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First Law of Demand
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The consumer purchases more as price falls
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Demand Curve
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Tells you how much (Q) consumers will purchase at a given price
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Consumer Surplus
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the difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer pays
- as the price of products decrease the consumer surplus increases
- as the price of products decrease the consumer surplus increases
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Aggregate Demand Curve
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The sum of all the individual demand curves used to describe the buying behavior of a group of consumers
- Relationship between the price and the number of purchases made by a group of consumers
- Always slopes downward
- Relationship between the price and the number of purchases made by a group of consumers
- Always slopes downward
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How do you determine Quantity Demanded (Qd)?
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On the demand curve look at the price on the x-axis and find the corresponding quantity on the y-axis
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What happens whens MR>MC?
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Sell more by reducing the price
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What happens whens MC>MR?
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Sell less by increasing the cost
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What does it mean when MR is positive?
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the loss in revenue due to lower contribution is smaller than the gain in revenue due to increased quantity
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What does it mean when MR is negative?
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the loss in revenue due to lower contribution is greater than the gain in revenue due to increased quantity
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What does it mean when MR is zero?
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the loss in revenue due to lower contribution is equal to the gain in revenue due to increased quantity
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Price Elasticity
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- Measures how sensitive demand is to change in price
- Captures % Change in quantity with respect to % change in quantity
- Captures % Change in quantity with respect to % change in quantity
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Price Elasticity Formula
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= (% Change in Quantity Demanded)/(% Change in Price)
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% Change in Quantity Demanded Formula
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Q2 - Q1 / Q1 x 100%
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% Change in Price Formula
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new price - old price / old price
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What does it means when something is elastic?
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-A demand curve for which quantity changes more than price or is sensitive to price
§ IeI > 1
§ an increase in price leads to a decrease in revenue
§ a decrease in price leads to an increase in revenue
§ We have to check MR with MC when something is elastic
§ Price and revenue are negatively correlated
§ MR of an additional unit is positive when elastic
§ IeI > 1
§ an increase in price leads to a decrease in revenue
§ a decrease in price leads to an increase in revenue
§ We have to check MR with MC when something is elastic
§ Price and revenue are negatively correlated
§ MR of an additional unit is positive when elastic
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What does it means when something is inelastic?
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A demand curve for with quantity changes less than price
§ IeI < 1
§ an increase in price leads to an increase in revenue
§ a decrease in price leads to an decrease in revenue
§ Always raise the price when inelastic because quantity doesn't change much when you raise the price. However we have to re-estimate the elasticity because it will change as you change the price
§ Price and revenue are positively correlated
§ MR of an additional unit is negative when inelastic
§ IeI < 1
§ an increase in price leads to an increase in revenue
§ a decrease in price leads to an decrease in revenue
§ Always raise the price when inelastic because quantity doesn't change much when you raise the price. However we have to re-estimate the elasticity because it will change as you change the price
§ Price and revenue are positively correlated
§ MR of an additional unit is negative when inelastic
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Is price elasticity always positive or negative?
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-Price elasticity is always negative that is why we use the absolute value sign because price and quantity always move opposite of each other
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What is the Current Margin? And formula?
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(P-MC)/P
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What is the Desired Margin? And formula?
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1/IeI
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Loss Leader
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when a firm deliberately prices an item too low as a way to attract new customers to the store hoping customers would spend money on other items once they get to the store
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5 Factors that affect Demand Elasticity and Optimal Pricing
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- Products with close substitutes have more elastic demand
- Demand for an individual brand is more elastic than industry aggregate demand
- Products with many complements have less elastic demand
- In the long run, demand curves become more elastic
- As price increases, demand becomes more elastic
- Demand for an individual brand is more elastic than industry aggregate demand
- Products with many complements have less elastic demand
- In the long run, demand curves become more elastic
- As price increases, demand becomes more elastic
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Substitutes and Elasticity of Demand
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- Products with close substitutes have more elastic demand
- Products with no substitutes have less elastic demand
- Products with no substitutes have less elastic demand
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Individual Brands and Elasticity of Demand
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- Demand for an individual brand is more elastic than industry aggregate demand
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Complements and Elasticity of Demand
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- Products with many complements have less elastic demand
- Products with few complements have more elastic demand
- Products with few complements have more elastic demand
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Elasticity of Demand Curves: Long Run vs. Short Run
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- In the long run, demand curves become more elastic
- In the short run, demand curves become less elastic
- In the short run, demand curves become less elastic
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Prices and Elasticity of Demand
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- As price increases, demand becomes more elastic
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% Change in Quantity Formula
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= e x (% Change in Price)
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Factor Elasticity of Demand Formula
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(% Change in Quantity Demanded) / % Change in Factor
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Income Elasticity of Demand
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measures the changes in demand arising from changes in income
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Positive Income Elasticity
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- means that the good is normal; that as income increases, demand increases and vice versa
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Negative Income Elasticity
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- means that the good in inferior; that as income increases, demand decreases
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Cross-price Elasticity of Demand
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- measures the change in quantity for X caused by the change in price of Y
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Negative Cross-price Elasticity of Demand
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- means Good Y is a complement to Good X: as the price of complement increases, demand decreases
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Stay-Even Analysis
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- a two-step procedure that tells you whether a given price increase will be profitable
- Step 1: compute how much quantity you can afford to lose before the price increase becomes unprofitable
· % Change in Quantity Demanded= (% Change in Price)/(% Change in Price + Margin)
- Step 2: you predict how much quantity will go down if you raise the price by the given amount
- Step 1: compute how much quantity you can afford to lose before the price increase becomes unprofitable
· % Change in Quantity Demanded= (% Change in Price)/(% Change in Price + Margin)
- Step 2: you predict how much quantity will go down if you raise the price by the given amount
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Monopolistic (simple) Pricing
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where a single firm sells a sing product at the price they chose
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