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Elasticity and demand

Elasticity and demand. Paul C. Godfrey Mark H. Hansen Marriott School of Management. What strategists need to know:. What determines demand? How sensitive is demand? How can managers work with/influence demand to create competitive advantage?. How sensitive is demand?.

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Elasticity and demand

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  1. Elasticity and demand Paul C. Godfrey Mark H. Hansen Marriott School of Management

  2. What strategists need to know: • What determines demand? • How sensitive is demand? • How can managers work with/influence demand to create competitive advantage?

  3. How sensitive is demand?

  4. The principle of elasticity • Measures changes in quantity demanded (Q) in response to changes in • Price of the product, Px (own-price elasticity of demand) • Price of substitutes/ compliments, Py (cross-price elasticity) • Changes in income, M (income elasticity) • If demand changes a lot (relative to the price change) a good is elastic • If demand changes very little (relative to price change) a good is inelastic

  5. The price elasticity of demand Inelastic Price Perfectly elastic Elastic Quantity

  6. The Own Price Elasticity of Demand  The percentage change in the quantity demanded of our good (X), given the percentage change in the price of our good (X) this tells us about the power of buyers this tells us how constrained we are in pricing

  7. The Own Price Elasticity of Demand Total Revenue P Elastic Unitary Inelastic Q  when demand is elastic, you can increase total revenue by lowering price  when demand is inelastic, you can increase total revenue by raising price  when demand is unitary, total revenue is maximized

  8. The Own Price Elasticity of Demand Demand: Q = 197 – 4P Elastic Unitary Inelastic Inverse Demand: P = 49.25 – 0.25Q

  9. Measuring Elasticity • Elasticity measures the percentage change in quantity demanded relative to the percentage change in price, or %DQ/%DP • If %DQ > %DP (an elastic product), then |DQ/DP| > 1 • If %DQ < %DP (an inelastic product), then |DQ/DP| < 1 • If %DQ = %DP (unitary elasticity), then |DQ/DP| = 1 • More formally: • e = %DQ / %DP = ((Q1-Q0)/Q0) / ((P1-P0)/P0) = (DQ/Q0) / (DP/P0) • or

  10. Measuring Elasticity Ties What is the own price elasticity in moving from $18 to $15? What is the own price elasticity in moving from $28 to $25?

  11. Measuring Elasticity What is the own price elasticity in moving from $18 to $15? Elastic Unitary Inelastic What is the own price elasticity in moving from $28 to $25?

  12. The cross-price elasticity of demand  The percentage change in the quantity demanded of our good (X), given the percentage change in the price of some good (Y) (could be a substitute or complement) this tells us about the ‘closeness’ of a substitute this tells us about the strength of a complement  this tells us about the threat of substitutes and/or the threat of rivalry

  13. Measuring Cross Price Elasticity Demand: Qh = 60 + 1.5Phd Inverse Demand: Phd = 0.6667Qh - 40

  14. Measuring Cross Price Elasticity What is the cross price elasticity when hot dogs go from $1.00 to $1.50? What is the cross price elasticity when hot dogs go from from $3.00 to $3.50? Hot dogs are substitutes for hamburgers as indicated by the positive elasticity

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