VOLUNTARY EXERCISES Demand Theory

Example 1 After the Milk Company did some statistical analysis with their data, they found out that the demand function for their product is the following: Q = 1200 30P a) b) c) d) Calculate the point elasticity at P = 15. Calculate the arc elasticity at P = 15. (Use P = 16 as your second reference point.) Why is there a difference between the two numbers? Calculate the marginal revenue curve.

Example 2 Use the given demand function to compute the following numbers. Qx = 100 8Px + 0.5Py + 2I Qx Quantity demanded of good x Px Price of good x Py Price of good y I Income Px = 7, Py = 12, I = 4.5 a) b) c) d) Calculate the cross price elasticity for the given values. Is good y a substitute or a complementary product? Calculate the income elasticity. Is good x a normal or an inferior good?

Estimating Demand Functions Example 3 The French Cheese Company hired a consultant to estimate the demand function in the cheese market. After the consultant did some research about the market during the last year, he came up with the following equation: log Q = 1200 log 2.4P + log 0.8A log 1.2PW Q = Quantity demanded, P = Price of cheese, A = Advertisement; PW = Price of red wine (complementary good) a) What is the economic concept called that is described by the log-numbers?

b) Is it true, that the quantity demanded would increase by 4.8 % if the price would be reduced by 2 %? In the last year the cheese market experienced rapid growth. Not only more and more consumers enjoy cheese, but there are several new producers of diary products, which offer cheese and other milk products. c) What does that mean for our estimated demand function? Do you think it is a very reliable guess?

Example 4 The marketing department did some analysis of the demand of a good and came to the following result: Demand function: T-values: R: Q = 50 0.78 P + 0.1 I + 0.25 A + 0.02 Px
(4.2) (2.7) (0.8) (2.1) (1.2)

0.85

Q = Quantity demanded, P = Price of the good, I = Income, A = Advertisement, PW = Price of good x a) What does the R value state and is this a good value? b) What des the t-values represent and what do the given values suggest?

Technological Change and Industrial Innovation Example 5 A company produced 50,000 units in 2005 and 65,000 units in 2006. Given the data below, calculate the change in total factor productivity? Input Steel Labor Coal Quantity 2005 1,000 tons 40,000 hours 1,200 tons Price 2005 500,8,2,Quantity 2006 1,300 tons 55,000 hours 1,400 tons Price 2006 650,9,3.5

SOLUTIONS Example 1 a) The formula to calculate the point elasticity is: dQ P * dP Q

= 30 *

15 = 0.6 (1200 30 * 15)

The point elasticity at a price of 15 is -0.6

b) The formula to calculate the arc elasticity is:

Q ( P + P2 ) / 2 * 1 P (Q1 + Q2 ) / 2

Quantity demanded at a price of 15 is: 1200 - 30*15 = 750 Quantity demanded at a price of 16 is: 1200 30*16 = 720

30 (15 + 16) / 2 * = 0.633 1 (750 + 720) / 2

The arc elasticity at a price of 15 (with a reference price of 16) is -0.633 c) The different values for are a result of the fact that you actually measure the elasticity at different positions of the demand curve. With the point elasticity you measure the elasticity at the point P=15. With the arc elasticity you measure the elasticity between P=15 and P=16. d) Q = 1200 30P P = (1200 Q)/30 P = 40 Q/30 TR = 40Q Q2/30 dTR = 40 Q/15 MR = dQ The marginal revenue curve is: MR = 40 Q/15
Example 2

a) The formula for the cross price elasticity is: x , y =

dQx Py * dPy Qx

Qx for the given numbers is: Qx = 100 8*7 + 0.5*12+2*4.5 = 59 12 x , y = 0.5 * = 0.102 59

The cross price elasticity is 0.102

b) Good y is a substitute product to good x. Since the quantity demanded of good x increases as the price of good y increases (positive sign of the cross price elasticity), while quantity demanded for good y decreases, we find an inverse relationship between the quantities demanded of those two goods.

Example 3

a)

The log-numbers represent the elasticities. P, A ,and PW represent the price elasticity, the advertisement elasticity, and the cross price elasticity, respectively. Example: Price elasticity log Q P = = 2.4 log P

b) c)

Yes, thats true. Change in quantity demanded = price change * elasticity = -2% * -2.4 = 4.8 % No. Since there were some changes during the time the consultant did his research and collected the data, one should assume that both, demand and supply curve shifted. Therefore one should not rely on that function.

Example 4

a)

The R value shows you the percentage of total variations in Q that can be explained with these variables. 0.85 is a pretty good value and shows a strong relationship between the variables and Q. The t-value shows the probability if a variable is just random or really reliable. If the value is higher than 2 or so, it is very likely that the relationship really exists and you can work with that number. With the given t-values you should disregard the relationship between Q and I and between Q and Px.
dQ x dI I
*

b)

c) Formula for the income elasticity: hI =

Qx

59

The income elasticity of good x is 0.153 d) The positive sign of the income elasticity indicates that good x is a normal good, which means that quantity demanded increases as income rises.

Example 5

To calculate total factor productivity, you need to compute the coefficient for both years.

2005 = 2005 = 2006

1 2005

*p

1 2005

Q2005 + I 2005 * p 2 2005 + I 32005 * p 32005

50,000 = 0.060798 1,000 *500 + 40,000 *8 + 1,200 * 2 Q2006 = 1 1 2 I 2006 * p 2005 + I 2006 * p 2 2005 + I 32006 * p 32005 65,000 = 0.05948 1,300 *500 + 55,000 *8 + 1,400 * 2

2006 =

Now, divide the two coefficients to find the proportion of these productivities. TFP = 0.9783 This means that total factor productivity was lower by 2.17 % in 2006 than in 2005.