1 law of demand law of demand people do less of what they want to do as the cost of doing it rises...
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Law of DemandLaw of Demand
Law of Demand People do less of what they want to do as
the cost of doing it risesRecall the Cost-Benefit Principle
Pursue an action if and only if its benefits are at least as great as its costs
Recall the Reservation PriceThe highest price we’d be willing to pay
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Total ExpenditureTotal Expenditure
Total Expenditure equalsThe number of units sold multiplied by
the price of the good
Total Expenditure = Total RevenueThe dollar amount that consumers spend
on a product is equal to the dollar amount that sellers receive
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The Law of Demand and Total Expenditure
The Law of Demand and Total Expenditure
“Will consumers spend more on my product if I sell more units at a lower price or fewer units at a higher price?”Depends upon price elasticity of demand
When price rises, total expenditure may increase, decrease, or stay the same
This is due to the Law of DemandAs price rises, quantity demanded fallsAs price falls, quantity demanded rises
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Fig. 5.7The Demand Curve for Movie Tickets
Fig. 5.7The Demand Curve for Movie Tickets
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Fig. 5.8The Demand Curve for Movie Tickets
Fig. 5.8The Demand Curve for Movie Tickets
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Fig. 5.10 Total Expenditure as a Function of Price
Fig. 5.10 Total Expenditure as a Function of Price
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Price Elasticity of DemandPrice Elasticity of DemandIn order to predict what will happen to
total expenditures,We must know how much quantity will
change when the price changes
Price elasticity of demand isthe percentage change in the quantity
demanded that results from a one-percent change in its price
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Price Elasticity of DemandPrice Elasticity of Demand
P
QD
D
P
%
%
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Price ElasticityPrice ElasticityElastic – quantity changes by a lot when
price changes even a littleprice elasticity is greater than one
Inelastic – quantity changes by a little when price changes even a lotprice elasticity is less than one
Unit elastic – quantity change = price changeprice elasticity equals one
When calculating price elasticity of demand, you will always get a negative- WHY?For convenience we will take the absolute value
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Fig. 5.11 Elastic and Inelastic Demand
Fig. 5.11 Elastic and Inelastic Demand
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Price Elasticity and Expenditures
Price Elasticity and ExpendituresFor an elastic product
Quantity demanded is highly responsivePercentage change in quantity dominatesAn increase in price will reduce total expenditureA decrease in price will increase total expenditure
For an inelastic productQuantity demanded is not responsivePercentage change in price dominatesAn increase in price will increase total expenditureA decrease in price will decrease total expenditure
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Determinants of ElasticityDeterminants of ElasticitySubstitution possibilities
Price elasticity of demand will be relatively high if it is easy to substitute between products – Why?
Budget shareThe larger the share of the budget the good uses
tends to have higher price elasticities of demand – Why?
TimeBecause substitution takes time, price elasticity
will be higher in the long run than in the short run
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ExamplesExamples
What are some goods that will have very elastic demand?
What are some goods that will have very inelastic demand?
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Calculating Price ElasticityCalculating Price Elasticity
Proportion by which quantity demanded changes divided by the proportion by which price changes
slope
QP
PP
P
Q1%
%
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Fig. 5.12 Graphical Interpretation of Price
Elasticity of Demand
Fig. 5.12 Graphical Interpretation of Price
Elasticity of Demand
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Other Elasticities of Demand
Other Elasticities of Demand
Income Elasticity of DemandThe amount by which the quantity
demanded changes in response to a one-percent change in income
Positive for normal goodsNegative for inferior goods
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Other Elasticities of DemandOther Elasticities of Demand
Cross Price Elasticity of DemandThe amount by which the quantity
demanded of one good changes in response to a one-percent change in the price of another good
Positive for substitutesNegative for complements
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Perfect ElasticityPerfect ElasticityPerfectly Elastic demand
Price elasticity of demand is infiniteEven the slightest change in price leads
consumers to find substitutes
Perfectly Inelastic demandPrice elasticity of demand is zeroConsumers do not switch to substitutes
even when price increases dramatically
Do goods like these exist?
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Fig. 5.14Perfectly Elastic and Perfectly Inelastic
Demand Curves
Fig. 5.14Perfectly Elastic and Perfectly Inelastic
Demand Curves
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Price Elasticity of SupplyPrice Elasticity of Supply
The percentage change in the quantity supplied that will occur in response to a one-percent change in its price
slope
QP
PP
S
S
P P
Q1%
%
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Determinants of Supply Elasticity
Determinants of Supply Elasticity
The more easily additional units of inputs can be acquired, the higher the price elasticity (more elastic)
Flexibility of InputsMobility of InputsAbility to Produce Substitute InputsTimeUnique and Essential Inputs
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Perfect ElasticityPerfect ElasticityPerfectly Inelastic
Elasticity of supply is zeroWhether the price is high or low, the same
amount is availablePerfectly Elastic
Elasticity of supply is infiniteWhen additional units can be produced
using the same combination of inputs purchased at the same prices
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Fig. 6.10A Perfectly Inelastic Supply Curve
Fig. 6.10A Perfectly Inelastic Supply Curve
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Fig. 6.11A Perfectly Elastic Supply Curve
Fig. 6.11A Perfectly Elastic Supply Curve
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Elasticity of SupplyElasticity of SupplyWhat determines whether the supply of
a particular good will be elastic or inelastic?Availability of resources used to produce
the good – how quickly and easily can producers respond to a price change?
Eg of good with inelastic supply?Eg of good with elastic supply?
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Naturalist QuestionsNaturalist Questions
Why do you pay $5 for a beer in the airport when you can buy the same beer for less than $1 outside the airport?
Why do you get a discounted airfare when you stay over a Saturday night?
Why are there so many personalized license plates in Virginia vs. NC?