Pricing, Costs, and Profits

PRICING, COSTS, AND PROFITS
MANAGERIAL ECONOMICS -
SIMPLE PRICING
First Law of Demand: Consumers demand more as

price falls, assuming other factors are held
constant.
SIMPLE PRICING
Hotdog Demand Schedule

6
0
P5.00 P4.00 P3.00 P2.00 P1.00
Hotdog Purchased
SIMPLE PRICING
Marginal value is the value to a consumer of the last unit of

consumption. In an industry demand curve it is the value of the
good to the consumer who bought the good but receives the
lowest value from consumption. That is, the value to the
consumer of the first unit that would no longer be purchased if
the price rose.
SIMPLE PRICING
HOTDOGS PURCHASED MARGINAL VALUE TOTAL VALUE

1 P5.00 P5.00
2 P4.00 P9.00
3 P3.00 P12.00
4 P2.00 P14.00
5 P1.00 P15.00
SIMPLE PRICING
HOTDOG PRICE HOTDOGS TOTAL PRICE TOTAL VALUE SURPLUS

PURCHASED PAID
P5.00 1 P5.00 P5.00 P0.00
P4.00 2 P8.00 P9.00 P1.00
P3.00 3 P9.00 P12.00 P3.00
P2.00 4 P8.00 P14.00 P6.00
P1.00 5 P5.00 P15.00 P10.00
SIMPLE PRICING
Demand curves describe buyer behavior and tell

you how much consumers will buy at a given price.
SIMPLE PRICING
AGGREGATE DEMAND CURVE

8
7
6
5
4
3
2
1
0
P1.00 P2.00 P3.00 P4.00 P5.00 P6.00 P7.00
Series 3
SIMPLE PRICING
Demand curves present sellers with dilemma. Sellers can raise

price and sell fewer units, but earn more on each unit sold. Or
they can reduce price, and sell more, but earn less on each unit
sold.
This fundamental trade-off is at the heart of pricing decisions.
This can be resolved thru MARGINAL ANALYSIS.
SIMPLE PRICING
If marginal revenue (MR) is greater than marginal cost

(MC), you can increase profit by selling another unit.
Reduce price (sell more) if MR > MC
Increase price (sell less) if MR < MC
SIMPLE PRICING
PRICE QUANTITY REVENUE MR MC PROFIT

P7.00 1 P7.00 7.00 1.50 5.50
P6.00 2 P12.00 5.00 1.50 9.00
P5.00 3 P15.00 3.00 1.50 10.50
P4.00 4 P16.00 1.00 1.50 10.00
P3.00 5 P15.00 -1.00 1.50 7.50
P2.00 6 P12.00 -3.00 1.50 3.00
P1.00 7 P7.00 -5.00 1.50 -3.50
PRICE ELASTICITY AND MARGINAL REVENUE
Price Elasticity of Demand (e) = (% change in quantity

demanded) ÷ (% change in price)
Price elastic – sensitive to price
Price inelastic – insensitive to price
PROBLEM
The store’s managers decreased the price of three-liter Coke

(diet, caffeine free, and classic) from P1.79 to P1.50 because
they wanted to match a price offered at a nearby grocery store.
In response to the price drop, the quantity sold doubled, from
210 to 420 units per week. Find the price elasticity.
ELASTIC DEMAND
 Price increase – revenue decrease (decrease in Q is bigger than increase in P)

 Price decrease – revenue increase (increase in Q is bigger than decrease in P)
INELASTIC DEMAND
 Price increase – revenue increase (increase in Q is bigger than increase in P)

 Price decrease – revenue decrease (decrease in Q is bigger than decrease in P)
WHAT MAKES DEMAND MORE ELASTIC
 Products with close substitutes have elastic demand.

 Demand for an individual brand is more elastic than industry aggregate demand.
 Products with many complements have less elastic demand.
 In the long run demand curves become more elastic: |e| increases.
 As price increases, demand becomes more elastic: |e| increases
FORECASTING DEMAND USING ELASTICITY
 With an elasticity and percentage change in price, you can predict the corresponding
change in quantity:
%Δquantity ≈ e(% Δprice)
FORECASTING DEMAND USING ELASTICITY
Factor elasticity of demand = (% change in quantity) ÷ %

change in factor)
Income elasticity of demand
Cross-price elasticity of demand
STAY-EVEN ANALYSIS
 %ΔQ = %ΔP/(% ΔP + margin), where margin = (P – MC)/P

PROBLEMS
 A company currently sells 60,000 units a month at P10/unit. The marginal cost per unit is P6. The company is
considering the price by 10% to P11. If the price elasticity of demand is ______ in that price rang, then profit
would increase if the company decided to raise the price by 10%.
a. Equal to -3
b. > +1
c. < -3.5
d. > -2
PROBLEMS
The PED for bread is -0.5. If the price falls by 5%, the quantity
demanded will change by, what?
PROBLEMS
 Assume that beer and pretzels are complements in consumption, if the price of beer increases, we
would expect to see:
a. An increase in demand for pretzels
b. A decrease in the demand for pretzels
c. An increase in the quantity of pretzels demanded
d. A decrease in the quantity of potatoes demanded
PROBLEMS
 Suppose you have 10 individuals with values {P1, P2, P3, P4, P5, P6, P7, P8, P9,
P10}. Your marginal costs of production is P2.50. What is the profit maximizing
price?
 Using above, your boss tells you that price cannot drop below P9 because you
cannot earn enough profit to cover your fixed cost. What should you tell her?

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PRICING, COSTS, AND PROFITS

First Law of Demand: Consumers demand more as

Hotdog Demand Schedule

Marginal value is the value to a consumer of the last unit of

HOTDOGS PURCHASED MARGINAL VALUE TOTAL VALUE

HOTDOG PRICE HOTDOGS TOTAL PRICE TOTAL VALUE SURPLUS

Demand curves describe buyer behavior and tell

AGGREGATE DEMAND CURVE

Demand curves present sellers with dilemma. Sellers can raise

If marginal revenue (MR) is greater than marginal cost

PRICE QUANTITY REVENUE MR MC PROFIT

Price Elasticity of Demand (e) = (% change in quantity

The store’s managers decreased the price of three-liter Coke

 Price increase – revenue decrease (decrease in Q is bigger than increase in P)

 Price increase – revenue increase (increase in Q is bigger than increase in P)

 Products with close substitutes have elastic demand.

Factor elasticity of demand = (% change in quantity) ÷ %

 %ΔQ = %ΔP/(% ΔP + margin), where margin = (P – MC)/P

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