Chapter 3 of 'The Economics of Managerial Decisions' focuses on measuring and using demand through regression analysis and elasticity. It explains various elasticity measures, including price elasticity of demand, income elasticity, and cross-price elasticity, as well as their significance in making managerial decisions. The chapter also discusses how different factors affect elasticity and their implications for total revenue based on changes in price.

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The Economics of Managerial Decisions
First Edition
Chapter 3
Measuring and Using
Demand

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Learning Objectives
3.1 Explain the basics of regression analysis.
3.2 Interpret the results from a regression.
3.3 Describe the limitations of regression analysis and how
they affect its use by managers.
3.4 Discuss different elasticity measures and their use.
3.5 Use regression analysis and the different elasticity
measures to make better managerial decisions.

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Introduction
Regression analysis: A statistical method used to estimate
the relationship between two or more variables.
Elasticity: A measure of the responsiveness of the demand
for a product to a change in a factor affecting the demand.

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Elasticity
Learning Objective 3.4
Price elasticity of demand: A measure of how strongly the
quantity demanded changes when the price changes.
• It is equal to the absolute value of the percentage change in the
quantity demanded divided by the percentage change in the
price.
=
Ɛ

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Point Elasticity Formula
Learning Objective 3.4
The elasticity formula, Ɛ = , can be manipulated to
This is the Point Elasticity Formula. In it the coefficient b is
the change in the quantity demanded brought about by a $1
change in the price.
= |b × (
Ɛ P/Qd
)|

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Figure 3.10 Price Elasticity of Demand
Along a Linear Demand Curve
The point elasticity
formula, Ɛ = |b × (P/Qd
)|,
can be used to calculate
the price elasticity of
demand at each point on
a demand curve.
On a linear, downward-
sloping demand curve, as
the figure shows the price
elasticity of demand falls
in value moving down the
curve.
Learning Objective 3.4

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Elastic, Unit-Elastic, and Inelastic Demand
Learning Objective 3.4
• Elastic demand: The percentage change in the quantity
demanded exceeds the percentage change in the price.
• The price elasticity of demand is greater than 1.00, Ɛ > 1.00.
• Unit-elastic demand: The percentage change in the quantity
demanded equals the percentage change in the price.
• The price elasticity of demand is equal to 1.00, Ɛ = 1.00.
• Inelastic demand: The percentage change in the quantity
demanded is less than the percentage change in the price.
• The price elasticity of demand is less than 1.00, Ɛ < 1.00.

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Elasticities Table
Learning Objective 3.4
Regions of Demand Curve Price Elasticity Price and Quantity Changes
Elastic demand ε > 1.0 ΔQd
> ΔP
Unit Elastic demand ε = 1.0 ΔQd
= ΔP
Inelastic Demand ε < 1.0 ΔQd
< ΔP

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Perfectly Elastic Demand
Learning Objective 3.4
Perfectly elastic demand: A rise in the price decreases the
quantity demanded to zero, and a fall in the price increases
the quantity demanded to infinity.
• The elasticity is equal to infinity,
Ɛ = ∞.
Demand curves that are perfectly
elastic are horizontal.

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Perfectly Inelastic Demand
Learning Objective 3.4
Perfectly inelastic demand: A change in the price creates
the smallest possible response, no change in the quantity
demanded.
• The elasticity is equal to zero, Ɛ = 0.
Demand curves that are perfectly
inelastic are vertical.

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Size of the Price Elasticity of Demand
Learning Objective 3.4
Two general factors affect the size of the price elasticity of
demand:
• Number of close substitutes: The more substitutes for a
product, the larger the price elasticity of demand.
• The fraction of the budget spent on the product: The larger
the percentage of a consumer’s budget, the larger the
price elasticity of demand.

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Elasticity and Total Revenue
Learning Objective 3.4
The size of the price elasticity of demand determines how a
change in price affects the total revenue (P × Q) spent on a
product:
• Elastic demand: Price increases causes large decreases
in the quantity demanded, so the total revenue decreases.
• Inelastic demand: Price increases cause small decreases
in the quantity demanded, so the total revenue increases.
• Unit-elastic demand: Price increases cause
proportionally equal decreases in the quantity demanded,
so the total revenue does not change.

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Figure 3.14 Relationship Between Total Revenue and Elasticity
Along a Linear, Downward-Sloping Demand Curve
• Inelastic values near the bottom of the demand curve will
cause an increase in total revenue when price increases
• Elastic values near the top the demand curve will cause a
decrease in total revenue when price increases
Learning Objective 3.4

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Income Elasticity of Demand (1 of 2)
Learning Objective 3.4
Income elasticity of demand: A measure of how strongly
the quantity demanded responds to a change in consumers’
income.
• It is equal to the percentage change in the quantity demanded
divided by the percentage change in income:
ƐINC =

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Income Elasticity of Demand (2 of 2)
Learning Objective 3.4
The sign of the income elasticity of demand indicates
whether the good is normal or inferior:
• Normal Good: Income elasticity is positive. The quantity
demanded increases when income increases.
• Inferior Good: Income elasticity is negative. The quantity
demanded decreases when income increases.

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Cross-Price Elasticity of Demand (1 of 2)
Learning Objective 3.4
Cross-price elasticity of demand: A measure of how
strongly the quantity demanded changes when the price of a
related product changes.
• It equals the percentage change in the quantity demanded divided
by the percentage change in the price of the related product.
ƐCROSS =

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Cross-Price Elasticity of Demand (2 of 2)
Cross Price Elasticity of Demand
The sign of the income elasticity of demand indicates
whether the goods are substitutes or complements:
• Substitutes: Cross-price elasticity is positive. The quantity
demanded of Good X increases when the price of Good Y
increases.
• Complements: Cross-price elasticity is negative. The
quantity of Good X decreases when the price of Good Y
increases.

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Using Regression and Elasticity
Learning Objective 3.5
• Use regression analysis to estimate demand functions and
make forecasts and predictions that improve your
decisions.
• Use the price elasticity of demand, the income elasticity of
demand, and/or the cross price elasticity of demand to
estimate or forecast the effect of changes in market factors
such as prices or incomes.

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