Total Revenue

1
Total Revenue

• Total Revenue Price Quantity
• Law of Demand says that if price increases,
  quantity will fall. And if price falls, quantity
  will increase.
• So
• If a firm increases price, what will happen to
  total revenue?
• If a firm decreases price, what will happen to
  total revenue?

2
Total Revenue and Elasticity

• Total Revenue Price Quantity Total dollar
  value of units sold
• If change in Q gt change in P decreasing the
  price will increase TR
• If change in Q lt change in P increasing the
  price will increase TR

3
Profit and Elasticity

• Profit Total Revenue - Total Cost
• If demand is inelastic (i.e. change in Q lt
  change in P) an increase in price will increase
  TR.
• Because Q falls (law of demand), so too will
  Total Cost
• Why? Total Cost (which we will discuss later) is
  an increasing function of output. The more you
  produce, the higher your total cost.
• Consequently, if demand is inelastic, a firm can
  raise its price and increase its profits.

4
Elasticity, The Basics

• Elasticity Responsiveness
• Elasticity - percentage change in Y / percentage
  change in X
• Elasticity is a Ratio!!!
• Price elasticity of demand - a measure of
  responsiveness of quantity demanded to changes in
  price.
• BACK TO TOTAL REVENUE

5
Percentage Change

• Elasticity Percentage Change in Quantity
  (Sales)/ Percentage Change in (X)
• Percentage change (X2-X1)/X1
• So
• Elasticity (in general terms)
• (Q2-Q1)/Q1 / (X2-X1)/X1
• in terms of price
• (Q2-Q1)/Q1 / (P2-P1)/P1

6
The Point Formula

• (Q2-Q1)/Q1 / (P2-P1)/P1
• Problems
• Order of events dictate outcomes
• Does not impose ceteris paribus.

7
The Arc Formula

• (Q2-Q1)/(Avg.Q / (P2-P1)/(Avg.P
• Problem
• 1. Does not impose ceteris paribus

8
The Slope Formula

• Elasticity
• ?Q / ?P ((Q2-Q1)/Q1) / ((P2-P1)/P1)
• Note Q2-Q1 ?Q and P2-P1 ?P
• Therefore Elasticity ?Q /Q / ?P/P
• Note If you divide by a fraction you multiply
  by the reciprocal.
• Therefore Elasticity ?Q /Q P/?P
• or Elasticity ?Q / ?P P/Q
• Where do we get ?Q / ?P?
• This is the inverse slope of the demand curve,
  which we can estimate empirically (via basic
  econometrics), and therefore we can impose
  ceteris paribus.

9
Interpretation of Price Elasticity

• change in Q gt change in P
• (elastic or responsive) Ep gt 1
• change in Q lt change in P
• (inelastic or unresponsive) Ep lt 1
• change in Q change in P
• (unitary elastic) Ep 1

10
Next 10 slides are from Colander (2003)
11
Elasticity Is Not the Same as Slope

• The steeper the curve at a given point, the less
  elastic is supply or demand.
• There are two limiting examples of this.

12
Elasticity Is Not the Same as Slope

• When the curves are flat, we call the curves
  perfectly elastic.

• The quantity changes enormously in response to a
  proportional change in price (E ).

13
Elasticity Is Not the Same as Slope

• When the curves are vertical, we call the curves
  perfectly inelastic.

• The quantity does not change at all in response
  to an enormous proportional change in price (E
  0).

14
Perfectly Inelastic Demand Curve
15
Perfectly Elastic Demand Curve
16
Elasticity Changes Along Straight-Line Curves

• Elasticity is not the same as slope.
• Elasticity changes along straight line supply and
  demand curvesslope does not.

17
Elasticity Changes Along Straight-Line Curves

• On a demand curve, elasticity is perfectly
  elastic (E ) at the price intercept.

• It becomes smaller as you move down the demand
  curve until it becomes zero at the quantity
  intercept.

18
Elasticity Changes Along Straight-Line Curves

• Elasticity is perfectly elastic (ES ) where a
  straight line supply curve intercepts the price
  axis.

• Points become less elastic as you move out along
  the supply curve.

19
Elasticity Changes Along Straight-Line Curves

• Elasticity is perfectly inelastic (ES 0) where
  a straight line supply curve intercepts the
  quantity axis.

• Points become more elastic as you move out along
  the supply curve.

20
Elasticity Along a Demand Curve
Elasticity declines along demand curve as we move
toward the quantity axis
21
Summarizing Demand

• The Law of Demand - Quantity demanded rises as
  price falls, ceteris paribus. Quantity demanded
  falls as price rises, ceteris paribus
• The Law of Demand is based upon Gossens First
  and Second Laws.
• The Law of Demand gives us the Demand Curve
• Via own-price elasticity, we move from the demand
  curve to total revenue.
• Total Revenue Price Quantity
• Without own-price elasticity we do not know how
  changes in price and quantity will impact total
  revenue.
• The variation in total revenue gives us the
  concept of marginal revenue.

22
Marginal Revenue

• Marginal Revenue - amount of revenue from the
  last unit sold.
• the rate of change in total revenue
• the slope of the total revenue curve.
• If demand is downward sloping, then price will
  exceed marginal revenue. In other words, the
  amount of revenue generated by an additional sale
  will be less than the price the firm charges.
• Why? To increase quantity the firm will need to
  lower the price, not just for the last unit sold,
  but also for every unit the firm wishes to sell.

23
Determinants of the price elasticity of demand

• Determinants of price elasticity of
  demand Substitutes and Elasticity
• Time
• Necessity vs. Luxury
• More specific the good the more elastic demand
• Price of the good relative to income

24
Short-Run and Long-Run Elasticities of Demand
25
Other Elasticity Concepts

• Cross price elasticity of demand
• change in quantity / change in the
• price of another good
• Income elasticity
• change in quantity / change in income

26
Income Elasticities of Selected Goods
27
Cross-Price Elasticities
28
Elasticity Applications

• Taxation and Elasticity
• Why are we no longer a nation of farmers?
• What motivates a basketball player?

29
Taxation and Elasticity

• Taxes are paid by whoever is least able to avoid
  the tax.
• In other words, who ever is least responsive to a
  price change will pay the majority of a tax.
• Therefore, given equations for a demand and
  supply, you should be able to determine who will
  pay the majority of a tax.

30
Supply and Demand in Farming in the 19th Century

• From 1860 to 1890 the number of farmers grew from
  2.04 million to 4.58 million. In addition, the
  United States government also invested in a
  number of public universities who were charged
  with conducting research in how to improve
  agricultural output. Both of these changes
• were welcomed by farmers
• caused supply of output to increase dramatically
• Demand conditions were rising (due to population
  and income increases). This did not keep pace
  with increases in supply, due in part to Engels
  Law (food is income inelastic).
• So supply exceeded demand. And that means prices
  fell. How would this impact the individual
  farmer?

31
Elasticity and Farming

• Food is price inelastic. Again, the more
  general the good the lower the elasticity (the
  more specific the more elastic).
• What does inelastic pricing mean?
• Prices tend to fall a greater percentage than
  increases in output, thus revenues tend to
  decline.
• Total Revenue Prices Output
• If prices fall, output will increase. But if a
  good is price inelastic, the percentage decline
  in prices will exceed the percentage increase in
  output.
• Therefore revenue will fall because the change in
  prices (which are going down) exceed the change
  in output (which is going up).
• Because much of farming costs are fixed, declines
  in revenue tend to reduce profits. Hence the
  farmers share of GDP (or national income)
  declined.
• And consequently, many people chose not to be
  farmers.

32
A Young Glenn Robinson Explains the NBA

• Five games into his NBA career Glenn Robinson
  made the following observation quoted in an
  Associated Press article written by Jim Litke
  (1994) I expect to do what Im supposed to do.
  But a lot of people that dont know the game,
  they think its all about scoring. I look at it
  from a team perspective. We have to do well as a
  team. I dont need to go out there and score 30
  points a game and have us lose. That wont do us
  any good. It would help me individually.
  Robinson added But I want to see all of us get
  something done.
• So a very young Robinson notes that scoring helps
  him individually but may not help the team. It is
  interesting that this quote captures the essence
  of the argument made in The Wages of Wins.
• Scoring does help a player earn more money. Wins,
  though, are about more than scoring.

33
Thats Factorial

• Tommy Cragg writing in New York Magazine
  offered the following about Stephon Marbury
• In the midst of our upbeat Charleston
  conversation about religion and the new season,
  he raised the subject of his (Marbury) reputation
  for selfishness. If I didnt play the way how I
  played, I wouldnt have gotten no max contract,
  he said. They can talk about whatever they wanna
  talk about me, because I got maxed. Im a max
  player. Dont get mad at me, because Im telling
  you whats real. One plus one is two, all day
  long, and its never gonna change. And thats
  factorial.
• Again, this is the same story.  Marbury is a
  scoring point guard.  And Starbury explains quite
  clearly why he plays the game this way.  Scoring
  or selfishness is what gets you a maximum
  contract. And it appears he is right. For his
  career Marbury has been above average with
  respect to scoring, but only about average with
  respect to his production of wins.
• Despite all this, Marbury got his money.  And
  people can call him selfish or anything else,
  but its clear Marbury understands the NBA. 
  Scoring gets you paid.  And you cant argue with
  something that is so factorial. 

34
Doc Rivers and coaching young players

• People seem to think its easier to coach
  younger players than older players, but its
  really the opposite. Most veterans in our league
  have had their day and chased the idea of being a
  star, and now theyve fallen back to whatever
  they really are. They know who they are. Young
  guys always want to prove theyre better than
  whatever role you give them. They wont buy into
  the system. They always say that they will, but
  the minute they have the chance to score, theyll
  try to prove that they can be a scorer.

35
Jerry Sloan in 2008

• After a preseason game where Almond scored 10
  points in 19 minutes, Sloan made the following
  observation
• Well, he scored points, but Im disappointed
  with the way he runs the floor. He looks like
  hes not concerned about running the floor and
  helping defensively. We cant afford to have
  that, especially out of our mid-sized people. I
  mean, everybody likes to score. But if thats all
  youre going to do, then its hard to play to
  win. Numbers are one thing, but you can win with
  less numbers and more effort on the other side.
  Hes got to rebound the ball, pass the
  basketball, learn to do some other things, rather
  than just being a one-dimensional player.
• Almond was not the only player to get on the
  wrong side of Sloan. In a preseason game against
  Portland, C.J. Miles started off the half by
  taking jump shots on consecutive possessions.
  Sloan was neither surprised or amused by the
  play of Miles. Its like I dont get any shots
  the first half, so Ive got to show you I can get
  them off the second half. Thats not a good way
  to do it.
• Kosta Koufos had a similar problem in the same
  game, missing all five shots he took in the
  second quarter. After the game, Sloan was
  observed scolding Koufas for shooting every time
  he touched the ball.

36
Larry Brown and playing the right way

• Such comments are quite consistent with the
  teachings of Larry Brown. For more than three
  decades Brown has coached numerous teams in the
  NBA and college ranks. At each spot, Brown has
  taught his teams to play the right way. What
  is the right way? The 2004 Pistons won the NBA
  championship with a leading scorer Richard
  Hamilton who didnt even rank among the top 25
  in the league in points scored per game. The
  construction of Browns lone NBA championship
  team suggests that scoring is not his primary
  focus.
• Rick Bonnell of the Charlotte Observer noted
  that Shannon Brown was introduced to Larry
  Browns perspective during the 2008 training camp
  of the Charlotte Bobcats.
• Charlotte Bobcats guard Shannon Brown had a
  simple, yet stark, question for one of his
  coaches a couple of weeks ago Why dont you like
  me? Brown now says he was joking, but assistant
  coach Dave Hanners had a serious reply. He liked
  Brown just fine. It was Browns game Hanners
  didnt like.
• I said Coach (Larry Brown) is asking you to do
  certain things, and youre not doing them,
  Hanners recalled. Most guys are misguided about
  how to do well. They think, If I score 15 or 18
  points, Coach has to play me! We have Jason
  Richardson and Adam Morrison and a whole lot of
  guys who can make shots. We need Shannon to do
  something else to help.

37
What gets you paid in the NBA?

• FROM
• Berri, David J., Stacey L. Brook, and Martin B.
  Schmidt. (2007) Does One Simply Need to Score to
  Score? International Journal of Sport Finance,
  2, n4 (November) 190-205.
• LOG(AVGSAL)
• ?j ?1 PROD ?2GP ?3 GAMES ?4 POP ?5 XP
  ?6 POS ?7 RACE ei
• Where
• PROD Vector of player statistics, NBA
  efficiency, or Wins Produced
• POS Dummy variable for center, power forward,
  small forward, or shooting guard
• In the following table
• - denotes significance at the 1 level
• - denotes significance at the 5 level
• - denotes significance at the 10 level

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Importance of Elasticity in the NBA

• From 2001 to 2006, scoring is the primary factor
  driving salary in the NBA.
• A study of the free agent market from 2001 to
  2011 confirms that result (although in recent
  years, shooting efficiency is much more
  important)
• Studies of the NBA draft, voting for awards, and
  the allocation of minutes confirms the basic
  story. Point totals drive player evaluation in
  basketball.
• But scoring totals as Marbury and Robinson
  indicated can be manipulated. Take more shots
  and your scoring totals will rise. So players
  arent just competing to win the game. Players
  also compete with each other to take more shots.