Managerial Economics and Business Strategy:

Ch. 3 - Quantitative Demand Analysis

Rayhan Gunaningrat, SE., MM.

Department of Management
Faculty of Law and Business
Universitas Duta Bangsa
headLINE:
SuperIndo Berharap Ada Pertunjukan Besar di Hari Raya
Dua bulan menjelang Ramadhan, direktur penjualan nasional SuperIndo
mengetahui bahwa selalu ada rapat yang membahas tentang prediksi penjualan.
Tahun ini, kinerja perusahaan ketika Ramadhan dan Idul Fitri sangat penting,
setelah penjualan yang mengecewakan hingga saat ini.

Direktur mengungkapkan harapannya untuk penjualan Ramadhan dan Idul Fitri

yang kuat, investor dan reporter —manajer lokal — mencari prediksi yang memiliki
bukti untuk mendukungnya. Maka, dia mengandalkan departemen analitiknya, yang
telah mengumpulkan banyak data untuk SuperIndo selama bertahun-tahun di 381
kota di Indonesia.
headLINE:
SuperIndo Berharap Ada Pertunjukan Besar di Hari Raya (2)
Beberapa variabel utama seperti penjualan hari raya, harga rata-rata, dan
kepercayaan konsumen digunakan sebagai prediktor. Dengan menggunakan data
ini, analis sampai pada persamaan berikut, yang dirancang untuk memprediksi
pendapatan HolidaySales:

Direktur mencatat bahwa sebagian besar kota mengalami penurunan kepercayaan

konsumen sekitar 4 persen. Berdasarkan informasi ini, apakah bukti tersebut
mendukung optimisme untuk penjualan hari raya jika harga tetap tidak berubah?
Bisakah perubahan harga membantu meningkatkan pendapatan?
INTRODUCTION
In Chapter 2 we saw that the demand for a firm’s product (Qdx) depends on its
price (Px), the prices of substitutes or complements (Py), consumer incomes (M),
and other variables (H) such as advertising, the size of the population, or consumer
expectations.

Until now, our analysis of the impact of changes in prices and income on consumer
demand has been qualitative rather than quantitative; that is, we focused on the
“big picture” to identify only the directions of the changes and said little about their
magnitude.
THE ELASTICITY CONCEPT
THE ELASTICITY CONCEPT
Suppose some variable, such as the price of a product, increased by 10 percent. What
would happen to the quantity demanded of the good?

The primary tool used to determine the magnitude of such a change is elasticity
analysis. An elasticity measures the responsiveness of one variable to changes in
another variable. For example:

If EG,S > 0, then S and G are directly related.

If EG,S < 0, then S and G are inversely related.

If EG,S = 0, then S and G are unrelated.

THE ELASTICITY CONCEPT (2)
Two aspects of an elasticity are important:

(1) whether it is positive or negative and

(2) whether it is greater than 1 or less than 1 in absolute value.

The sign of the elasticity determines the relationship between G and S. If the elasticity is
positive, an increase in S leads to an increase in G. If the elasticity is negative, an
increase in S leads to a decrease in G.

Whether the absolute value of the elasticity is greater or less than 1 determines how
responsive G is to changes in S. If the absolute value of elasticity is > 1, then the
relationship between G and S is elastic. If the absolute value of elasticity < 1, then the
relationship between G and S is inelastic.
THE ELASTICITY CONCEPT Using Calculus
An alternative way to measure the elasticity of a function G = f(S) is

If EG,S > 0, then S and G are directly related.

If EG,S < 0, then S and G are inversely related.

If EG,S = 0, then S and G are unrelated.

OWN PRICE ELASTICITY OF DEMAND
We begin with a very important elasticity concept: the own price elasticity of
demand, which measures the responsiveness of quantity demanded to a change in
the price of that good.

Negative according to the “law of demand.”

OWN PRICE ELASTICITY OF DEMAND Using Calculus
An alternative way to measure the elasticity of a function Qdx = f( Px, Py, M, H ) is

Negative according to the “law of demand.”

Own-Price Elasticity and Total Revenue
If demand is elastic, an increase (decrease) in price will lead to a decrease
(increase) in total revenue.

If demand is inelastic, an increase (decrease) in price will lead to an increase

(decrease) in total revenue.

Total revenue is maximized at the point where demand is unitary elastic.

This relationship among the changes in price, elasticity, and total revenue is called
the total revenue test.
Marginal Revenue and the Own Price Elasticity of Demand
Notice that when −∞ < E < −1, demand is
elastic, and the formula implies that MR is
positive.

When E = −1, demand is unitary elastic, and

MR is zero. As we learned in Chapter 1, the
point where marginal revenue is zero
corresponds to the output at which revenue is
maximized.

Finally, when −1 < E < 0, demand is inelastic,

and MR is negative. These general results
are consistent with what you saw earlier in
Table 3–1 for the case of linear demand.
Perfectly Elastic & Inelastic Demand
Factors Affecting the Own Price Elasticity
Available Substitutes
The more substitutes available for the good, the more elastic the demand.

Time
Demand tends to be more inelastic in the short term than in the long term.
Time allows consumers to seek out available substitutes.

Expenditure Share
Goods that comprise a small share of consumer’s budgets tend to be more inelastic
than goods for which consumers spend a large portion of their incomes.
CROSS-PRICE ELASTICITY
Cross-price elasticity of demand, which reveals the responsiveness of the demand
for a good to changes in the price of a related good.

If EQX,PY > 0, then X and Y are substitutes.

If EQX,PY < 0, then X and Y are complements.
If EQX,PY = 0, then X and Y are unrelated.
CROSS-PRICE ELASTICITY Using Calculus
An alternative way to measure the cross-price elasticity of a function Qdx = f( Px, Py,
M, H ) is

If EQX,PY > 0, then X and Y are substitutes.

If EQX,PY < 0, then X and Y are complements.
If EQX,PY = 0, then X and Y are unrelated.
INCOME ELASTICITY
Income elasticity is a measure of the responsiveness of consumer demand to
changes in income.

If EQX,PY > 0, then X is a normal good.

If EQX,PY < 0, then X is an inferior good.
If EQX,PY = 0, then X and M are unrelated.
INCOME ELASTICITY Using Calculus
An alternative way to measure the income elasticity of a function Qdx = f( Px, Py, M,
H ) is

If EQX,PY > 0, then X is a normal good.

If EQX,PY < 0, then X is an inferior good.
If EQX,PY = 0, then X and M are unrelated.
Uses of Elasticities
Pricing.

Managing cash flows.

Impact of changes in competitors’ prices.

Impact of economic booms and recessions.

Impact of advertising campaigns.

And lots more!

OBTAINING
ELASTICITIES FROM
DEMAND
FUNCTIONS
Elasticities for Linear Demand Functions
Elasticities for Nonlinear Demand Functions

where c is a constant. If we take the natural logarithm of this equation, we obtain an

expression that is linear in the logarithms of the variables:

where β0 = ln(c) and the βi’s are arbitrary real numbers. This relation is called a
log-linear demand function.
Elasticities for Nonlinear Demand Functions (2)
Source: Brooks, Chris. 2014. Introduction Econometrics for Finance 3rd edition.
New York: Cambridge Press.
REGRESSION ANALYSIS
REGRESSION ANALYSIS
Suppose a television manufacturer has data on the price and quantity of TVs sold
last month at 10 outlets in Central Java. Here we use price and quantity as our
independent and dependent variables, respectively.
REGRESSION ANALYSIS (2)
QdTV = f(PTV )

QdTV = ⍺0 + 𝛼1PTV+ ei

where,
⍺0 = constant (intercept)
⍺1 = coefficient (slope)
ei = error term

Uses a regression software

package to find the fittest
values of ⍺0 and ⍺1 that minimize the sum of the squared errors, ei ,between the
actual points and the line. This method is called the least squares regression.
REGRESSION ANALYSIS (3)
Tutorial Linear Regression in MS Excel:
https://www.ablebits.com/office-addins-blog/2018/08/01/linear-regression-analysis-excel/

QdTV = 1631.47 + (–2.60)PTV

QdTV = 1631.47 –2.60PTV

Evaluating the Statistical Significance of Estimated Coefficients

The standard error of each estimated coefficient is a measure of how accurate

each estimated coefficient to its true value. The smaller the standard error of an
estimated coefficient, the more accurate “unbiased” the coefficient estimate is.

A confidence interval is a range of estimated coefficient values we are fairly sure

the true coefficient value lies in. The confidence interval that is often used in
statistics is 95%. That is, the range of values for an estimated coefficient where the
probability of the true coefficient value falls within that range is 95%.

and

where, σ is the standard error.

Evaluating the Statistical Significance of Estimated Coefficients (2)

The t-statistic of a parameter estimate is the ratio of the value of the parameter
estimate to its standard error. The rule of thumb is that if the absolute value of a
t-statistic is greater than or equal to 2, the manager can be 95 percent confident
that the true value of the underlying parameter in the regression is not zero.

and

The p-value is the probability of obtaining a more extreme or equal to estimated

coefficient value that has been obtained. P-values of .05 or lower are considered
low enough for a researcher to be confident that the estimated coefficient is
statistically significant. If the P-value is .05, we say that the estimated coefficient is
statistically significant at the 5 percent level.
Evaluating the Overall Fit of the Regression Line
The R-square (also called the coefficient of determination) tells the fraction of the
total variation in the dependent variable that is explained by the regression. The
closer the R-square is to 1, the “better” the overall fit of the estimated regression
equation to the actual data.

Problem with the R-square is that it cannot decrease when additional explanatory
variables are included in the regression. For this reason, many researchers use the
adjusted R-square as a measure of goodness of fit. The adjusted R-square
“penalizes” the researcher for performing a regression with only a few degrees of
freedom (that is, estimating numerous coefficients from relatively few observations).
Evaluating the Overall Fit of the Regression Line (2)
An alternative measure of goodness of fit, called the F-statistic. The F-statistic
provides a measure of the total variation explained by the regression relative to the
total unexplained variation.

The greater the F-statistic, the better the overall fit of the regression line through
the actual data.

As with P-values, the lower the significance value of the F-statistic, the more
confident you can be of the overall fit of the regression equation.
Regression for Nonlinear Functions
Sometimes, a plot of the data will reveal
nonlinearities in the data, as seen in Figure 3–5
“Log-Linear Regression Line”.

Here, it appears that price and quantity are not

linearly related: The demand function is a curve.
The log-linear demand curve we examined
earlier in this chapter has such a curved shape.

To estimate a log-linear demand function, the

econometrician takes the natural logarithm of
prices and quantities before executing the
regression routine that minimizes the sum of
squared errors (e).
Multiple Regression
In general, the demand for a good will depend not only on the good’s price, but
also on demand shifters. For the case of a linear demand relation, one might
specify the demand function as

Alternatively, a log-linear specification might be appropriate if the quantity

demanded is not linearly related to the explanatory variables:
ANSWERING THE headLINE

Since this is a log-linear equation, the coefficients are elasticities. In particular, the
coefficient of ln(ConsumerConfidence) (0.9) tells us the percentage change in
holiday sales (HS) resulting from each 1 percent change in consumer confidence.
Consequently, when consumer confidence decreases by 4 percent, this means
ln(HS) = 25.8 + 0.9(–4) = 25.8 –3.6 = 22.2.

In other words, the director should expect holiday sales to be 3.6 percent lower in
the city where consumer confidence has declined by 4 percent, and so should not
be particularly optimistic about holiday sales this year. The results indicate the
director could mitigate the sales decrease by lowering price.