Assignment Prompt & Instructions
– ## EconomicsforManagersECO6301UnitIIDB.docx
– ## UnitIIStudyGuide.pdf
**## EconomicsforManagersECO6301UnitIIDB.docx**
2
Economics for Managers ECO 6301 Unit II
This unit's readings include information on pricing. You are introduced to the shutdown price, using elasticity to determine the effects of price changes, and cost-based pricing. Discuss the importance of considering elasticity in pricing decisions and the danger of relying solely on costs.
Your initial post should be at least 300 words in length.
Your initial post should include at least one APA-formatted scholarly, professional, or textbook reference with accompanying in-text citation to support any paraphrased, summarized, or quoted material.
**## UnitIIStudyGuide.pdf**
ECO 6301, Economics for Managers 1
Course Learning Outcomes for Unit II
At the end of this unit, you should be able to:
2. Apply the different types of elasticity concepts to business scenarios.
2.1 Predict demand using elasticity.
7. Explain the implications of uncertainty in managerial decision-making.
7.1 Describe how marginal analysis can lead to better decision-making.
Required Unit Resources
Chapter 5: Investment Decisions: Look Ahead and Reason Back (ULO 2.1)
Chapter 6: Simple Pricing (ULO 7.1)
Chapter 7: Economies of Scale and Scope (ULO 7.1)
Unit Lesson
Lesson: Production Decisions, Costs, and Prices (ULOs 2.1 and 7.1)
This lesson will introduce you to the ways that business use tools for decision-making.
This unit’s material focuses on business decision-making and explores some tools that can help businesses
make good decisions. Costs are the first type of information firms need to know for decision-making. If firms
do not know their own costs, it is really difficult to make decisions. Of course, information is seldom known
100%, but the closer firms can get to 100%, the better their decision-making will be.
There are some obvious costs businesses need to know, such as their rent, cost of material, and cost of
labor. With these costs, firms need to know how the costs will change with their decisions. For example, if
a business wants to double production, will its cost double to do so? Some probably will, but not all of them.
Rent and CEO salary are examples of fixed costs. Fixed costs are costs that do not change with changes
in output. Variables costs are expenses such as labor or materials that change with production. If
McDonald’s wants to produce another Quarter Pounder, they need more hamburger patties. So when
making production decisions, fixed costs should not be considered. They do not change, so they do not
matter to production decisions.
The Shutdown
This leads to one of the first important decisions a business should make called the shutdown decision.
Shutting down does not mean closing-up shop for good. In fact, it can often be reasonable for a business to
operate even if it is earning at a loss. Consider that fixed costs should not be involved in this decision since
they cannot be avoided. Fixed costs are important, however, for determining profit. So, if a business shuts
down, it still has to pay the fixed costs. If a business is able to sell their product for more than it costs to
produce the product (meaning just looking at variable costs), then a firm can offset some of the loss of the
fixed costs by continuing to operate. If this is the case, the business would want to continue operating so long
as the fixed costs remain (a time period economists refer to as the short-run). Once their fixed costs are no
longer fixed and the business has decision-making control over them (the long-run), then the business owners
can consider exiting the market entirely. So just to reiterate, it can make perfectly good sense for a business
UNIT II STUDY GUIDE
Production Decisions, Costs, and Prices
ECO 6301, Economics for Managers 2
UNIT x STUDY GUIDE
Title
to operate at a loss; simply earning a loss does not mean the business should shutdown. As long as price
exceeds average variable cost (variable cost per unit), the firm should continue to operate.
The shutdown decision applies to more than just firms operating at a loss, however. The same approach is
used by just about every business, just about every day. It is not based on the income statement the business
might produce for a month or a quarter or a year, but on a daily decision—on something as simple as which
hours to be open. Breakfast restaurants typically close shortly after lunch time as there is not a lot of demand
for omelets at dinner time. Fancy steak houses are often open only at dinner time as there is not a demand
for $50 steaks at breakfast or even lunch.
More Tools
Other decisions by firms involve comparisons to other alternatives. To make these decisions, firms need to
have information about their alternatives to help make good choices. What is the value of doing different
alternatives? Economists call this opportunity cost. If a frozen yogurt shop opts to replace their chocolate
yogurt with mint yogurt, what is the cost of doing that? It is not just the cost of the mint yogurt, it is also the
revenue they would have earned from selling chocolate yogurt. If chocolate yogurt would have sold more,
then the frozen yogurt shop is essentially losing money by selling mint instead. This is known as economic
profit (or loss). Firms should not just be concerned with how much money their accountant tells them they
are making; they should be concerned about how much money they could make by choosing different
alternatives.
Oftentimes, looking at different alternatives can be cumbersome. It can be difficult to compare the
alternatives; however, there are financial tools businesses can use to make comparing the options easier.
Discounting, for example, uses a rate of return to compare cash flows across different time periods. Is a dollar
tomorrow worth the same as a dollar today? No, the dollar today is more valuable. Discounting allows
decision-makers to make a better apples-to-apples comparison of the financial projections for different
potential projects.
Financial analysis can also help businesses determine what they need to do to break even on a project.
Determining the break-even quantity is fairly straight forward. It is simply the fixed costs divided by the
difference between price and marginal cost (the cost of producing an additional unit). The more challenging
part is determining what costs to include. As discussed above, opportunity costs are an important cost to
consider in decision-making.
Comparing apples to oranges is
not exactly an equal comparison.
(Gregory, n.d.)
ECO 6301, Economics for Managers 3
UNIT x STUDY GUIDE
Title
While deciding what costs to include in decision-making is important, equally important is knowing what costs
should not be included in decision-making. When making a decision, only costs that are controllable should
be considered. Costs that have already been incurred (or committed to), known as sunk costs, should not be
considered in the decision. This again reflects the shutdown decision when fixed costs should not be
considered. If something will not change based on your decision, then do not bother including it in your
decision-making process.
Pricing and Elasticity
On the other side of the decision-making ledger from costs is prices. Costs need to be managed, but real
strategy comes with setting prices. Set the price too high and customers will not buy the product.
Some businesses will set price based on costs (firms that use a standard mark-up over costs are an
example of basing price on costs), but this completely ignores demand. Businesses might be over-charging or
under-charging.
Set the price too low and businesses will not bring in as much revenue as they could have. This is where
elasticity comes into play. Elasticity is the responsiveness of one variable to a change in another. The most
commonly used elasticity is the elasticity of demand, which is the responsiveness of quantity demanded to a
change in price. If quantity demanded changes a lot when price changes a little, the product or good has an
elastic demand. If quantity demanded does not change very much when price changes considerably, the
good has an inelastic demand.
The most obvious application of elasticity is the effect price changes have on total revenue. If a good has an
elastic demand, then a price decrease will result in an increase in total revenue. Since total revenue is equal
to price times quantity, then if price is decreasing a little but quantity increases a lot, then total revenue will
increase. If a good has an inelastic demand, then a price increase will result in an increase in total revenue.
Looking back at total revenue, if price can increase a lot without much loss in quantity, then total revenue
will increase.
Firms can estimate elasticity using regression analysis (note: to do this, take the natural log of price and the
natural log of quantity—just putting price and quantity into a regression will not yield elasticities). This requires
sufficient data to estimate a demand function. Businesses can get most of what they need for making
decisions by understanding what determines elasticity.
There are three main determinants of elasticity, but really, they can be boiled down to one: what other
available options consumers have. The more options you have, the more sensitive you will be to a price
change of a good. Options can arise in a variety of ways.
The first option is the amount of time a consumer has to make the purchase decision. Imagine you are at a
baseball game and you are getting hungry. You can certainly go get a hotdog. You will pay more money for it
ECO 6301, Economics for Managers 4
UNIT x STUDY GUIDE
Title
at a concession within the venue, but the other option is to wait until the game is over. But that might be
longer than you would like to wait to eat.
Elasticity can also change based on how broadly the good is defined. Gas is an inelastic good. People need it
to get to work, the grocery store, go on trips, take their kids to school, etc. But that does not mean a gas
station can simply charge as high of a price for gas as they want because there is likely to be a gas station
across the street or at most just down the road. If a particular gas station increases price much more than
competitor gas stations, then consumers will simply go to the competitor.
If a business understands the nature of their product and understands the alternatives consumers have to
their product, the business will be able to make sound decisions on whether they should raise or cut prices.
The business may not know exactly what will happen to the demand for their product, but they will have a
pretty good idea. In business, often being able to make an educated, informed decision in a world of
uncertainty is the best that can be asked.
References
Gregory, R. (n.d.). Comparing apples to oranges. Concept, isolated (ID 597747) [Photograph]. Dreamstime.
https://www.dreamstime.com/royalty-free-stock-photography-comparing-apples-to-oranges-
image597747
Siddique, K., Ali, G., Ullah, I., Shah, A. U., & Fayaz, M. (2019). An estimation of expenditure, own and cross
price elasticities of meat in Pakistan. Sarhad Journal of Agriculture, 35(2), 623–629.
https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc
t=true&db=asn&AN=136655162&site=ehost-live&scope=site
Suggested Unit Resources
Elasticities of Meat in Pakistan (Optional)
This article gives an example of estimating elasticities, both own-price and cross-price elasticities. The article
also demonstrates how understanding elasticities can be used to make inferences about buying habits of
consumers being studied (in this case, consumers in rural and urban areas of Pakistan).
**## UnitIIStudyGuide.pdf**
ECO 6301, Economics for Managers 1
Course Learning Outcomes for Unit II
At the end of this unit, you should be able to:
2. Apply the different types of elasticity concepts to business scenarios.
2.1 Predict demand using elasticity.
7. Explain the implications of uncertainty in managerial decision-making.
7.1 Describe how marginal analysis can lead to better decision-making.
Required Unit Resources
Chapter 5: Investment Decisions: Look Ahead and Reason Back (ULO 2.1)
Chapter 6: Simple Pricing (ULO 7.1)
Chapter 7: Economies of Scale and Scope (ULO 7.1)
Unit Lesson
Lesson: Production Decisions, Costs, and Prices (ULOs 2.1 and 7.1)
This lesson will introduce you to the ways that business use tools for decision-making.
This unit’s material focuses on business decision-making and explores some tools that can help businesses
make good decisions. Costs are the first type of information firms need to know for decision-making. If firms
do not know their own costs, it is really difficult to make decisions. Of course, information is seldom known
100%, but the closer firms can get to 100%, the better their decision-making will be.
There are some obvious costs businesses need to know, such as their rent, cost of material, and cost of
labor. With these costs, firms need to know how the costs will change with their decisions. For example, if
a business wants to double production, will its cost double to do so? Some probably will, but not all of them.
Rent and CEO salary are examples of fixed costs. Fixed costs are costs that do not change with changes
in output. Variables costs are expenses such as labor or materials that change with production. If
McDonald’s wants to produce another Quarter Pounder, they need more hamburger patties. So when
making production decisions, fixed costs should not be considered. They do not change, so they do not
matter to production decisions.
The Shutdown
This leads to one of the first important decisions a business should make called the shutdown decision.
Shutting down does not mean closing-up shop for good. In fact, it can often be reasonable for a business to
operate even if it is earning at a loss. Consider that fixed costs should not be involved in this decision since
they cannot be avoided. Fixed costs are important, however, for determining profit. So, if a business shuts
down, it still has to pay the fixed costs. If a business is able to sell their product for more than it costs to
produce the product (meaning just looking at variable costs), then a firm can offset some of the loss of the
fixed costs by continuing to operate. If this is the case, the business would want to continue operating so long
as the fixed costs remain (a time period economists refer to as the short-run). Once their fixed costs are no
longer fixed and the business has decision-making control over them (the long-run), then the business owners
can consider exiting the market entirely. So just to reiterate, it can make perfectly good sense for a business
UNIT II STUDY GUIDE
Production Decisions, Costs, and Prices
ECO 6301, Economics for Managers 2
UNIT x STUDY GUIDE
Title
to operate at a loss; simply earning a loss does not mean the business should shutdown. As long as price
exceeds average variable cost (variable cost per unit), the firm should continue to operate.
The shutdown decision applies to more than just firms operating at a loss, however. The same approach is
used by just about every business, just about every day. It is not based on the income statement the business
might produce for a month or a quarter or a year, but on a daily decision—on something as simple as which
hours to be open. Breakfast restaurants typically close shortly after lunch time as there is not a lot of demand
for omelets at dinner time. Fancy steak houses are often open only at dinner time as there is not a demand
for $50 steaks at breakfast or even lunch.
More Tools
Other decisions by firms involve comparisons to other alternatives. To make these decisions, firms need to
have information about their alternatives to help make good choices. What is the value of doing different
alternatives? Economists call this opportunity cost. If a frozen yogurt shop opts to replace their chocolate
yogurt with mint yogurt, what is the cost of doing that? It is not just the cost of the mint yogurt, it is also the
revenue they would have earned from selling chocolate yogurt. If chocolate yogurt would have sold more,
then the frozen yogurt shop is essentially losing money by selling mint instead. This is known as economic
profit (or loss). Firms should not just be concerned with how much money their accountant tells them they
are making; they should be concerned about how much money they could make by choosing different
alternatives.
Oftentimes, looking at different alternatives can be cumbersome. It can be difficult to compare the
alternatives; however, there are financial tools businesses can use to make comparing the options easier.
Discounting, for example, uses a rate of return to compare cash flows across different time periods. Is a dollar
tomorrow worth the same as a dollar today? No, the dollar today is more valuable. Discounting allows
decision-makers to make a better apples-to-apples comparison of the financial projections for different
potential projects.
Financial analysis can also help businesses determine what they need to do to break even on a project.
Determining the break-even quantity is fairly straight forward. It is simply the fixed costs divided by the
difference between price and marginal cost (the cost of producing an additional unit). The more challenging
part is determining what costs to include. As discussed above, opportunity costs are an important cost to
consider in decision-making.
Comparing apples to oranges is
not exactly an equal comparison.
(Gregory, n.d.)
ECO 6301, Economics for Managers 3
UNIT x STUDY GUIDE
Title
While deciding what costs to include in decision-making is important, equally important is knowing what costs
should not be included in decision-making. When making a decision, only costs that are controllable should
be considered. Costs that have already been incurred (or committed to), known as sunk costs, should not be
considered in the decision. This again reflects the shutdown decision when fixed costs should not be
considered. If something will not change based on your decision, then do not bother including it in your
decision-making process.
Pricing and Elasticity
On the other side of the decision-making ledger from costs is prices. Costs need to be managed, but real
strategy comes with setting prices. Set the price too high and customers will not buy the product.
Some businesses will set price based on costs (firms that use a standard mark-up over costs are an
example of basing price on costs), but this completely ignores demand. Businesses might be over-charging or
under-charging.
Set the price too low and businesses will not bring in as much revenue as they could have. This is where
elasticity comes into play. Elasticity is the responsiveness of one variable to a change in another. The most
commonly used elasticity is the elasticity of demand, which is the responsiveness of quantity demanded to a
change in price. If quantity demanded changes a lot when price changes a little, the product or good has an
elastic demand. If quantity demanded does not change very much when price changes considerably, the
good has an inelastic demand.
The most obvious application of elasticity is the effect price changes have on total revenue. If a good has an
elastic demand, then a price decrease will result in an increase in total revenue. Since total revenue is equal
to price times quantity, then if price is decreasing a little but quantity increases a lot, then total revenue will
increase. If a good has an inelastic demand, then a price increase will result in an increase in total revenue.
Looking back at total revenue, if price can increase a lot without much loss in quantity, then total revenue
will increase.
Firms can estimate elasticity using regression analysis (note: to do this, take the natural log of price and the
natural log of quantity—just putting price and quantity into a regression will not yield elasticities). This requires
sufficient data to estimate a demand function. Businesses can get most of what they need for making
decisions by understanding what determines elasticity.
There are three main determinants of elasticity, but really, they can be boiled down to one: what other
available options consumers have. The more options you have, the more sensitive you will be to a price
change of a good. Options can arise in a variety of ways.
The first option is the amount of time a consumer has to make the purchase decision. Imagine you are at a
baseball game and you are getting hungry. You can certainly go get a hotdog. You will pay more money for it
ECO 6301, Economics for Managers 4
UNIT x STUDY GUIDE
Title
at a concession within the venue, but the other option is to wait until the game is over. But that might be
longer than you would like to wait to eat.
Elasticity can also change based on how broadly the good is defined. Gas is an inelastic good. People need it
to get to work, the grocery store, go on trips, take their kids to school, etc. But that does not mean a gas
station can simply charge as high of a price for gas as they want because there is likely to be a gas station
across the street or at most just down the road. If a particular gas station increases price much more than
competitor gas stations, then consumers will simply go to the competitor.
If a business understands the nature of their product and understands the alternatives consumers have to
their product, the business will be able to make sound decisions on whether they should raise or cut prices.
The business may not know exactly what will happen to the demand for their product, but they will have a
pretty good idea. In business, often being able to make an educated, informed decision in a world of
uncertainty is the best that can be asked.
References
Gregory, R. (n.d.). Comparing apples to oranges. Concept, isolated (ID 597747) [Photograph]. Dreamstime.
https://www.dreamstime.com/royalty-free-stock-photography-comparing-apples-to-oranges-
image597747
Siddique, K., Ali, G., Ullah, I., Shah, A. U., & Fayaz, M. (2019). An estimation of expenditure, own and cross
price elasticities of meat in Pakistan. Sarhad Journal of Agriculture, 35(2), 623–629.
https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc
t=true&db=asn&AN=136655162&site=ehost-live&scope=site
Suggested Unit Resources
Elasticities of Meat in Pakistan (Optional)
This article gives an example of estimating elasticities, both own-price and cross-price elasticities. The article
also demonstrates how understanding elasticities can be used to make inferences about buying habits of
consumers being studied (in this case, consumers in rural and urban areas of Pakistan).
**## EconomicsforManagersECO6301UnitIIDB.docx**
2
Economics for Managers ECO 6301 Unit II
This unit's readings include information on pricing. You are introduced to the shutdown price, using elasticity to determine the effects of price changes, and cost-based pricing. Discuss the importance of considering elasticity in pricing decisions and the danger of relying solely on costs.
Your initial post should be at least 300 words in length.
Your initial post should include at least one APA-formatted scholarly, professional, or textbook reference with accompanying in-text citation to support any paraphrased, summarized, or quoted material.
**## UnitIIStudyGuide.pdf**
ECO 6301, Economics for Managers 1
Course Learning Outcomes for Unit II
At the end of this unit, you should be able to:
2. Apply the different types of elasticity concepts to business scenarios.
2.1 Predict demand using elasticity.
7. Explain the implications of uncertainty in managerial decision-making.
7.1 Describe how marginal analysis can lead to better decision-making.
Required Unit Resources
Chapter 5: Investment Decisions: Look Ahead and Reason Back (ULO 2.1)
Chapter 6: Simple Pricing (ULO 7.1)
Chapter 7: Economies of Scale and Scope (ULO 7.1)
Unit Lesson
Lesson: Production Decisions, Costs, and Prices (ULOs 2.1 and 7.1)
This lesson will introduce you to the ways that business use tools for decision-making.
This unit’s material focuses on business decision-making and explores some tools that can help businesses
make good decisions. Costs are the first type of information firms need to know for decision-making. If firms
do not know their own costs, it is really difficult to make decisions. Of course, information is seldom known
100%, but the closer firms can get to 100%, the better their decision-making will be.
There are some obvious costs businesses need to know, such as their rent, cost of material, and cost of
labor. With these costs, firms need to know how the costs will change with their decisions. For example, if
a business wants to double production, will its cost double to do so? Some probably will, but not all of them.
Rent and CEO salary are examples of fixed costs. Fixed costs are costs that do not change with changes
in output. Variables costs are expenses such as labor or materials that change with production. If
McDonald’s wants to produce another Quarter Pounder, they need more hamburger patties. So when
making production decisions, fixed costs should not be considered. They do not change, so they do not
matter to production decisions.
The Shutdown
This leads to one of the first important decisions a business should make called the shutdown decision.
Shutting down does not mean closing-up shop for good. In fact, it can often be reasonable for a business to
operate even if it is earning at a loss. Consider that fixed costs should not be involved in this decision since
they cannot be avoided. Fixed costs are important, however, for determining profit. So, if a business shuts
down, it still has to pay the fixed costs. If a business is able to sell their product for more than it costs to
produce the product (meaning just looking at variable costs), then a firm can offset some of the loss of the
fixed costs by continuing to operate. If this is the case, the business would want to continue operating so long
as the fixed costs remain (a time period economists refer to as the short-run). Once their fixed costs are no
longer fixed and the business has decision-making control over them (the long-run), then the business owners
can consider exiting the market entirely. So just to reiterate, it can make perfectly good sense for a business
UNIT II STUDY GUIDE
Production Decisions, Costs, and Prices
ECO 6301, Economics for Managers 2
UNIT x STUDY GUIDE
Title
to operate at a loss; simply earning a loss does not mean the business should shutdown. As long as price
exceeds average variable cost (variable cost per unit), the firm should continue to operate.
The shutdown decision applies to more than just firms operating at a loss, however. The same approach is
used by just about every business, just about every day. It is not based on the income statement the business
might produce for a month or a quarter or a year, but on a daily decision—on something as simple as which
hours to be open. Breakfast restaurants typically close shortly after lunch time as there is not a lot of demand
for omelets at dinner time. Fancy steak houses are often open only at dinner time as there is not a demand
for $50 steaks at breakfast or even lunch.
More Tools
Other decisions by firms involve comparisons to other alternatives. To make these decisions, firms need to
have information about their alternatives to help make good choices. What is the value of doing different
alternatives? Economists call this opportunity cost. If a frozen yogurt shop opts to replace their chocolate
yogurt with mint yogurt, what is the cost of doing that? It is not just the cost of the mint yogurt, it is also the
revenue they would have earned from selling chocolate yogurt. If chocolate yogurt would have sold more,
then the frozen yogurt shop is essentially losing money by selling mint instead. This is known as economic
profit (or loss). Firms should not just be concerned with how much money their accountant tells them they
are making; they should be concerned about how much money they could make by choosing different
alternatives.
Oftentimes, looking at different alternatives can be cumbersome. It can be difficult to compare the
alternatives; however, there are financial tools businesses can use to make comparing the options easier.
Discounting, for example, uses a rate of return to compare cash flows across different time periods. Is a dollar
tomorrow worth the same as a dollar today? No, the dollar today is more valuable. Discounting allows
decision-makers to make a better apples-to-apples comparison of the financial projections for different
potential projects.
Financial analysis can also help businesses determine what they need to do to break even on a project.
Determining the break-even quantity is fairly straight forward. It is simply the fixed costs divided by the
difference between price and marginal cost (the cost of producing an additional unit). The more challenging
part is determining what costs to include. As discussed above, opportunity costs are an important cost to
consider in decision-making.
Comparing apples to oranges is
not exactly an equal comparison.
(Gregory, n.d.)
ECO 6301, Economics for Managers 3
UNIT x STUDY GUIDE
Title
While deciding what costs to include in decision-making is important, equally important is knowing what costs
should not be included in decision-making. When making a decision, only costs that are controllable should
be considered. Costs that have already been incurred (or committed to), known as sunk costs, should not be
considered in the decision. This again reflects the shutdown decision when fixed costs should not be
considered. If something will not change based on your decision, then do not bother including it in your
decision-making process.
Pricing and Elasticity
On the other side of the decision-making ledger from costs is prices. Costs need to be managed, but real
strategy comes with setting prices. Set the price too high and customers will not buy the product.
Some businesses will set price based on costs (firms that use a standard mark-up over costs are an
example of basing price on costs), but this completely ignores demand. Businesses might be over-charging or
under-charging.
Set the price too low and businesses will not bring in as much revenue as they could have. This is where
elasticity comes into play. Elasticity is the responsiveness of one variable to a change in another. The most
commonly used elasticity is the elasticity of demand, which is the responsiveness of quantity demanded to a
change in price. If quantity demanded changes a lot when price changes a little, the product or good has an
elastic demand. If quantity demanded does not change very much when price changes considerably, the
good has an inelastic demand.
The most obvious application of elasticity is the effect price changes have on total revenue. If a good has an
elastic demand, then a price decrease will result in an increase in total revenue. Since total revenue is equal
to price times quantity, then if price is decreasing a little but quantity increases a lot, then total revenue will
increase. If a good has an inelastic demand, then a price increase will result in an increase in total revenue.
Looking back at total revenue, if price can increase a lot without much loss in quantity, then total revenue
will increase.
Firms can estimate elasticity using regression analysis (note: to do this, take the natural log of price and the
natural log of quantity—just putting price and quantity into a regression will not yield elasticities). This requires
sufficient data to estimate a demand function. Businesses can get most of what they need for making
decisions by understanding what determines elasticity.
There are three main determinants of elasticity, but really, they can be boiled down to one: what other
available options consumers have. The more options you have, the more sensitive you will be to a price
change of a good. Options can arise in a variety of ways.
The first option is the amount of time a consumer has to make the purchase decision. Imagine you are at a
baseball game and you are getting hungry. You can certainly go get a hotdog. You will pay more money for it
ECO 6301, Economics for Managers 4
UNIT x STUDY GUIDE
Title
at a concession within the venue, but the other option is to wait until the game is over. But that might be
longer than you would like to wait to eat.
Elasticity can also change based on how broadly the good is defined. Gas is an inelastic good. People need it
to get to work, the grocery store, go on trips, take their kids to school, etc. But that does not mean a gas
station can simply charge as high of a price for gas as they want because there is likely to be a gas station
across the street or at most just down the road. If a particular gas station increases price much more than
competitor gas stations, then consumers will simply go to the competitor.
If a business understands the nature of their product and understands the alternatives consumers have to
their product, the business will be able to make sound decisions on whether they should raise or cut prices.
The business may not know exactly what will happen to the demand for their product, but they will have a
pretty good idea. In business, often being able to make an educated, informed decision in a world of
uncertainty is the best that can be asked.
References
Gregory, R. (n.d.). Comparing apples to oranges. Concept, isolated (ID 597747) [Photograph]. Dreamstime.
https://www.dreamstime.com/royalty-free-stock-photography-comparing-apples-to-oranges-
image597747
Siddique, K., Ali, G., Ullah, I., Shah, A. U., & Fayaz, M. (2019). An estimation of expenditure, own and cross
price elasticities of meat in Pakistan. Sarhad Journal of Agriculture, 35(2), 623–629.
https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc
t=true&db=asn&AN=136655162&site=ehost-live&scope=site
Suggested Unit Resources
Elasticities of Meat in Pakistan (Optional)
This article gives an example of estimating elasticities, both own-price and cross-price elasticities. The article
also demonstrates how understanding elasticities can be used to make inferences about buying habits of
consumers being studied (in this case, consumers in rural and urban areas of Pakistan).
**## EconomicsforManagersECO6301UnitIIDB.docx**
2
Economics for Managers ECO 6301 Unit II
This unit's readings include information on pricing. You are introduced to the shutdown price, using elasticity to determine the effects of price changes, and cost-based pricing. Discuss the importance of considering elasticity in pricing decisions and the danger of relying solely on costs.
Your initial post should be at least 300 words in length.
Your initial post should include at least one APA-formatted scholarly, professional, or textbook reference with accompanying in-text citation to support any paraphrased, summarized, or quoted material.
**## UnitIIStudyGuide.pdf**
ECO 6301, Economics for Managers 1
Course Learning Outcomes for Unit II
At the end of this unit, you should be able to:
2. Apply the different types of elasticity concepts to business scenarios.
2.1 Predict demand using elasticity.
7. Explain the implications of uncertainty in managerial decision-making.
7.1 Describe how marginal analysis can lead to better decision-making.
Required Unit Resources
Chapter 5: Investment Decisions: Look Ahead and Reason Back (ULO 2.1)
Chapter 6: Simple Pricing (ULO 7.1)
Chapter 7: Economies of Scale and Scope (ULO 7.1)
Unit Lesson
Lesson: Production Decisions, Costs, and Prices (ULOs 2.1 and 7.1)
This lesson will introduce you to the ways that business use tools for decision-making.
This unit’s material focuses on business decision-making and explores some tools that can help businesses
make good decisions. Costs are the first type of information firms need to know for decision-making. If firms
do not know their own costs, it is really difficult to make decisions. Of course, information is seldom known
100%, but the closer firms can get to 100%, the better their decision-making will be.
There are some obvious costs businesses need to know, such as their rent, cost of material, and cost of
labor. With these costs, firms need to know how the costs will change with their decisions. For example, if
a business wants to double production, will its cost double to do so? Some probably will, but not all of them.
Rent and CEO salary are examples of fixed costs. Fixed costs are costs that do not change with changes
in output. Variables costs are expenses such as labor or materials that change with production. If
McDonald’s wants to produce another Quarter Pounder, they need more hamburger patties. So when
making production decisions, fixed costs should not be considered. They do not change, so they do not
matter to production decisions.
The Shutdown
This leads to one of the first important decisions a business should make called the shutdown decision.
Shutting down does not mean closing-up shop for good. In fact, it can often be reasonable for a business to
operate even if it is earning at a loss. Consider that fixed costs should not be involved in this decision since
they cannot be avoided. Fixed costs are important, however, for determining profit. So, if a business shuts
down, it still has to pay the fixed costs. If a business is able to sell their product for more than it costs to
produce the product (meaning just looking at variable costs), then a firm can offset some of the loss of the
fixed costs by continuing to operate. If this is the case, the business would want to continue operating so long
as the fixed costs remain (a time period economists refer to as the short-run). Once their fixed costs are no
longer fixed and the business has decision-making control over them (the long-run), then the business owners
can consider exiting the market entirely. So just to reiterate, it can make perfectly good sense for a business
UNIT II STUDY GUIDE
Production Decisions, Costs, and Prices
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to operate at a loss; simply earning a loss does not mean the business should shutdown. As long as price
exceeds average variable cost (variable cost per unit), the firm should continue to operate.
The shutdown decision applies to more than just firms operating at a loss, however. The same approach is
used by just about every business, just about every day. It is not based on the income statement the business
might produce for a month or a quarter or a year, but on a daily decision—on something as simple as which
hours to be open. Breakfast restaurants typically close shortly after lunch time as there is not a lot of demand
for omelets at dinner time. Fancy steak houses are often open only at dinner time as there is not a demand
for $50 steaks at breakfast or even lunch.
More Tools
Other decisions by firms involve comparisons to other alternatives. To make these decisions, firms need to
have information about their alternatives to help make good choices. What is the value of doing different
alternatives? Economists call this opportunity cost. If a frozen yogurt shop opts to replace their chocolate
yogurt with mint yogurt, what is the cost of doing that? It is not just the cost of the mint yogurt, it is also the
revenue they would have earned from selling chocolate yogurt. If chocolate yogurt would have sold more,
then the frozen yogurt shop is essentially losing money by selling mint instead. This is known as economic
profit (or loss). Firms should not just be concerned with how much money their accountant tells them they
are making; they should be concerned about how much money they could make by choosing different
alternatives.
Oftentimes, looking at different alternatives can be cumbersome. It can be difficult to compare the
alternatives; however, there are financial tools businesses can use to make comparing the options easier.
Discounting, for example, uses a rate of return to compare cash flows across different time periods. Is a dollar
tomorrow worth the same as a dollar today? No, the dollar today is more valuable. Discounting allows
decision-makers to make a better apples-to-apples comparison of the financial projections for different
potential projects.
Financial analysis can also help businesses determine what they need to do to break even on a project.
Determining the break-even quantity is fairly straight forward. It is simply the fixed costs divided by the
difference between price and marginal cost (the cost of producing an additional unit). The more challenging
part is determining what costs to include. As discussed above, opportunity costs are an important cost to
consider in decision-making.
Comparing apples to oranges is
not exactly an equal comparison.
(Gregory, n.d.)
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While deciding what costs to include in decision-making is important, equally important is knowing what costs
should not be included in decision-making. When making a decision, only costs that are controllable should
be considered. Costs that have already been incurred (or committed to), known as sunk costs, should not be
considered in the decision. This again reflects the shutdown decision when fixed costs should not be
considered. If something will not change based on your decision, then do not bother including it in your
decision-making process.
Pricing and Elasticity
On the other side of the decision-making ledger from costs is prices. Costs need to be managed, but real
strategy comes with setting prices. Set the price too high and customers will not buy the product.
Some businesses will set price based on costs (firms that use a standard mark-up over costs are an
example of basing price on costs), but this completely ignores demand. Businesses might be over-charging or
under-charging.
Set the price too low and businesses will not bring in as much revenue as they could have. This is where
elasticity comes into play. Elasticity is the responsiveness of one variable to a change in another. The most
commonly used elasticity is the elasticity of demand, which is the responsiveness of quantity demanded to a
change in price. If quantity demanded changes a lot when price changes a little, the product or good has an
elastic demand. If quantity demanded does not change very much when price changes considerably, the
good has an inelastic demand.
The most obvious application of elasticity is the effect price changes have on total revenue. If a good has an
elastic demand, then a price decrease will result in an increase in total revenue. Since total revenue is equal
to price times quantity, then if price is decreasing a little but quantity increases a lot, then total revenue will
increase. If a good has an inelastic demand, then a price increase will result in an increase in total revenue.
Looking back at total revenue, if price can increase a lot without much loss in quantity, then total revenue
will increase.
Firms can estimate elasticity using regression analysis (note: to do this, take the natural log of price and the
natural log of quantity—just putting price and quantity into a regression will not yield elasticities). This requires
sufficient data to estimate a demand function. Businesses can get most of what they need for making
decisions by understanding what determines elasticity.
There are three main determinants of elasticity, but really, they can be boiled down to one: what other
available options consumers have. The more options you have, the more sensitive you will be to a price
change of a good. Options can arise in a variety of ways.
The first option is the amount of time a consumer has to make the purchase decision. Imagine you are at a
baseball game and you are getting hungry. You can certainly go get a hotdog. You will pay more money for it
ECO 6301, Economics for Managers 4
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at a concession within the venue, but the other option is to wait until the game is over. But that might be
longer than you would like to wait to eat.
Elasticity can also change based on how broadly the good is defined. Gas is an inelastic good. People need it
to get to work, the grocery store, go on trips, take their kids to school, etc. But that does not mean a gas
station can simply charge as high of a price for gas as they want because there is likely to be a gas station
across the street or at most just down the road. If a particular gas station increases price much more than
competitor gas stations, then consumers will simply go to the competitor.
If a business understands the nature of their product and understands the alternatives consumers have to
their product, the business will be able to make sound decisions on whether they should raise or cut prices.
The business may not know exactly what will happen to the demand for their product, but they will have a
pretty good idea. In business, often being able to make an educated, informed decision in a world of
uncertainty is the best that can be asked.
References
Gregory, R. (n.d.). Comparing apples to oranges. Concept, isolated (ID 597747) [Photograph]. Dreamstime.
https://www.dreamstime.com/royalty-free-stock-photography-comparing-apples-to-oranges-
image597747
Siddique, K., Ali, G., Ullah, I., Shah, A. U., & Fayaz, M. (2019). An estimation of expenditure, own and cross
price elasticities of meat in Pakistan. Sarhad Journal of Agriculture, 35(2), 623–629.
https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc
t=true&db=asn&AN=136655162&site=ehost-live&scope=site
Suggested Unit Resources
Elasticities of Meat in Pakistan (Optional)
This article gives an example of estimating elasticities, both own-price and cross-price elasticities. The article
also demonstrates how understanding elasticities can be used to make inferences about buying habits of
consumers being studied (in this case, consumers in rural and urban areas of Pakistan).
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