Module 2: Optimal Decision Using Marginal Analysis

Introduction
This marginal analysis of Optimal Decision Module offers a very good background to the
comprehension of how marginal variation in costs and revenues affect business decision-making.
It discusses the importance of marginal analysis, marginal revenue and marginal cost in assisting
managers and accountants make informed decisions that maximize profits in different business
situations. Through the module, students learn the role of marginal analysis in providing support
to the central managerial activities, such as planning, decisions, and evaluation of outcomes. The
emphasis is not on totals like total expense or total income of making an additional unit. This
opposition assists in explaining the real-life business scenarios.
One of the important concepts of this unit is profit maximization where output of extra
revenue is the same as extra cost. This guideline will assist leaders to select intelligent
production levels that also affect the price and resource utilization. Decisions are based on
quantifiable outcomes of actual performance rather than guesswork. This can be in the form of
efficiency in managing costs, or in that of judging an order, based on its real effect. Pricing
decisions are made more vivid as soon as direct cost relations are pinpointed. The course
provides students with practical ways of enhancing workplace performance, as it teaches how to
make major decisions within the various company environments with simple techniques instead
of complicated theories, and with emphasis on the practical application instead of theoretical
concepts.
Learning Outcomes
 Understand the use of marginal analysis in managerial decision-making.
 Calculate or solve the Marginal Revenue (MR) and Marginal Cost (MC).
 Apply Marginal Analysis for Firm Decision-Making
 Analyze how marginal revenue and marginal cost influence shutdown and continuation
decisions.
 Evaluate how marginal analysis helps firms allocate resources efficiently, minimize
waste, and achieve optimal production levels.
Key Terms and Definitions
Marginal Analysis. It entails the process of assessing the extra benefits and costs that come about
due to a small or small change in the business activities with the aim of making efficient and
profitable decisions.
Marginal Cost. Added costs through incurring by producing more pieces of products or services,
assist managers in determining the merits of increasing production.
Marginal Revenue. Extra profits created after selling some added items of production, used to
assess how changes in sales affect overall profit.
Total Cost. It includes every cost a business must bear while making a product, including fixed
and variable costs, serving as the basis for calculating marginal expenses.
Fixed costs are those expenditures stay unchanged irrespective of the intensity of output
produced by a firm. Whether production increases, decreases, or even stops for a short period,
these costs continue to be incurred. They are time-related rather than output-related and must be
paid to keep the business operational.
Variable costs are referred to as the costs that change with the production level. It is the reverse
of the fixed costs that do not fluctuate with the output. (such as rent or machinery), the variable
costs grow when a firm produces more and decrease when production slows down. They are
directly tied to the use of resources such as labor, raw materials, and utilities.

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Topic 1. Marginal Analysis, Revenue, and Cost
What is marginal analysis?
Marginal analysis is a way to make decisions by looking at how small or gradual changes
in business activities affect things. It does not examine the total values but examines the impact
of increasing or decreasing more units of production or sales on the costs, revenue, and profit.
The method assists managers to make accurate decisions that dictate the level of production,
price, and the allocation of resources. Additionally, Marginal analysis it is the analysis of the
extra benefits of extra costs of extra increase in an activity. Marginal refers to the word extra or
incremental. Marginal analysis does not look at the total amount of revenue or the total amount
of cost, but rather looks at the change in totals when the output is raised a little.
Competition is low because the business operates with limited resources, hence it has to utilize
the resources effectively. Marginal analysis can be used to prevent wastage and maximize profit
by making sure that each decision to be made contributes more value than cost. A firm will also
keep on producing more since the marginal revenue produced by producing an extra unit of the
good is larger than the marginal cost of producing an extra unit of the good.
As an illustration, a small furniture store manufactures tables. The shop owner would like to
understand whether this is a good decision to make an additional table. The decision does only
depend on: The decision has already been made with regard to fixed costs such as rent and
machinery.
 The extra cost of materials and labor for one table
 The extra income earned from selling that table
If the additional income is higher than the additional cost, producing the table is beneficial. This
simple comparison is the foundation of marginal analysis.
Marginal analysis is not limited to production decisions. It is also used in hiring workers,
expanding business operations, adjusting prices, and even personal choices such as deciding
whether to work extra hours.
Importance of Marginal Analysis
 Guides managers in choosing the most profitable production level.
 Helps in pricing strategies, cost control, and evaluating special orders.
 Supports key management functions such as planning, decision-making, and performance
evaluation.
The profit-maximizing point is when the income from one more unit is exactly the same as the
cost to produce it, indicating the optimal level of production.
Example:
A bakery produces 100 cakes at a total cost of ₱10,000 or ₱15,000 sales. Producing one
additional cake increases the total cost to ₱10,080 or ₱15,150 sales. If the extra cake can be sold
for ₱150:
• Marginal Cost (MC) = ₱80
(₱10,080-₱10,000 = ₱80)
(Total cost(new) minus total cost (old) with additional increase in cost)

• Marginal Revenue (MR) = ₱150

(₱15,150 – ₱15,000)
(Total sales (new) – Total sales (old) with additional increase on sales)

If MR > MC, producing the additional cake is profitable. The bakery should continue
producing until MR = MC to maximize profit.
The Optimal Decision Using Marginal Analysis gives a clear look at methods guiding
managerial choices. Instead, it examines tiny shifts in expenses and income affecting total
earnings. Somewhat, when examining extra gains versus additional costs per choice, learners
identify optimal levels of output by identifying steps leading to an increase in profits.
Specifically, in this section, marginal analysis and related concepts, such as marginal cost and
revenue, which are important in enhancing company performance, are highlighted.
Marginal Revenue and Marginal Cost:
1. Marginal Revenue (MR)
Marginal revenue. supplementary profits generated through offering single additional
item of a product or service. It indicates how total revenue changes with small increases in sales.
Marginal revenue is calculated as:
Marginal Revenue = Change in Total Revenue ÷ Change in Quantity Sold

Marginal Revenue (MR):

MR = ΔTR = TR(new) – TR(old)

Example:
A smartphone company sells 500 phones at ₱10,000 each, earning ₱5,000,000. Selling
one more phone increase total revenue to ₱5,010,000.
Marginal Revenue (MR):

MR = ΔTR = TR(new) – TR(old)

MR = ΔTR= ₱5,010,000 - ₱5,000,000
MR = ₱10,000

Marginal revenue is important because it helps firms estimate whether increasing sales
will actually raise total profit or simply increase revenue while reducing profit due to higher
costs. Marginal revenue is directly proportional to the market price in competitive markets
whereas in less competitive markets; marginal revenue tends to decline with an increase in the
output. This comes about as a result of the necessity to lower prices so as to be able to sell more
units and this diminishes the extra revenue offered by the extra units sold. Since the production is
continuously growing, the marginal revenue can also become very low or negative which means
that any additional increase in production is not going to contribute to the growth of the revenues
significantly. Knowing marginal revenue enables the firms to analyze whether selling more is
going to bring them better financial results and make informed decisions about the prices and
output.
2. Marginal Cost (MC)

It is the extra rate of producing one more product. It assists managers in finding out
whether it is worthwhile to increase production.

Marginal Cost (MC):

MC = ΔTC = TC(new) − TC(old)

Example:
A Smart phone company is selling 500 phones at 10,000 and 9,000 each at cost, at
4,500,000. The cost of producing one additional phone was ₱4,509,000.

Marginal Cost (MC):

MC = ΔTC = TC(new) − TC(old)

MC = ΔTC = ₱4,509,000 - ₱ 4,500,000
MC = ΔTC= ₱ 9,000

It is used when a small increase or change in the overall cost of production is to be

determined and all other variable costs incurred to produce the additional unit are also included
in it. The efficiency of production, availability of resources and the magnitude of the operations
are some of the factors that affect marginal cost. Marginal cost can also be relatively lower at
lower levels of output because it is used efficiently, and production inputs are coordinated more
efficiently. But marginal cost tends to go up with increase in production due to capacity
limitation, inefficiency and decreasing returns to variable inputs. This marginal cost is on the rise
and this is due to the fact that it is becoming more difficult to produce more units since the
resources are being strained. Marginal cost is very important to the firms because it helps them to
contain costs, keep efficiency and also to produce not more than they produce optimally.

Decision Rule:
  To the extent that MR is greater than MC, produce more units.
 Stop production when MR = MC = maximization of profit.

Incremental Decision-Making are decisions made in terms of small changes that are step-by-step
changes, instead of making decisions in terms of large or total changes, which is the core of
marginal analysis.

Thus, marginal analysis, as well as MR and MC, guarantee that managers take incremental
decisions and maximize profit. Through producing at the point of MR=MC, the firms utilize
resources effectively and enhance the overall business performance.

Topic 2. Marginal Analysis for Firm Decision-Making

Efficiency and Resource Allocation
Efficiency and resource allocation are the efficiency of limited resources like labor, capital and
materials in the production of goods and services. In economics, efficient allocation is said to be
the use of resources in a manner that generates the highest benefit at a minimal cost. The tools
that are important in the attainment of this efficiency are marginal revenue and marginal cost
since they help firms determine the quantity of production to perform and the allocation of their
resources.
As an illustration, a factory that produces shoes can be used. In example where the marginal
revenue of producing one additional pair of shoes is 700 pesos and the marginal cost of
producing another pair is 500 pesos, then the consumption of materials, labor and machine in
producing an additional one pair is efficient. Nonetheless, when the cost of producing a second
pair later will be 750 but this will increase the revenue by only 700, then the resources are
inefficient anymore. Rather than allocating the same resources to the same product or activity
that creates less value, at this stage they can be allocated to a different product or activity that
creates more value. Working with the marginal revenue equals marginal cost rule, companies
assist in making sure that no resources are wasted and they are moved to their most effective
applications, enhancing the efficiency of the economy as a whole.
Shutdown and Continuation Decisions
Shut down and continuation decisions are made in regard to whether a firm will proceed to
operate or temporarily halt production particularly in the short run. These decisions depend on
whether the revenue earned from production is sufficient to cover variable costs. Marginal
revenue and marginal cost play a key role in this analysis because they show whether producing
additional units helps reduce losses or increases them.
For example, suppose a small food business earns ₱20,000 in revenue while its variable costs
amount to ₱15,000 and fixed costs are ₱8,000. Even though total costs exceed total revenue, the
business should continue operating in the short run because revenue covers variable costs and
contributes ₱5,000 toward fixed costs. If the business shuts down, it would still have to pay the
₱8,000 fixed cost with no revenue at all. On the other hand, if revenue falls to ₱12,000 while
variable costs remain at ₱15,000, continuing production would increase losses. In this case,
shutting down temporarily is the better decision.

Module 3: Market Forces- Demand and Supply

Introduction
This module on Market Forces: Demand and Supply offer a clear and practical discussion
of how consumers and producers shape the behavior of markets. It explains how different factors
influence the willingness of buyers to purchase goods and the ability of sellers to provide them.
The module also shows how these forces interact to determine prices, output levels, and overall
market conditions. By understanding these relationships, learners are better prepared to interpret
market movements, anticipate changes brought about by economic events, and make informed
decisions in business settings. By working through the module, students explore how marginal
analysis aids core managerial functions including planning, choices, and assessing results.
Instead of just totals such as overall expense or income the focus shifts to incremental changes
brought by making one extra unit. This contrast helps clarify real-world business situations.
Using this guideline helps leaders choose smart production amounts also influencing price and
how resources are used. Instead of guesswork, decisions rely on measurable results tied to real
performance. Examples include managing expenses efficiently - or assessing one-time orders
based on actual impact.
The course gives students practical methods to boost workplace performance while guiding key
choices across different company settings using simple techniques instead of complex theories,
focusing on real-world use rather than abstract ideas.
Learning Outcomes

 Explain the rules of buying and selling in a market.

 Figure out what can make demand or supply increase or decrease.
 Calculate and explain consumer and producer surplus in simple terms.
 Interpret how prices result in shortages and surpluses in the market.

Key Terms and Definitions

Market Forces. These are the natural economic forces of supply and demand that influence
amounts and also the availability of products and services offered in the market.
Demand. This is the amount of goods or services the amount people are ready and able to get at a
particular price over time. Demand usually decreases when prices go up and increases when
prices go down.
Law of demand. This principle when the price rises, fewer people buy it; when it falls, more
people buy it, assuming nothing else changes.
Supply. The amount a company or producer is ready to sell depending on the price. Higher prices
generally motivate producers to supply more, while lower prices may discourage production.
Law of supply. Product becomes more expensive, producers make more of it; if it gets cheaper,
they make less, assuming all else stays equal.
Equilibrium Price. It is the market price where buyers get what they want and sellers sell exactly
what they have.
Surplus. Means there’s more product than needed at the current price.
Shortage. Means there aren’t enough goods to meet what people want.
Shift in demand. Changes when things like trends, income, or what people expect to happen to
prices in the future change.
Shifts in Supply. Factors aside to price that can affect supply, like production costs, technology,
number of sellers, and natural conditions.
Topic 1. Market Forces: Demand and Demand Shifters
What is Market Forces?
Market forces refer to the economic factors of the level of demand and supply in a market
control both pricing and the quantity of goods offered. They explain how resources are allocated,
by what means amounts are set, and by what means marketplaces respond to differences in
circumstances. Understanding market forces is important for managers because it helps them
anticipate customer behavior, plan production, and make decisions about pricing and strategy.
Market forces involve the interaction between buyers and sellers. Consumers show their
preferences and willingness to pay through demand, while producers respond with how many
units’sellers are willing to provide depends on what the product sells for. The outcome of this
interaction determines the market equilibrium, The condition in which what consumers want
equals what producers make available.
1. Demand and Demand Shifters
Demand measures how much consumers want and can buy at different prices over time. The
cheaper it is, the more people buy; the more expensive it is, the less people buy.

 When the price is low, the quantity demanded increases.

 When price increases the quantity demanded decreases.

Demand Shifters: Demand shifts when variables other than price, like income levels, tastes,
related product prices, expectations, or the number of buyers, change:
a. Consumer income: Higher income levels generally cause demand for normal goods to go
up; lower income increases When income drops, people tend to buy more inferior goods;
when income rises, they buy less. Example, during the COVID-19 economic downturn,
many people lost jobs or faced salary cuts. As a result, demand for expensive items such
as new cars and luxury goods decreased, while demand for cheaper foods like instant
noodles and canned food increased.
 b. Substitutes and complements affect demand. If the amount of a substitute increases,
people acquire the product of another alternative. If the amount of a complement rises,
people buy less of both. Example, when pork prices increased in several countries due to
African swine fever, many consumers switched to chicken and fish, increasing their
demand. At the same time, smartphones and mobile data plans are complements, so when
the cost of mobile data rises, some consumers reduce smartphone usage or delay buying
new phones.

c. Consumer preferences: Changes in tastes or trends. Example, The health-consciousness

of people also lowered the demand of sugary soft drinks, and rose the demand of bottled
water, diet soda and organic food.

d. Population and demographics: More consumers or target groups can increase demand.
Example, as urban populations grow, the demand for apartments, public transportation,
and fast food increases because more people live and work in cities.

e. Expectations: Expected price changes or income may shift demand. Example, when
governments announce future increases in fuel prices or electricity tariffs, consumers
often buy more fuel or electrical appliances before the price increase takes effect,
increasing current demand.
2. The Demand Function
It links quantity demanded (Qd) to factors like price and income
Qd=a−bP
Where:
a= quantity demanded at price of zero (intercept)
b= slope of the demand curve (change in quantity with changes in price)
P= price of the good
The quantity demanded = units - increase in price + increase in income. The unit demanded at
each quantity or price of a product that has the demand function of Qd =100- 2P + 0.5I will
increase with the increase in the consumer income (I), and will move the demand curve to the
right.
Given Demand Function:
Q_d=100-2P+0.5I
Where:
Q_d= quantity demanded
P= price of the product
 I= consumer income

Step 1: Initial Scenario

Suppose:
 Price P=20
 Income I =60
Plug into the demand function:

Qd =100−2(20)+ 0.5(60)Qd =100−40+30Qd =90

Consumers demand 90 units at this price and income.

Step 2: Income Increases
Now assume consumer income rises from I =60to I =80 .

Qd =100−2(20)+ 0.5(80)Qd =100−40+ 40Qd =100

Quantity demanded increases to 100 units, even though the price is the same.
Step 3: What This Means
 The whole demand curve shifts to the right in the fact that at each price, consumers now
would demand more.
 This is a real-world example of how increasing income increases demand for normal
goods.

Topic 2. Supply and Supply Shifters

Supply and Supply Shifters
Supply is the quantity of stuff being bought or sold in the market. suppliers are ready to sell at
different prices in particular period. Think of it like this, higher profits encourage more
production, lower profits lead to less.
Supply Shifters: factor that affects how much sellers can or want to supply shifts the supply
curve:
a. If it gets more expensive to make something, companies produce less; if it gets cheaper,
they produce more. Example, when the price of wheat rises due to a drought, producing
bread becomes more expensive for bakeries. As a result, bakeries produce less bread at
the same selling price. Conversely, if the cost of flour drops, bakeries can produce more
bread.
 b. New technology makes it easier to make goods, so supply goes up. Example, when
smartphone manufacturers adopt automated assembly robots, they can produce phones
faster and cheaper. As a result, the supply of smartphones increases at every price.

c. More sellers in the market mean more products available; fewer sellers mean less.
Example, a new bakery opens in a town, the total supply of bread in the town rises. If one
of the main bakeries closes, total supply decreases.

d. Government taxes make production costlier and reduce supply, subsidies help producers
supply more, and rules can either help or hurt production. Example, A government raises
taxes on cigarette production hence, fewer cigarettes are supplied; A subsidy for electric
car production lowers costs hence, supply of electric cars increases; Strict safety
regulations on food production may slow production hence, supply decreases, but food
safety improves.
Example:
Subsidy makes it cheaper to produce electric cars, so companies make more supply goes up
(curve shifts right).
Higher labor costs for shoes make production more expensive, so companies produce less supply
goes down (curve shifts left).
Rising costs like higher wages make production more expensive, so companies cut back on
supply goes down or vice versa.
4. The Supply Function
The supply is the relationship between quantity supplied and determinants of supply that include
price, cost of production, and technology.
Qs=c+dP
Where:
c= minimum quantity supplied (intercept, which is 0 in some cases)
d= slope of the supply curve (the amount supplied varies with the price)
P= price of the good
Example:
If the supply function is Qs = –20 + 3P – 0.5C, an increase in production costs will reduce the
number supplied at each price, shifting the supply curve to the left.
Given Supply Function:
Qs =−20+3 P−0.5 C
Where:
 Qs = quantity supplied

 P= price of the product

 C = production cost

Step 1: Initial Scenario

Suppose:
 Price P=50
 Production cost C=40
Plug into the supply function:

Qs =−20+3(50)−0.5(40)Qs =−20+150−20Qs =110

Initially, 110 units are supplied at this price.

Step 2: Production Costs Increase
Now suppose production costs rise from C=40 to C=60:

Qs =−20+3(50)−0.5(60)Qs =−20+150−30Qs =100

Quantity supplied decreases to 100 units, even though the price stayed the same.
Step 3: What This Means
 Higher production costs make it more expensive for producers to make the product.
 At every price, producers supply less, so the supply curve shifts to the left.
 This is a real-world example of how cost increases reduce supply.

Topic 3. Price Restriction and Market Equilibrium

Market Equilibrium (ME)
If the price is too high, products pile up on the shelves; if it is too low, people fight over limited
supply. Equilibrium avoids both.
Equilibrium. think of it like Goldilocks: not too high (so you don’t have unsold products) and not
too low (so you don’t run out). Basically, quantity demand is equal to quantity supplied.
Equilibrium Quantity (Qe) is the number of goods or services bought and sold at the equilibrium
price (Pe).
Example:
If the demand for laptops is Qd = 500 – 5P and supply is Qs = 100 + 10P, equilibrium occurs
where Qd = Qs:
500 – 5P = 100 + 10P therefore, P = 26.67, Q = 366.7 units.
Price Restrictions and Market Equilibrium
Governments sometimes impose ceilings or amount floors or maximum and minimum price,
respectively. These interventions can create shortcomings or excesses by preventing the market
from reaching equilibrium. Moreover, Market equilibrium is a situation where consumer demand
(Q d ) matches the producer supply (Q s ) at a given price. This is the market clearing price (P 0 )
and the market clearing quantity (Q 0 ). The market is now functioning efficiently where the
resources are distributed based on the consumer demand and the producer supply.
However, governments sometimes impose price restrictions to influence the affordability of
goods, protect consumers, or support producers. These restrictions prevent the market from
naturally reaching equilibrium and include price ceilings and price floors.
a. Price Ceiling
Price ceiling is a top level of a price beyond which the sellers are not permitted to charge. It is
normally placed at a lower price point than the equilibrium price to make basic commodities
cheaper. A price ceiling is well meant but in many cases, it has unintended effects.
Mechanism:
 At the ceiling price, the good will be below the equilibrium price.
 Consumers desire to purchase quantities more as it is cheaper (quantity demanded
increases).
 The producers will be ready to produce less due to the fact that, the reduced price will
decrease profit (quantity supplied drops).
This brings about scarcity (demand is more than supply).
Example:
A typical one is rent control in cities. Assume that the equilibrium market rent of an apartment is
1, 500 per month. The government has established a rent ceiling of 1,000. Agreements to
purchase apartments increase as more people are able to buy them hence the quantity demanded
increases. Nevertheless, landlords can convert apartments to offices, do less maintenance or keep
apartments empty, decreasing quantity supplied. The outcome is a crunch: there are not enough
apartments to rent at the regulated price to most of the renters. In some extreme cases, there is
the emergence of black markets where people pay an overcharge in order to rent out the houses.
b. Price Floor
Price floor entails a low price at which the sellers must sell, which is most of the time fixed
above the equilibrium price. This is usually aimed at making sure that producers make a decent
income or cushioning workers with minimum wages.
Mechanism:
At the floor price, the good will be costly as compared to the equilibrium price.
• The consumers desire to purchase less due to the increased price of the good (quantity
demanded reduces).
• This will result in a surplus (quantity supplied will be greater than the quantity demanded).
Example:
A typical example is the minimum wage laws. Assuming that the unskilled laborers are paid the
minimum wage of 400/hour, and the government raises the equal pay value to 350/hour,
employers will employ fewer laborers as it will make labor more expensive. This leads to the
surplus of labor, or unemployment.
Governments also at times ensure that some crops like wheat or milk have minimum prices in the
agricultural sector. When minimum price is low than market equilibrium, then farmers produce
higher than what consumers demand resulting in surplus. Governments can purchase the surplus
to avoid wastage and store or even destroy it.
Comparative Statics
Comparative statics analyzes how changes in demand or supply affect equilibrium price and
quantity. By comparing the initial equilibrium to the new equilibrium after a shift, managers can
predict the effect of economic changes.
Example:
If new technology reduces the cost of producing solar panels, supply increases. Comparative
statics shows that the equilibrium price will fall, and the quantity sold will increase. Similarly, if
consumer income rises, demand for luxury cars increases, raising both equilibrium price and
quantity.

Module 4: Quantitative Demand Analysis

Introduction
This module on Quantitative Demand Analysis offers a clear and practical guide to
understanding how buyers react to different market conditions. It focuses on examining how
price adjustments, levels of income, and the cost of similar goods influence consumer choices.
Through the use of numerical data, demand estimation techniques, and elasticity measures, this
module equips learners with the tools needed to interpret real market behavior. By applying these
concepts, managers and students can make sound decisions, anticipate how consumers will
respond to various strategies, and create plans that are supported by actual demand patterns
rather than assumptions. In addition, the module explains how demand functions are constructed
and interpreted, highlighting their importance in forecasting future sales, setting appropriate
pricing strategies, and evaluating market opportunities. It also explains how different factors
shape consumer decisions by highlighting understanding how a demand curve shift differs from a
movement along the curve due to price fluctuations.
By the end of this section, learners to get a deeper insight of what quantitative demand analysis
supports informed managerial decision-making. The topic reinforces the importance of using
accurate, data-driven insights to guide business strategies, anticipate market trends, and respond
effectively to changes in consumer behavior.
Learning Outcomes
 Illustrate the correlation between demand elasticity and total revenue.
 Identify factors influencing the product’s elasticity of demand.
 Demonstrate the method used for calculating elasticities from linear and log-linear
demand functions.
 Distinguish between elastic, inelastic, and unitary demand in different market
situations.
 Evaluate how elasticity affects total revenue and pricing decisions of firms.
 Apply demand analysis techniques in real-world business and managerial contexts.
 Use demand estimation and forecasting to support planning and decision-making.

Key Terms and Definitions

Demand. Value of a outcome that buyers are wanting to acquire at different price levels.
Quantity Demanded. The exact number of units buyers want at a specific price.
Law of Demand. A basic idea in economics that says people usually buy more when prices go
down and buy less when prices go up.
Demand Curve. A visual drawing or graph that shows how price and the quantity people want to
buy are related.
Factors Affecting Demand. These are the factors that can affect consumers' decisions, including
their income, preferences, expectations, and the cost of similar or related goods.
Normal Goods. It refers to goods that consumers typically purchase in greater quantities when
their income increases.x`
Inferior Goods. Products people often buy when their budget is tight or when their income drops.
Substitute Goods. Products that can replace each other. When the price of one goes up, buyers
switch to the other.
Complementary Goods. Goods that go together when used, like shoes and socks. When one
becomes expensive, demand for the other usually falls.
Elasticity of Demand. Measuring how strongly buyers react when prices or income change.
Price Elasticity of Demand. This determines the change in quantity demanded which changes
with the change in prices.
Income Elasticity of Demand. This means that the product required reacts to changes in the level
of profitability of buyers.
Cross-Price Elasticity of Demand. It describes the effect of a change on the requirements of a
certain product when the price of a related unit changes.
Demand Function. A formula or an expression expressing the relationship between the Demand
and their primary factors that may augment or diminish it.
Demand Forecasting. It is the art of estimating or predicting future demand using previous data,
trends and any other information.

Topic 1. The Elasticity Concept

The Elasticity Concept
Elasticity describes how sensitive or responsive customers are, how economic changes, like
income or price variations, influence demand and the price of comparable commodities. It helps
us understand consumer behavior and guides businesses in setting prices, planning production,
and predicting trades.
When a product’s sales respond strongly to even small price adjustments, a minor change in price
results in a significant change in the quantity purchased. In contrast, when demand is inelastic,
purchasers do not respond much to price shifts.
Example:
If the amount of soft drinks declines by 5%, sales rise by 15%, and demand is elastic because
buyers responded strongly to the lower price.
Own Price Elasticity of Demand
Own price elasticity shows the shift in quantity demanded due to a price change, assuming all
else is equal. It helps firms decide whether increasing or decreasing prices will raise total
revenue.
 Elastic demand (>1): Buyers are reacting strongly to price changes
 Inelastic demand (<1): Buyers are less reacting strongly to price movements.
 Unitary elastic (=1): When quantity demanded shifts by the same rate as the price shifts.
Example:
When a movie theater increases its ticket price by 10% and the number of moviegoers decreases
by 20%, the demand is elastic (2.0). People are sensitive to the price change.
Types of own Price Elasticity of Demand
1. Elastic demand (>1)
Buyers are reacting strongly to price changes.
The elastic demand is state of consumer being very sensitive to changes in price of a commodity.
This implies that a comparatively low change in price either up or down causes a relatively high
percentage change in the quantity demanded. That is, when the demand is elastic, the buyers who
buy the goods tend to change the purchase level very fast in case of a price alteration.
In an elastic demand, the reverse of price change takes place on the total revenue. Price increase
results in the total revenue reducing since the change in quantity demanded decreases more than
the actual change in price. A price reduction will have the effect of raising the total revenue
because the rise in quantity demanded will be greater than the resultant drop in price.
Example: Luxury chocolates.
If the price rises by 10%, quantity demanded might fall by 15%.
 Revenue effect: Lowering price increases total revenue.
2. Inelastic demand (<1)
Buyers are less reacting strongly to price movements.
Inelastic demand is a state whereby the amount demanded of a commodity responds very slowly
to the changes in the price of a good. This implies that consumers would still purchase almost the
same quantity of the product regardless of the large increase or decrease in the price. When this
happens the percentage change in quantity demanded is lower than the percentage change in
price.
In the case of inelastic demand, an increase in the price results in a corresponding increase in
total revenue since the decrease in the quantity demanded is not significant as compared to the
increase in price. Conversely, a fall in price will lead to a fall in total revenue because the growth
in the quantity demanded will not be significant to counteract the reduction in price.
Example: Salt or electricity.
If the price rises by 10%, quantity demanded might fall by only 2%.
 Revenue effect: Raising price increases total revenue.
3. Unitary elastic (=1)
In case the quantity demanded changes when the price changes at the same rate. The situation
whereby the percentage change in quantity demanded is equal to the percentage change in price
is called unitary elastic demand. This implies that consumers will adjust to price variation in the
same proportions and therefore demand will not be responsive. The price elasticity of demand
value is one in this case.
In the case of unitary elasticity of demand, the price does not influence the amount of revenue. A
rise in price will result in a proportionate fall in the level of quantity demanded, and the total
expenditure will remain the same. Equally, when price falls the percentage change in quantity
demanded will be equivalent thus the total revenue will be the same. Unitary elasticity is very
often a phenomenon at a certain point on a straight line demand curve and not at a price range.
Example: Certain types of clothing in a balanced market.
If the price rises by 10%, quantity demanded falls by 10%.
 Revenue effect: Total revenue remains constant.

Cross-Price Elasticity of Demand

Cross-price elasticity reveals substitute or complementary relationships by measuring how one
good’s demand responds to the other’s price
 Positive value: The two products and/ or alternatives (e.g., Coke and Pepsi).
 Negative value: The two products are paired off (e.g., coffee and creamer).
 Zero value: The goods are unrelated.
Example:
If amount of chicken increases, then more people start buying pork, the two goods are
substitutes. But if the price of gasoline rises and fewer people drive, gasoline and car use are
complements.

Topic 2. Types of Cross-Price Elasticity of Demand

1. Positive value means the two products and/ or substitutes. This implies that the higher the
price of one product, the higher the quantity demanded of the other product and vice versa.
The larger the positive value, the closer the substitutes are. Goods with many close alternatives,
such as competing brands, usually have a high positive cross-price elasticity, while weaker
substitutes have a smaller positive value.
If the price of one product rises, the demand for its substitute rises.
 Examples:
Coca-Cola and Pepsi; higher Coca-Cola price. Therefore, More Pepsi purchased.

Online streaming platforms: Netflix vs. Disney; higher Netflix subscription. Therefore,
More Disney subscriptions.

 Key Point: Substitute goods.

2. Negative value means the two products are paired off.
When the price of a given product increases, the demand of the complement decreases. This
implies that when price of one good increases, the quantity demanded of the other good will
decrease and when the price of one good decreases, the quantity demanded of the other will
increase.
The stronger the complementary relationship between the two goods, the larger the negative
value of cross-price elasticity. Goods that are closely linked in consumption, such as printers and
ink cartridges, tend to have a high negative cross-price elasticity.
 Example
Cars and fuel: car prices rise; fewer cars bought, therefore less fuel demanded.
Printers and ink cartridges; printer prices rise, therefore fewer cartridges sold.
Smartphones and apps; higher smartphone prices therefore fewer app downloads.
 Key Point: complementary goods.
3. Zero value: The goods are unrelated.
Any change in price of one commodity makes no difference in the demand of a different
commodity. This would take place when the commodities are fully autonomous in the
consumption. An instance is that an adjustment in the price of salt will not impact the demand of
clothing and a change in the price of mobile phones will not impact the demand of vegetables.
The amount demanded of any good will not change with changes in the price of the other since
the two goods are not related.
Therefore, when cross-price elasticity of demand is zero, it shows that the goods are neither
substitutes nor complements and do not influence each other in the market.
 Examples:
Bread and bicycles: price of bicycles doesn’t affect bread demand.
Milk and textbooks: no relationship.
Coffee and shoes: price changes in coffee don’t affect shoe demand.

 Key Point: indicates unrelated goods.

Income Elasticity of Demand
Income elasticity shows how needs change when consumers’ profit levels change. It helps
identify whether a product is a regular or less preferred good.

a. Positive income elasticity: The product is a regular, demand rises as profit rises. This
means there is a direct relationship between income and demand, so the income elasticity
of demand has a positive value.
b. Negative income elasticity: The product is a less preferred, demand falls profit rises. This
shows an inverse relationship between income and demand, so the income elasticity of
demand has a negative value. Goods with negative income elasticity are known as
inferior goods. As people become richer, they tend to replace these goods with better-
quality alternatives. Examples include low-quality staple foods, second-hand clothing, or
public transport when consumers switch to private cars as their income rises.

Topic 3: Other Elasticities

Aside from price, cross-price, and income elasticity, there are other forms that help
businesses understand market reactions.
1. Advertising Elasticity of Demand- measures how sales respond when a firm increases or
decreases its advertising budget.

Example: A 10% rise in promotional spending results to a 15% rise in sales, it means the
product’s demand is responsive to advertising.

2. Price Elasticity of Supply- measures how much producers adjust their production when the
amount of the item varies.

Example: If the amount of rice increases, growers may decide to plant more rice next season.
3. Composite or Combined Elasticities- considers several factors at once, such as how price,
income, and advertising together influence demand.

Topic 4. Law of Demand

Price/demand: Inversely, the relationship between price and demand is that low price results in
high demand and the reverse. The demand of a commodity responds in the opposite direction as
the price, where at high prices, the level of demand goes down and when prices go down, the
level of demand goes up.
Reasons:
1. Substitution effect: A rise in price motivates buyers to switch to cheaper options that
serve the same purpose.
2. Income effect: Consumers decrease their demand when price increases reduce their
purchasing power.
The demand law functions because of the following reasons:
1. Diminishing Marginal Utility.
The law of diminishing marginal utility says that, the more of a good a consumer consumes, the
less satisfaction he would get with each extra unit of the item. Consumers will be ready to pay a
greater price in the first unit because the satisfaction will be greater, however, they will not
purchase more units unless the price is reduced. Thus, as the price decreases, consumers
purchase in large quantities and as the price increases, they purchase in small quantities.
2. Substitution Effect
In cases where a commodity price is high, people will opt to substitute it with a substitute which
has a lower price. As an example, consumers could switch to coffee or other drinks in case there
is an increase in the price of tea. On the same note, when prices of branded shoes go up,
consumers might purchase unbranded or domestic substitutes. This change pulls down the
demand of the costly commodity. On the other hand, cheaper the price, the more that good is
demanded as compared to substitutes.
3. Income Effect
A price change influences the real income or purchasing power of the consumers. Once the price
of a good is low, consumers will be able to purchase more of the same good using the same
income and this will boost the quantity demanded. On an increase in price, the purchasing power
of the consumers is reduced leading to reduced quantity demanded. This effect on income is a
big adherence to the law of demand.
4. Multiple Uses of a Commodity
Some goods have many uses. When their prices are high, they are only utilized under the most
essential purposes. They are also utilized in lesser purposes when the price is down. As an
illustration when prices are high then people ought to use electricity or petrol sparingly, when
prices are low people are more likely to use it and the demand is higher.
The Law of Demand Assumptions.
Following are the assumptions used in the law of demand:
 Income levels of the consumers are fixed.
• Related goods do not change in prices.
• Tastes, habits and preferences do not change.
 Population size: This is one which does not change.
• None of the anticipations of the future prices.

Topic 5. Law of Supply

Price increases act as an incentive for producers to supply more goods, whereas price decreases
reduce the incentive to produce. Suppliers respond to price changes by increasing supply when
prices rise and decreasing supply when prices fall.
Reasons:
1. Profit incentive: Higher prices encourage producers to supply more.
2. Resource allocation: Rising prices justify using more resources to produce the good.
Furthermore, The Law of Supply states that the price of a commodity is the higher the supplied
quantity and the lower the price and vice versa as other things remain constant (ceteris paribus).
This shows that price and quantity supplied have direct (positive) relationship.
The law of supply functions because of the following reasons:
1. Profit Motive
Maximization of profit is the primary aim of the producers. Profit per unit increases when
a price of a good increases. This will motivate the producers to produce more goods and
supply more to the market. The decrease in price leads to a decrease in profit hence
producers will decrease supply.
2. Rising Marginal Cost
As the firms scale up production, they might have to incur more costs because of
overtime payments, inefficiency or even lack of inputs. The manufacturers would only
like to produce more at a higher price to meet these increased costs. This causes a rise in
quantity supplied with rise in price.
3. Entry of New Firms
The industry attracts new producers into the market because of high prices and high
profits. The total supply is also on the rise as more firms join the market. On the other
hand, low prices can also cause firms to leave the market and this decreases supply.
 4. Alternative Application of Resources.
Various goods could be produced with the use of resources. Increase in price of a
commodity causes the producers to shift resources of other commodities to the high-
profit commodity. This increases its supply. In case the price is low the resources shift to
other uses.
Law of Supply Assumptions:
• Cost of production is fixed.
• Technology has not changed.
• The prices on the related goods are unchanged.
• None of the government (taxes/subsidies).
• Seniority of firms is the same.
Price Elasticity of demand (PED)
Determines the responsiveness of the quantity demanded of a good to a change in the price of a
good. Indicates how consumers increase or decrease their purchases as a result of a change in
price.
Formula:
PED= (% change in quantity demanded)/% change in price.
Example
The cost of a laptop rises up to ₱50,000 to ₱40,000. Subsequently the amount demanded goes
down to 400 units. Determine price elasticity of demand and explain the finding.
Solution:
Step 1: PED formula
PED= (% change in quantity demanded)/% change in price.

Step 2: percentage change in the quantity demanded.

400−500
%ΔQ= × 100=−20 %
500
Step 3: % change in price
50,000−40,000
%ΔP= × 100=25 %
40,000
Step 4: PED
−20 %
PED= =−0.8
25 %
Step 5: Interpretation
 Absolute value: 0.8 (<1) → inelastic demand
 Consumers are relatively unresponsive to the price increase.
Income Elasticity of Demand (YED)
Measures how sensitive the quantity demanded of a good is to a change in consumers’ income.
Shows how demand changes as people earn more or less.
Formula:
% change in quantity demanded
YED=
% change in income

Example:
Income of consumers rises from ₱20,000 to ₱25,000 per month. As a result, the quantity
demanded of restaurant meals increases from 50 to 65 meals per month. Calculate the income
elasticity of demand and classify the good.
Solution:
Step 1: YED formula
% change in quantity demanded
YED=
% change in income
Step 2: % change in quantity demanded
65−50
%ΔQ= ×100=30 %
50
Step 3: % change in income
25,000−20,000
%ΔI = ×100=25 %
20,000
Step 4: YED
30 %
YED= =1.2
25 %
Step 5: Interpretation
Demand for restaurant meals increases more than proportionally as income rises.

Topic 6. Demand Estimation and Forecasting

Demand estimation and forecasting is an important concept in economics and business decision-
making. It deals with measuring the current demand for a product and predicting future demand
under changing economic conditions. Accurate demand estimation and forecasting help firms
plan production, pricing, investment, and marketing strategies effectively.
Demand estimation is considered as the process of analysis and measurement of the relationship
between the demand and the factors that determine it like price, income, advertising, and prices
of the related goods. It primarily dwells on current and historical information in order to know
the behavior of demand given the prevailing circumstances.
Demand forecasting, on the other hand, is the one, which is defined as the future demand of a
product within a given time. It is futuristic and is founded on the previous demand patterns,
present market environment, and anticipation regarding future developments.
Demand Estimation Objectives.
• To identify price-demand relationship
• To determine the responsiveness among consumers (elasticity of demand)
• To help in pricing decisions
• To determine the impact of advertising and promotion.
Demand Forecasting Objectives.
• To schedule the production and inventory levels.
• To prevent surplus or lack of production.
• To design manpower and capacity growth.
• To aid in long-term investing.
• To minimize business risk and uncertainty.
Techniques of Demand Forecasting.
1. Survey Method
This approach gathers data about the consumers by asking them directly via:
• Questionnaires
• Interviews
• Opinion polls
It is applicable to new products and short-term predictions.
2. Statistical Method
This is a technique of determining the future demand based on past demand. Common
techniques include:
 • Trend projection
• Time-series analysis
• Regression analysis
It is applicable when one has the reliable historical data.
3. Expert Opinion Method
Demand is predicted on the assumption of the experts / sales managers, or the market
analysts.
• A typical example is the Delphi technique.
This is a method that is applicable in cases where there is limited data.
4. Market Experiment Method
A test market changes prices, advertisement or features of a product to examine
the consumer response. Its outcomes are useful in predicting the demand.
5. Barometric Method
It is based on the economic indicators to predict demand, which includes income,
employment, inflation, and industrial production.
Estimation and forecasting of demand is important in business economics. Whereas
demand estimation is useful in learning the current demand patterns, demand forecasting is
useful in predicting the future demand. These two allow firms to make informed decisions,
reduce risk, and grow in the long term.

Module 5: Game Theory

Introduction
 This module on Game Theory provides an insightful and practical approach to
understanding how individuals and firms make strategic decisions in competitive and
cooperative environments. It explores how participants anticipate the actions of others, assess
possible outcomes, and choose strategies that maximize their benefits. By studying concepts such
as Nash equilibrium, dominant strategies, and payoff matrices, learners will gain a deeper
understanding of strategic interaction and interdependence in decision-making. Through real-
world applications and analytical tools, this module enables students and managers to predict
competitor behavior, develop effective strategies, and make rational choices that lead to better
outcomes in business and economics. Throughout this module, learners examine different game
structures such as simultaneous-move games, repeated games, and multistage games. Each type
reflects common decision-making situations faced by firms, managers, and organizations. By
studying these models, students learn how strategies are formed, how outcomes are evaluated,
and how the best decisions can be identified under uncertainty. The skills developed here
encourage logical thinking, careful planning, and a deeper understanding of strategic behavior in
business and everyday life.
Understanding Game Theory allows decision-makers to better evaluate competition, recognize
when cooperation is possible, and design strategies that improve long-term outcomes. Managers
who apply these ideas can reduce uncertainty, anticipate the actions of rivals, and make more
informed choices that support their goals. Another key idea introduced in this section is
equilibrium, situations where players reach stable outcomes because no one benefits from
changing their strategy alone. By studying these concepts, learners gain insight into how rational
decision-makers behave, how strategies evolve, and how predictable patterns emerge in strategic
interactions.
By the end of this section, students are equipped to apply Game Theory concepts to real
decision-making situations, anticipate the behavior of others, and select strategies that lead to
either mutually beneficial results or the best possible individual outcomes.
Learning Outcomes

 Understand and identify the different forms of game theory and how each is applied in
strategic decision-making.
 Differentiate between dominant, secure, Nash, mixed, and subgame perfect equilibrium
strategies, and apply these concepts to analyze various strategic games.

Key Terms and Definitions

Game Theory. This refers to the study of how individuals or groups make strategic decisions
when outcomes depend on the actions of others.
Player. This refers to an individual, firm, or group that makes decisions within a game.
Strategy. This refers to a planned course of action chosen by a player to achieve the best
possible result.
Payoff. This refers to the result or reward a player receives based on the strategies chosen by all
players.
Dominant Strategy. An option that remains the most beneficial for a player, no matter how
others act.
Nash Equilibrium. This refers to a situation A stable situation where every player’s current
choice is optimal by changing strategy while others keep theirs unchanged.
Simultaneous-Move Game. This refers to a game in which players Choices are made at once,
independently of other players’ decisions.
Finitely Repeated Game. This refers to a game played a fixed number of times, allowing
players to adjust strategies across rounds.
Infinitely Repeated Game. This refers to a game with no definite ending, where future
interactions influence current decisions.
Multistage Game. This refers to a game with several decision stages, where earlier choices
affect later outcomes.
Cooperative Game. Players can form binding agreements to achieve shared benefits.
Non-Cooperative Game. A game in which players act individually, without enforceable
cooperation.
Payoff Matrix. This refers to a table that shows the outcomes and payoffs for all possible
combinations of player strategies.
Zero-Sum Game. A game in which the sum of all players’ payoffs remains constant, so one’s
gain is another’s loss.
Mixed Strategy. This refers to a strategy where players randomize among possible actions to
avoid predictability.
Subgame Perfect Equilibrium. This refers to an equilibrium where players choose optimal
strategies at every stage of a sequential game.
Rational Player. This refers to a decision-maker who seeks to maximize their expected payoff
using available information.
Strategic Interaction. This refers to decision-making that takes into account the possible
responses of others.
Topic 1. Types of Games
Game Theory explores how decision-makers act in situations where the result is shaped by each
player’s strategy and the strategies of the other players. actions of others. It provides learners
with structured tools to analyze strategic interactions in competitive or cooperative settings. By
understanding these principles, students can anticipate behavior, evaluate options, and make
decisions that lead to optimal outcomes.
Four types of games:

 Simultaneous-Move, One-Shot Games

 Infinitely Repeated Games
 Finitely Repeated Games
 Multistage Games

Learning these concepts strengthens critical thinking, planning skills, and rational
decision-making, applicable to business, economics, and daily strategic choices.
1. Simultaneous-Move, One-Shot Games
In simultaneous-move, one-shot games, everyone acts at the same time, independently of what
the other players do. Players aim to select the strategy that gives the best outcome, taking into
account possible choices of opponents. Furthermore, In game theory, a simultaneous-move, one-
shot game is a form of strategic interaction, where all the players make their decisions
simultaneously, and the other players are unaware of their decisions, and the game is played once
only. Since the players lack information concerning their opponents choices, they have to choose
based on an expectation of what the other player would do and attempt to maximize their own
payoff. The games are also referred to as the static games of complete information since although
the players are aware of the structure of the game and payoffs of each combination of strategies,
they have no idea what the other player is doing and cannot respond to it until they make their
decision.
• Dominant Strategy. A choice that is always the most beneficial, no matter the strategies
of others.

 Nash Equilibrium. An arrangement of strategies in which every player is making the

optimal decision given everyone else’s choice.

Example:

Two coffee shops, A and B, independently decide whether to offer a weekend discount.

Payoff Matrix:
 Shop B: High Price Shop B: Low Price
Shop A: High Price 10, 10 2, 12
Shop A: Low Price 12, 2 5, 5

Player A

High Price ──┐

Low Price ──┘

Player B

Types of Simultaneous-Move, One-Shot Games

 Pure Strategy Games. In a pure strategy game, each player picks one clear action and
sticks with it for the entire game. For example, in a one-round Prisoner’s Dilemma, a
player might choose to cooperate or defect, and that choice is their fixed strategy, with no
randomness involved.

 Mixed Strategy Games. In a mixed strategy game, players don’t stick to a single move
but instead mix their choices, giving each option a certain probability to make their
actions unpredictable. For instance, in rock-paper-scissors, a player might choose rock,
paper, or scissors with equal chances so their opponent can’t guess what they’ll do,
creating a strategic advantage.

2. Infinitely Repeated Games

Infinitely repeated games occur when players interact repeatedly over an unlimited number of
rounds. Long-term considerations, such as reputation and trust, influence strategic decisions.
Infinitely repeated games are strategic games where the same players repeat the same stage game
again and again, and there is no definite endpoint, and it may continue without a clear stop. In
contrast to one-shot games, in games with an infinite repetition, players are able to base their
present actions on the past outcomes of other rounds and strategies may be affected by history
and reputation.

• Tit-for-Tat Strategy. Players respond by mimicking the previous move of their opponent,
promoting cooperation.
  Players avoid short-term aggressive moves that could reduce long-term gains.

Example:

Two delivery companies compete indefinitely on pricing and service quality. Each observes the
other’s actions and adjusts strategies over time. Cooperation may emerge to ensure mutual
profitability.

Round 1 to Round 2 to Round 3 and so on and so forth.

Past outcomes influence future choices

Types of Infinitely Repeated Games
 Discounted Infinite Repeated Games: In these games, players care more about rewards
they get now than those in the future, so they might cooperate early to secure bigger long-
term benefits, like companies keeping prices stable to maintain profits, even though
future gains are slightly less valuable.

 Undiscounted (Average Payoff) Infinite Repeated Games: Here, all future rewards are
treated as equally important, so players focus on strategies that maximize their average
payoff over time, such as firms cooperating indefinitely in a market where each round
matters the same.

 Folk Theorem Situations: In some infinitely repeated games, a wide range of outcomes
including cooperative ones that wouldn’t work in a single round can be maintained
because the possibility of future punishment encourages everyone to stick to cooperative
strategies, like companies colluding on high prices to keep profits steady.

3. Finitely Repeated Games

Finitely repeated games are played for a known number of rounds. Strategic interaction Strategic
interactions are finitely repeated games where the same stage game is repeated a known number
of times among the same players. There is no uncertainty about the final round, as in infinitely
repeated games, which makes a great difference in strategy on the part of the players

Players’ strategies change depending on the remaining rounds:

 Early rounds: Cooperation may occur to build trust.

 Final rounds: Aggressive strategies often appear because future interactions are limited.

Example:
Two firms compete in a 4-week marketing campaign. Early weeks may involve moderate
competition, but the last week may see aggressive discounts and promotions to maximize end-of-
period payoff.

Week 1 to Week 2 to Week 3 to Week 4

Aggressive moves

Types of Finitely Repeated Games

 Stage Game Repetition. In finitely repeated games, the same game is played a set
number of times, so players can adjust their strategies in each round based on what
happened before, like two firms negotiating prices over three rounds.

 Strategy Variation Across Rounds. Players may choose different strategies in different
rounds, for instance cooperating early to build trust and then competing more
aggressively in the final round.

 Backward Induction Outcome. Because the last round is known, players often think
backward from the final round to decide the best moves earlier, such as in a repeated
Prisoner’s Dilemma where knowing the final round might lead both players to defect at
the end.

4. Multistage Games

Multistage games involve sequential decisions were early moves influence later outcomes.
Multistage games are strategic interactions, which are played in sequential steps, with the
decision made at one step may influence the decisions and payoffs of subsequent steps. In
contrast to simultaneous-move games, in multistage games, the decisions that players take
usually follow one another in specific order with some players seeing the moves that have been
played before making their decisions.

• Decisions at each stage consider both immediate results and future consequences.

 Subgame perfect equilibrium ensures optimal play at every stage.

Example:

A tech company plans:

1. Stage 1: Launch a new product?

2. Stage 2: Allocate marketing budget based on launch.
3. Stage 3: Adjust pricing after observing competitors’ reactions.
Stage 1: Launch?
├─ Yes → Stage 2: Marketing Budget
│ └─ Stage 3: Adjust Pricing
└─ No → End
Understanding these game types allows learners to:

 Predict competitors’ moves

 Identify opportunities for cooperation
 Make strategic decisions that maximize benefits in business, economics, and daily life.

Types of Multistage Games

 Sequential-Move Games. In sequential-move games, players take turns making
decisions, and each player can respond to the moves made by those who acted earlier,
like in chess or a business negotiation where one firm moves first and the other reacts.

 Perfect Information Games. These are games where every player knows all the
previous actions before making a decision, which allows them to plan strategies with
full knowledge, as in tic-tac-toe or certain board games.

 Imperfect Information Games. In these games, players make decisions without

knowing all the previous moves, so they must anticipate or guess others’ actions, like
in poker or bidding in an auction.

 Subgame Perfect Games. In subgame perfect games, players choose strategies that
are optimal at every stage of the game, not just overall, ensuring the best possible
decisions at each point, such as firms making step-by-step investment or production
choices over time.

Topic 2. Different types of strategies and equilibria

1. Dominant Strategy
A dominant strategy is the option which is optimal, regardless of the action of the other player.
Consider the case of Juan and Maria who are selling snacks in a school fair. Juan has an option
of selling ice cream or lemonade. In case Maria would prefer lemonade, then Juan makes more
money on ice cream. Provided that Maria will buy ice cream, Juan will get more revenue by
selling ice cream. In this case, the overriding strategy that Juan will use to sell an ice cream is
that the latter will provide him with more profit in pesos, irrespective of what Maria wants to do.
The point is in the fact that in case of a dominant strategy, you do not have to consider the choice
of the opponent; you are sure that your choice will have the best effect.

2. Secure Strategy
A safe approach is one that plays on the safe side. It is interested in reducing the losses that are
possible instead of maximizing profits. Suppose that Juan has a decision between two jobs. Job
A has a good pay, but in the event that the market is unfavourable, he may not receive anything.
Job B provides a moderate level of salary, and in the worst-case scenario, he would still receive a
decent amount. Although Job A is the most profitable option, Job B is a safe strategy as it
ensures that Juan will receive a safe minimum income in pesos. This is a good strategy to use in
cases where it is unclear as to what the other player or the environment would do.

3. Nash Equilibrium
A Nash equilibrium is a situation in which no participant can gain more by making unilateral
adjustments to the situation and assuming that the rest of the player maintains their strategy. As
an example, prices are being determined by two ice cream stores located in the same city. When
the two charge high prices they both make profits. However, when one store drops the price and
the other one does not, the shop which drops its price gains more, and the other shop loses its
customers. A Nash equilibrium is finally reached where both the shops can no longer manage to
improve their positions by acting individually. In such a case, these two stores may find
themselves in the middle ground where they make a consistent gain in pesos since nobody will
unilaterally decide to alter their approach.

4. Mixed Strategy Equilibrium

The mixed strategy is applied when no good strategy exists and therefore, the players make their
moves randomly in order to remain unpredictable. Suppose that Juan and Maria are playing the
rock-paper-scissors game with a bet of ₱100. In case Juan plays rock at all times, Maria will
anticipate this and will always play paper to win. Juan decides to be random by playing rock,
paper, or scissors in one-third of the cases in order to become unpredictable. Maria does the
same. In that way, both players can not benefit by shifting their strategy and this equilibrium is
known as a mixed strategy equilibrium. In this case, the anticipated payoff in pesos is equal,
since randomization denies the opponent the ability to play against predictable strategies.

5. Subgame Perfect Equilibrium.

A subgame perfect equilibrium is used with sequential or multi-stage games, where the decisions
are made in a sequence or a stage by the players. In such games, the balance is that everyone is
making the best choice at any given stage, not only in general. As an example, suppose that Juan
and Maria are discussing ₱100. First offer is made by Juan who offers to give Maria 40 and
retains 60. Maria can accept or reject. Juan may give her another split on the subsequent round in
case she rejects. Both players think ahead which makes them predict the future. Juan will offer a
better offer than waiting which Maria will accept and accept an offer. Such a prudent step-by-
step planning is a subgame perfect equilibrium where no player can improve upon at any point
on the game.

Module 6: Pricing Strategies for Firms with Market Power

Introduction
This module looks at how firms that can influence market prices decide the best prices
for their products or services. Unlike companies in perfectly competitive markets, these firms
have flexibility in setting prices and must consider factors such as customer demand, production
costs, and the level of competition. Through this module, students will develop a clear
understanding of how pricing strategies are planned, why firms choose different approaches, and
how these decisions impact profitability, market outcomes, and consumer experiences.
Learning Outcomes
 Explain market power and distinguish firms that can set prices from those that are price
takers.
 Analyze demand, costs, and competitive factors to understand their influence on pricing
decisions.
 Apply elasticity-based calculations to determine profit-maximizing prices for firms
with market power.
 Evaluate strategic pricing practices including price-matching guarantees, loyalty
programs, and variable pricing and assess their impact on profitability.
 Assess the effects of pricing strategies on firm performance, market efficiency, and
consumer welfare using practical examples and economic reasoning.

Key Terms and Definitions

Market Power. The ability of a firm to influence the price of its product rather than accepting the
prevailing market price.

Profit-Maximizing Price. The price at which a firm achieves the highest possible profit, usually
where marginal revenue equals marginal cost.

Basic Pricing Strategies. Standard approaches to setting prices, including cost-plus pricing,
value-based pricing, and competitor-oriented pricing.

Advanced Pricing Strategies. Techniques designed to increase profitability beyond standard

pricing, such as price discrimination, dynamic pricing, and customer loyalty programs.

Consumer Welfare. The benefit or satisfaction that consumers derive from purchasing goods or
services at a given price.

Topic 1. Market Power

Market power is when a business can control the price of its goods instead of just accepting what
the market sets. Businesses with this power can change prices on purpose to earn the most
money, keeping in mind what customers do and what the market is like. Unlike businesses in
very competitive markets, they don't just depend on supply and demand to decide prices.
It’s important to grasp market power to understand how businesses make smart choices about
prices. Businesses with a lot of market influence don't have to accept the usual market prices.
They can set prices to make the most money and reach certain business aims. They can use
strategies like charging different prices to different customers based on how much they're ready
to pay, setting high prices for products seen as high-quality, or changing prices in real-time based
on demand.
Looking at market power helps students see how pricing impacts things overall. For , it helps
them guess how customers will react, like buying less of things that cost more, or staying loyal to
brands with discounts. It also shows how competitors might act, like changing their prices or
creating new products. By checking these interactions, people can better get the trade-off
between making profit and keeping a share of the market, and also how it might affect the public
and how well the market works.
For example:

 A high-end smartphone brand can ask for more money than other companies because
people think its products are new and special. This lets the business make more money
for each item sold while keeping its customers loyal. Likewise, an airline might change
ticket prices based on how many people want to travel, making the most money during
busy times without losing its edge in the market.

 A local phone company starts a high-end data plan. Because not many competitors have
something similar, the company can charge extra without losing customers, which shows
how market power is used in real life.
By really seeing how market power works, students understand how businesses use their power
to reach money-related goals, deal with market pressure, and change what customers do in
different fields.

Topic 2. Basic Pricing Strategies

1. Cost-Based Pricing
Cost-based pricing is also a simple approach in which a company sets the selling price of a
product by marking up on the total production cost; the fixed and variable costs. This will make
sure that the expenses are well reimbursed and the profit margin remains constant. Though easy
and dependable, this method fails to consider the demand of the consumers and the price of
competitors which at times can restrain the possible income.
For example: A bakery estimates that making a specialty cake would cost ₱200, including the
cost of the ingredients, the labor, and the overhead. A 50% markup will be applied and the cake
will be sold at 300 pesos and ensure the business will recover costs and make a profit on every
cake sold.
2. Value-Based Pricing
Value-based pricing puts emphasis on what customers view as the value of the product and not
the cost of production of the value. This plan builds on the perception of quality, brand image, or
differentiators of the consumer.
For example: A cafe offers a handcrafted latte which costs 120 to make. Customers perceive the
drink to be of high value because of its high quality of beans and craftsmanship of presentation
and are ready to spend ₱250. It will enable the café to make more money by taking advantage of
perceived quality instead of merely breaking even.
3. Competition-Based Pricing
Competition based pricing involves pricing of products through analysis of prices charged by
competitors on similar products. This strategy is applicable in markets where buyers direct prices
and little product differentiation. As much as it makes a business competitive, competitor pricing
may cause price wars or low margins when not well handled.
For examples: The bakery notices that other bakeries in the locality can sell cake of the same
type between PHP280 and PHP320. By selling its specialty cake at ₱300, the bakery can be
competitive, and it is important to focus on the unique formula to prove the price.
Integration of Basic Pricing Strategies.

A combination of these strategies is most often adopted by firms to produce the best results.
Pricing based on cost can establish an entry level in terms of profitability, pricing based on value
may provide extra income of the revenue that the company may obtain by taking advantage of
those consumers who can pay more and, finally, competition based pricing guarantees that the
company remains relevant in the market.

Advanced Pricing Strategies that Maximize Profits

1. Price Discrimination
Price discrimination is a practice where a company provides various prices on the same product
or service to different customers based on their attributes, when they buy a product or service and
how much they can afford. This strategy will enable companies to attract more revenue as they
match the prices with the perceived value by various categories of consumers.
3 Types of Price Discrimination

1. First-degree (Perfect) Price Discrimination. Every customer will pay the amount that
he/she is ready to pay, taking away all consumer surplus.

2. Second-degree Price Discrimination. The charges depend on volume of purchase or type

of product, e.g., volume pricing or luxury editions.
 3. Third-degree Price Discrimination. Various prices are provided to the various market
segments, which include students, the elderly, or members of the various regions.
For example:
A theater will be selling standard tickets at a normal price, however, discounts will be given to
students and senior citizens. Also, the VIP seating with additional facilities will be sold at a
premium point to reflect the willingness of the customers.
2. Dynamic Pricing
Dynamic pricing is the movement of prices which are calculated on a real time basis depending
on the demand, stock inventory, season, or even on the market terms. It is applied to perishable
inventory or demand variability industries like airlines, hotels, e-commerce, and event ticketing.
For example: A ticket in an airline is altered based on the time a customer books the ticket and
the seat availability. The prices of early bookings are lower to promote sales, whereas the prices
of last-minute purchases are higher because of the inability to supply enough and the willingness
to pay more.
3. Loyalty Programs
The loyalty program will help to motivate the customer to buy the product again and keep the
loyalty. Firms can grow their customer retention and lifetime value by providing points,
discounts, or exclusive offers.
For example: There is a coffee shop that offers a card that is buy 9 to get 10 th. Give rewards to
frequent customers and chances of returning to them and achieving massive sales are higher and
brand loyalty is strengthened.
4. Bundling and Product Versioning

a. Bundling. There are several products sold jointly at one and sometimes discounted price.
This motivates the customers to make purchases of a higher nature and can escalate the
total revenue.

b. Product Versioning. Companies present products with varied features and prices to attract
various groups of customers with different needs. Most of the higher-level types also
offer extra benefits as a higher price thus letting the company to gain higher income
provided the customer can pay more.

For example: A cinema offers a family package, which consists of two adult tickets, two child
tickets and snacks at a single price, which is lower than purchasing each good separately.
Moreover, the customers who are ready to spend money on additional comfort are sold premium
seats with additional services that are more expensive.
5. Advanced Pricing Strategic Application
Advanced pricing strategies demand a thorough study of consumer behavior and the market
conditions and costs. Companies have to strike the balance between achieving the business
objective of maximizing short-term incomes and maintaining long-term relationships with
customers.
For example: A web-based retailer can use dynamic pricing on products with high demand, offer
packages of related products to sell more products and have a loyalty program to retain more
regular customers. The combined approach will enable the company to boost the total revenue
and enhance customer loyalty and satisfaction.

Topic 3. Elasticity of Price and Pricing Decisions

Price elasticity of demand is a measure that tells us how much the quantity demanded of a good
changes when the price increases. It gives information on consumer behavior, and assists
companies to predict the effect of price changes on sales and revenue. High elastic products will
undergo big alterations in the demand with alterations in the prices, but inelastic products
undergo minimal changes yet the prices alter. The knowledge of elasticity enables businesses to
make wise pricing choices to ensure that revenues are achieved and at the same time the market
is not oversold.
1. Significance in Pricing Choices.
Price elasticity helps firms to identify the best price to apply on every product. With inelastic
products, consumers that are comparatively inelastic to price, companies have the ability to
either increase the price to raise the total revenue without losing a high number of customers. In
contrast, when the products are highly elastic, a slight price rise can cause very significant
demand declines which can lower the total revenue. The promotional strategies, the development
of discount plans, and the positioning of products are also informed by elasticity in order to
maximize sales and profitability.
2. Practical Application

 Revenue Optimization. Elasticity allows firms to set prices to maximize revenue through
charging higher prices on products that are price inelastic or through making discounts on
products that are price elastic.

 Marketing and Promotions. Elasticity can be used in establishing useful promotions, sales
season, or loyalty programs. To illustrate, a temporary discount can be offered on the
elastic products and higher prices can be charged on inelastic products.

 Strategic Planning. The understanding of elasticity aids the long-term pricing,

determination of product introduction/launch, market segmentation, and competitive
positioning.

When combined with elasticity analysis within the pricing strategies, the certain
companies acquire an effective means of ensuring profitability and market demand balance, by
making sure that pricing strategies are in tandem with the financial objectives, and consumer
behavior.

Effects of Pricing Strategies to Profitability and Market Outcomes.

1. Profitability
Pricing policies have a direct bearing on the level of profits made by a firm. Market demand and
competitive forces provide businesses with the opportunity to set their prices such that they can
be able to recover their costs at the same time achieve regular profit margins.
For example: A bakery making artisan breads charges a higher price on their organic sourdough
that is priced higher because of the increased cost of ingredients, but will provide profit. At the
same time, it is able to sell standard breads at an equivalent cost to sustain the volume of sales by
the price-sensitive consumers. This two-pronged strategy will ensure that the maximum
profitability is realized since various market segments will be reached.
2. Market Outcomes
Pricing choices have an effect on the wider market in the sense that they determine the
efficiency, consumer involvement and the general well being. Excessive prices can drive away
buyers and decrease consumer interest and properly planned prices can help to bring more
buyers, increase market turnover, and enhance a competitive equilibrium.
For example: A mobile phone retailer sets the price of a new smart phone at a slightly lower price
than the competitors. The low prices motivate more consumers to buy as well as participate in
the market and also raise the store share in the local market without reducing profitability.
3. Consumer Behavior
Pricing strategies play a critical role in determining the buying decision of the consumers.
Purchasing behavior, brand perception, and a repeat purchase can be influenced by the use of a
loyalty program, discounts, the importance of a product, and the use of promotional offers.
For example: A coffee shop implements the loyalty program that gives customers a free beverage
after every tenth purchase. Besides, it sometimes has an discounted seasonal drink. These plans
have the effects of encouraging repeat buying and improving the probability of buying something
with higher margins.

Topic 4. Strategic Decisions with Business Objectives.

To maximize profit, consumer behaviour and long-term goals of the business. The focus is put on
the demand and supply situation, cost-managing, competition, and consumer sensitivity in the
determination of business objectives and strategic decisions.

1. Business Goal Alignment.

Pricing policies should always be in tandem with the overall goals of a firm of growing market
share and profitability over the long-term and building brand positioning. Decent pricing
decisions are based on the sound information regarding the cost of production, consumer
demand, and the behavior of competitors and the general situation at the market.
For example: A software company presents a level pricing system. The entry level is a cheap
product and is aimed at new users in order to increase the penetration in the market. The typical
version is offered at a mid range price with moderate features to ordinary users that would give
them a balance between value and revenue. Its costly premium version, with more sophisticated
features, is priced expensive to attract those who are ready to spend heavily. This multi-story
approach is in line with market growth, profitability, and brand positioning objectives.
2. Data-Driven Decision Making
Pricing strategy demands a continuous market data analysis. Companies have to evaluate the
behavior of consumers, their sales patterns, and price pricing of their competitors in order to
establish the best pricing structure.
For example: Online retailer is an e-commerce retailer who monitors the sales data of various
product lines. Through the analysis of the products that sell at what prices, the company
increases and decreases prices on a weekly basis to maximize revenue, make competitive offers
and avoid stock.
3. Striking the Balance between Short-Term and Long-Term Goals.
The price question should relate to short-term (financial) and long-term (strategic) performance–
both. A promotion on a short-term basis can increase sales in the short run, but to preserve value
and profitability in the long-term, retaining a higher price can be effective.
For example: A luxury watch company will do a promotion occasionally which is limited time in
order to generate demand although in most cases, the prices are kept high as that will sustain the
brand name of being high end. By doing this, the short-term sales goals are managed in a way
that agrees with the long-term aim of brand prestige.
4. The Customer-Centric Strategies.
Prices must mirror the benefits and appraisal of the customers. The firms may have loyalty
programs, bundling or versioning of products so as to take care of the different market segments
so that they can realize profitability whilst keeping a good rapport with customers.
For example: A streaming service has a basic plan, a high-end plan at a higher price and a student
plan at a lower price. This layered model addresses the various market segments and maximises
the revenues and promotes loyalty of the subscribers.
 Review and Summary
Managerial Economics introduce the core concepts that can enable managers and
business decision-makers to analyze issues, learn about market behavior, and create successful
strategies. provides the role of managerial economics in the decision-making process. It
describes practical application of economic principles to the real business problems and it
highlights the importance of organized decision making. To be able to recognize issues,
formulate specific objectives, gather the appropriate data, deliberate on the available options,
assess the available consequences, execute the most appropriate solution, and track the outcomes
of the decision are the required qualities of a manager to answer the question of whether a
particular decision was successful or not. The process assists in minimizing uncertainty and
enhancing quality of business decisions. The module also brings out the fact that business
organizations are run in situations of scarcity meaning that resources are limited and thus
managers have to allocate them effectively. Sighted on the costs and benefits of the various
options, as well as in relation to the analysis of customer behavior and the conditions of the
market, managers are capable of making a decision that leads to better business performance and
the sustainability of the business in the long term.
Marginal Analysis is devoted to the greatest decision-making through marginal analysis
which is one of the key tools of managerial economics. Marginal analysis is used to look at the
extra costs and benefits, which come as a result of producing one more unit of a product or
making a minor adjustment in a business decision. Managers do not simply examine total costs
and revenues, but look at the impact of incremental changes on profitability. The important
principle of marginal analysis is that maximization of the profit is achieved when marginal
revenue (MR) is equal to marginal cost (MC). Marginal revenue is the incremental revenue of
selling an extra unit of a product and marginal cost is the incremental cost of producing the extra
unit. When the marginal revenue exceeds the marginal cost, then the firm ought to produce more
due to the extra profit it will make. Nevertheless, when the marginal cost is high than the
marginal revenue, producing more units would decrease profits. The concept is common in the
planning of production, to indicate the price, to receive more workers and allocate resources.
With marginal analysis, managers are able to make more sound and informed decisions as
opposed to using their gut feelings or their best guesses.
The market forces especially the demand and supply interaction with each other that
dictate the functioning of markets. Demand is defined as the quantity that can be purchased by
consumers at various prices and supply is defined as the amount that can be sold by producers.
The law of demand between price and quantity demanded is that, when the price of a good in the
market gets higher the demand of that commodity will tend to go down; and when prices of
goods in the market reduce, then demand will tend to go up. Conversely, the supply law observes
that as the price increases, the producers will produce more commodities and when the price
goes down the quantity supplied decreases. The module further describes demand shifters and
supply shifters which are the aspects that make the demand or supply curve shift. The factors that
may change demand include the income of consumers, tastes and preferences, prices of
associated products, population fluctuation and future expectations. Production costs,
technological advancement, government policies, taxes, subsidies, and the quantity of sellers in
the market can cause a change in supply. Equilibrium in the market is achieved when the
quantity demanded equals the quantity supplied and this helps in determining the market price
and the level of output.
Quantitative demand analysis that aims at the utilization of numerical information and
economic instruments to comprehend the consumer behavior and market demand. This module
describes demand forecasting and demand estimation. Demand estimation is the method of
determining demand in terms of its relationship with those factors that drive demand like price,
income, advertisement as well as the prices of other related commodities. It will be based on both
historical data and the present market conditions to know how the consumers react to these
factors. Demand forecasting however is more concerned with the future demand of a particular
product in the future in reference to its past trend and anticipated alteration in the economy. In
his module, a number of methods of demand forecasting are given, such as survey techniques,
statistical techniques, the use of expert opinions, market experiments, and the barometric
technique applying economic indicators. Price elasticity of demand is another critical concept
that has been brought out in this module and it is used to determine the responsiveness of
consumers to price changes. Products having elastic demand undergo big alterations in the
quantity demanded in response to change in prices whereas those with inelastic demand undergo
smaller alterations. Knowledge of elasticity can assist companies to determine the pricing
strategies, marketing campaigns and also predict the impact of increase or decrease in prices on
revenue.
The game theory and the strategic decisions in competitive settings. Game theory is used
to analyze a situation in which the action of a decision is not only determined by the decision
taken by a firm but also by the actions of other players, like competitors. There are key concepts
that have been introduced in the module and they include players, strategies, payoffs, dominant
strategies, and Nash equilibrium. Dominating strategy is a strategy that leads to the most optimal
result to a player despite the strategy of other players. Nash equilibrium is reached when
strategies are selected by all the players so that no one can make his strategy better by altering it
when other players maintain their agreed strategies. Other categories of games described in the
module are simultaneous-move games, finitely repeated games, infinitely repeated games and
multistage games. In simultaneous-move games, participants choose simultaneously without
information of other players. In repeated games, the players come into contact more than once
and this can promote cooperation or competition based on the circumstances. Multistage games
entail sequential decisions in which previous decisions influence subsequent decisions. The
concepts assist managers to predetermine the behavior of competitor, study strategic interaction,
and create competitive strategies that work effectively in markets where decisions of one firm
affect the decisions of the other firm.
Pricing of market-power firms. Market power is the capacity of a firm to play the market
price rather than just accept the market price as dictated by supply and demand. Market power
companies need to take a keen interest in the market analysis of the market by looking at the
demand, costs of production, and the behavior of competitors to establish the best pricing
approach to make a profit.