Maneco Lesson 1 4

AE11 - MANAGERIAL ECONOMICS
AE 11- MANAGERIAL ECONOMICS ||
LESSON 1: INTRODUCTION TO ECONOMICS

At present, we are facing different economic problems such as increase in transportation fares, increase
in electricity and water bills, increase in the price of basic commodities, and other services. We are
dealing with these present problems by proper use and allocation of available resources without
realizing that this process of careful use of resources is actually the key concept of economics.
ORIGIN OF THE TERM ECONOMICS
The two Greek roots of the word Economics are “oikos” – meaning
household and “nomus” – meaning system or management. Oikonomia or
Oikonomus, therefore, means the “management of a household”.
Managerial Economics-is the study of how to direct scarce resources in the way that most efficiently
achieves a managerial goal. Also, it is defined as the utilization of managerial skills in the business by
applying economic theories and concepts to maintain efficiency in costing and production and its
effectiveness on every decision making by the firms to fully maximize their profits.
Economics is the study of the proper allocation and efficient use of scarce resources to produce
commodities for the maximum satisfaction of unlimited human needs and wants. This definition of
economics gives us key term:
 Needs are essential for human survival like food, clothing, and shelter.
 Wants are goods that give more satisfaction and make life more pleasant and worth living.
 Resources are most basic elements that people use to produce the goods and services that
they want.
 Scarcity is a condition where there are insufficient resources to satisfy all the needs and wants
of a population. Scarcity may be relative or absolute.
 Relative Scarcity is when a good is scarce compared to its demand. For example, coconuts
are abundant in the Philippines since the plant easily grows in our soil and climate. However,
coconuts become scarce when the supply is not sufficient to meet the needs of the people.
Relative scarcity occurs not because the good is scarce and is difficult to obtain but because
of the circumstances that surround the availability of the good.
CARD-MRI Development Institute, Inc.

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 Absolute Scarcity is when supply is limited. Cherries are absolutely scarce in our country
since we do not have the right climate to grow them and we have to rely on imports for our
supply of cherries. This also explains why cherries are very expensive in the Philippines.
Because of the presence of scarcity, there is a need for man to make decisions in choosing how
to maximize the use of the scarce resources to satisfy as many wants as possible. A homemaker who
has a monthly budget needs to decide on how to utilize it to pay rent, to buy food, to pay for children’s
tuition fees, and to buy new clothes and shoes. If the budget is not enough, then the homemaker has
to give up some of these things. She needs to make choice. Without scarcity, a person does not need
to make choices since he/she can have everything he/she wants.
Opportunity Cost refers to the foregone value of the next best alternative. It is the value of what is
given up when one makes a choice. The thing thus given up is called the opportunity cost of one’s
choice. The concept of opportunity cost holds true for individuals, businesses, and even society. In
making choices, trade-offs are involved. The opportunity cost of watching a movie in a cinema is the
value of other things that you could have bought with that money such as a pint of ice cream, a combo
meal in fast food, or a simple t-shirt.
3 E’s in Economics
Q8
1. Efficiency – it refers to productivity and proper allocation of economic resources. It also refers
to the relationship between scarce factor inputs and outputs of goods and services. This
relationship can be measured in physical terms (technological efficiency), or cost terms
(economic efficiency). Being efficient in the production and allocation of goods and services
saves time and money, and also increases a company’s output.
2. Equity – means justice and fairness. Thus, while technological advancement may increase
production, it can also bear disadvantages to the employment of workers. Due to the presence
of new equipment and machinery, manual labor may not be necessary, and this can result in
the retrenchment or displacement of workers.
3. Effectiveness – means attainment of goals and objectives. Economics is an important and

functional tool that can be utilized by other fields. Produced goods or services will be considered
effective if they achieve the goals of both parties, that is, satisfaction for the consumer and
profit for business.

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Goals of Economics
The numerous economic goals Filipinos have in mind can be reduced to five fundamental goals reflect
their economic aspirations.
1. To strengthen economic freedom.

Economic freedoms include consumer choice, freedom of occupational choice, freedom to
consume or save, freedom to own properties, and freedom of enterprise. A competitive market
functions to protect the freedom and rights of consumers, workers, and producers. This
protection is in the form of legal framework wherein free markets can operate to maintain
competition, preserve high standards in goods and services, and shield against fraud.
2. To promote economic efficiency.

Efficiency is producing more output with the use of fewer resources. There are many factors
that contribute to efficiency, such as modern technologies and managerial skills. An efficient
economy responds to both consumer demand and the relative scarcity of resources. Scarcities
reflect the flexibility in prices. The kind and amount of goods and services mirror consumer
preferences, and not the other way around.
3. To promote economic stability.

Stability means there are no violent ups and downs in the economy. The goal is a consistent
growth in a changing world, thus, the movement of output of the economy, employment, and
prices of goods and services should be kept at reasonable ranges. Economic freedom, efficiency,
and growth in the economy emanate mainly from the actions of individuals with government
assistance in the form of legal framework and social institutions to protect them from market
imperfections.
4. To promote economic security.

To increase individual security has been an important goal of economics. The continued
existence of the market economy depends on this economic security, because incomes are
established in the market place. People with corresponding skills, capital, and assets are sold in
exchange for income, and the value of those agents depends on the worth of the final goods
and services produced by them.
5. To attain high level of growth in the economy.

Economic growth means that the capacity to produce goods and services is increasing, and it is
growing rapidly than the population.

ECONOMIC RESOURCES, also known as ||factors of production, are the resources used to
produce goods and services. These resources are, by nature, limited and therefore, command a
payment that becomes the income of the source owner.
These economic resources include:
1. Land – it includes all-natural resources (gifts of nature and are not man-made) used in the
production process. These include mineral and oil deposits, water fertile soil, air, climate forest,
wildlife, and rain. These are irreproducible.
 Payment for the use of land is called rent. Rent is income to the owner of the land.
2. Labor – also called human resources. It refers to human inputs such as manpower skills which
are used in transforming resources into different products that answer people’s needs.
 Payment for the use of labor is called wage. Wage is income to laborers, who own their
labor.
3. Capital – man-made or manufactured resources or also known as capital goods used in
producing consumer goods. These include buildings, machines, tools, equipment, roads,
highways, bridges, and even software.
 Payment for the use of capital is called interest.
4. Entrepreneurship (Enterprise) – special skills of an individual needed to produce goods and
services like managerial and organizational skills. It means that people are combining the other
three factors of production to create some products or services to sell.
 Payment for entrepreneurship is called profit. The income of an entrepreneur after
deducting the payments from the owners of land, labor, and capital.
Ten Principles of Economics

1. People face trade-offs. ||

 Trade-offs is a situation that involves losing one quality or aspect of something in return for
gaining another quality or aspect.
 Another trade-off society faces is between efficiency and equality. Efficiency means that society
is getting the maximum benefits from its scarce resources. Equality means that those benefits
are distributed uniformly among society’s members.
2. The cost of something is what one gives up to get it.

 Making decisions requires comparing the costs and benefits of alternative courses of action.
 The Opportunity Cost refers to the foregone value of the next best alternative.
 Explicit Cost – these are the expenses made for the use of resources not owned by the firm
itself.
Examples of explicit costs include the wages paid to labor, the rental charges for a plant or office
building, the cost of electricity and phone bills, the cost of raw materials.
 Implicit costs are the opportunity costs of using resources owned by the firm. These are
opportunity costs of resources because the firm makes no actual payment.
3. Rational people think at the margin.

 Rational people systematically and purposefully do the best they can to achieve their
objectives, given the available opportunities. A rational decision-maker takes an action if and
only if the marginal benefit of the action exceeds the marginal cost.
 Economists use the term marginal change to describe a small incremental adjustment to an
existing plan of action. Margin means “edge”, so marginal changes are adjustments around the
edges of what you are doing. Rational people often make decisions by comparing marginal
benefits and marginal costs.
 Marginal Analysis – the process of breaking down a decision into a series of “yes” or “no”
decision – making. Marginal Analysis is an examination of the additional benefits of an activity
compared to the additional costs incurred by that same activity. Companies use marginal analysis
as a decision-making tool to help them maximize their potential profits.
4. People respond to incentives.

 An incentive is something that induces a person to act, such as the prospect of a punishment
or a reward. People respond to incentive because people make decision by comparing costs and
benefits.
5. Trade can make everyone better off.

 Trade allows each person to specialize in the activities he or she does best, whether it is farming,
sewing or home building. By trading with others, people can buy a greater variety of goods and
services at a lower cost. Countries as well as families benefit from the ability to trade with one

another. Trade allows countries to specialize||in what they do best and to enjoy a greater variety
of goods and services.
6. Markets are usually a good way to organize economic activity.

 Market economy an economy that allocates resources through the decentralized decisions of
many firms and households as they interact in markets for goods and services. In a market
economy, the decisions of a central planner are replaced by the decisions of millions of firms
and households. Firms decide whom to hire and what to make. Households decide which firms
to work for and what to buy with their incomes. These firms and households interact in the
marketplace, where places and self-interest guide their decisions. In a market economy, no one
is looking out for the economic well-being of society as a whole. Free markets contain many
buyers and sellers of numerous goods and services, decentralized decision-making and self-
interested decision makers, market economies have proven remarkably successful in organizing
economic activity to promote overall economic well-being.
 Invisible Hand - The unobservant market force that helps the demand and supply of goods in
a free market to reach equilibrium automatically. The phrase invisible hand was introduced by
Adam Smith in his book 'The Wealth of Nations'. He assumed that an economy can work well in
a free market scenario where everyone will work for his/her own interest.
 Adam Smith – Father of Economics
7. Governments can sometimes improve market outcomes

 One reason we need government is that the invisible hand can work on its magic only if the
government enforces the rules and maintains the institutions that are key to a market economy.
Most important, market economies need institutions to enforce property rights so individuals
can own and control scarce resources. We all rely on government-provided police and courts to
enforce our rights over the things we produce, and the invisible hand counts on our ability to
enforce our rights.
 Property Rights – the ability of an individual to own and exercise control over scarce
resources.
8. A country’s standard of living depends on its ability to produce goods and services.
 Almost all variation in living standards is attributable to differences in countries’ productivity. In
nations where workers can produce a large quantity of goods and services per unit of time, most
people enjoy a high standard of living: in nations where workers are less productive, most people
endure a more meagre existence. Similarly, the growth rate of a nation’s productivity determines
the growth rate of its average income.
 Productivity – the quantity of goods and services produced from each unit of labor input.
9. Prices rise when the government prints too much money.

 || of prices in the economy. When a government

Inflation is an increase in the overall level
creates large quantities of the nation’s money, the value of the money falls.
10. Societies face a short run trade-off between inflation and unemployment.
 Increasing the amount of money in the economy stimulates the overall level of spending and
thus the demand for goods and services. Higher demand may over time cause firms to raise
their prices, but in the meantime, it also encourages them to hire more workers and produce a
larger quantity of goods and services. More hiring means lower unemployment.
LESSON 2: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Managerial Economics is a valuable tool for analyzing business situations. Managerial economics is not
only valuable to managers of profit oriented companies; it is also valuable to managers of not-for-profit
organizations. In fact, managerial economics provides useful insights into every facet of the business
and non-business world in which we live – including household decision making.
Manager - Is a person who directs resources to achieve a stated goal. It includes all individual who:
1. Direct the effort of others, including those who delegate tasks within an organization such as a
firm, a family, or a club;
2. Purchase inputs to be used in the production of goods and services such as the output of a firm,
food for the needy, or shelter for the homeless; or
3. Are in charge of making other decisions, such as product price or quality.
A manager generally has responsibility for his or her own actions of individuals, machines, and other
inputs under the manager’s control. This control may involve responsibilities for the resources of a
multi-national corporation or for those of a single household.
PRINCIPLES OF EFFECTIVE MANAGEMENT
The nature of sound managerial decisions varies depending on the underlying goals of the manager.
Since this course is designed primarily for managers of firms, we will focuses on managerial decisions
as they relate to maximizing profits or, more generally, the value of the firm. Provided below are the
basic principles that comprise effective management.
1. Identify goals and constraints. The first step in making sound decisions is to have well-
defined goals because achieving different goals entails making different decisions. If your goal
is to maximize your grade in this course rather than maximize your overall grade point average,
your study habits will differ accordingly. Notice that the decision maker faces constraints that
affect the ability to achieve a goal.

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2. Recognize the nature and importance of profits.
The overall goal of most firms is to maximize profits or the firm’s value. We know that profit is
the difference between revenue and costs. But did you know that costs itself is categorized into
two? And this categorization has a significant role in understanding the difference between
accounting and economic profits.
Now, let us differentiate the types of profits.
Total Revenue – Explicit cost = Accounting profit

Total Revenue – Explicit cost – Implicit cost = Economic profit
Accounting profit is the total amount of money taken in from sales (total revenue, or price
times quantity sold) minus the cost of producing goods or services. Accounting profits are what
show up on the firm’s income statement and are typically reported to the manager by the firm’s
accounting department.
Economic profits are the difference between the total revenue and the total opportunity cost
of producing the firm’s goods or services. The opportunity cost of using resource includes both
the explicit (or accounting) cost of the resource and the implicit cost of giving up the best
alternative use of the resource. The opportunity cost of producing a good or service generally is
higher than accounting costs because it includes both the value of costs (explicit, or accounting,
costs) and any implicit costs.
Explicit costs – is an easily identified expenditure that is accounted for in the general ledger
or financial statements (e.g. salaries and wages, supplies, etc.)
Implicit costs – is any cost that has already occurred but not necessarily shown or reported
as a separate expense. It is also called as opportunity cost - the foregone value
of the next best alternative.
Why the role of profit is important?

 Profits - signal the owners of resources where the resources are most highly valued by
society. By moving scarce resources toward the production of goods most valued by
society, the total welfare of society is improved. Profits is also a sign of success – success
in decision-making, efficiency in utilizing resources, and effective execution or
implementation of all the activities in the organization.

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The story of Carding…

Carding owns a building in Tagum City where he use it to run his small carenderia. Everyday
Carding spends Php5,000 for the ingredients of the foods he will be cooking. But at the end of
the day Carding generates Php10,000 revenue. Assuming, that Carding opens his store 30 days
in one month, his total revenue is Php300,000 and his total cost is Php150,000. Therefore, if
we subtract the total revenue from his total cost, Carding has a profit of Php150,000. This is
an accounting profit!
To compute the economic profit, we need to put value on the opportunity cost of Carding. But
what is it? First, Carding’s opportunity to earn a salary through working.
Before Carding decided to put up a business, he served as a Head Cook in a restaurant wherein
he earns Php40,000 per month. This can be used as his opportunity cost of time. Second, if
Carding put his building into rent instead of having a carenderia, he would have earned
Php50,000 per month. Adding it together, Carding’s total opportunity cost is Php90,000.
Therefore, Carding’s economic profit is Php60,000.
How this was computed?
Total Revenue
Explicit Cost Implicit Cost Economic Profit
Php 300,000
Php150,000 Php90,000 Php60,000
3. Understand Incentives
What does this suggest? It means that Carding’s decision to put up a carenderia was a good
 Incentives affect how resources are used and how hard workers work. The first step in
choice rather than working as a head cook and even putting his property for a rent.
constructing incentives within a firm is to distinguish between the worlds, or the business
place, as it is and the way you wish it were.
 The thrust of managerial economics is to provide you with a broad array of skills that enable
you to make sound economic decisions and to structure appropriate incentives within your
organization.
4. Understanding the Market
A market is one of the many varieties of systems, institutions, procedures, social relations
and infrastructures whereby parties engage in exchange. While parties may exchange goods
and services by barter, most markets rely on sellers offering their goods or services (including
labor) in exchange for money from buyers.
3 Sources of Rivalry that exist in Economic Transactions

a. Consumer-Producer Rivalry -Consumers attempt to negotiate or locate low prices,
while producers attempt to negotiate high prices.

b. Consumer-Consumer Rivalry -When || limited quantities of goods are available,

consumers will compete with one another for the right to purchase the available goods.
c. Producer-Producer Rivalry -Producers compete with one another for the right to
service the customers available.
5. Recognize the Time Value of Money
Present value (PV) – it is the amount that would have to be invested today at the prevailing
interest rate to generate the given future value. The present value is always less
than or equal to the future value because money has interest-earning potential.
Formula (Present Value - PV) Sample Problem: Present Value
What is the present value of $100.00 in 10

years if the interest rate is at 7 percent?
$100 $100
𝑷𝑽 = (1+0.07)10 = = $𝟓𝟎. 𝟖𝟑
1.9672
This means that if you invested $50.83 today at a

7 percent interest rate, in 10 years your
investment would be worth $100.
Present Value of a Stream

The basic idea of the present value of a future amount can be extended to a series of future
payments. For example, if you are promised 𝐹𝑉1 one year in the future, 𝐹𝑉2 two years in the
future, and so on for n years, the present value of this sum of future payments is,
𝐹𝑉1 𝐹𝑉2 𝐹𝑉3 𝐹𝑉𝑛

𝑃𝑉 = + +⋯+
(1 + 𝑖 )1 (1 + 𝑖 )2 (1 + 𝑖 )3 (1 + 𝑖 )𝑛
Net Present Value (NPV) of a project is simply the present value (PV) of the income stream
generated by the project minus the current cost (C0) of the project.
If the Net Present Value of a project is positive, then the project is profitable because the present
value of the earnings from the projects exceeds the current cost of the project. On the other

hand, a manager should reject a project that|| has a negative net present value, since the cost of
such a project exceeds the present value of the income stream that project generates.
Sample Problem: Present Value of a Stream and Net Present Value

The manager of Automated Products is contemplating the purchase of a new machine that will
cost $300,000 and has a useful life of five years. The machine will yield (year-end) cost
reductions to Automated Products of $50,000 in year 1, $60,000 in year 2, $75,000 in year 3,
and $90,000 in years 4 and 5. What is the present value of the cost savings of the machine if
the interest rate is 8 percent? Should the manager purchase the machine?
50,000 60,000 75,000 90,000 90,000

𝑃𝑉 = + + + +
(1 + .08)1 (1 + .08)2 (1 + .08)3 (1 + .08)4 (1 + .08)5
50,000 60,000 75,000 90,000 90,000

𝑃𝑉 = + + + +
1.08 1.1664 1.2597 1.3605 1.4693
𝑃𝑉 = 46,296.30 + 51,440.33 + 59,537.99 + 66,152.15 + 61,253.66
𝑃𝑉 = $284,680.43
𝑁𝑃𝑉 = 284,680.43 − 300,000
𝑁𝑃𝑉 = −$15,319.57
Since the net present value of the machine is negative, the manager should not purchase the
machine. In other word, the manager could earn by investing the $300,000 at 8 percent than
by spending the money on the cost-saving technology.
Profit Maximization: Value of the Firm
Profit is simply defined as, “total revenue minus total cost”. Maximizing profits means
maximizing the value of the firm, which is the present value of current and future profits. For a
given interest rate and growth rate of the firm, it follows that maximizing the lifetime value of
the firm (long-term profits) is equivalent to maximizing the firm’s current (short-term) profits.

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Sample Problem: Profit Maximization: Value of the Firm

Suppose the interest is 10 percent and the firm is expected to grow at a rate of 5 percent for
the foreseeable future. The firm’s current profits are $100 million.
a. What is the value of the firm?
b. What is the value of the firm immediately after it pays a dividend equal to its current profits?
The Value of the firm is:
1+𝑖
𝑃𝑉𝐹𝑖𝑟𝑚 = ∏ 0 ( )
𝑖−𝑔
1 + .10
𝑃𝑉𝐹𝑖𝑟𝑚 = $100 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 ( ) = $100 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 (22)
. 10 − .05
𝑃𝑉𝐹𝑖𝑟𝑚 = $2,200 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
The value of the firm after it pays its dividend:
1+𝑔
𝑃𝑉𝑒𝑥−𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = ∏ 0( )
𝑖−𝑔
1 + .05
𝑃𝑉𝑒𝑥−𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = $100𝑚𝑖𝑙𝑙𝑖𝑜𝑛 ( ) = $100 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 (21)
. 10 − .05
𝑃𝑉𝐹𝑖𝑟𝑚 = $2,100 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

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6. Use marginal analysis

Marginal Analysis is one of the most important managerial tools – a tool we will use repeatedly
throughout this course. Marginal Analysis states that optimal managerial decisions involve
comparing the marginal (or incremental) benefits of a decision with the marginal (or
incremental) costs.
Marginal Benefit refers to the additional benefits that arise by using an additional unit of the
managerial control variable.
Marginal Cost, on the other hand, is the additional cost incurred by using an additional unit of
the managerial control variable.
Marginal Net Benefits are the change in net benefits that arise from a one-unit change in Q.
Control Total Net Marginal Marginal Marginal Net
Total
Variable Benefits Benefits Benefit Cost Benefits
Costs (C)
(Q) (B) NB MB MC MNB
Given
Given Given (B-C) B C MB-MC
0 0 0 0 - - -
1 90 10 80 90 10 80
2 170 30 140 80 20 60
3 240 60 180 70 30 40
4 300 100 200 60 40 20
5 350 150 200 50 50 0
6 390 210 180 40 60 -20
7 420 280 140 30 70 -40
8 440 360 80 20 80 -60
9 450 450 0 10 90 -80
10 450 550 -100 0 100 -100
To maximize net benefits, the manager should increase the managerial control variable to the point
where marginal benefits equal marginal costs. This level of the managerial control variable corresponds
to the level at which marginal net benefits are zero; nothing more can be gained by further changes in
that variable.

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LESSON 3: MARKET FORCES: DEMAND AND SUPPLY
The first driving force of the market: The Demand.
Demand - pertains to the quantity of a good or service that people are ready to buy at given prices
within a given time period, when other factors besides price are held constant.
The demand for a product is the quantity of a good or service that buyers are willing to buy given its
price at a particular time.
Demand, therefore, implies three things:

1. Desire to possess a thing;
2. The ability to pay for it or means of purchasing it.
3. Willingness to utilize it.
SHRINKFLATION
Shrinkflation is the practice of reducing the size of a product while maintaining its sticker price. It is
a rise in the general price level of goods per unit of weight or volume, brought about by a reduction in
the weight or size of the item sold.
Examples: Instant noodles, canned goods, and soap bars, products consumed mostly by the poor
suddenly seem to have loose packaging, or the usually comfortable packaging becomes very tight.
Shrinkflation is a term made up of two separate words: shrink and inflation. The "shrink" in
shrinkflation relates to the change in product size, while the "flation" part refers to inflation—the rise
in the price level.
Shrinkflation is basically a form of hidden inflation. Companies are aware that customers will likely
spot product price increases and so opt to reduce the size of them instead, mindful that minimal
shrinkage will probably go unnoticed. More money is squeezed out not by lifting prices but by charging
the same amount for a package containing a little bit less.
● Price is one of the top considerations when buying food and consumers will always look
for bargains. As most of what we purchase are already staples, who’s to notice on the onset
when the goods we constantly put in our baskets appear to be smaller than usual, especially
when the price didn’t change at all?

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● The impact of inflation pressure is not always in the form of increased prices,
companies oftentimes protect their market base by making adjustments other than price
increases, i.e. by reducing ingredients, altering the packaging, or most commonly, downsizing
the product itself.
What Causes Shrinkflation?
1. Higher Production Costs

Rising production costs are generally the primary cause of shrinkflation. Increases in the cost of
ingredients or raw materials, energy commodities, and labor increase production costs and
subsequently diminish the profit margins of producers.
Reducing the weight, volume, or quantity of the products while keeping the same retail price tag
can improve the producer’s profit margin. At the same time, the average consumer will not notice
a small reduction in quantity. Thus volume will not be affected.
2. Intense Market Competition
Fierce competition in the marketplace may also cause shrinkflation. The food and beverage industry
is generally an extremely competitive one, as consumers are able to access a variety of available
substitutes. Therefore, producers look for options that will enable them to keep the favour of their
customers and maintain their profit margins at the same time.
Demand schedule is a table that shows the relationship

of prices and the specific quantities demanded at each of
these prices. The information provided by a demand
schedule can be used to construct a demand curve.
The table shows the Hypothetical Demand Schedule for

SUV. It shows the various prices and quantities for the
demand for SUV.
The demand curve is a graphical representation showing the relationship between price and
quantities demanded per time period. A demand curve has a negative slope, thus it slopes downward

|| inverse relationship between price and quantity
from left to right. The downward slope indicates the
demanded.
This figure illustrates a typical demand curve. The Y-axis represents price (P), while the X-axis
represents the quantity demanded (Qd). The demand curve is negatively sloped or downward sloping.
The (negative) slope measures the change in quantity demanded a unit change in price. This indicates
that as the price of commodities decreases, more goods will be bought by the consumer.
The Law of Demand states that if the price goes UP, the quantity demanded will go DOWN.
Conversely, if the price goes DOWN, the quantity demanded will go UP. The reason for this is because
consumers always tend to MAXIMIZE SATISFACTION.
The law of demand is only true ceteris paribus. This is only true if other variables remain constant
such as the consumer’s income. Suppose that the income of the consumer decreases by around 75%,
the quantity demanded such product will fall even though the price decreases because the consumer
has less purchasing power brought by the decline in income.
P D P D
Note that the law of demand is a relationship between price and demand .
DEMAND SHIFTERS
Demand Shifters are variables other than the price of a good that influences demand. They cause
the demand to change even if prices remain the same. These demand shifters are also factors that
influence the quantity demanded of a particular product. These are referred to as non-price
determinants enumerated below:
Examples of Demand Shifters
1. Consumer Income – it affects the ability of consumers to purchase a good, change in income
affects how much consumers will buy at any price.
Increasing incomes of households raise the demand for certain goods or services, and vice versa.
This is because an increase in one’s income generally raises his capacity or power to demand goods
and services which he/she cannot purchase at a lower income. On the other hand, a decrease in
one’s income reduces their purchasing power, and consequently, the demand for some goods or
services ultimately declines.

Two types|| of goods

a. Normal Good – a good whose demand increases when consumer incomes rise.
Example: goods that are considered as part of our basic necessities such as rice, utilities
(electricity and water), medical and dental services.
b. Inferior Good – a good whose demand decreases when consumer income rises.
Example: Public Transportation – as the income of passengers in Manila increase significantly,
they tend to reduce their consumption for the services of public utility vehicles (PUVs) as a mode
of transportation and instead drive their own car.
It is important to point out those inferior goods don’t mean poor quality products, we use the term
inferior simply to define products that consumers purchase less of when their incomes rise and
purchase more of when their incomes fall.
2. Price of related goods - Changes in the price of related goods generally shifts the demand curve
for a good. The demand for any particular good will is affected by changes in the prices of related
goods. The direction in which the demand will change in response to a change in prices of related
goods depends on the relationships of the products.
Two types of related goods

a. Complements – are goods that go together or cannot be used without the other. They are
related in such a way that an increase in the price of one good will cause a decrease in the
demand for the other good. Example: sugar and coffee.
b. Substitutes – are goods that can be used in place of other goods. They are related in such
a way that an increase in the price of one good causes an increase in the demand for the
other goods or vice versa. Example: pork and beef, pepsi and coke, coffee and tea.
3. Advertising and Consumer Taste – a change in tastes and preferences in favour of a commodity
will mean that at each price, more will be demanded than previously. On the other hand, a change
in tastes and preferences away from a commodity will mean that, at each price, less will be
demanded than previously.
● Advertising often provides consumers with information about the existence or quality of a
product, which in turn induces more consumers to buy the product. Advertising can also
influence demand by altering the underlying tastes of consumers.
● Tastes and preferences affect the desirability of a product. Consumers’ tastes and preferences
are major factors in determining the demand for any product. Religion, culture, traditions, and
age are some of the factors that can affect them.

4. Population - The demand for a product is also||influenced by changes in the size and composition
of a population. As the population rises, more and more individuals wish to buy a given product.
5. Consumer Expectations - consumers are responding based on what they expect to happen in the
future. The quantity of a good demanded within any period depends not only on prices in that period
but also on prices expected in future periods.
If buyers expect the price of a good or service to rise (or fall) in the future, it may cause the current
demand to increase (or decrease). Also, expectations about the future may the alter demand for a
specific commodity.
By now you should understand the factors that affect demand and how to use graphs to illustrate those
influences. The final step in our analysis of the demand side of the market is to show that all the factors
that influence demand may be summarized in what economists refer to as a demand function.
Demand Function shows the relationship between demand for a commodity and the factors that
determine or influence this demand. The demand function explicitly recognizes that the quantity of a
good consumed depends on its price and on-demand shifters. Different products will have demand
functions of different forms.
CHANGE IN QUANTITY DEMANDED VS. CHANGE IN DEMAND

Change in Quantity Demanded ||
There is a change in quantity demanded if the movement is along the same demand curve. It is due
only to a change in the price of goods and services. Graphically, it is represented by a movement along
a demand curve which indicates a movement from one point to another point of the same demand
curve.
Change in Demand
There is a change in demand if the entire demand curve shifts to the right side resulting in increased
demand. Therefore, goods and services that remain at the same price are demanded in higher amounts
by consumers. Conversely, demand decreases or falls if the entire demand curve shifts downward or
to the left. Fewer amounts of a good or service (at the same price) are demanded by consumers.
An increase (decrease) in demand is brought by factors other than the price of the good itself, such as
tastes and preferences, price of substitute goods, etc., resulting in the shift of the entire demand curve
either upward or downward.
That would be for the basic of demand, remember that demand is just the one-side of market force.
So let us proceed in discussing the other side of the market force which is the supply.
Demand is generally affected by the behaviour of consumers, while supply is usually affected by the
conduct of producers. The interplay between these two is the foundation of economic activity. Thus,
the consumer identifies his/her needs, wants, and demands, while producers address these by
producing goods and services accordingly. In the end, the consumer gains satisfaction while the
producer gains profit.
As the economy cannot operate without this interaction between the consumer and the producer, it is
essential, therefore, that we have to understand the different movements of the demand and supply,
as well as the concept of market equilibrium.
SUPPLY
The first thought that comes to mind when we hear the word supply is the “availability” of goods and
services as if there are fixed amounts. Supply as compared to demand can also change, and the
quantities of goods and services supplied are based on the decisions of the producers in the market
Supply is the number of goods or services that firms are ready and willing to sell at a given price
within a period of time, other factors being held constant. Supply is a product made available for sale
by firms. It should be remembered that sellers normally sell more at a higher price than at a lower
price. This is because higher price results to higher profits.

||
A supply schedule is a table listing the various prices of a
product and the specific quantities supplied at each of these
prices at a given point in time. Generally, the information
provided by a supply schedule can be used to construct a
supply curve showing the price versus quantity supplied
relationship in a graphical form.
The supply schedule for SUV shows the different quantities

supplied when only its price changes and other factors
affecting the quantity supplied are held constant.
SUPPLY CURVE
After developing the supply schedule, the supply curve can now be obtained. A supply curve is a
graphical representation showing the relationship between the prices of the product sold or factor of
production and the quantity supplied per time period. The supply curve is upward sloping. It describes
the positive or direct relationship789 between the prices of a good and the quantity that suppliers are
willing and able to sell at a given price.
The figure illustrates a typical supply curve. The Y-axis represents

the price (P) and the X-axis represents the quantity supplied (Q).
The supply curve is positively sloped or upward sloping. This
positive slope indicates that as the price of commodities increases
(decreases), more (less) goods will be offered for sale by the
producers.
The supply curve shows what happens to the quantity supplied

of a good when its price varies, holding constant all the other
variables that influence sellers. When one of these other variables
changes, the supply curve shifts.

The Law of Supply states that if the price of a good || or service goes up, the quantity supplied for such
good or service will also go up; if the price goes down the quantity supplied also goes down. The Law
of Supply implies that a higher price is an incentive for business firms to produce more goods or services
as this will maximize their profits. This means that the higher the price of a certain good service,
the higher the quantity supplied. This is because producers tend to supply more at a higher price
because it could them more profit.
P S P S
Note that the law of supply is a relationship between price
and supply.
Just like the law of demand, the law of supply is only correct if the assumption of ceteris paribus is
applied. This means that there is no change in the non-price determinants of supply. For example, the
price of goods increases from P4 to P6 and with the cost of production remaining constant, the producer
certainly gets more profit and is induced to produce more. Now, assuming that as the price increases
from P4 to P6, the cost of production also increases, and producers may reduce their quantity supplied
or stop altogether if they get no profit anymore.
An increase (decrease) in supply is caused by factors other than the price of the good itself, such as a
change in technology, business goals, etc., resulting in the movement of the entire supply curve
downward (upward).
SUPPLY SHIFTERS
There are variables that affect the position of the supply curve that is called supply shifters. Just like
demand, there are also forces that cause the supply curve to change. Below are some of the reasons
that cause the supply curve to change:
Examples of Supply Shifters
1. Prices of Input – the supply curve reveal how much producers are willing to produce at
alternative prices. As production costs change, the willingness of producers to produce output at
a given price change. In particular, as the price of input rises, producers are willing to produce less
output at each given price.
2. Technology or Government Regulations - Technological changes and changes in government

regulations also can affect the position of the supply curve.

Change in Technology. State-of-the-art technology

|| that uses high-tech machines increases the
quantity supply of goods and services which causes the reduction of production cost.
Government Regulations. Subsidies or the financial aids/assistance given by the government

reduce the cost of production which encourages more supply.
3. Number of Firms – as additional firms enter an industry, more and more output is available at
each given price. The number of sellers has a direct impact on the quantity supplied. Simply put, the
more sellers there are in the market, the greater supply of goods and services will be available.
4. Taxes – it is expected that taxes imposed by the government increases the cost of production
which in turn discourages production because it reduces producers’ earnings. A higher degree of
regulation will translate to lower supply in the market.
Excise Tax –is a tax on each unit of output sold, where the tax revenue is collected from the
supplier. Excise tax is commonly included in the price of the product such as cigarettes or alcohol
as well as in the price of an activity, often gambling.
Ad Valorem Tax –literally means “according to the value”. An ad valorem tax is a percentage tax,
an example is the sales tax.
5. Producer Expectations – if firms suddenly expect prices to be higher in the future and the
product is not perishable, producers can hold back output today and sell it later at a higher price.
Expectations about future prices can shift the supply curve. When producers expect higher prices
in the future commodities, the tendency is to keep their goods and release them when the price
rises. Inversely, supply for such goods decreases if producers expect prices to decline in the future.
CHANGE IN QUANTITY SUPPLIED VS. CHANGE IN SUPPLY

Change in Quantity Supplied ||

There is a change in quantity supplied if the movement is along the same supply curve. A change in
quantity supplied is brought about by an increase (decrease) in the product’s own price. The direction
of the movement is positive, considering the Law of Supply. Change in quantity supplied, therefore,
occurs if the price of the good (being sold in the market by sellers) changes, and this is illustrated by
movement from one point o0t another point along the same supply curve.
Change in Supply
There is a change in supply when the entire demand-supply curve shifts upward or downward. At the
same price, producers or sellers are able to supply more amounts of a good or service. Producers sell
fewer amounts of a good or service at the same price.
You need to remember whether you need to shift or move along the
supply curve, keep in mind that a curve shifts only when there is a change
in a relevant variable that is not named on either axis. The price is on the
vertical axis, so a change in price represents a movement along the supply
curve. By contrast, because input prices, technology, expectations, and
the number of sellers are not measured on either axis, a change in one
of these variables shifts the supply curve.
MARKET EQUILIBRIUM
From a separate discussion of demand and supply, we now

proceed to reconcile the two. The meeting of supply and demand
results to what is referred to as “market equilibrium”. It is a
state which implies a balance between the opposing
forces, a situation in which quantity demanded and
quantity supplied are equal.
The market equilibrium is determined by the intersection of the demand and supply curves. The
price at this intersection is called the equilibrium price, and the quantity is called the equilibrium
quantity. At the equilibrium price, the quantity of the good that buyers are willing and able to buy
exactly balances the quantity that sellers are willing and able to sell.

||
To illustrate, the following table combines the demand and supply schedules:
Quantity Price Quantity Qs - Qd

Demanded (Php) Supplied (+)surplus, (-) shortage
10 300.00 50 40
20 250.00 40 20
30 200.00 30 0
40 150.00 20 -20
50 100.00 10 -40
WHAT HAPPENS WHEN THERE IS MARKET DISEQUILIBRIUM?
When there is market disequilibrium, two conditions may occur a surplus or a shortage.
Surplus is a condition in the market where the quantity supplied is more than the quantity
demanded. When there is a surplus, the tendency is for sellers to lower market prices in order for
the goods to be easily disposed from the market. This means that when there is a surplus there is
downward pressure on price, in order to restore equilibrium to the market.
Shortage is a condition in the market in which demand is higher than supply. When the market is
experiencing a shortage, there is a possibility that consumers can be abused, while the producers
enjoy imposing higher prices for their own interest. When there is a shortage, there is upward
pressure on prices to restore equilibrium to the market. This is due to the fact that consumers bid
for prices in order for them to acquire the goods or services that are in short supply.
This figure shows the equilibrium between quantity

demanded and quantity supplied.
As we can observe in the figure, the surplus is a

situation above the equilibrium point, while shortage is
a situation below the equilibrium point.

What happens if disequilibrium in the market

|| persists at a longer period of time? If this
happens, the government may intervene by imposing price controls.
Price Control is the specification by the government of minimum and/or maximum prices for goods
and services.
The government may wish to keep the price of some goods (e.g. food) down as a means of assisting
poor consumers. In the latter case, the aim may be to ensure that producers receive an adequate
return (price support for farmers, for instance). Generally, price controls may be applied across a
wide range of goods and services as part of price and income policy, aimed at combating inflation.
Price Controls are classified into two types: price floor, price ceiling, and price freeze.
Price Floor is the minimum legal price that can be charged in a market. Price floors are most often
placed on markets for goods that are an important source of income for the sellers, such as labor
market. Price floor generate surpluses on the market. Example: minimum wage.
Price Floor is a form of assistance to producers by the government for them to survive in their
business. Generally, price floor are imposed on agricultural products by the government, especially
when there is bumper harvest.
Price Ceiling is the maximum legal price that can be charged in a market. Price ceiling
generates shortages on the market. Example: Rent control.
Price Ceiling is generally imposed by the government to protect consumers from abusive producers
or sellers who take advantage of a shortage situation. This is usually done by government after the
occurrence of a calamity, like typhoon or severe flooding.
Price Freeze is the situation in which prices or the price of a particular product are fixed at
a particular level and no increases are allowed.
• The end of nationwide price freeze on all basic necessities on May 15 was in accordance with
DTI, DA and DOH Joint Memorandum Circular (JMC) No. 2020-01.
• With its end, consumers and retailers shall refer to the SRPs published by the DTI, DA and DOH
for the purchase and sale of basic necessities and prime commodities.

||
MARKET EQUILIBRIUM
(MATHEMATICAL APPROACH)
As we discussed earlier, market is in equilibrium when quantity demanded equals quantity supplied.
Given the demand function and supply function, the equilibrium price and quantity can be derived as:
𝑄𝑑𝑥 = 𝑄𝑠𝑥
𝑎 − 𝑏𝑃 = 𝑐 + 𝑑𝑃
Qd for Qs for
Points Price
From the table on the right side, Compute SUV SUV
For the market equilibrium of the given A 0 4,000 -2,000
Demand and supply schedule of SUV and
Equate the two. B 1 3,500 -1,000
C 2 3,000 0
D 3 2,500 1,000
E 4 2,000 2,000
F 5 1,500 3,000
G 6 1,000 4,000
H 7 500 5,000

||
Since market is not always in balance, therefore market equilibrium equation is not always
applicable. Hence, The Partial Equilibrium Analysis should be used.
The Partial Equilibrium Analysis:

The Equation System
Price Qd Qs Surplus/Shortage
6 32 27 Shortage

1 ||
Example:
Look for the 𝑃𝐸 and 𝑄𝐸

Given: 𝑄𝑑 = 68 − 6𝑃
𝑄𝑠 = −33 + 10𝑃
Solving for Price Equilibrium:

Equate Quantity Demand and Quantity Supplied:
68 − 6𝑃 = −33 + 10𝑃
68 + 33 = 10𝑃 + 6𝑃
101 16𝑃
=
16 16
𝑃𝐸 = 6.3125

||
LESSON 4: THE CONCEPT OF ELASTICITY
Elasticity is a measure of how much the quantity demanded of a service/good changes in relation to
its price, income or supply. Elasticity can be applied to demand in order to measure its responsiveness
to the changes on its selected determinants.
WHY ELASTICITY MATTERS:
Elasticity is important because it describes the fundamental relationship between the price of a good
and the demand for that good.
The concept of elasticity has several applications both in business and economic decision making.
Having knowledge of elasticity helps every policy formulating body develop and/or formulate
appropriate strategies and programs. It can determine the effect of price changes on the revenue.
Hence, producers can assess consumers’ responsiveness with respect to any change in the price of
commodity.
Two aspect of elasticity

1. Whether it is positive or negative.
2. Whether it is greater than 1 or less than 1.
Below is the list of types of Elasticity, its definition and its formula. As we go through in our course, we
will discuss each type one by one.
Types of Elasticity Definition Formula
The price elasticity of demand

measures the responsiveness of the
Price Elasticity of
quantity demanded with respect to the
Demand
changes in Its price.
Arc elasticity of demand measures

Arc Elasticity of elasticity between two points on a
Demand curve – using a mid-point between the
two curves.
The responsiveness of quantity

Income Elasticity of
demanded in response to a change in
Demand
income.
Measures the responsiveness of

Cross-Price Elasticity
quantity demanded of a good to a
of Demand
change in the price of another good.

Measures the responsiveness || of

Price Elasticity of quantity supplied in response to a
Supply percentage change in the price of the
products.
Degree of Price Elasticity of Demand – EXPLAINED
1. Elastic Demand – demand is price elastic when the elasticity coefficient is greater than one.
This means that a small change in price results to a greater change in quantity demanded. For
example, doubling the increase in price led to almost three times increase in quantity demanded.
Thus, the price of good is responsive to its quantity demanded. This means that consumers are
relatively sensitive to the price of goods.
2. Inelastic Demand – demand is price inelastic when the elasticity coefficient is less than one.
This means that a percentage change in quantity demanded is less than the percentage change
in price. For example, doubling the change (increase) in price resulted to half an increase in
quantity demanded. It only shows that consumers are relatively not sensitive to any change in
price. Goods of this type are essential to the consumers so that it is difficult for them to be
without it. As a result, any change in price has little significance.
3. Unitary Elastic Demand – demand is unitary elastic when elasticity coefficient is equal to one.
This means that a change in price is equal to a change in quantity demanded. For instance, the
change in price exactly matches the change in quantity demanded.
Determinants of Price Elasticity of Demand

Some goods are more responsive to any change in price while others are not. Some are prone to being
elastic or inelastic than others. There are several reasons behind these elasticity differences:
1. The importance or degree of necessity of the goods. The more essential or necessary the
goods or services, the more inelastic the demand. Necessities tend to have inelastic demands,
whereas luxuries have elastic demands.
2. Number of available substitutes. Demands for goods with greater number of substitutes are
elastic, while goods with less or no substitute have inelastic demand. This is because an increase
in the price of a certain product encourages consumers to look for alternative or substitute goods
available in the market. Power distributors like MERALCO are good examples.
3. The proportion in income in price changes. Demand is inelastic for a product whose changes
in price seemingly have no effect on the consumer income or budget. However, any change in price
resulting to a substantial effect on consumers’ income has elastic demand.

||
4. The time period. The longer the time period is the more elastic or less inelastic the demand will
be. This is because consumers have enough time to adjust their buying behaviour.
Price Elasticity of Demand, Total Revenue and Pricing Decisions

Total revenue responds differently with the result given by the degrees of elasticity or how the
consumer will respond in price changes. Notice that every time we discuss elasticity, we speak of total
revenue. This is because any change in price has a direct effect on the total revenue, such that if a
decrease in price leads to a decrease in total revenue, inelastic demand occurs; if a certain decrease
in price leads to an increase in total revenue, elastic demand occurs; and if decrease in price leads to
no change in total revenue, unitary elastic exist. Applying this knowledge about elasticity will help us
in making an appropriate pricing decision.
The price elasticity of demand measures the responsiveness of the quantity demanded with respect
to the changes in its price. The price elasticity of demand for any good measures how willing consumers
are to buy less of the good as its price rises.
The basic formula used to calculate the coefficient of price elasticity of demand is:
Where:
Q1=original quantity demanded
Q2=new quantity demanded
P1=original price
P2=new price
Demonstration Problem #1
Cecilia sells bangus for Php100 and her quantity demanded is 500. When she decides to sell it at
Php125, her quantity demanded becomes 450. Should Cecilia sell her bangus at Php100 or Php125? Is
Qd elastic or inelastic?
Let us now compute for the price elasticity of demand, total revenue and determine the pricing decision.
𝑄2 −𝑄1 450−500 −50

𝑄1 500 500 −0.10
𝐸𝑑 = 𝑃2 −𝑃1 = 125−100 = 25 = = 0.4 𝑂𝑅 ∣ 𝟎. 𝟒 ∣ 𝑰𝑵𝑬𝑳𝑨𝑺𝑻𝑰𝑪
.25
𝑃1 100 100
The ABSOLUTE VALUE is used to omit the

negative sign in price elasticity of demand.
||
TOTAL REVENUE = Price X Quantity Demanded

TR1 = P1 X Qd1 = 100 X 500 = 50,000
𝐓𝐑𝟐 = 𝐏𝟐 𝐗 𝐐𝐝𝟐 = 𝟏𝟐𝟓 𝐗 𝟒𝟓𝟎 = 𝟓𝟔, 𝟐𝟓𝟎
Pricing Decisions: Cecilia should sell her bangus at P125, for she can get higher revenue with her
new price.
Interpretation of the value:
⮚ In price elasticity of demand, the computed value is 0.4 in absolute term. This value indicates that
consumers are relatively not sensitive to any change in price. The bangus that Cecilia sells are
essential to the consumers.
Why the negative sign is usually ignored when computing for price elasticity of demand.
A positive percentage change in price implies a negative percentage change in quantity

demanded, and vice versa. ... In essence, the minus sign is ignored because it is expected that
there will be a negative (inverse) relationship between quantity demanded and price.
ARC ELASTICITY OF DEMAND

One of the problems with the price elasticity of demand formula is that it gives different values
depending on whether price rises or falls. To eliminate this problem, the arc elasticity can be used. Arc
elasticity measures elasticity at the midpoint between two selected points on the demand curve by
using a midpoint between the two points.
To get out of the asymmetry problem of having a price elasticity of demand dependent on which of
the two given points on a demand curve is chosen as the “original” point and which as the “new” one,
compute the percentage change in price and quantity relative to the average of the two prices and the
average of the two quantities, rather than just the change relative to one point or the other. We have
to take the average of the initial and new values of price and quantities. Using averages, we are now
estimating the price elasticity of demand at the midpoint of an arc drawn between the new and initial
points in a demand curve.
Arc Elasticity of demand measures elasticity between two points on a curve – using a mid-point
between the two curves.

||
In computing the Arc Elasticity of Demand we will consider the demonstration problem we use in
price elasticity of demand.
Cecilia sells bangus for Php100 and her quantity demanded is 500. When she decides to sell it at
Php125, her quantity demanded becomes 450. Should Cecilia sell her bangus at Php100 or Php125? Is
Qd elastic or inelastic?
Let us now compute for the arc elasticity of demand:
First we take the midpoint:
𝑄1 + 𝑄2 500+450 950
𝑀𝑖𝑑 𝑄 = = = = 475
2 2 2
After getting the midpoint, we can now calculate the arc

elasticity of demand:
𝑄2 −𝑄1 450−500 −50
𝑀𝑖𝑑 𝑄 475 475 −0.11
𝐸𝑎𝑟𝑐 = 𝑃2 −𝑃1 = 125−100 = 25 = = −0.5 𝑂𝑅 ∣ 0.5 ∣ 𝐼𝑁𝐸𝐿𝐴𝑆𝑇𝐼𝐶
0.22
𝑀𝑖𝑑 𝑃 112.50 112.50
If Theresa sells tilapia for Php80 per kilo, the demand for it is 200. When she raises it by Php100, the
quantity demanded diminishes to 100. At what price will Theresa maximize her profit? Is the demand
elastic or inelastic?

Let us now compute for the arc elasticity of demand:

||
First we take the midpoint:
𝑄1 + 𝑄2 200+100 300 𝑃1 + 𝑃2 80+100 180

𝑀𝑖𝑑 𝑄 = = = = 150 𝑀𝑖𝑑 𝑃 = = = = 90
2 2 2 2 2 2
After getting the midpoint, we can now calculate the arc elasticity of demand:
𝑄2 −𝑄1 100−200 −100

𝑀𝑖𝑑 𝑄 150 150 −0.67
𝐸𝑎𝑟𝑐 = 𝑃2 −𝑃1 = 100−80 = 20 = = −3.05 𝑂𝑅 ∣ 3.05 ∣ 𝐸𝐿𝐴𝑆𝑇𝐼𝐶
0.22
𝑀𝑖𝑑 𝑃 90 90

INCOME ELASTICITY OF DEMAND
Consumers’ income is one of the most important determinants of goods and services. In general, it
might be considered that as income rises, more goods and services will be demanded. But this is not
always true.
Income Elasticity of Demand is the responsiveness of quantity demanded in response to a change

in income. This measures the percentage change in demand over the percentage change in income.
Income elasticity simply measures whether the product is a normal or inferior good. With income
elasticity of demand, the value of elasticity (positive or negative) coefficient must be properly observed.
The coefficient sign should not be ignored and must be indicated.
The formula in computing the Income Elasticity of Demand is:
Q 2 − Q1
Q1
𝑬𝒚 =
𝒀𝟐−𝒀𝟏
𝒀𝟏

The table below summarizes the results of income ||coefficient:
Summary of Income Elasticity Coefficient
TYPES OF GOODS INCOME ELASTICITY INTERPRETATION

COEFFICIENT
Normal, Luxury Good Positive elasticity greater than one As income increases, more
(E > 1) goods and services will be
Normal, Necessity Positive elasticity but less than one demanded.
Good (E < 1)
Inferior Good Negative Elasticity As income increases, quantity
demand for such goods
declines.
Consider the hypothetical data in the table. By applying the formula of income elasticity of demand,
we can determine the type of good.
Y Qd
%ΔY % Δ𝑸𝒅 Ey Type of Good
(Given) (Given)
400 20 - - - -
500 35 0.25 0.75 3 Normal Luxury
600 43
700 47
800 50
900 48
1000 47

Sample computation: ||
𝑌2 − 𝑌1 500 − 400 100

%𝜟𝒀 = = = = 𝟎. 𝟐𝟓
𝑌1 400 400
𝑄𝑑2 − 𝑄𝑑1 35 − 20 15
%𝜟𝑸𝒅 = = = = 𝟎. 𝟕𝟓
𝑄𝑑1 20 20
%∆𝑄𝑑 0.75
𝑬𝒚 = = = 𝟑 Normal Luxury
%∆𝑌 0.25
Another elasticity arises when we look at the response of consumers when buying certain products if
the price of another changes. This cross effect is commonly known as the cross-price elasticity of
demand; it measures whether the good is substitute, complementary or unrelated to other products.
Cross-Price Elasticity of demand measures the responsiveness of quantity demanded of a good to
a change in the price of another good.
We can compute for the cross elasticity of the product using the formula:
𝑄𝑑𝑥2− 𝑄𝑑𝑥1 Where:

𝑄𝑑𝑥1 = original quantity demanded of Good X
𝐸𝑥𝑦 = 𝑃𝑦2− 𝑃𝑦1
= new quantity demanded of Good X
= original price of Good Y
𝑃𝑦1 = new price of Good Y
= Cross-price elasticity of demand
Summary of Cross-Price Elasticity Coefficient
CROSS-PRICE ELASTICITY
TYPES OF GOODS INTERPRETATION
COEFFICIENT
Elasticity coefficient is negative Goods that are used in conjunction
Complementary
E = (-) with other goods
Elasticity coefficient is positive Goods that can be used in place of
Substitute
E = (+) another goods
Elasticity coefficient is zero Goods are neither substitute nor
Unrelated
E=O complementary

Demonstration Problem #1 ||
Let’s consider the following hypothetical data in computing the cross-price elasticity of demand:
Before After
Product
Price/unit Quantity/unit Price/unit Quantity/unit
Personal Computer (Y) 60,000 25,000 40,000 30,000
Operating System (X) 30,000 7,000 8,000 12,000
Computation:
𝑄𝑑𝑥2 − 𝑄𝑑𝑥1 12,000 − 7000 5,000
𝑄𝑑𝑥1 7,000 7,000 0.71
𝐸𝑥𝑦 = = = = = −2.15 𝑐𝑜𝑚𝑝𝑙𝑒𝑚𝑒𝑛𝑡𝑎𝑟𝑦
𝑃𝑦2− 𝑃𝑦1 40,000 − 60,000 −20,000 −0.33
𝑃𝑦1 60,000 60,000
This implies that the goods are complementary, personal computer and operating system should be
used in conjunction with each other.
Just like in income elasticity, cross-price elasticity can also be computed through a given word problem.
The price of bicycle increased from P3, 500 to P4,000. The demand for motorcycle went up from 12,000
units to 12,500 units. Compute for the cross elasticity of demand. Determine whether substitute or
complement product.
Computation:
𝑄𝑑𝑥2 − 𝑄𝑑𝑥1 12,500 − 12,000 500
𝑄𝑑𝑥1 12,000 12,000 0.04
𝐸𝑥𝑦 = = = = = 0.29 𝑠𝑢𝑏𝑠𝑡𝑖𝑡𝑢𝑡𝑒
𝑃𝑦2− 𝑃𝑦1 4,000 − 3,500 500 0.14
𝑃𝑦1 3,500 3,500
The cross effect of the price of bicycle on the demand for motorcycle is positive and this implies that
the products are substitutes for each other.

||
PRICE ELASTICITY OF SUPPLY
The concept of price elasticity of supply measures the responsiveness of quantity supplied in
response to a percentage change in the price of the products.
The price elasticity of supply depends on the flexibility of sellers to change the amount of the good
they produce.
Degrees of Price Elasticity of Supply
Like demand elasticity, suppliers also tend to respond to any price changes.
Degree of Elasticity Interpretation Symbol

A change in price leads to a greater change in quantity
Elastic Supply Es>1
supplied.
A change in price leads to a lesser change in quantity

Inelastic Supply Es <1
supply.
A change in price leads to an equal change in quantity

Unitary Elastic Supply Es =1
supplied.
When there is no change in price, and there is an

Perfectly Elastic Supply Es =∞
infinite change in quantity supplied.
Perfectly Inelastic When a change in price has no effect on quantity

Es =0
Supply supplied.
Determinants of Price Elasticity of Supply

The primary determinant of price elasticity of supply is the time period involved. A noted economist,
Alfred Marshall distinguished the time period of supply as follows:
1. Monetary or intermediate – in this period, supply will be perfectly inelastic and the supply is
fixed.
2. Short-run – in this state, supply is inelastic. The output of production can increase even if
equipment is fixed.
3. Long-run – in this period, supply is elastic. New firms are expected to enter or the old one may
leave the industry.

COMPUTING FOR THE PRICE ELASTICITY OF||SUPPLY

Now that we have a general understanding about the price elasticity of supply, let us be more precise.
The formula of price elasticity of supply is identical to that of price elasticity of demand, only that supply
substitutes demand, as follows:
𝑸𝒔𝟐 −𝑸𝒔𝟏 Where:

𝑸𝒔𝟏 𝐐𝒔𝟏 = original quantity supplied
𝑬𝑺 = 𝑷𝟐 −𝑷𝟏
𝐐𝒔𝟐 = new quantity supplied
𝑷𝟏 = original price of good
𝑷𝟏 𝑷𝟐 = new price of good
When the price of refined sugar increases from P40 per kilo to P50 per kilo, the quantity supplied in
the market increased from 300 sacks per day to 500 sacks per day. Compute the price elasticity of
supply.
Let us now compute for the price elasticity of supply:
Qs2 −Qs1 500−300 200

Qs1 300 300 0.67
𝐄𝐒 = P2 −P1 = 50−40 = 10 =
0.25
= 𝟐. 𝟔𝟖 𝐄𝐥𝐚𝐬𝐭𝐢𝐜 𝐒𝐮𝐩𝐩𝐥𝐲
P1 40 40
Interpretation of the Value:
 The supply in refined sugar is said to be elastic, an increase in price leads to an increase in quantity
supplied.
Solve for the price elasticity of supply between point B and point D.
Point Price (P) Quantity Supplied (Qs)

A 5 20
B 10 25
C 15 30
D 20 35
E 25 40

Q s2 − Q s1 ||
35 − 25 10
Q s1 25 0.4
𝐄𝐒 = = = 25 = = 𝟎. 𝟒 𝐈𝐧𝐞𝐥𝐚𝐬𝐭𝐢𝐜 𝐒𝐮𝐩𝐩𝐥𝐲
P2 − P1 20 − 10 10 1
P1 10 10
Interpretation of the Value:

The results show a 40% change in quantity supplied for every 100% change in price of the product.

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AE11 - MANAGERIAL ECONOMICS

AE 11- MANAGERIAL ECONOMICS ||

LESSON 1: INTRODUCTION TO ECONOMICS

ORIGIN OF THE TERM ECONOMICS

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3. Effectiveness – means attainment of goals and objectives. Economics is an important and

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1. To strengthen economic freedom.

2. To promote economic efficiency.

3. To promote economic stability.

4. To promote economic security.

5. To attain high level of growth in the economy.

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These economic resources include:

Ten Principles of Economics

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1. People face trade-offs. ||

2. The cost of something is what one gives up to get it.

3. Rational people think at the margin.

4. People respond to incentives.

5. Trade can make everyone better off.

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6. Markets are usually a good way to organize economic activity.

7. Governments can sometimes improve market outcomes

9. Prices rise when the government prints too much money.

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 || of prices in the economy. When a government

LESSON 2: FUNDAMENTALS OF MANAGERIAL ECONOMICS

PRINCIPLES OF EFFECTIVE MANAGEMENT

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Now, let us differentiate the types of profits.

Total Revenue – Explicit cost = Accounting profit

Why the role of profit is important?

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The story of Carding…

How this was computed?

3 Sources of Rivalry that exist in Economic Transactions

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b. Consumer-Consumer Rivalry -When || limited quantities of goods are available,

Formula (Present Value - PV) Sample Problem: Present Value

What is the present value of $100.00 in 10

This means that if you invested $50.83 today at a

Present Value of a Stream

𝐹𝑉1 𝐹𝑉2 𝐹𝑉3 𝐹𝑉𝑛

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Sample Problem: Present Value of a Stream and Net Present Value

50,000 60,000 75,000 90,000 90,000

50,000 60,000 75,000 90,000 90,000

𝑃𝑉 = 46,296.30 + 51,440.33 + 59,537.99 + 66,152.15 + 61,253.66

𝑁𝑃𝑉 = 284,680.43 − 300,000

Profit Maximization: Value of the Firm

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Sample Problem: Profit Maximization: Value of the Firm

𝑃𝑉𝐹𝑖𝑟𝑚 = $2,200 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

The value of the firm after it pays its dividend:

𝑃𝑉𝐹𝑖𝑟𝑚 = $2,100 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

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6. Use marginal analysis

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LESSON 3: MARKET FORCES: DEMAND AND SUPPLY