Chapter 3: DEMAND ANALYSIS AND OPTIMAL PRICING
1. Examine the determinants of demand
2. Study the common elasticities of demand including various forms of each
3. Introduce key relationships involving the price elasticity of demand
4. Examine pricing strategies
5. Study 1st, 2nd and 3rd degree forms of price discrimination
Reading: All (excluding the Appendix)
Problems: 1-3, 5-10, 13, 14.
WHAT YOU SHOULD BE ABLE TO DO
1. Understand and work with demand functions including demand shifts
2. Understand and work with 3 elasticity concepts: point, arc, calculus
3. Compute price elasticity, income elasticity and cross-price elasticity of demand. Understand the geometric computation of Ep.
4. Recognize complement, substitute, normal, and inferior goods
5. Applications of elasticities to project or determine unknown values
6. Understand the algebraic and geometric relationships between Ep, total and marginal revenues. Determine the optimal price under conditions of constant marginal cost.
7. Understand 1st, 2nd and 3rd degree price discrimination.
8. Compute the loss in consumers' surplus under 1st degree. Compute profit-maximizing prices and quantities under 3rd degree price discrimination.
EXAMPLE
A firm faces the following demand for its product: Q = 20000 - 8P + 0.2Y - 85Po, where Y is average family income and Po represents the price of another good.
c. Determine the quantity demanded at a price of $825. Compute Ep (arc method) if price increases from $825 to $850.
d. Using calculus, compute Ep at a price of $825.
e. Determine Ey (calculus) at an income level of $30,000 if P = $825 and Po = $60.
f. Suppose that the firm has a constant marginal cost of $500 and no fixed costs. Determine the profit-maximizing price and quantity. Compute the firm's profits.
g. Suppose that the firm can be a prefect (1st degree) price discriminator. How much will the firm produce and what are its maximum profits?