Cebu Institute of Technology – University

Reporting in Managerial Economics

Submitted by:

Gasang, Shyra Grace

Informanes, Syd Marie D.

Neri, Beto Domineh R.

Peligro, Ma. Stephanie Sandryll

Yaranon, Seth Roem D.

Submitted to:

Mr. Marvin Ian Niere

 Chapter 6: Simple pricing

-a single firm, selling a single product, at a single price.

- involves charging what competitors charge for similar goods and services. This strategy is
often used by retailers and wholesalers selling commodities. Companies that make simple
pricing decisions often try to increase sales by making small, competitive adjustments such as
purchase discounts, volume discounts and purchase allowances

6.1. Background: Consumer Values and Demand Curves

The consumer uses marginal analysis to decide how much to consume because it is an extent
decision. If the marginal value is above the price, the consumer consumes another unit.

It is easy to see from Table .2 that the consumer purchases more as price falls, which is called
the First Law of Demand.

A Demand Curve tells you how much consumers will purchase at a given price.

The Law of Demand – There is an inverse relationship between price and quantity demanded.

The Law of Demand occurs for 3 reasons:

1. The Substitution Effect

2. The Income Effect
3. The Law of Diminishing Marginal Utility

5 Shifters (Determinates) of Demand:

1. Tastes and Preferences

2. Number of Consumers
3. Price of Related Goods
4. Income
5. Future Expectations

Changes in Price don’t shift the curve. It only causes movement along the curve.

Consumer Surplus – the difference between total value and amount paid, increases.

 There is no surplus as the consumer pays a price exactly equal to his total value.
 In macroeconomics, the focus is on the demand and supply of all goods and services
produced by an economy.

Aggregate Demand or Market Demand – is the total number of units that will be purchased by
a group of consumers at a given price.

*Note also that economists have a special jargon describing the response of demand to price.
“We say that as price decreases, ’quantity demanded’ increases. If something other than price
causes an increase in demand, we instead say that the “demand Shifts” to the right, or “demand
increases”, such that consumers purchase more at the same price.
6.2 Marginal Analysis of Pricing

Pricing decisions tend to involve analysis regarding marginal contributions to revenues and cost.
Business tend to accomplish their objectives of getting higher profit by raising the price of the
production until marginal revenue equals marginal cost, and then charging a price which
determined by the demand curve. In marginal analysis of pricing, if marginal revenue is greater
than marginal cost at some level of output, marginal profit is positive and thus greater quantity
should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal
profit is negative and lesser quantity should be produced. At the output level at which marginal
revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes
profit.

6.3 Price Elasticity and Marginal Revenue

Finding the right price for your goods and services is essential to maximizing your revenues,
and one of the key factors in making this determination entails using price elasticity to predict
marginal revenue. There's a direct relationship between price elasticity and marginal revenue.
The more elastic a good is, the more its demand is affected by changes in supply.

Price Elasticity

In the world of microeconomics, goods are either elastic or inelastic. The demand for an elastic
good is heavily influenced by price. For example, there are many different brands of almond
butter. There are also many different substitutes for a product, including peanut butter and
cashew butter. For this reason, an increase in price will decrease demand as customers opt for
a lower-priced product. The more demand changes with price, the more elastic a good is.

 MR > MC, reduce price (sell more)

 MR < MC, increase price (sell less)

Price Elasticity of Demand = % change in Quanity Demand

% change in Price

• If the price elasticity of demand is greater than 1, demand is elastic.

• If the price elasticity of demand is less than 1, demand is inelastic.

Price Inelasticity

An inelastic good is one where changes in price do not change demand. If you raise the price of
a life-altering drug, it will not change demand, and substitutes rarely exist for life-altering drugs.
Only legal monopolies exist for price-inelastic goods, since price is not a driver of demand. A
legal monopoly is created by a patent, copyright or exclusive right to the use of intangible asset.
 Midpoint formula

Price Elastivity of Demand = (Q2 – Q1) / [(Q2 – Q1) / 2]

(P2 – P1) / [(P2 – P1) / 2

Marginal Revenue

Marginal revenue is the incremental revenue for each unit sold. A company that sells high-
volume products benefits from economies of scale, which allows them to lower prices, which
increase sales volume. To keep demand high, the price is lowered even more. The more a
company sells, the more it can save, and the more of those savings can be passed along to the
customer. The natural monopoly is driven by the low-cost leader.

6.4 WHAT MAKES DEMAND MORE ELASTIC?

There are factors that affect demand elasticity and optimal pricing.

 Products with close substitutes have more elastic demand.

the more close substitutes there are in the market, the more elastic is demand because
consumers find it easy to switch. E.g. Air travel and train travel are weak substitutes for
inter-continental flights but closer substitutes for journeys of around 200-400km e.g.
between major cities in a large country.
Demand for a commodity with large number of substitutes will be more elastic. The
reason is that even a small rise in its prices will induce the buyers to go for its
substitutes.
If there is a greater availability of substitutes, then the good is likely to be more elastic.

 Demand for an individual brand is more elastic than industry aggregate demand.
As a rough estimate, brand price elasticity is approximately equal to industry price
elasticity divided by the brand share.
This will indicate the extent to which production can be increased in response to an
increase in the price of the product.

 Products with many complements have less elastic demand.

Individual products that are consumed as part of a larger bundle of complementary
goods say, computers, operating systems, and the applications that run on them have
less elastic demand.
Price elasticity of demand is always related to a period of time. It can be a day, a week,
a month, a year or a period of several years. Elasticity of demand varies directly with the
time period. It happens because consumers find it difficult to change their habits, in the
short period, in order to respond to a change in the price of the given commodity.

 In the long run, demand curves become more elastic.

Time also exerts considerable influence on the elasticity of supply. Supply is more
elastic in the long run than in the short run. The reason is easy to find out. The longer
 the time period the easier it is to shift resources among products, following a change in
their relative prices.

 As price increases, demand becomes more elastic

raising prices increases revenue. Elastic demand is more sensitive to price, so small
changes in price results in larger changes in quantities, changing revenue in the
opposite direction to prices. Hence, increasing prices decreases revenue.

6.5 Forecasting Demand Using Elasticity

Factors can be anything that affects demand such as temperature, prices of substitute and
complements, advertising, incomes, or tastes.

Examples:

Income Elasticity of Demand

Normal goods are positive, referred to as necessity goods, which are products and services
that consumers will buy regardless of changes in their income levels. Examples of necessity
goods and services include tobacco products, haircuts, water and electricity.

Inferior goods have a negative income elasticity of demand; as consumers' income rises,
they buy fewer inferior goods. A typical example of such type of product is margarine, which
is much cheaper than butter.

Cross-Price Elasticity of Demand

Substitute

When the cross elasticity of demand for product A relative to a change in the price of product B is
positive, it means that in response to an increase in the price of product B, the quantity demanded
of product A has increased. An increase in the price of product B means that more people will
consume A instead of B, and this will increase the quantity demanded of product A.

Examples: online streaming vs Direct DVD purchases

Kopiko vs Nescafe
 Complementary

Two goods that complement each other have a negative cross elasticity of demand: as the price of
good Y rises, the demand for good X falls.

Examples: Cars and Fuel

If the price of coffee increases, the quantity demanded for coffee stir sticks drops
as consumers are drinking less coffee and need to purchase fewer sticks.

6.6 Stay-Even Analysis, pricing, and Elasticity

Stay-even analysis can be used to determine the volume required to offset a change in costs or
prices. Prices at the point where MR=MC, is sometimes implemented by using a version of
break-even analysis. Instead of asking which price maximizes profit, you will ask “will a given
price increased 5%, be profitable?” to answer the question, we will compute the stay even
quantity, the quantity you can afford to lose and still break even. Then predict whether the actual
quantity lost will be greater or less that the stay-even quantity. If the actual quantity is less than
stay-even, then the price increase will be profitable.

6.7 Cost-Based Pricing

Example: a toaster manufacturer has the following costs: Variable costs: $10, Fixed costs: $300,000.
Expected unit sales are 50,000.

To calculate the unit cost, we need the following formula:

Cost-based pricing Unit Cost

Now suppose the company wants to earn a 20 percent markup on sales. The markup-price in cost-
based pricing is determined by the following formula:
 Cost-based pricing Markup price

Consequently, the company will charge dealers $20 per toaster and hence make a profit of $4 per
unit. The dealers, in turn, will add their own markup, making the product more expensive for the
final customers.