenditure (budget).

Managerial Economics
 Interpretation of the result: If a 10% increase in advertising
expenditure causes an increase in sales by 4%, advertising
elasticity is 0.40. [ Advertisement = % Change in Sales/ %
Change in Ad. Expenditure)
This means, advertising campaign was not effective from a
sales perspective.

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 PED (=Ed) = - [ normal]
 Em = - [ inferior

Managerial Economics
 Em = + but less than 1, the product is a necessity, if Em
>1 [ + ,>1 , luxury]

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