hubbard obrien macroeconomics 2nd edition chapter 6

Chapter 6

Consumer Choiceand ElasticityCan Jay-Z Get You toDrink Cherry Coke?

Coca-Cola hired rapper Shawn “Jay-Z”Carter to appear in television com-mercials as part of the marketingcampaign to relaunch Cherry Coke.Why would the Coca-Cola Companyhire Jay-Z? Lucia James, of the con-sulting firm Agenda, explains: “Jay-Zbrings a sense of genuine hip-hopauthenticity to the brands. . . . There’sreassurance that[the brands]won’t appearlike an out-of-touch uncle trying toact cool.” Over the years, Coca-Cola has used other celebrities,including LeBron James, LanceArmstrong, Paula Abdul, andRay Charles, to advertise its prod-ucts. Coca-Cola is not alone inusing celebrity endorsements. FromBritney Spears and Sean “P. Diddy”Combs endorsing Pepsi to MichaelJordan endorsing Nike basketballshoes to Oprah Winfrey endorsingPontiac cars, celebrities appear con-stantly in television, magazine, andonline advertising. What do firmshope to gain from celebrity endorse-ments? The obvious answer is thatfirms expect that celebrity advertisingwill increase sales of their products.But why should consumers buy moreof a product just because a celebrityendorses it? In this chapter, we will examine how consumers make

decisions about which products tobuy. Firms must understand consumerbehavior to determine whether strate-gies such as using celebrities in theiradvertising are likely to be effective.

Coca-Cola has been a leader ininnovative advertising, including theuse of celebrity endorsements. Coca-Cola was founded in Atlanta, Georgia,in 1886 by John Styth Pemberton.After Asa G. Candler bought the com-pany in 1891, Coke began to be soldnationally, first primarily in drugstore

soda fountains. The

firm’s advertising inmagazines, newspapers, bill-boards, and calendars featured pic-tures of attractive young womendrinking Coke—instead of emphasiz-ing the taste or other qualities ofthe cola.

By the 1910s, Coca-Cola hadmoved from using unnamed womenin its advertising to using movie stars.The attempt to associate Coke withcelebrities in the minds of consumerscontinued through the followingdecades. From the 1950s on, Coke’stelevision commercials often featuredpopular singers or sports figures of thetime, including the Supremes, the

Moody Blues, and football star“Mean” Joe Greene.

Firms’ attempts to distinguishtheir products in the minds of con-sumers from the products of rivalfirms will be an important theme inseveral of the following chapters.Advertising is one way in which firmstry to distinguish their products. ANINSIDE LOOK on page xxx dis-cusses whether Elizabeth Ardenmade a good decision in hiringMariah Carey to

endorse its products.As firms analyze consumer

demand, one key factor they study ishow changes in the price of a productaffect the quantity of the productconsumers are willing to purchase.In this chapter we will see how tomeasure the responsiveness of thequantity demanded of a product toits price.

Source: Kenneth Hein, “Cherry Coke Gets Fresh Jay-ZRemix,” Brandweek, January 29, 2007, p. 4.

M06_HUBB6239_02_SE_C06.QXD 7/11/08 8:04 PM 62 MARKED SET

LEARNING ObjectivesAfter completing this chapter, youshould be able to:

6.1 Define utility and explain howconsumers choose goods andservices to maximize their utility,page 164.

6.2 Use the concept of utility toexplain the law of demand,page 171.

6.3 Explain how social influencescan affect consumption choices,page 173.

6.4 Describe the behavioraleconomics approach tounderstanding decision making, page 178.

6.5 Define the price elasticityof demand and understand how to measure it, page 183.

6.6 Understand the determinantsof the price elasticity of demand, page 187.

6.7 Understand the relationshipbetween the price elasticityof demand and total revenue,page 191.

Economics in YOUR Life!

Do You Make Consistent Decisions?Economists generally assume that people make decisions in a rational, consistent way. But are peopleactually as consistent as economists assume? Consider the following situation: You bought a concertticket for $75, which is the most you were willing to pay. While you are in line to enter the concerthall, someone offers you $90 for the ticket. Would you sell the ticket? Would an economist think it isrational to sell the ticket? As you read the chapter, see if you can answer these questions. You cancheck your answers against those we provide at the end of the chapter. >> Continued on page xxx 163

M06_HUBB6239_02_SE_C06.QXD 7/11/08 8:04 PM Page 163 MARKED SET

164 PA R T 3 | Microeconomic Foundations: Consumers and Firms

We begin this chapter by exploring how consumers make decisions. In Chapter 1,

we saw that economists usually assume that people act in a rational, self-

interested way. In explaining consumer behavior, this means economists

believe consumers make choices that will leave them as satisfied as possible,

given their tastes, their incomes, and the prices of the goods and services available to them. We will

see how the downward-sloping demand curves we encountered in Chapters 3 and 4 result from

the economic model of consumer behavior. We will also see that in certain situations, knowing

the best decision to make can be difficult. In these cases, economic reasoning provides a powerful

tool for consumers to improve their decision making. Finally, we will see that experimental eco-

nomics has shown that factors such as social pressure and notions of fairness can affect consumer

behavior.We will look at how businesses take these factors into account when setting prices.

Whether you are managing a publishing company, bookstore, or coffee shop, you need

to know how an increase or decrease in the price of your products will affect the quantity

consumers are willing to buy. We saw in Chapter 3 that cutting the price of a good increases

the quantity demanded and that raising the price reduces the quantity demanded. But the

critical question is this: How much will the quantity demanded change as a result of a price

increase or decrease? Economists use the concept of elasticity to measure how one economic

variable-such as the quantity demanded-responds to changes in another economic variable-

such as the price. For example, the responsiveness of the quantity demanded of a good to

changes in its price is called the price elasticity of demand. Knowing the price elasticity of

demand allows you to compute the effect of a price change on the quantity demanded.

6.1 | Define utility and explain how consumers choose goods and services to maximize their utility.

Utility and Consumer Decision MakingWe saw in Chapter 3 that the model of demand and supply is a powerful tool for analyzinghow prices and quantities are determined. We also saw that, according to the law of demand,whenever the price of a good falls, the quantity demanded increases. In this section, we willshow how the economic model of consumer behavior leads to the law of demand.

The Economic Model of Consumer Behavior in a NutshellImagine walking through a shopping mall, trying to decide how to spend your clothingbudget. If you had an unlimited budget, your decision would be easy: Just buy as muchof everything as you want. Given that you have a limited budget, what do you do?Economists assume that consumers act so as to make themselves as well off as possible.Therefore, you should choose the one combination of clothes that makes you as well offas possible from among those combinations that you can afford. Stated more generally,the economic model of consumer behavior predicts that consumers will choose to buythe combination of goods and services that makes them as well off as possible fromamong all the combinations that their budgets allow them to buy.

This prediction may seem obvious and not particularly useful. But as we explore theimplication of this prediction, we will see that it leads to conclusions that are both use-ful and not obvious.

UtilityUltimately, how well off you are from consuming a particular combination of goods andservices depends on your tastes, or preferences. There is an old saying—“There’s noaccounting for tastes”—and economists don’t try to. If you buy Cherry Coke instead of

6.1 LEARNING OBJECTIVE

Elasticity A measure of how muchone economic variable responds tochanges in another economic variable.


C H A P T E R 6 | Consumer Choice and Elasticity 165

Utility The enjoyment or satisfactionpeople receive from consuming goodsand services.

Pepsi, even though Pepsi has a lower price, you must receive more enjoyment or satisfac-tion from drinking Cherry Coke. Economists refer to the enjoyment or satisfaction peo-ple receive from consuming goods and services as utility. So we can say that the goal ofa consumer is to spend available income so as to maximize utility. But utility is a difficultconcept to measure because there is no way of knowing exactly how much enjoyment orsatisfaction someone receives from consuming a product. Similarly, it is not possible tocompare utility across consumers. There is no way of knowing for sure whether Jillreceives more or less satisfaction than Jack from drinking a bottle of Cherry Coke.

Two hundred years ago, economists hoped to measure utility in units called “utils.”The util would be an objective measure in the same way that temperature is: If it is 70degrees in New York and 70 degrees in Los Angeles, it is just as warm in both cities. Theseeconomists wanted to say that if Jack’s utility from eating a hamburger is 10 utils andJill’s utility is 5 utils, then Jack receives exactly twice the satisfaction from eating a ham-burger that Jill does. In fact, it is not possible to measure utility across people. It turnsout that none of the important conclusions of the economic model of consumer behav-ior depend on utility being directly measurable (a point we demonstrate in the appendixto this chapter). Nevertheless, the economic model of consumer behavior is easier tounderstand if we assume that utility is something directly measurable, like temperature.

The Principle of Diminishing Marginal UtilityTo make the model of consumer behavior more concrete, let’s see how a consumermakes decisions in a case involving just two products: pepperoni pizza and Coke. Tobegin, consider how the utility you receive from consuming a good changes with theamount of the good you consume. For example, suppose that you have just arrived at aSuper Bowl party where the hosts are serving pepperoni pizza, and you are very hungry.In this situation, you are likely to receive quite a lot of enjoyment, or utility, from con-suming the first slice of pizza. Suppose this satisfaction is measurable and is equal to 20units of utility, or utils. After eating the first slice, you decide to have a second slice.Because you are no longer as hungry, the satisfaction you receive from eating the secondslice of pizza is less than the satisfaction you received from eating the first slice.Consuming the second slice increases your utility by only an additional 16 utils, whichraises your total utility from eating the two slices to 36 utils. If you continue eating slices,each additional slice gives you less and less additional satisfaction.

The table in Figure 6-1 shows the relationship between the number of slices of pizzayou consume while watching the Super Bowl and the amount of utility you receive. The sec-ond column in the table shows the total utility you receive from eating a particular numberof slices. The third column shows the additional utility, or marginal utility (MU ), youreceive from consuming one additional slice. (Remember that in economics, “marginal”means additional.) For example, as you increase your consumption from 2 slices to 3 slices,your total utility increases from 36 to 46, so your marginal utility from consuming the thirdslice is 10 utils. As the table shows, by the time you eat the fifth slice of pizza that evening,your marginal utility is very low: only 2 utils. If you were to eat a sixth slice, you wouldbecome slightly nauseated, and your marginal utility would actually be a negative 3 utils.

Figure 6-1 also plots the numbers from the table as graphs. Panel (a) shows howyour total utility rises as you eat the first five slices of pizza and then falls as you eat thesixth slice. Panel (b) shows how your marginal utility declines with each additional sliceyou eat and finally becomes negative when you eat the sixth slice. The height of the mar-ginal utility line at any quantity of pizza in panel (b) represents the change in utility as aresult of consuming that additional slice. For example, the change in utility as a result ofconsuming 4 slices instead of 3 is 6 utils, so the height of the marginal utility line inpanel (b) is 6 utils.

The relationship illustrated in Figure 6-1 between consuming additional units of aproduct during a period of time and the marginal utility received from consuming eachadditional unit is referred to as the law of diminishing marginal utility. For nearlyevery good or service, the more you consume during a period of time, the less youincrease your total satisfaction from each additional unit you consume.

Marginal utility (MU ) The changein total utility a person receives fromconsuming one additional unit of agood or service.

Law of diminishing marginal utilityThe principle that consumersexperience diminishing additionalsatisfaction as they consume more of a good or service during a givenperiod of time.


Figure 6-1Total and Marginal Utility from Eating Pizza on Super Bowl Sunday

The table shows that for the first 5 slices ofpizza, the more you eat, the more your totalsatisfaction or utility increases. If you eat asixth slice, you start to feel ill from eating toomuch pizza, and your total utility falls. Eachadditional slice increases your utility by lessthan the previous slice, so your marginal util-ity from each slice is less than the one before.Panel (a) shows your total utility rising as youeat the first 5 slices and falling with the sixthslice. Panel (b) shows your marginal utilityfalling with each additional slice you eat andbecoming negative with the sixth slice. Theheight of the marginal utility line at any quan-tity of pizza in panel (b) represents the changein utility as a result of consuming that addi-tional slice. For example, the change in utilityas a result of consuming 4 slices instead of 3 is6 utils, so the height of the marginal utility linein panel (b) for the fourth slice is 6 utils.


52

46

0

Totalutility

0 7Quantity of pizza

654321

(a) Total utility

Total utility

The change in total utilityas a result of consuming4 slices rather than 3is 6 . . .

0

20

–5

Marginalutility

7

Marginal utility

Quantityof pizza

654321

(b) Marginal utility

. . . so the height of themarginal utility line for the fourth slice is 6.

6

0

1

2

3

4

5

6

Total Utility fromEating Pizza

Numberof Slices

0

20

36

46

52

54

51

Marginal Utility fromthe Last Slice Eaten

--

20

16

10

6

2

-3



TABLE 6-1 | Total Utility and Marginal Utility from Eating Pizza and Drinking Coke

NUMBER OF TOTAL UTILITY MARGINAL UTILITY TOTAL UTILITY MARGINAL UTILITYSLICES FROM EATING FROM THE NUMBER OF CUPS FROM FROM THE

OF PIZZA PIZZA LAST SLICE OF COKE DRINKING COKE LAST CUP

0 0 — 0 0 —

1 20 20 1 20 20

2 36 16 2 35 15

3 46 10 3 45 10

4 52 6 4 50 5

5 54 2 5 53 3

6 51 −3 6 52 −1

The Rule of Equal Marginal Utility per Dollar SpentThe key challenge for consumers is to decide how to allocate their limited incomesamong all the products they wish to buy. Every consumer has to make trade-offs: If youhave $100 to spend on entertainment for the month, then the more DVDs you buy, thefewer movies you can see in the theater. Economists refer to the limited amount ofincome you have available to spend on goods and services as your budget constraint.The principle of diminishing marginal utility helps us understand how consumers canbest spend their limited incomes on the products available to them.

Suppose you attend a Super Bowl party at a restaurant, and you have $10 to spendon refreshments. Pizza is selling for $2 per slice, and Coke is selling for $1 per cup.Table 6-1 shows the relationship between the amount of pizza you eat, the amount ofCoke you drink, and the amount of satisfaction, or utility, you receive. The values forpizza are repeated from the table in Figure 6-1. The values for Coke also follow theprinciple of diminishing marginal utility.

How many slices of pizza and how many cups of Coke do you buy if you want tomaximize your utility? If you did not have a budget constraint, you would buy 5 slices ofpizza and 5 cups of Coke because that would give you total utility of 107 (54 + 53),which is the maximum utility you can achieve. Eating another slice of pizza or drinkinganother cup of Coke during the evening would lower your utility. Unfortunately, you dohave a budget constraint: You have only $10 to spend. To buy 5 slices of pizza (at $2 perslice) and 5 cups of Coke (at $1 per cup), you would need $15.

To select the best way to spend your $10, remember this key economic principle:Optimal decisions are made at the margin. That is, most of the time, economic decisionmakers—consumers, firms, and the government—are faced with decisions aboutwhether to do a little more of one thing or a little more of an alternative. In this case, youare choosing to consume a little more pizza or a little more Coke. BMW chooses to man-ufacture more roadsters or more SUVs in its South Carolina factory. Congress and thepresident choose to spend more for research on heart disease or more for research onbreast cancer. Every economic decision maker faces a budget constraint, and every eco-nomic decision maker faces trade-offs.

The key to making the best consumption decision is to maximize utility by follow-ing the rule of equal marginal utility per dollar spent. As you decide how to spend yourincome, you should buy pizza and Coke up to the point where the last slice of pizza pur-chased and the last cup of Coke purchased give you equal increases in utility per dollar.By doing this, you will have maximized your total utility.

It is important to remember that to follow this rule, you must equalize your mar-ginal utility per dollar spent, not your marginal utility from each good. Buying season

Budget constraint The limitedamount of income available toconsumers to spend on goods and services.



TABLE 6-3 | Equalizing Marginal Utility per Dollar Spent

COMBINATIONS OF PIZZA AND COKE WITH EQUAL MARGINAL UTILITIES MARGINAL UTILITY PER DOLLAR

PER DOLLAR (MARGINAL UTILITY/PRICE) TOTAL SPENDING TOTAL UTILITY

1 slice of pizza and 3 cups of Coke 10 $2 + $3 = $5 20 + 45 = 65

3 slices of pizza and 4 cups of Coke 5 $6 + $4 = $10 46 + 50 = 96

4 slices of pizza and 5 cups of Coke 3 $8 + $5 = $13 52 + 53 = 105

tickets for your favorite NFL team or for the opera or buying a BMW may give you a lotmore satisfaction than drinking a cup of Coke, but the NFL tickets may well give you lesssatisfaction per dollar spent. To decide how many slices of pizza and how many cups ofCoke to buy, you must convert the values for marginal utility in Table 6-1 into marginalutility per dollar. You can do this by dividing marginal utility by the price of each good,as shown in Table 6-2.

In column (3), we calculate marginal utility per dollar spent on pizza. Because theprice of pizza is $2 per slice, the marginal utility per dollar from eating one slice of pizzaequals 20 divided by $2, or 10 utils per dollar. Similarly, we show in column (6) that becausethe price of Coke is $1 per cup, the marginal utility per dollar from drinking 1 cup of Cokeequals 20 divided by $1, or 20 utils per dollar. To maximize the total utility you receive, youmust make sure that the utility per dollar of pizza for the last slice of pizza is equal to theutility per dollar of Coke for the last cup of Coke. Table 6-2 shows that there are three com-binations of slices of pizza and cups of Coke where marginal utility per dollar is equalized.Table 6-3 lists the combinations, the total amount of money needed to buy each combina-tion, and the total utility received from consuming each combination.

If you buy 4 slices of pizza, the last slice gives you 3 utils per dollar. If you buy 5 cupsof Coke, the last cup also gives you 3 utils per dollar, so you have equalized your marginalutility per dollar. Unfortunately, as the third column in the table shows, to buy 4 slicesand 5 cups, you would need $13, and you have only $10. You could also equalize yourmarginal utility per dollar by buying 1 slice and 3 cups, but that would cost just $5, leav-ing you with $5 to spend. Only when you buy 3 slices and 4 cups have you equalized yourmarginal utility per dollar and spent neither more nor less than the $10 available.

TABLE 6-2 | Converting Marginal Utility to Marginal Utility per Dollar

(3) (6)

(1) (2)

MARGINAL UTILITY

(4) (5)

MARGINAL UTILITY

SLICES MARGINAL UTILITY

PER DOLLAR

CUPS MARGINAL UTILITY

PER DOLLAR

OF PIZZA (MUPIZZA) OF COKE (MUCOKE)

1 20 10 1 20 20

2 16 8 2 15 15

3 10 5 3 10 10

4 6 3 4 5 5

5 2 1 5 3 3

6 −3 −1.5 6 −1 −1

MUP

Coke

Coke

⎛

⎝⎜⎞⎠⎟

MU

Ppizza

pizza

⎛

⎝⎜

⎞

⎠⎟



Solved Problem|6-1Finding the Optimal Level of Consumption

The following table shows Lee’s utility from consuming ice cream cones and cans of Lime Fizz soda.

a. Ed inspects this table and concludes, “Lee’s optimalchoice would be to consume 4 ice cream cones and 5cans of Lime Fizz because with that combination, hismarginal utility from ice cream cones is equal to hismarginal utility from Lime Fizz.” Do you agree withEd’s reasoning? Briefly explain.

b. Suppose that Lee has an unlimited budget to spend onice cream cones and cans of Lime Fizz. Under these

SOLVING THE PROBLEM:Step 1: Review the chapter material. This problem involves finding the optimal con-

sumption of two goods, so you may want to review the section “The Rule ofEqual Marginal Utility per Dollar Spent,” which begins on page xxx.

Step 2: Answer question (a) by analyzing Ed’s reasoning. Ed’s reasoning is incorrect.To maximize utility, Lee needs to equalize marginal utility per dollar for thetwo goods.

circumstances, how many ice cream cones and howmany cans of Lime Fizz will he consume?

c. Suppose that Lee has $7 per week to spend on icecream cones and Lime Fizz. The price of an ice creamcone is $2, and the price of a can of Lime Fizz is $1. IfLee wants to maximize his utility, how many ice creamcones and how many cans of Lime Fizz should hebuy?

TOTAL MARGINAL TOTALNUMBER OF UTILITY FROM UTILITY NUMBER UTILITY FROM MARGINALICE CREAM ICE CREAM FROM LAST OF CANS CANS OF UTILITY FROM

CONES CONES CONE OF LIME FIZZ LIME FIZZ LAST CAN

0 0 — 0 0 —

1 30 30 1 40 40

2 55 25 2 75 35

3 75 20 3 101 26

4 90 15 4 119 18

5 100 10 5 134 15

6 105 5 6 141 7

We can summarize the two conditions for maximizing utility:

1

2 Spending on pizza + Spending on Coke = Amount available to be spent

The first condition shows that the marginal utility per dollar spent must be the same forboth goods. The second condition is the budget constraint, which states that total spendingon both goods must equal the amount available to be spent. Of course, these conditions formaximizing utility apply not just to pizza and Coke but to any two pairs of goods.

MU

P

MU

PPizza

Pizza

Coke

Coke

=


>> End Solved Problem 6-1


Step 3: Answer question (b) by determining how Lee would maximize utilitywith an unlimited budget. With an unlimited budget, consumers maxi-mize utility by continuing to buy each good as long as their utility isincreasing. In this case, Lee will maximize utility by buying 6 ice creamcones and 6 cans of Lime Fizz.

Step 4: Answer question (c) by determining Lee’s optimal combination of icecream cones and cans of Lime Fizz. Lee will maximize his utility if he spendshis $7 per week so that the marginal utility of ice cream cones divided by theprice of ice cream cones is equal to the marginal utility of Lime Fizz divided bythe price of Lime Fizz. We can use the following table to solve this part of theproblem:

ICE CREAM CONES CANS OF LIME FIZZ

QUANTITY MU MU

1 30 15 40 40

2 25 12.5 35 35

3 20 10 26 26

4 15 7.5 18 18

5 10 5 15 15

6 5 2.5 7 7

Lee will maximize his utility by buying 1 ice cream cone and 5 cans of LimeFizz. At this combination, the marginal utility of each good divided by itsprice equals 15. He has also spent all of his $7.

YOUR TURN: For more practice, do related problems 1.7 and 1.8 on pages xxx–xxx at the end of

this chapter.

What if the Rule of Equal Marginal Utility per Dollar Does Not Hold?The idea of getting the maximum utility by equalizing the ratio of marginal utility toprice for the goods you are buying can be difficult to grasp, so it is worth thinking aboutin another way. Suppose that instead of buying 3 slices of pizza and 4 cups of Coke, youbuy 4 slices and 2 cups. Four slices and 2 cups cost $10, so you would meet your budgetconstraint by spending all the money available to you, but would you have gotten themaximum amount of utility? No, you wouldn’t have. From the information in Table 6-1,we can list the additional utility per dollar you are getting from the last slice and the lastcup and the total utility from consuming 4 slices and 2 cups:

Marginal utility per dollar for the fourth slice of pizza = 3 utils per dollar

Marginal utility per dollar for the second cup of Coke = 15 utils per dollar

Total utility from 4 slices of pizza and 2 cups of Coke = 87 utils

Obviously, the marginal utilities per dollar are not equal. The last cup of Coke gaveyou considerably more satisfaction per dollar than did the last slice of pizza. You couldraise your total utility by buying less pizza and more Coke. Buying 1 less slice of pizzafrees up $2 that will allow you to buy 2 more cups of Coke. Eating 1 less slice of pizzareduces your utility by 6 utils, but drinking 2 additional cups of Coke raises your utilityby 15 utils (make sure you see this), for a net increase of 9. You end up equalizing yourmarginal utility per dollar (5 utils per dollar for both the last slice and the last cup) andraising your total utility from 87 utils to 96 utils.

MUP

MUP



6.2 | Use the concept of utility to explain the law of demand.

Where Demand Curves Come FromWe saw in Chapter 3 that, according to the law of demand, whenever the price of a prod-uct falls, the quantity demanded increases. Now that we have covered the concepts oftotal utility, marginal utility, and the budget constraint, we can look more closely at whythe law of demand holds.

In our example of optimal consumption of pizza and Coke at the Super Bowl party,we found the following:

Price of pizza = $2 per slice ⇒ Quantity of pizza demanded = 3 slices

Price of pizza = $1.50 per slice ⇒ Quantity of pizza demanded = 4 slices

In panel (a) of Figure 6-2, we plot the two points showing the optimal number ofpizza slices you choose to consume at each price. In panel (b) of Figure 6-2, we draw aline connecting the two points. This downward-sloping line represents your demandcurve for pizza. We could find more points on the line by changing the price of pizza andusing the information in Table 6-2 to find the new optimal number of slices of pizza youwould demand at each price.

To this point in this chapter, we have been looking at an individual demand curve.As we saw in Chapter 3, however, economists are typically interested in market demandcurves. We can construct the market demand curve from the individual demand curvesfor all the consumers in the market. To keep things simple, let’s assume that there areonly three consumers in the market for pizza: you, David, and Sharon. The table inFigure 6-3 shows the individual demand schedules for the three consumers. Becauseconsumers differ in their incomes and their preferences for products, we would notexpect every consumer to demand the same quantity of a given product at each price.The final column gives the market demand, which is simply the sum of the quantitiesdemanded by each of the three consumers at each price. For example, at a price of $1.50per slice, your quantity demanded is 4 slices, David’s quantity demanded is 6 slices, andSharon’s quantity demanded is 5 slices. So, at a price of $1.50, a quantity of 15 slices is


$2.00

0

Price(dollars

per slice)

Demand

4 Quantity(slices per day)

(a) Your optimal consumption

1.50

3

Optimal consumptionof pizza when price =$2.00 per slice

Optimal consumptionof pizza when price =$1.50 per slice

$2.00

0

Price(dollars

per slice)

4 Quantity(slices per day)

(b) Your demand curve

1.50

3

Your demandcurve for pizza

A consumer responds optimally to a fall in the price of a product by consuming moreof that product. In panel (a), the price of pizza falls from $2 per slice to $1.50, and the

optimal quantity of slices consumed rises from 3 to 4. When we graph this result inpanel (b), we have the consumer’s demand curve.

Figure 6-2 | Deriving the Demand Curve for Pizza



Quantity (slices per day)

Price(dollars per slice)

$2.50

2.00

1.50

1.00

0.50

You

2

3

4

5

6

David

4

5

6

7

8

Sharon

1

3

5

7

9

Market

7

11

15

19

23

2 4 Quantity(slices

per day)(b) David’s demand curve

+

$3.00

0

Price(dollars

perslice)

2.50

2.00

1.50

1.00

0.50

3 5 6

$3.00

0

Price(dollars

perslice)

2.50

2.00

1.50

1.00

0.50

4 5 6 7 8

+

Quantity(slices

per day)

Demand Demand

(a) Your demand curve

MarketDemand

$3.00

0

Price(dollars

perslice)

2.50

2.00

1.50

1.00

0.50

$3.00

0

Price(dollars

perslice)

2.50

2.00

1.50

1.00

0.50

1 3 5 7 9 7 11 15 19 23

=

Quantity(slices

per day)

Quantity(slices

per day)

Demand

(d) Market demand curve(c) Sharon’s demand curve

The table shows that the total quantity demanded in a market is the sum of the quan-tities demanded by each buyer.We can find the market demand curve by adding hor-izontally the individual demand curves in parts (a), (b), and (c). For instance, at a

price of $1.50, your quantity demanded is 4 slices, David’s quantity demanded is 6 slices, and Sharon’s quantity demanded is 5 slices. Therefore, part (d) shows a priceof $1.50, and a quantity demanded of 15 is a point on the market demand curve.

Figure 6-3 | Deriving the Market Demand Curve from Individual Demand Curves


Substitution effect The change inthe quantity demanded of a good thatresults from a change in price makingthe good more or less expensiverelative to other goods, holdingconstant the effect of the price changeon consumer purchasing power.

Income effect The change in thequantity demanded of a good thatresults from the effect of a change inprice on consumer purchasing power,holding all other factors constant.


demanded in the market. The graphs in the figure show that we can obtain the marketdemand curve by adding horizontally the individual demand curves.Remember that according to the law of demand, market demand curves always slopedownward. We saw in Chapter 3 that the income and substitution effects of a fall in pricecause consumers to increase the quantity of the good they demand. (Recall that thesubstitution effect is the change in the quantity demanded of a good that results froma change in price making the good more or less expensive relative to other goods thatare substitutes. And the income effect is the change in quantity demanded of a goodthat results from the effect of a change in the good’s price on consumer purchasingpower.) There is a complicating factor, however. only for normal goods will theincome effect result in consumers increasing the quantity of the good they demandwhen the price falls. If the good is an inferior good, then the income effect leads con-sumers to decrease the quantity of the good they demand. The substitution effect, onthe other hand, results in consumers increasing the quantity they demand of bothnormal and inferior goods when the price falls. So, when the price of an inferior goodfalls, the income and substitution effects work in opposite directions: The incomeeffect causes consumers to decrease the quantity of the good they demand, whereasthe substitution effect causes consumers to increase the quantity of the good theydemand. Is it possible, then, that consumers might actually buy less of a good whenthe price falls? If this happened, the demand curve would be upward sloping.

For a market demand curve to be upward sloping, the good would have to be aninferior good, and the income effect would have to be larger than the substitution effect.Goods that have both of these characteristics are called Giffen goods. Although we canconceive of there being Giffen goods, none has ever been discovered because for allactual goods, the substitution effect is larger than the income effect. Therefore, even foran inferior good, a fall in price leads to an increase in quantity demanded, and a rise inprice leads to a decrease in the quantity demanded.

6.3 | Explain how social influences can affect consumption choices.

Social Influences on Decision MakingSociologists and anthropologists have argued that social factors such as culture, cus-toms, and religion are very important in explaining the choices consumers make.Economists have traditionally seen such factors as being relatively unimportant, if theytake them into consideration at all. Recently, however, some economists have begun tostudy how social factors influence consumer choice.

For example, people seem to receive more utility from consuming goods theybelieve are popular. As the economists Gary Becker and Kevin Murphy put it:

The utility from drugs, crime, going bowling, owning a Rolex watch, votingDemocratic, dressing informally at work, or keeping a neat lawn depends onwhether friends and neighbors take drugs, commit crimes, go bowling, ownRolex watches, vote Democratic, dress informally, or keep their lawns neat.

This reasoning can help to explain why one restaurant is packed, while anotherrestaurant that serves essentially the same food and has a similar décor has many fewercustomers. Consumers decide which restaurant to go to partly on the basis of food anddécor but also on the basis of the restaurant’s popularity. People receive utility frombeing seen eating at a popular restaurant because they believe it makes them appearknowledgeable and fashionable. Whenever consumption takes place publicly, many con-sumers base their purchasing decisions on what other consumers are buying. Examplesof public consumption include eating in restaurants, attending sporting events, wearingclothes or jewelry, and driving cars. In all these cases, the decision to buy a productdepends partly on the characteristics of the product and partly on how many other peo-ple are buying the product.



Why Do Firms Pay Tiger Woods to Endorse Their Products?Tiger Woods may be the best golfer who’s ever lived. In his firstfive years as a professional, he won 27 tournaments on the

Professional Golfers’Association (PGA) tour. When he won the Masters in 2001, he becamethe first golfer ever to win all four major professional golf championships in the same year.In late 2006 and early 2007, Tiger seemed hotter than ever when he won seven straight tour-naments on the PGA tour. Even though Tiger Woods is a great golfer, should consumers carewhat products he uses? A number of major companies apparently believe consumers docare. The General Motors, Nike, Titleist, American Express, and Rolex companies collec-tively pay him more than $50 million per year to endorse their products.

There seems little doubt that consumers care what products Tiger uses, but why dothey care? It might be that they believe Tiger has better information than they do aboutthe products he endorses. The average weekend golfer might believe that if Tigerendorses Titleist golf clubs, maybe Titleist clubs are better than other golf clubs. But itseems more likely that people buy products associated with Tiger Woods or othercelebrities because using these products makes them feel closer to the celebrity endorseror because it makes them appear to be fashionable.

YOUR TURN: Test your understanding by doing related problem 3.9 on page xxx at the end

of this chapter.

Network ExternalitiesTechnology can play a role in explaining why consumers buy products that manyother consumers are already buying. There is a network externality in the consump-tion of a product if the usefulness of the product increases with the number of con-sumers who use it. For example, if you owned the only cell phone in the world, itwould not be very useful. The usefulness of cell phones increases with the numberof people who own them. Similarly, your willingness to buy an iPod depends in parton the number of other people who own iPods. The more people who own iPods,the more music that will be available to download and the more useful an iPod is to you.

Some economists have suggested the possibility that network externalities may havea significant downside because they might result in consumers buying products thatcontain inferior technologies. This outcome could occur because network externalitiescan create significant switching costs to changing products: When a product becomesestablished, consumers may find it too costly to switch to a new product that contains abetter technology. The selection of products may be path dependent. This means thatbecause of switching costs, the technology that was first available may have advantages

In 2007, Tiger Woods earned $11million from playing golf and $100million from product endorsements.

|Making the

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Network externality This situationwhere the usefulness of a productincreases with the number ofconsumers who use it.

The Effects of Celebrity EndorsementsIn many cases, it is not just the number of people who use a product that makes it desir-able but the types of people who use it. If consumers believe that movie stars or profes-sional athletes use a product, demand for the product will often increase. This may bepartly because consumers believe public figures are particularly knowledgeable aboutproducts: “Tiger Woods knows more about cars than I do, so I’ll buy the same car hedrives.” But many consumers also feel more fashionable and closer to famous people ifthey use the same products these people do. These considerations help to explain whycompanies are willing to pay millions of dollars to have celebrities endorse their prod-ucts. As we saw at the beginning of this chapter, Coke has been using celebrities in itsadvertising for decades.



over better technologies that were developed later. In other words, the path along whichthe economy has developed in the past is important.

One example of path dependency and the use of an inferior technology is theQWERTY order of the letters along the top row of most computer keyboards. Thisorder became widely used when manual typewriters were developed in the late nine-teenth century. The metal keys on manual typewriters would stick together if a usertyped too fast, and the QWERTY keyboard was designed to slow down typists and min-imize the problem of the keys sticking together. With computers, the problem thatQWERTY was developed to solve no longer exists, so keyboards could be changed easilyto have letters in a more efficient layout. But because the overwhelming majority of peo-ple have learned to use keyboards with the QWERTY layout, there might be significantcosts to them if they had to switch, even if a new layout ultimately made them fastertypists.

Other products that supposedly embodied inferior technologies are VHS videorecorders—supposedly inferior to Sony Betamax recorders—and the Windows com-puter operating system—supposedly inferior to the Macintosh operating system. Someeconomists have argued that because of path dependence and switching costs, networkexternalities can result in market failures. As we saw in Chapter 5, a market failure is asituation in which the market fails to produce the efficient level of output. If networkexternalities result in market failure, government intervention in these markets mightimprove economic efficiency. Many economists are skeptical, however, that networkexternalities really do lead to consumers being locked into products with inferior tech-nologies. In particular, economists Stan Leibowitz of the University of Texas, Dallas,and Stephen Margolis of North Carolina State University have argued that in practice,the gains from using a superior technology are larger than the losses due to switchingcosts. After carefully studying the cases of the QWERTY keyboard, VHS videorecorders, and the Windows computer operating system, they have concluded thatthere is no good evidence that the alternative technologies were actually superior. Theimplications of network externalities for economic efficiency remain controversialamong economists.

Does Fairness Matter?If people were only interested in making themselves as well off as possible in a materialsense, they would not be concerned with fairness. There is a great deal of evidence, how-ever, that people like to be treated fairly and that they usually attempt to treat othersfairly, even if doing so makes them worse off financially. Tipping servers in restaurants isan example. Diners in restaurants typically add 15 percent to their food bills as tips totheir servers. Tips are not required, but most people see it as very unfair not to tip, unlessthe service has been exceptionally bad. You could argue that people leave tips not to befair but because they are afraid that if they don’t leave a tip, the next time they visit therestaurant they will receive poor service. Studies have shown, however, that most peopleleave tips at restaurants even while on vacation or in other circumstances where they areunlikely to visit the restaurant again.

There are many other examples where people willingly part with money whenthey are not required to do so and when they receive nothing material in return. Themost obvious example is making donations to charity. Apparently, donating moneyto charity or leaving tips in restaurants that they will never visit again gives peoplemore utility than they would receive from keeping the money and spending it onthemselves.

A Test of Fairness in the Economic Laboratory: The Ultimatum GameExperiment Economists have used experiments to increase their understanding of therole that fairness plays in consumer decision making. Experimental economics has beenwidely used during the past two decades, and a number of experimental economics lab-oratories exist in the United States and Europe. Economists Maurice Allais, Reinhard



Selten, and Vernon Smith were awarded the Nobel Prize in Economics in part because oftheir contributions to experimental economics. Experiments make it possible to focuson a single aspect of consumer behavior. The ultimatum game, first popularized byWerner Güth of the Max Planck Institute of Economics, is an experiment that testswhether fairness is important in consumer decision making. Various economists haveconducted the ultimatum game experiment under slightly different conditions, but withgenerally the same result. In this game, a group of volunteers—often college students—are divided into pairs. One member of each pair is the “allocator,” and the other memberof the pair is the “recipient.”

Each pair is given an amount of money, say $20. The allocator decides how much ofthe $20 each member of the pair will get. There are no restrictions on how the allocatordivides up the money. He or she could keep it all, give it all to the recipient, or anythingin between. The recipient must then decide whether to accept the allocation or reject it.If the recipient decides to accept the allocation, each member of the pair gets to keep hisor her share. If the recipient decides to reject the allocation, both members of the pairreceive nothing.

If neither the allocator nor the recipient cared about fairness, optimal play in theultimatum game is straightforward: The allocator should propose a division of themoney in which the allocator receives $19.99 and the recipient receives $0.01. The allo-cator has maximized his or her gain. The recipient should accept the division becausethe alternative is to reject the division and receive nothing at all: Even a penny is betterthan nothing.

In fact, when the ultimatum game experiment is carried out, both allocators andrecipients act as if fairness is important. Allocators usually offer recipients at least a 40percent share of the money, and recipients almost always reject offers of less than a 10percent share. Why do allocators offer recipients more than a negligible amount? Itmight be that allocators do not care about fairness but fear that recipients do care andwill reject offers they consider unfair. This possibility was tested in an experimentknown as the dictator game carried out by Daniel Kahneman (a psychologist who sharedthe Nobel Prize in Economics), Jack Knetsch, and Richard Thaler, using students atCornell University. In this experiment, the allocators were given only two possible divi-sions of $20: either $18 for themselves and $2 for the recipient or an even division of $10for themselves and $10 for the recipient. One important difference from the ultimatumgame was that the recipient was not allowed to reject the division. Of the 161 allocators,122 chose the even division of the $20. Because there was no possibility of the $18/$2split being rejected, the allocators must have chosen the even split because they valuedacting fairly.

Why would recipients in the ultimatum game ever reject any division of the moneyin which they receive even a very small amount, given that even a small amount ofmoney is better than nothing? Apparently, most people value fairness enough that theywill refuse to participate in transactions they consider unfair, even if they are worse offfinancially as a result.

Business Implications of Fairness If consumers value fairness, how does that affectfirms? One consequence is that firms will sometimes not raise prices of goods and ser-vices, even when there is a large increase in demand, because they are afraid their cus-tomers will consider the price increases unfair and may buy elsewhere.

For example, the Broadway play The Producers was extremely popular during itsfirst year in production. Even though ticket prices were an average of $75, on mostnights, many more people wanted to buy tickets at that price than could be accommo-dated in the St. James Theater, where the play was running. Figure 6-4 illustrates thissituation.

Notice that the supply curve in Figure 6-4 is a vertical line, which indicates that thecapacity of the St. James Theater is fixed at 1,644 seats. At a price of $75 per ticket, therewas a shortage of more than 400 tickets. Why didn’t the theater raise ticket prices to$125, where the quantity supplied would equal the quantity demanded?


Figure 6-4The Market for Tickets to The Producers

The St. James Theater could have raised pricesfor the Broadway musical The Producers to$125 per ticket and still sold all of the 1,644tickets available. Instead, the theater kept theprice of tickets at $75, even though the resultwas a shortage of more than 400 seats. Is itpossible that this strategy maximized profits?


Demand

Supply

$125

0

Price oftickets

2,100 Numberof tickets

75

1,644

Supply is fixedat 1,644 seats.

At $75 perticket, there isa shortage of456 seats.

Let’s look at two other examples in which it seems that businesses could increase theirprofits by raising prices. First, each year, many more people would like to buy tickets to seethe Super Bowl than there are tickets for them to buy at the price the National FootballLeague charges. Why doesn’t the National Football League raise prices? Second, at popularrestaurants, there are often long lines of people waiting to be served. Some of the peoplewill wait hours to be served, and some won’t be served at all before the restaurant closes.Why doesn’t the restaurant raise prices high enough to eliminate the lines?

In each of these cases, it appears that a firm could increase its profits by raisingprices. The seller would be selling the same quantity—of seats in a theater or a footballstadium or meals in a restaurant—at a higher price, so profits should increase.Economists have provided two explanations why firms sometimes do not raise prices inthese situations. Gary Becker, winner of the Nobel Prize in Economics, has suggestedthat the products involved—theatrical plays, football games, rock concerts, or restaurantmeals—are all products that buyers consume together with other buyers. In those situa-tions, the amount consumers wish to buy may be related to how much of the productother people are consuming. People like to consume, and be seen consuming, a popularproduct. In this case, a popular restaurant that increased its prices enough to eliminatelines might find that it had also eliminated its popularity.

Daniel Kahneman, Jack Knetsch, and Richard Thaler have offered another explana-tion for why firms don’t always raise prices when doing so would seem to increase theirprofits. In surveys of consumers, these researchers found that most people considered itfair for firms to raise their prices following an increase in costs but unfair to raise pricesfollowing an increase in demand. For example, Kahneman, Knetsch, and Thaler con-ducted a survey in which people were asked their opinion of the following situation: “Ahardware store has been selling snow shovels for $15. The morning after a large snow-storm, the store raises the price to $20.” Eighty-two percent of those surveyedresponded that they considered the hardware store’s actions to be unfair. Kahneman,Knetsch, and Thaler have concluded that firms may sometimes not raise their priceseven when the quantity demanded of their product is greater than the quantity sup-plied out of fear that in the long run, they will lose customers who believe the priceincreases were unfair.

These explanations share the same basic idea: Sometimes firms will give up someprofits in the short run to keep their customers happy and increase their profits in thelong run.


Professor Krueger Goes to the Super BowlEconomist Alan Krueger of Princeton University has studiedthe question of why the National Football League does not

charge a price for Super Bowl tickets that is high enough to make the quantity of tick-ets demanded equal to the quantity of tickets available. The prices may seem high—$400 for the best seats, $325 for the rest—but the quantity demanded still greatlyexceeds the quantity supplied. Most Super Bowl tickets are allocated to the two teamsplaying in the game or to the league’s corporate sponsors. To give ordinary fans achance to attend the game, in 2001, the NFL set aside 500 pairs of tickets. They held a

lottery for the opportunity to buy these tickets, and more than36,000 people applied. Some fans were willing to pay as much as$5,000 to buy a ticket from ticket scalpers. (Scalpers buy tickets attheir face value and then resell them at much higher prices, eventhough in Florida, where the 2001 Super Bowl was held, ticketscalping is illegal.)

Why didn’t the NFL simply raise the price of tickets to clearthe market? Krueger decided to survey football fans attending thegame to see if their views could help explain this puzzle. Krueger’ssurvey provides support for the Kahneman, Knetsch, and Thalerexplanation of why companies do not always raise prices when thequantity demanded is greater than the quantity supplied. Whenasked whether it would “be fair for the NFL to raise the [price oftickets] to $1,500 if that is still less than the amount most peopleare willing to pay for tickets,” 92 percent of the fans surveyedanswered “no.” Even 83 percent of the fans who had paid morethan $1,500 for their tickets answered “no.” Krueger concluded

that whatever the NFL might gain in the short run from raising ticket prices, it wouldmore than lose in the long run by alienating football fans.

Source: Alan B. Krueger, “Supply and Demand: An Economist Goes to the Super Bowl,” Milken Institute Review, SecondQuarter 2001.

YOUR TURN: Test your understanding by doing related problems 3.11 and 3.12 on page xxx

at the end of this chapter.

6.4 | Describe the behavioral economics approach to understanding decisionmaking.

Behavioral Economics: Do People Make Their Choices Rationally?When economists say that consumers and firms are behaving “rationally,” they meanthat consumers and firms are taking actions that are appropriate to reach their goals,given the information available to them. In recent years, some economists have begunstudying situations in which people do not appear to be making choices that are eco-nomically rational. This new area of economics is called behavioral economics. Whymight consumers or businesses not act rationally? The most obvious reason would bethat they do not realize that their actions are inconsistent with their goals. As we dis-cussed in Chapter 1, one of the objectives of economics is to suggest ways to make betterdecisions. In this section, we discuss ways in which consumers can improve their deci-sions by avoiding some common pitfalls.

Consumers commonly commit the following three mistakes when making decisions:

• They take into account monetary costs but ignore nonmonetary opportunity costs.


|Making the

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Behavioral economics The study of situations in which people makechoices that do not appear to beeconomically rational.

Should the NFL raise the price of Super Bowl tickets?

M06_HUBB6239_02_SE_C06.QXD 7/11/08 8:04 PM 8 MARKED SET


Opportunity cost The highest-valuedalternative that must be given up toengage in an activity.

• They fail to ignore sunk costs.

• They are overly optimistic about their future behavior.

Ignoring Nonmonetary Opportunity CostsRemember from Chapter 2 that the opportunity cost of any activity is the highest-valued alternative that must be given up to engage in that activity. For example, if youown something you could sell, using it yourself involves an opportunity cost. It isoften difficult for people to think of opportunity costs in these terms.

Consider the following example: Some of the fans at the 2001 Super Bowl partici-pated in a lottery run by the National Football League that allowed the winners to pur-chase tickets at their face value, which was either $325 or $400, depending on where in thestadium the seats were located. Alan Krueger surveyed the lottery winners, asking themtwo questions:

Question 1: If you had not won the lottery, would you have been willing to pay $3,000for your ticket?Question 2: If after winning your ticket (and before arriving in Florida for the SuperBowl) someone had offered you $3,000 for your ticket, would you have sold it?

In answer to the first question, 94 percent said that if they had not won the lottery,they would not have paid $3,000 for a ticket. In answer to the second question, 92 per-cent said they would not have sold their ticket for $3,000. But these answers are contra-dictory! If someone offers you $3,000 for your ticket, then by using the ticket ratherthan selling it, you incur an opportunity cost of $3,000. There really is a $3,000 costinvolved in using that ticket, even though you do not pay $3,000 in cash. The alterna-tives of either paying $3,000 or not receiving $3,000 amount to exactly the same thing.

If the ticket is really not worth $3,000 to you, you should sell it. If it is worth $3,000to you, you should be willing to pay $3,000 in cash to buy it. Not being willing to sell aticket you already own for $3,000, while at the same time not being willing to buy aticket for $3,000 if you didn’t already own one is inconsistent behavior. The inconsis-tency comes from a failure to take into account nonmonetary opportunity costs.Behavioral economists believe this inconsistency is caused by the endowment effect,which is the tendency of people to be unwilling to sell a good they already own even ifthey are offered a price that is greater than the price they would be willing to pay to buythe good if they didn’t already own it.

The failure to take into account opportunity costs is a very common error in deci-sion making. Suppose, for example, that a friend is in a hurry to have his roomcleaned—it’s the Friday before parents’ weekend—and he offers you $50 to do it forhim. You turn him down and spend the time cleaning your own room, even though youknow somebody down the hall who would be willing to clean your room for $20. Leaveaside complicating details—the guy who asked you to clean his room is a real slob, oryou don’t want the person who offered to clean your room for $20 to go through yourstuff—and you should see the point we are making. The opportunity cost of cleaningyour own room is $50—the amount your friend offered to pay you to clean his room. Itis inconsistent to turn down an offer from someone else to clean your room for $20when you are doing it for yourself at a cost of $50. The key point here is this:Nonmonetary opportunity costs are just as real as monetary costs and should be taken intoaccount when making decisions.

Business Implications of Consumers IgnoringNonmonetary Opportunity CostsBehavioral economist Richard Thaler has studied several examples of how businessesmake use of consumers’ failure to take into account opportunity costs. Whenever youbuy something with a credit card, the credit card company charges the merchant a fee toprocess the bill. Credit card companies generally do not allow stores to charge higher

Endowment effect The tendency of people to be unwilling to sell agood they already own even if theyare offered a price that is greater thanthe price they would be willing to payto buy the good if they didn’t alreadyown it.


Why Do Hilton Hotels and other Firms Hide Their Prices?Economists recently began to use ideas from behavioral eco-nomics to understand a puzzling aspect of how some busi-

nesses price their products. David Laibson of Harvard University and Xavier Gabaix ofNew York University note that some products consist of a “base good” and “add-ons.”For instance, to use a printer, you buy the printer itself—the base good—and replace-ment ink cartridges—the add-on. Typically, firms compete on the price of the base goodbut do their best to hide the prices of the add-ons. Because consumers sometimes spendmore on the add-ons than on the base good, it may seem surprising that firms are ableto successfully hide the prices of add-ons. For instance, over the life of a printer, con-sumers spend, on average, 10 times the price of the printer in buying ink cartridges. Yetone survey indicates that only 3 percent of consumers know the true cost of using aprinter, including the cost of the ink cartridges. Similarly, many consumers are unawareof the add-on charges from using a checking account, such as ATM fees, returned checkcharges, and minimum balance fees. Many consumers making a hotel reservation areunaware of the hotel’s charges for Internet access, for food from minibars, for breakfastat the hotel restaurant, or for local phone calls.

How are firms able to hide the prices of add-ons? Why doesn’t competition leadsome firms to offer lower-priced add-ons and advertise that their competitors’ add-onsare higher priced? Laibson and Gabaix explain this puzzle by arguing that there are twotypes of consumers: sophisticated consumers, who pay attention to prices of add-ons,and myopic consumers, who ignore the prices of add-ons. It turns out that using adver-tising to convert myopic consumers into sophisticated consumers is not a profitablestrategy. Consider the following example: Suppose that Hilton Hotels charges $80 pernight for a room and the typical myopic consumer also spends $20 per night on localphone calls, food from the minibar, high-priced breakfasts, and other add-ons. Could acompeting hotel, such as Marriott, attract Hilton’s customers by advertising thatMarriott’s add-ons were more fairly priced than Hilton’s? Laibson and Gabaix arguethat this strategy would not work because its main effect would be to turn myopic con-sumers into sophisticated consumers. Once Hilton’s customers become sophisticated,they will avoid the add-on fees, by, for instance, using their cell phones rather than thehotel phones to make calls or by eating breakfast in nearby restaurants rather than inthe hotel. According to Laibson and Gabaix, Marriott’s advertising campaign, “hurtsHilton—which sells fewer add-ons—but helps Hilton’s customers, who are taught tosubstitute away from add-ons.” But these sophisticated consumers are no more likely toswitch from Hilton to Marriott than they were before Marriott incurred the cost of its

Some hotels hide what they chargefor room service and Internet access.

|Making the

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prices to customers who use credit cards. A bill was introduced in Congress that wouldhave made it illegal for credit card companies to enforce this rule. The credit card indus-try was afraid that if this law passed, credit card usage would drop because stores mightbegin charging a fee to credit card users. They attempted to have the law amended sothat stores would be allowed to give a cash discount to people not using credit cards butwould not be allowed to charge a fee to people using credit cards. There really is no dif-ference in terms of opportunity cost between being charged a fee and not receiving adiscount. The credit card industry was relying on the fact that not receiving a discountis a nonmonetary opportunity cost—and, therefore, likely to be ignored by con-sumers—but a fee is a monetary cost that people do take into account.

Film processing companies provide another example. Many of these companieshave a policy of printing every picture on a roll of film, even if the picture is very fuzzy.Customers are allowed to ask for refunds on pictures they don’t like. Once again, thecompanies are relying on the fact that passing up a refund once you have already paidfor a picture is a nonmonetary opportunity cost rather than a direct monetary cost. Infact, customers rarely ask for refunds.



advertising campaign. Exposing a competitor’s hidden costs, say Laibson and Gabaix, “isgood for the consumer and bad for both firms. Neither firm has an incentive to do it.”As a result, many consumers remain unaware of the true prices of some of the productsthey purchase.

Sources: Christopher Shay, “The Hidden-Fee Economy,” New York Times, December 10, 2006; and Xavier Gabaix and DavidLaibson, “Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets,” QuarterlyJournal of Economics, Vol. 121, No. 2, May 2006, pp. 351–397.


of this chapter.

Failing to Ignore Sunk CostsA sunk cost is a cost that has already been paid and cannot be recovered. Once you havepaid money and can’t get it back, you should ignore that money in any later decisionsyou make. Consider the following two situations:

Situation 1: You bought a ticket to a play for $75. The ticket is nonrefundable and mustbe used on Tuesday night, which is the only night the play will be performed. OnMonday, a friend calls and invites you to a local comedy club to see a comedian you bothlike who is appearing only on Tuesday night. Your friend offers to pay the cost of going tothe club.Situation 2: It’s Monday night, and you are about to buy a ticket for the Tuesday nightperformance of the same play as in situation 1. As you are leaving to buy the ticket, yourfriend calls and invites you to the comedy club.

Would your decision to go to the play or to the comedy club be different in situation1 than in situation 2? Most people would say that in situation 1, they would go to theplay, because otherwise they would lose the $75 they had paid for the ticket. In fact,though, the $75 is “lost” no matter what you do because the ticket is not refundable. Theonly real issue for you to decide is whether you would prefer to see the play or prefer togo with your friend to the comedy club. If you would prefer to go to the club, the factthat you have already paid $75 for the ticket to the play is irrelevant. Your decisionshould be the same in situation 1 and situation 2.

Psychologists Daniel Kahneman and Amos Tversky explored the tendency of con-sumers to not ignore sunk costs by asking two samples of people the following questions:

Question 1: One sample of people was asked the following question: “Imagine that youhave decided to see a play and have paid the admission price of $10 per ticket. As youenter the theater, you discover that you have lost the ticket. The seat was not marked, andthe ticket cannot be recovered. Would you pay $10 for another ticket?” Of those asked,46 percent answered “yes,” and 54 percent answered “no.”Question 2: A different sample of people was asked the following question: “Imaginethat you have decided to see a play where admission is $10 per ticket. As you enter thetheater, you discover that you have lost a $10 bill. Would you still pay $10 for a ticket tothe play?” Of those asked, 88 percent answered “yes,” and 12 percent answered “no.”

The situations presented in the two questions are actually the same and should havereceived the same fraction of yes and no responses. Many people, though, have troubleseeing that in question 1, when deciding whether to see the play, they should ignore the$10 already paid for a ticket because it is a sunk cost.

Being Unrealistic about Future BehaviorStudies have shown that a majority of adults in the United States are overweight. Whydo many people choose to eat too much? One possibility is that they receive moreutility from eating too much than they would from being thin. A more likely explana-tion, however, is that many people eat a lot today because they expect to eat less

Sunk cost A cost that has alreadybeen paid and cannot be recovered.


Why Don’t Students Study More?Government statistics show that students who do well in col-lege earn at least $10,000 more per year than students whofail to graduate or who graduate with low grades. So, over the

course of a career of 40 years or more, students who do well in college will have earnedupwards of $400,000 more than students who failed to graduate or who received low

grades. Most colleges advisethat students study at leasttwo hours outside of classfor every hour they spend inclass. Surveys show that stu-dents often ignore thisadvice.

If the opportunity costof not studying is so high,why do many studentschoose to study relatively lit-tle? Some students havework or family commit-ments that limit the amountof time they can study. Butmany other students studyless than they would if they

were more realistic about their future behavior. On any given night, a student has tochoose between studying and other activities—like watching television, going to themovies, or going to a party—that may seem to provide higher utility in the short run.Many students choose one of these activities over studying because they expect to studytomorrow or the next day, but tomorrow they face the same choices and make similardecisions. As a result, they do not study enough to meet their long-run goal of graduat-ing with high grades. If they were more realistic about their future behavior, they wouldnot make the mistake of overvaluing the utility from activities like watching television orpartying because they would realize that those activities can endanger their long-rungoal of graduating with honors.


of this chapter.

|Making the

Connection


tomorrow. But they never do eat less, and so they end up overweight. (Of course,some people also suffer from medical problems that lead to weight gain.) Similarly,some people continue smoking today because they expect to be able to give it upsometime in the future. Unfortunately, for many people that time never comes, andthey suffer the health consequences of prolonged smoking. In both these cases, peopleare overvaluing the utility from current choices—eating chocolate cake or smoking—and undervaluing the utility to be received in the future from being thin or not get-ting lung cancer.

Economists who have studied this question argue that many people have prefer-ences that are not consistent over time. In the long run, you would like to be thin or giveup smoking or achieve some other goal, but each day, you make decisions (such as to eattoo much or to smoke) that are not consistent with this long-run goal. If you are unreal-istic about your future behavior, you underestimate the costs of choices—like overeatingor smoking—that you make today. A key way of avoiding this problem is to be realisticabout your future behavior.

If the payoff to studying is so high, why don’t students study more?



Taking into account nonmonetary opportunity costs, ignoring sunk costs, and beingmore realistic about future behavior are three ways in which consumers are able toimprove the decisions they make.


Price elasticity of demandThe responsiveness of the quantitydemanded to a change in price,measured by dividing the percentagechange in the quantity demanded ofa product by the percentage change in the product’s price.

6.5 | Define the price elasticity of demand and understand how to measure it.

The Price Elasticity of Demand and Its MeasurementWe know from the law of demand that when the price of a product falls, the quantitydemanded of the product increases. But the law of demand tells firms only that thedemand curves for their products slope downward. More useful is a measure of theresponsiveness of the quantity demanded to a change in price. This measure is calledthe price elasticity of demand.

Measuring the Price Elasticity of DemandWe might measure the price elasticity of demand by using the slope of the demand curvebecause the slope of the demand curve tells us how much quantity changes as pricechanges. Using the slope of the demand curve to measure price elasticity has a drawback,however: The measurement of slope is sensitive to the units chosen for quantity andprice. For example, suppose a $1 decrease in the price of Harry Potter and the DeathlyHallows leads to an increase in the quantity demanded from 10.1 million books to 10.2million books. The change in quantity is 0.1 million books, and the change in price is −$1, so the slope is 0.1/−1 = −0.1. But if we measure price in cents, rather than dollars,the slope is 0.1/−100 = −0.001. If we measure price in dollars and books in thousands,instead of millions, the slope is 100/−1 = −100. Clearly, the value we compute for theslope can change dramatically, depending on the units we use for quantity and price.

To avoid this confusion over units, economists use percentage changes when measur-ing the price elasticity of demand. Percentage changes are not dependent on units. (Fora review of calculating percentage changes, see the appendix to Chapter 1.) No matterwhat units we use to measure the quantity of wheat, 10 percent more wheat is 10 percentmore wheat. Therefore, the price elasticity of demand is measured by dividing the per-centage change in the quantity demanded by the percentage change in the price. Or:

It’s important to remember that the price elasticity of demand is not the same as the slopeof the demand curve.

If we calculate the price elasticity of demand for a price cut, the percentage changein price will be negative, and the percentage change in quantity demanded will be posi-tive. Similarly, if we calculate the price elasticity of demand for a price increase, the per-centage change in price will be positive, and the percentage change in quantity will benegative. Therefore, the price elasticity of demand is always negative. In comparing elas-ticities, though, we are usually interested in their relative size. So, we often drop theminus sign and compare their absolute values. In other words, although −3 is actually asmaller number than −2, a price elasticity of −3 is larger than a price elasticity of −2.

Elastic Demand and Inelastic DemandIf the quantity demanded is responsive to changes in price, the percentage change inquantity demanded will be greater than the percentage change in price, and the priceelasticity of demand will be greater than 1 in absolute value. In this case, demand is

Price elasticity of demandPercentage chang= ee in quantity demanded

Percentage change in price.


Figure 6-5Elastic and Inelastic DemandCurves

Along D1, cutting the price from $30 to $20increases the number of copies sold from 16per day to 28 per day, so demand is elasticbetween point A and point B.Along D2, cuttingthe price from $30 to $20 increases the num-ber of copies sold from 16 per day to only 20per day, so demand is inelastic between pointA and point C.

elastic. For example, if a 10 percent fall in the price of bagels results in a 20 percentincrease in the quantity of bagels demanded, then:

and we can conclude that the price of bagels is elastic.When the quantity demanded is not very responsive to price, however, the percent-

age change in quantity demanded will be less than the percentage change in price, andthe price elasticity of demand will be less than 1 in absolute value. In this case, demandis inelastic. For example, if a 10 percent fall in the price of wheat results in a 5 percentincrease in the quantity of wheat demanded, then:

and we can conclude that the demand for wheat is inelastic.In the special case in which the percentage change in the quantity demanded is

equal to the percentage change in price, the price elasticity of demand equals −1 (or 1 inabsolute value). In this case, demand is unit-elastic.

An Example of Computing Price ElasticitiesSuppose you own a small bookstore and you are trying to decide whether to cut theprice you are charging for a new John Grisham mystery novel. You are currently atpoint A in Figure 6-1: selling 16 copies of the novel per day at a price of $30 per copy.How many more copies you will sell by cutting the price to $20 depends on the priceelasticity of demand for this novel. Let’s consider two possibilities: If D1 is the demandcurve for this novel in your store, your sales will increase to 28 copies per day, point B.But if D2 is your demand curve, your sales will increase only to 20 copies per day, pointC. We might expect—correctly, as we will see—that between these points, demand curveD1 is elastic, and demand curve D2 is inelastic.

To confirm that D1 is elastic between these points and that D2 is inelastic, we needto calculate the price elasticity of demand for each curve. In calculating price elasticitybetween two points on a demand curve, though, we run into a problem because we geta different value for price increases than for price decreases. For example, suppose we

Price elasticity of demand5%

10%=

−= −0 5. ,

Price elasticity of demand20%

10%=

−= −2,

Unit-elastic demand Demand isunit-elastic when the percentagechange in quantity demanded is equal to the percentage change inprice, so the price elasticity is equal to 1 in absolute value.


Inelastic demand Demand isinelastic when the percentage changein quantity demanded is less than thepercentage change in price, so theprice elasticity is less than 1 inabsolute value.

Elastic demand Demand is elasticwhen the percentage change inquantity demanded is greater than the percentage change in price, so theprice elasticity is greater than 1 inabsolute value.

$30

20

0

Price(dollars

percopy)

Quantity(copies per day)

20 2816

D1

BC

A

D2

D2 is inelasticbetween pointA and point C.

D1 is elasticbetween pointA and point B.



calculate the price elasticity for D2 as the price is cut from $30 to $20. This reduction isa 33 percent price cut that increases the quantity demanded from 16 books to 20 books,or by 25 percent. Therefore, the price elasticity of demand between points A and C is25/−33 = −0.8. Now let’s calculate the price elasticity for D2 as the price is increased from$20 to $30. This is a 50 percent price increase that decreases the quantity demandedfrom 20 books to 16 books, or by 20 percent. So, now our measure of the price elasticityof demand between points A and C is −20/50 = −0.4. It can be confusing to have differ-ent values for the price elasticity of demand between the same two points on the samedemand curve.

The Midpoint FormulaWe can use the midpoint formula to ensure that we have only one value of the price elas-ticity of demand between the same two points on a demand curve. The midpoint for-mula uses the average of the initial and final quantities and the initial and final prices. IfQ1 and P1 are the initial quantity and price and Q2 and P2 are the final quantity andprice, the midpoint formula is:

The midpoint formula may seem challenging at first, but the numerator is just the changein quantity divided by the average of the initial and final quantities, and the denominatoris just the change in price divided by the average of the initial and final prices.

Let’s apply the formula to calculating the price elasticity of D2 in Figure 6-5.Between point A and point C on D2, the change in quantity is 4, and the average of thetwo quantities is 18. Therefore, there is a 22.2 percent change in quantity. The change inprice is −$10, and the average of the two prices is $25. Therefore, there is a −40 percentchange in price. So, the price elasticity of demand is 22.2/−40.0 = −0.6. Notice thesethree results from calculating the price elasticity of demand using the midpoint formula:First, as we suspected from examining Figure 6-1, demand curve D2 is inelastic betweenpoints A and C. Second, our value for the price elasticity calculated using the midpointformula is between the two values we calculated earlier. Third, the midpoint formulawill give us the same value whether we are moving from the higher price to the lowerprice or from the lower price to the higher price.

We can also use the midpoint formula to calculate the elasticity of demandbetween point A and point B on D1. In this case, there is a 54.5 percent change inquantity and a –40 percent change in price. So, the elasticity of demand is 54.5/−40.0= −1.4. Once again, as we suspected, demand curve D1 is price elastic between pointsA and B.

Price elasticity of demand =−+⎛

⎝⎜

( )Q Q

Q Q2 1

1 2

2

⎞⎞⎠⎟

÷−+⎛

⎝⎜⎞⎠⎟

( ).

P P

P P2 1

1 2

2

Solved Problem|6-5Calculating the Price Elasticity of Demand

Scholastic Corporation’s suggested retail price for Harry Potterand the Deathly Hallows is $35. Suppose you own a small book-store, and you believe that if you keep the price of the book at$35, you will be able to sell 40 copies per day. You are consider-ing cutting the price to $25. The graph below shows two possible

increases in the quantity sold as a result of your price cut. Usethe information in the graph to calculate the price elasticitybetween these two prices on each of the demand curves. Usethe midpoint formula in your calculations. State whether eachdemand curve is elastic or inelastic between these two prices.


SOLVING THE PROBLEM:Step 1: Review the chapter material. This problem requires calculating the price elas-

ticity of demand, so you may want to review the material in the section “TheMidpoint Formula,” which begins on page 176.

Step 2: As the first step in using the midpoint formula, calculate the average quan-tity and the average price for demand curve D1.

Step 3: Now calculate the percentage change in the quantity demanded and the per-centage change in price for demand curve D1.

Step 4: Divide the percentage change in the quantity demanded by the percentagechange in price to arrive at the price elasticity for demand curve D1.

Because the elasticity is greater than 1 in absolute value, D1 is price elasticbetween these two prices.

Step 5: Calculate the price elasticity of demand curve D2 between these two prices.

Percentage change in quantity demanded = −50 400

45100 22 2

2

× =

=

. %

$Percentage change in price

55 35

30100 33 3

− × = −$

$. %

Price elasticity of demaand =−

= −22 2

33 30 7

. %

. %.

Price elasticity of demand =−

= −66 7

33 32

. %

. %

Percentage change in quantity demanded = −80 400

60100 66 7

2

× =

=

. %

$Percentage change in price

55 35

30100 33 3

− × = −$

$. %

Average quantity

Average price

= + =

=

40 80

260

35$ ++ =$$

25

230


$35

25

0

Price(dollars

percopy)


50 8040

D1

BC

A

D2






Perfectly inelastic demand The casewhere the quantity demanded iscompletely unresponsive to price,and the price elasticity of demandequals zero.

Perfectly elastic demand The casewhere the quantity demanded isinfinitely responsive to price, and the price elasticity of demand equalsinfinity.

Because the elasticity is less than 1 in absolute value, D2 is price inelasticbetween these two prices.

YOUR TURN: For more practice, do related problem 5.6 on page xxx at the end of this chapter.

When Demand Curves Intersect,the Flatter Curve Is More ElasticRemember that elasticity is not the same thing as slope. While slope is calculated usingchanges in quantity and price, elasticity is calculated using percentage changes. But it istrue that if two demand curves intersect, the one with the smaller slope (in absolutevalue)—the flatter demand curve—is more elastic, and the one with the larger slope (inabsolute value)—the steeper demand curve—is less elastic. In Figure 6-1, demand curveD1 is more elastic than demand curve D2.

Polar Cases of Perfectly Elastic and Perfectly Inelastic DemandAlthough they do not occur frequently, you should be aware of the extreme, or polar,cases of price elasticity. If a demand curve is a vertical line, it is perfectly inelastic . Inthis case, the quantity demanded is completely unresponsive to price, and the price elas-ticity of demand equals zero. However much price may increase or decrease, the quan-tity remains the same. For only a very few products will the quantity demanded be com-pletely unresponsive to the price, making the demand curve a vertical line. The druginsulin is an example. Diabetics must take a certain amount of insulin each day. If theprice of insulin declines, it will not affect the required dose and thus will not increase thequantity demanded. Similarly, a price increase will not affect the required dose ordecrease the quantity demanded. (Of course, some diabetics will not be able to affordinsulin at a higher price. If so, even in this case, the demand curve may not be completelyvertical and, therefore, not perfectly inelastic.)

If a demand curve is a horizontal line, it is perfectly elastic. In this case, the quantitydemanded would be infinitely responsive to price, and the price elasticity of demandequals infinity. If a demand curve is perfectly elastic, an increase in price causes thequantity demanded to fall to zero. Once again, perfectly elastic demand curves are rare,and it is important not to confuse elastic with perfectly elastic. Table 6-1 summarizes thedifferent price elasticities of demand.

6.6 | Understand the determinants of the price elasticity of demand.

The Determinants of the Price Elasticity of DemandWe have seen that the demand for some products may be elastic, while the demandfor other products may be inelastic. In this section, we examine why price elasticitiesdiffer among products. The key determinants of the price elasticity of demand are asfollows:

• Availability of close substitutes

• Passage of time

• Necessities versus luxuries

• Definition of the market

• Share of the good in the consumer’s budget



TABLE 6-4Summary of the PriceElasticities of Demand

(Note that the percentage increases shown inthe boxes in the graphs were calculated usingthe midpoint formula on page 176.)


IF DEMAND IS... THEN THE ABSOLUTE VALUEOF PRICE ELASTICITY IS

elastic greater than 1

inelastic less than 1

unit-elastic equal to 1

perfectly elastic equal to infinity

perfectly inelastic equal to 0

$30

20

0

Price

Quantity28

Demand

16

1. A 40percent cutin price...

2. ...causes a 55 percentincrease in quantity demanded.

$30

20

0

Price

Quantity20

Demand

16



$30

20

0

Price

Quantity24

Demand

16



$30

0

Price

Quantity

DemandAny increase inprice causesquantitydemanded tofall to 0.

30

20

$40

0

Price

Quantity

Demand

16

1. An increaseor decreasein price...

2. ...leaves the quantitydemanded unchanged.



Don’t Let This Happen to YOU!Don’t Confuse Inelastic with Perfectly Inelastic

You may be tempted to simplify the concept of elasticity byassuming that any demand curve described as being inelas-tic is perfectly inelastic. You should never assume thisbecause perfectly inelastic demand curves are rare. Forexample, consider the following problem: “Use a demandand supply graph to show how a decrease in supply affectsthe equilibrium quantity of gasoline. Assume that thedemand for gasoline is inelastic.” The following graphwould be an incorrect answer to this problem.

The demand for gasoline is inelastic, but it is notperfectly inelastic. When the price of gasoline rises, thequantity demanded falls. So, the graph that would be thecorrect answer to this problem would show a normaldownward-sloping demand curve rather than a verticaldemand curve.

YOUR TURN: Test your understanding by doing related

problem 4.11 on page xxx at the end of this chapter.

0

Price(dollars

pergallon)

Quantity(gallons per year)

Demand

S1

P1

Q1

S2

P2

P2

P1

0

Price(dollars

pergallon)

Quantity(gallons per year)

Q1

Demand

S1

S2

Q2

Availability of Close SubstitutesThe availability of substitutes is the most important determinant of price elasticity ofdemand because how consumers react to a change in the price of a product depends onwhat alternatives they have. When the price of gasoline rises, consumers have few alterna-tives, so the quantity demanded falls only a little. But if Domino’s raises the price of pizza,consumers have many alternatives, so the quantity demanded is likely to fall quite a lot. Infact, a key constraint on a firm’s pricing policies is how many close substitutes exist for itsproduct. In general, if a product has more substitutes available, it will have more elasticdemand. If a product has fewer substitutes available, it will have less elastic demand.

Passage of TimeIt usually takes consumers some time to adjust their buying habits when prices change.If the price of chicken falls, for example, it takes a while before consumers decide tochange from eating chicken for dinner once per week to eating it twice per week. If theprice of gasoline increases, it also takes a while for consumers to decide to shift towardbuying more fuel-efficient cars to reduce the quantity of gasoline they buy. The moretime that passes, the more elastic the demand for a product becomes.

Luxuries versus NecessitiesGoods that are luxuries usually have more elastic demand curves than goods that arenecessities. For example, the demand for milk is inelastic because milk is a necessity, andthe quantity that people buy is not very dependent on its price. Tickets to a concert are a



The Price Elasticity of Demand for Breakfast CerealMIT economist Jerry Hausman has estimated the price elastic-ity of demand for breakfast cereal. He divided breakfast cereals

into three categories: children’s cereals, such as Trix and Froot Loops; adult cereals, suchas Special K and Grape-Nuts; and family cereals, such as Corn Flakes and Raisin Bran.Some of the results of his estimates are given in the following table.

CEREAL PRICE ELASTICITY OF DEMAND

Post Raisin Bran −2.5

All family breakfast cereals −1.8

All types of breakfast cereals −0.9

Source: Jerry A. Hausman,“The Price Elasticity of Demand for Breakfast Cereal,” in Timothy F.Bresnahan and Robert J. Gordon, eds., The Economics of New Goods, Chicago: University ofChicago Press, 1997. Used with permission of The University of Chicago Press.

Just as we would expect, the price elasticity for a particular brand of raisin bran waslarger in absolute value than the elasticity for all family cereals, and the elasticity for allfamily cereals was larger than the elasticity for all types of breakfast cereals. If Postincreases the price of its Raisin Bran by 10 percent, sales will decline by 25 percent, asmany consumers switch to another brand of raisin bran. If the prices of all family break-fast cereals rise by 10 percent, sales will decline by 18 percent, as consumers switch tochild or adult cereals. In both of these cases, demand is elastic. But if the prices of alltypes of breakfast cereals rise by 10 percent, sales will decline by only 9 percent. Demandfor all breakfast cereals is inelastic.

Source: Jerry A. Hausman, “Valuation of New Goods under Perfect and Imperfect Competition,” in Timothy F. Bresnahanand Robert J. Gordon, eds., The Economics of New Goods, Chicago: University of Chicago Press, 1997.


of this chapter.

Share of a Good in a Consumer’s BudgetGoods that take only a small fraction of a consumer’s budget tend to have less elasticdemand than goods that take a large fraction. For example, most people buy salt infre-quently and in relatively small quantities. The share of the average consumer’s budgetthat is spent on salt is very low. As a result, even a doubling of the price of salt is likely toresult in only a small decline in the quantity of salt demanded.“Big-ticket items,” such ashouses, cars, and furniture, take up a larger share in the average consumer’s budget.Increases in the prices of these goods are likely to result in significant declines in quan-tity demanded. In general, the demand for a good will be more elastic the larger the shareof the good in the average consumer’s budget.

What happens when the price of raisin bran increases?

|Making the

Connection

luxury, so the demand for concert tickets is much more elastic than the demand formilk. The demand curve for a luxury is more elastic than the demand curve for a necessity.

Definition of the MarketIn a narrowly defined market, consumers have more substitutes available. If the priceof Kellogg’s Raisin Bran rises, many consumers will start buying another brand ofraisin bran. If the prices of all brands of raisin bran rise, the responsiveness of con-sumers will be lower. If the prices of all breakfast cereals rise, the responsiveness ofconsumers will be even lower. The more narrowly we define a market, the more elasticdemand will be.



6.7 | Understand the relationship between the price elasticity of demand and total

revenue.

The Relationship between Price Elasticityof Demand and Total RevenueA firm is interested in price elasticity because it allows the firm to calculate howchanges in price will affect its total revenue, which is the total amount of funds itreceives from selling a good or service. Total revenue is calculated by multiplying priceper unit by the number of units sold. When demand is inelastic, price and total rev-enue move in the same direction: An increase in price raises total revenue, and adecrease in price reduces total revenue. When demand is elastic, price and total rev-enue move inversely: An increase in price reduces total revenue, and a decrease inprice raises total revenue.

To understand the relationship between price elasticity and total revenue, considerFigure 6-6. Panel (a) shows a demand curve for a John Grisham novel (as in Figure 6-5on page xxx). This demand curve is inelastic between point A and point B. The total rev-enue received by a bookseller at point A equals the price of $30 multiplied by the 16copies sold, or $480. This amount equals the areas of the rectangles C and D in the figurebecause together the rectangles have a height of $30 and a base of 16 copies. Because thisdemand curve is inelastic between point A and point B (it was demand curve D2 inFigure 6-5), cutting the price to $20 (point B) reduces total revenue. The new total rev-enue is shown by the areas of rectangles D and E, and it is equal to $20 multiplied by 20copies, or $400. Total revenue falls because the increase in the quantity demanded is not


$30

20

0

Price(dollars

percopy)


(a) Cutting price when demand is inelastic reduces total revenue.

(b) Cutting price when demand is elastic increases total revenue.

20

Demand (inelastic)

16

B

A

C = $160

D = $320 E =$80

Total revenueafter price cut= D + E = $400

Total revenuebefore price cut= C + D = $480

$30

20

0

Price(dollars

percopy)


28

Demand(elastic)

16

B

A

Total revenueafter price cut= D + E = $560

Total revenuebefore price cut= C + D = $480

C = $160

D = $320

E = $240

When demand is inelastic, a cut in price will decrease total revenue. In panel (a), atpoint A, the price is $30, 16 copies are sold, and total revenue received by the book-seller equals $30 × 16 copies, or $480. At point B, cutting price to $20 increases thequantity demanded to 20 copies, but the fall in price more than offsets the increase inquantity.As a result, revenue falls to $20 × 20 copies, or $400.When demand is elastic,

a cut in price will increase total revenue. In panel (b), at point A, the area of rectanglesC and D is still equal to $480. But at point B, the area of rectangles D and E is equal to$20 × 28 copies, or $560. In this case, the increase in the quantity demanded is largeenough to offset the fall in price, so total revenue increases.

Figure 6-6 | The Relationship between Price Elasticity and Total Revenue

Total revenue The total amount offunds received by a seller of a good orservice, calculated by multiplyingprice per unit by the number of unitssold.


TABLE 6-5The Relationship between PriceElasticity and Revenue


IF DEMAND IS . . . THEN . . . BECAUSE . . .

elastic an increase in price reduces the decrease in quantity revenue demanded is proportionally

greater than the increase in price.

elastic a decrease in price increases the increase in quantity demanded revenue is proportionally greater than the

decrease in price.

inelastic an increase in price increases the decrease in quantity revenue demanded is proportionally

smaller than the increase in price.

inelastic a decrease in price reduces the increase in quantity demanded revenue is proportionally smaller than the

decrease in price.

unit elastic an increase in price does not affect the decrease in quantity revenue demanded is proportionally the

same as the increase in price.

unit elastic a decrease in price does not affect the increase in quantity demanded revenue is proportionally the same as the

decrease in price.

large enough to make up for the decrease in price. As a result, the $80 increase in revenuegained as a result of the price cut—dark-green rectangle E—is less than the $160 in rev-enue lost—light-green rectangle C.

Panel (b) of Figure 6-6 shows a demand curve that is elastic between point A andpoint B (it was demand curve D1 in Figure 6-5). In this case, cutting the price increasestotal revenue. At point A, the areas of rectangles C and D are still equal to $480, but atpoint B, the areas of rectangles D and E are equal to $20 multiplied by 28 copies, or $560.Here, total revenue rises because the increase in the quantity demanded is large enoughto offset the lower price. As a result, the $240 increase in revenue gained as a result of theprice cut—dark-green rectangle E—is greater than the $160 in revenue lost—light-green rectangle C.

The third, less common, possibility is that demand is unit elastic. In that case, achange in price is exactly offset by a proportional change in quantity demanded, leavingrevenue unaffected. Therefore, when demand is unit elastic, neither a decrease in pricenor an increase in price affects revenue. Table 6-5 summarizes the relationship betweenprice elasticity and revenue.

Elasticity and Revenue with a Linear Demand CurveAlong most demand curves, elasticity is not constant at every point. For example, astraight-line, or linear, demand curve for DVDs is shown in panel (a) of Figure 6-7. Thenumbers from the table are plotted in the graphs. The demand curve shows that whenthe price falls by $1, consumers always respond by buying 2 more DVDs per month.When the price is high and the quantity demanded is low, demand is elastic. This is truebecause a $1 fall in price is a smaller percentage change when the price is high, and anincrease of 2 DVDs is a larger percentage change when the quantity of DVDs is small. Bysimilar reasoning, we can see why demand is inelastic when the price is low and the quan-tity demanded is high.



1

2

3

4

6

$8

0

Price(dollars

perDVD)

0 16

Quantity(DVDs per month)

7

5

108 12 146

Demandfor DVDs

Inelastic

Elastic

42

(a) Demand curve for DVDs

$8

7

6

5

4

3

2

1

0

QuantityDemandedPrice

0

2

4

6

8

10

12

14

16

TotalRevenue

$0

14

24

30

32

30

24

14

0

16108 12 14642

10

20

30

0

Totalrevenue(dollars)

0

Quantity(DVDs per month)

$40

Revenuewhen thedemandcurve isinelastic

Revenuewhen thedemandcurve iselastic

Revenue when thedemand curve isunit-elastic

(b) Total revenue curve

Unit-elastic

The data from the table are plotted in the graphs.Panel (a) shows that as we move downthe demand curve for DVDs, the price elasticity of demand declines. In other words, athigher prices, demand is elastic, and at lower prices, demand is inelastic. Panel (b)

shows that as the quantity of DVDs sold increases from zero, revenue will increase untilit reaches a maximum of $32 when 8 DVDs are sold.As sales increase beyond 8 DVDs,revenue falls because demand is inelastic on this portion of the demand curve.

Figure 6-7 | Elasticity Is Not Constant Along a Linear Demand Curve

Panel (a) in Figure 6-7 shows that when price is between $8 and $4 and quantity isbetween 0 and 6, demand is elastic. Panel (b) shows that over this same range, total rev-enue will increase as price falls. For example, in panel (a), as price falls from $7 to $6,quantity demand increases from 2 to 4, and in panel (b), total revenue increases from$14 to $24. Similarly, when price is between $4 and zero and quantity is between 8 and16, demand is inelastic. Over this same range, total revenue will decrease as price falls.For example, as price falls from $3 to $2 and quantity increases from 10 to 12, total rev-enue decreases from $30 to $24.




SOLVING THE PROBLEM:Step 1: Review the chapter material. This problem deals with the effect of a price change

on a firm’s revenue, so you may want to review the section “The Relationshipbetween Price Elasticity and Total Revenue,” which begins on page xxx.

Step 2: Analyze the statement. We have seen that a price increase will increase rev-enue only if demand is inelastic. In Figure 6-7, for example, increasing therental price of DVDs from $1 to $2 increases revenue from $14 to $24because demand is inelastic along this portion of the demand curve. Butincreasing the price from $5 to $6 decreases revenue from $30 to $24 becausedemand is elastic along this portion of the demand curve. If the price is cur-rently $5, increasing revenue would require a price cut, not a price increase.As this example shows, the statement is incorrect and you should disagreewith it.

YOUR TURN: For more practice, do related problem 6.6 on page xxx at the end of this chapter.

Estimating Price Elasticity of DemandTo estimate the price elasticity of demand, economists need to know the demand curvefor a product. To calculate the price elasticity of demand for new products, firms oftenrely on market experiments. With market experiments, firms try different prices andobserve the change in quantity demanded that results.

For example, DVDs were a relatively new product in 2001.The movie studios producing them were unsure of the price elas-ticity of the demand curves they were facing, so they experimentedwith different prices to help determine the price elasticity. VHStapes had been on the market for many years, and the studios haddetermined their pricing strategies, given their estimates of theprice elasticity of demand. As a result, the prices of VHS tapes wereusually very similar.

At that time, the prices of DVDs were much less standardizedbecause the studios were unsure of their price elasticities. TomAdams, the head of Adams Market Research, a company that doesresearch on the home video market, summed up the situation:“The studios have different views of the market, so they are settingdifferent suggested retail prices, and the stores are discountingthose prices to different degrees.”

After several years of market experiments, the move studioshad more accurate estimates of the price elasticity of DVDs, andthe prices of most DVDs became similar. For instance, in 2008,

nearly all newly released DVDs had a list price of about $29, which was often dis-counted to about $17 when they were sold online or in discount department stores,such as Wal-Mart. When Blu-ray DVDs were introduced, the studios apparently feltconfident that they understood their price elasticity, because in 2008 most newlyreleased films had list prices of either $34.99 or $35.99.

When DVDs were first introduced, the movie studios wereuncertain about their price elasticity of demand.

Solved Problem|6-6Price and Revenue Don’t Always Move in the Same Direction

Briefly explain whether you agree or disagree with thefollowing statement: “The only way to increase the

revenue from selling a product is to increase the product’sprice.”



>> Continued from page xxx

Economics in YOUR Life!

At the beginning of the chapter, we asked you to consider a situation in which you hadpaid $75 for a concert ticket, which is the most you would be willing to pay. Just beforeyou enter the concert hall, someone offers you $90 for the ticket. We posed two ques-tions: Would you sell the ticket? and Would an economist think it is rational to sell theticket? If you answered that you would sell, then your answer is rational in the sense inwhich economists use the term. The cost of going to see the concert is what you have togive up for the ticket. Initially, the cost was just $75—the dollar price of the ticket. Thisamount was also the most you were willing to pay. However, once someone offers you$90 for the ticket, the cost of seeing the concert rises to $90. The reason the cost of theconcert is now $90 is that once you turn down an offer of $90 for the ticket you haveincurred a nonmonetary opportunity cost of $90 if you use the ticket yourself. Theendowment effect explains why some people would not sell the ticket. People seem tovalue things that they have more than things that they do not have. Therefore, a con-cert ticket you already own may be worth more to you than a concert ticket you haveyet to purchase. Behavioral economists study situations like this where people makechoices that do not appear to be economically rational.

ConclusionIn a market system, consumers are in the driver’s seat. Goods are produced only if con-sumers want them to be. Therefore, how consumers make their decisions is an impor-tant area for economists to study, a fact that was highlighted when Daniel Kahneman—whose research was mentioned several times in this chapter—shared the Nobel Prize inEconomics. Economists expect that consumers will spend their incomes so that the lastdollar spent on each good provides them with equal additional amounts of satisfaction,or utility. In practice, there are significant social influences on consumer decision mak-ing, particularly when a good or service is consumed in public. Fairness also seems to bean important consideration for most consumers. Finally, many consumers couldimprove the decisions they make if they would take into account nonmonetary oppor-tunity costs and ignore sunk costs.

In this chapter, we studied consumers’ choices. In the next several chapters, we willstudy firms’ choices. Before moving on to the next chapter, read An Inside Look on thenext page for a discussion of whether Elizabeth Arden made a good decision in hiringMariah Carey to endorse its products.


An Inside LOOK

196

believe will translate well into saleswhen the fragrance is launched. . . .She has already met with the fourmajor fragrance houses that we workwith, and has very definite ideas.”Rolleston noted that FederatedDepartment Stores, Belk and Dillard’sare stores that would be likely to carrythe scent.

Part of the reason retailersapplaud the category is that many ofthe celebrities are drawing lapseddepartment store consumers back intothe beauty department. “In Mariah,Arden has someone who is a provenhit-maker and an undervalued asset,”said Steve Stoute—managing partnerof Carol’s Daughter and chairman andchief creative officer, Translation—who has brokered celebrity endorse-ment deals. “Her music has alwaysbeen bigger than her personality, andshe not only appeals to a youngerconsumer, she has a consumer whohas grown up with her. I believe thatArden has her at the right time. I justhope that they have the bandwidth tomarket all of these celebrity brands.

Source: Julie Naughton, “Mariah Signs Scent Dealwith Arden,” Women’s Wear Daily, April 7, 2006,p.11. Copyright © 2006 Conde Nast Publications.All rights reserved.

WOMEN’S WEAR DAILY, APRIL 7, 2006

Can Mariah Carey Get You toBuy Elizabeth Arden Perfume?

b

a

arena. Coty is arguably the mostentrenched, with Jennifer Lopez,Sarah Jessica Parker, Kimora Lee Sim-mons, David and Victoria Beckham,Mary-Kate and Ashley Olsen, ShaniaTwain and the “Desperate House-wives” in its stable.

Arden’s deal with Britney Spears,signed in March 2004, has yielded twotop-five hits: Curious Britney Spearsand Fantasy Britney Spears. Arden hashad teen queen Hilary Duff undercontract for beauty products sinceSeptember (the first fruits of that dealhave not yet been released), and itsigned Catherine Zeta-Jones in Febru-ary 2002 to be the face of its core Eliz-abeth Arden brand. In addition,NASCAR star Jeff Gordon has beenthe face of its Halston Z-14 brandsince May 2004, and the originalcelebrity fragrance maven, ElizabethTaylor, is also part of the company’sconstellation.

“Mariah has immense popularitywith a very diverse consumer base—from teenagers to grandmothers,” RonRolleston, executive vice president ofglobal marketing for Elizabeth Arden,said in an interview. “She is global interms of her appeal, which spans gen-erations and cultures, which we

Mariah Signs ScentDeal with ArdenNEW YORK - The celebrity fragrancecraze has a new player—Mariah Carey.

The Grammy Award-winningsinger has signed with ElizabethArden to develop and market her ownline of fragrance products, the first ofwhich are to be launched in spring2007 in what the company describedas “prestige department stores.”

Financial terms of the deal,announced on Thursday, were notdisclosed. However, industry expertshave speculated that such agreementsoften include an up-front payout of $1million to $2 million, and 1 to 3 per-cent of fragrance sales after the scent ison the counter.

Carey, whose projects include aself-branded line sold by costume jew-elry retailer Claire’s, will be involvedwith all aspects of the fragrance’sdevelopment, Arden said in a state-ment. “I’ve already been involved withthe team at Elizabeth Arden in theearly stages of the creative process,”Carey said.

The deal further amps up the sig-nificance of celebrities in the beautyworld—particularly in the fragrance


197

Key Points in the ArticleThis article discusses how firms benefitfrom using celebrity endorsements in theiradvertising. Elizabeth Arden clearlybelieves that hiring Mariah Carey toendorse a new line of fragrances will payoff financially. The firm believes thatbecause Carey is a popular celebrity,some of that popularity will rub off on thenew fragrance products. Essentially, thefirm is betting that a large number of con-sumers will see Carey’s endorsement andpurchase the fragrance because of thatendorsement. Consumers may purchasethe fragrance to be like Mariah Carey orjust to signal that they are like MariahCarey. However, celebrity endorsementscome with risks. Mary-Kate and AshleyOlson were dropped from the “Got Milk?”campaign after Mary-Kate was reportedlyhospitalized for an eating disorder. Inaddition, Slim-Fast dropped WhoopiGoldberg from its advertisements aftershe made critical and vulgar commentsabout President George W. Bush. Once afirm hires a celebrity, consumers associatethe product with the celebrity. This associ-ation can be a good or a bad thingdepending on the celebrity’s actions.

Analyzing the NewsElizabeth Arden is giving MariahCarey a large up-front payment and a

significant part of the revenues from thefragrance sales. The firm is willing to hireCarey because it believes doing so willincrease its profits. Her endorsementcould lead to higher prices or a greaterquantity sold, but the firm’s profits willincrease only if its increase in revenue isgreater than the required payments toCarey.

We saw in Chapter 3 that when con-sumers’ taste for a product increases, thedemand curve will shift to the right, andwhen consumers’ taste for a productdecreases, the demand curve for the prod-uct will shift to the left. When a firm hires acelebrity to endorse its products, it is hop-ing to increase consumers’ taste for itsproduct. The figure shows that if theendorsement is successful, the demandcurve for Elizabeth Arden fragrances shiftsfrom D1 to D2. The increase in demandallows the firm to sell more fragrance bot-tles at every price. For example, at a price ofP1 it could sell Q1 bottles without theendorsement but Q2 fragrances with theendorsement.

a

0

Price(dollars

per bottle)

Q1

D1

Quantity(bottles per month)

P1

Q2

D2

Increase in demand dueto Mariah Carey endorsingArden perfume

When successful, a celebrity endorsement can shift the demand curve for a productto the right, from D1 to D2.

Elizabeth Arden’s experience withcelebrity endorsements has been very

positive. The firm has used many celebrityendorsements in the past and the collabo-ration with Britney Spears produced twovery successful fragrances. Therefore, thefirm’s experience suggests that celebrityendorsements can increase sales.

Thinking Critically1. Celebrity endorsements may be reward-

ing to firms, but they can also be risky.Elizabeth Arden has committed a signifi-cant amount of money to hiring MariahCarey and developing the fragrancesthat she will endorse. What do you thinkwould happen to the demand curve forthese fragrances if Mariah Carey getsinvolved in an embarrassing scandal?

2. Celebrity endorsements are also expen-sive. Should a firm whose celebrityendorser was just arrested make itsdecision about whether or not to cancelits ad campaign based on the amount ithas already spent on making the ads?Briefly explain.

b



Key TermsBehavioral economics, p. 178

Budget constraint, p. 167

Endowment effect, p. 179

Elastic demand, p. 184

Elasticity, p. 164

Income effect, p. 173

Inelastic demand, p. 184

Law of diminishing marginalutility, p. 165

Marginal utility (MU ), p. 165

Network externality, p. 174

Opportunity cost, p. 179

Perfectly elastic demand, p. 187

Perfectly inelastic demand, p. 187

Price elasticity of demand, p. 183

Substitution effect, p. 173

Sunk cost, p. 181

Total revenue, p. 191

Unit-elastic demand, p. 184

Utility, p. 165

6.1 LEARNING OBJECTIVE 6.1 | Define utility and explain how consumers choose goods and services

to maximize their utility, pages xxx–xxx.

Utility and Consumer Decision Making

Summary

Utility is the enjoyment or satisfaction that people receivefrom consuming goods and services. The goal of a consumeris to spend available income so as to maximize utility.Marginal utility is the change in total utility a person receivesfrom consuming one additional unit of a good or service. Thelaw of diminishing marginal utility states that consumersreceive diminishing additional satisfaction as they consumemore of a good or service during a given period of time. Thebudget constraint is the amount of income consumers haveavailable to spend on goods and services. To maximize utility,consumers should make sure they spend their income so thatthe last dollar spent on each product gives them the same mar-ginal utility. The income effect is the change in the quantitydemanded of a good that results from the effect of a change inthe price on consumer purchasing power. The substitutioneffect is the change in the quantity demanded of a good thatresults from a change in price making the good more or lessexpensive relative to other goods, holding constant the effectof the price change on consumer purchasing power.

Visit www.myeconlab.com to complete these exercisesonline and get instant feedback.

Review Questions

1.1 What is the economic definition of utility? Is utilitymeasurable?

1.2 What is the definition of marginal utility? What is thelaw of diminishing marginal utility? Why is marginalutility more useful than total utility in consumerdecision making?

1.3 What is meant by a consumer’s budget constraint? Whatis the rule of equal marginal utility per dollar spent?

Problems and Applications

1.4 Does the law of diminishing marginal utility holdtrue in every situation? Is it possible to think of goods

for which consuming additional units will result inincreasing marginal utility?

1.5 If consumers should allocate their income so that thelast dollar spent on every product gives them thesame amount of additional utility, how should theydecide the amount of their income to save?

1.6 You have six hours to study for two exams tomorrow.The relationship between hours of study and testscores is shown in the following table.

ECONOMICS PSYCHOLOGY

HOURS SCORE HOURS SCORE

0 54 0 54

1 62 1 60

2 69 2 65

3 75 3 69

4 80 4 72

5 84 5 74

6 87 6 75

a. Use the rule for determining optimal purchases todecide how many hours you should study eachsubject. Treat each point on an exam like 1 unit ofutility and assume that you are equally interestedin doing well in economics and psychology.

b. Now suppose that you are a psychology major,and that you value each point you earn on a psy-chology exam as being worth three times as muchas each point you earn on an economics exam.Now how many hours will you study each subject?

1.7 [Related to Solved Problem 6-1 on pagexxx] Joe has $16 to spend on Twinkies and Ho-Hos.Twinkies have a price of $1 per pack, and Ho-Hoshave a price of $2 per pack. Use the information inthe graphs on the following page to determine thenumber of Twinkies packs and the number of Ho-Hos packs Joe should buy to maximize his utility.Briefly explain your reasoning.


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>> End Learning Objective 6.1


1.8 [Related to Solved Problem 6-1 on pagexxx] Joe has $55 to spend on apples and oranges.Given the information in the following table, is Joemaximizing utility? Briefly explain.

MARGINALTOTAL UTILITY OF

PRODUCT PRICE QUANTITY UTILITY LAST UNIT

Apples $0.50 50 1,000 20

Oranges $0.75 40 500 30

1.9 Suppose the price of a bag of Frito’s corn chipsdeclines from $0.69 to $0.59. Which is likely to belarger: the income effect or the substitution effect?Briefly explain.

1.10 Mary is buying corn chips and soda. She has fourbags of corn chips and five bottles of soda in hershopping cart. The marginal utility of the fourth bagof corn chips is 10, and the marginal utility of thefifth bottle of soda is also 10. Is Mary maximizingutility? Briefly explain.

1.11 When the price of pizza falls in the Super Bowl exam-ple on pages xxx–xxx, both the income and the sub-stitution effect cause you to want to consume morepizza. If pizza were an inferior good, how would theanalysis be changed? In this case, is it possible that alower price of pizza might lead you to buy less pizza?Briefly explain.

6.2 LEARNING OBJECTIVE 6.2 | Use the concept of utility to explain the law of demand, pages xxx–xxx.

Where Demand Curves Come From

Summary

When the price of a good declines, the ratio of the marginalutility to price rises. This leads consumers to buy more ofthat good. As a result, whenever the price of a product falls,the quantity demanded increases. We saw in Chapter 3 thatthis is known as the law of demand. The market demandcurve can be constructed from the individual demandcurves for all the consumers in the market.


Review Questions

2.1 Explain how a downward-sloping demand curveresults from consumers adjusting their consumptionchoices to changes in price.

2.2 What would need to be true for a demand curve to beupward sloping?

24

6

8

10

20

0

Marginalutility ofHo-Hos

0 12

Quantity of Ho-Hos(number of packs)

12

14

16

18

8 10642

Marginal utilityof Ho-Hos

2

4

6

8

10

12

0

Marginalutility ofTwinkies

0 7

Quantity of Twinkies(number of packs)

4 5321 6

Marginal utilityof Twinkies





2.3 Considering only the income effect, if the price of aninferior good declines, would a consumer want tobuy a larger quantity or a smaller quantity of thegood? Does this mean that the demand curves forinferior goods should slope upward? Briefly explain.

2.4 The chapter states that “when the price of an inferiorgood falls, the income and substitution effects work inopposite directions.”Explain what this statement means.

2.5 Suppose the market for ice cream cones is made up ofthree consumers: Josh, Curt, and Tim. Use the infor-mation in the following table to construct the marketdemand curve for ice cream cones. Show the infor-mation in a table and in a graph.

JOSH CURT TIM

QUANTITY QUANTITY QUANTITYDEMANDED DEMANDED DEMANDED(CONES PER (CONES PER (CONES PER

PRICE WEEK) WEEK) WEEK)

$1.75 2 1 0

1.50 4 3 2

1.25 6 4 3

1.00 7 6 4

0.75 9 7 5

2.6 Suppose the wage you are being paid increases. Isthere an income and substitution effect involved? Ifso, what is being substituted for what?

6.3 LEARNING OBJECTIVE 6.3 | Explain how social influences can affect consumption choices, pages xxx–xxx.

Social Influences on Decision Making

Summary

Social factors can have an influence on consumption. Forexample, the amount of utility people receive from con-suming a good often depends on how many other peoplethey know who also consume the good. There is a networkexternality in the consumption of a product if the useful-ness of the product increases with the number of con-sumers who use it. There is also evidence that people like tobe treated fairly and that they usually attempt to treat othersfairly, even if doing so makes them worse off financially.This result has been demonstrated in laboratory experi-ments, such as the ultimatum game. When firms set prices,they take into account consumers’ preference for fairness.For example, hardware stores often do not increase theprice of snow shovels to take advantage of a temporaryincrease in demand following a snowstorm.


Review Questions

3.1 In which of the following situations are social influ-ences on consumer decision making likely to begreater: choosing a restaurant for dinner or choosinga brand of toothpaste to buy? Briefly explain.

3.2 Why do consumers pay attention to celebrity endorse-ments of products?

3.3 What are network externalities? For what types ofproducts are network externalities likely to be impor-tant? What is path dependence?

3.4 What is the ultimatum game? What insight does itprovide into consumer decision making?

3.5 How does the fact that consumers apparently valuefairness affect the decisions that businesses make?


3.6 Which of the following products are most likely tohave significant network externalities? Explain.a. Fax machinesb. Dog foodc. Board gamesd. Conventional (CRT) television setse. Plasma television sets

3.7 Linux is a computer operating system that is an alter-native to Microsoft’s Windows system. According to anewspaper article:

The dominance of the Windows operat-ing system, which runs 95 per cent of theworld’s PCs, is coming under greaterattack in Asia than in any other part of theworld, analysts say. Linux for PCs soldthree times as many copies in Asia as inthe US last year. . . . “In emerging marketssuch as India and China, where PCgrowth rates are the highest, Linux’smomentum seems to be accelerating,”said Robert Stimson, a Bank of Americaanalyst in San Francisco.




If network externalities are important in choos-ing a computer operating system, why might Linuxbe more successful in Asia than in the United States?

Source:“Gates Blitzes Asia to Stem Linux Threat,”New Zealand Herald, June29, 2004.

3.8 [Related to the Chapter Opener on pagexxx] Think of some firms that don’t use celebritiesto endorse their products. Why do some firms, likeCoca-Cola, use celebrity endorsers, while other firmsdon’t?

3.9 [Related to the Making the Connection onpage xxx] Tiger Woods is a professional golferwho knows more about golfing and golf relatedproducts than most consumers. However, this is notnecessarily the case for Buicks, Rolexes, andAmerican Express products. Consider the model ofutility maximizing behavior described in this chap-ter. For Buick’s use of Tiger Woods as a celebrityendorser to make economic sense, then how mustWoods’s endorsement affect the marginal utility thatat least some consumers receive from driving Buicks?What will this do to the demand curve for Buicks?

3.10 An article in the New York Times published during the2002 Winter Olympics held in Utah indicated thatmany businesses raised prices during the two-weekevent. The article described one incident as follows:

Susanne and Heather McDonald, sistersfrom the northwest Wyoming town ofMoose, said a friend was having sushi

at a restaurant in Park City, where skiingevents are held, and the waiter wasadding $3 for every side dish until theman identified himself as a local resident.“Then he got them for free,” SusanneMcDonald said.

When setting the price for a meal, why would itmatter to the restaurant whether the customer was alocal resident?

Source: Michael Janofsky, “Olympic Boom Leaves Visitors Feeling Busted,”New York Times, February 19, 2002.

3.11 [Related to the Making the Connection onpage xxx] Suppose the rock band U2 can sell outa concert at Madison Square Garden with ticketspriced at $45. U2’s manager estimates that they couldstill sell out the Garden at $85 per ticket. Why mightU2 and their manager want to keep ticket pricesat $45?

3.12 [Related to the Making the Connection onpage xxx] Suppose that Spider-Man 4 comes out,and hundreds of people arrive at a theater and dis-cover that the movie is already sold out. Meanwhile,the theater is also showing a boring movie in its thirdweek of release in a mostly empty theater. Why wouldthis firm charge the same $7.50 for a ticket to eithermovie, when the quantity of tickets demanded ismuch greater than the quantity supplied for onemovie, and the quantity of tickets demanded is muchless than the quantity supplied for the other?

6.4 LEARNING OBJECTIVE 6.4 | Describe the behavioral economics approach to understanding

decision making, pages xxx–xxx.

Behavioral Economics: Do People Make Their Choices Rationally?

Summary

Behavioral economics is the study of situations in whichpeople act in ways that are not economically rational.Opportunity cost is the highest-value alternative that mustbe given up to engage in an activity. People would improvetheir decision making if they took into account nonmonetaryopportunity costs. People sometimes ignore nonmone-tary opportunity costs because of the endowment effect. Theendowment effect is the tendency of people to be unwillingto sell something they already own even if they are offered aprice that is greater than the price they would be willing topay to buy the good if they didn’t already own it. Peoplewould also improve their decision making if they ignoredsunk costs. A sunk cost is a cost that has already been paidand cannot be recovered. Finally, people would improvetheir decision making if they were more realistic about theirfuture behavior.


Review Questions

4.1 What does it mean to be economically rational?

4.2 Define behavioral economics and give an example ofthree common mistakes that consumers often make.


4.3 Suppose your little brother tells you on Tuesday thatone of his friends offered him $20 for his AlbertPujols rookie baseball card, but your brother decidednot to sell the card. On Wednesday, your brother losesthe card. Your parents feel sorry for him and give him$20 to make up the loss. Instead of buying another




Albert Pujols card with the money (which we willassume he could have done), your brother uses themoney to go to the movies. Explain your brother’sactions by using the concepts in this chapter.

4.4 Economist Richard Thaler has argued that thebehavior of professional football teams during thecollege draft is an example of the endowment effect.Professional football teams take turns drafting eligi-ble college players. Suppose that the New EnglandPatriots now have a turn to pick, and the best collegeplayer not yet drafted is a quarterback. Suppose alsothat the Patriots already have a great quarterback anddon’t need another one. What should they do? Theiroptimal choice would appear to be to draft the quar-terback and then trade him to another team thatneeds a quarterback. The Patriots could then receivein return a player from the other team who plays aposition for which the Patriots need help. In fact,teams very rarely draft a college player and immedi-ately trade him. Explain how the endowment effectcould be involved here. (Hint: Consider the potentialreaction of a team’s fans to the team drafting a starcollege player and immediately trading him.)

Source: Richard Thaler, Quasi Rational Economics, New York: Russell Sage,1991, p. 10.

4.5 Oldies 93 has a promotion in which it announces thata local gas station will sell gasoline at 93 cents per gal-lon beginning in 30 minutes. Jack hops in his car anddrives to the station to fill up his half-empty tank. Hepays only $9.30 for 10 gallons instead of the goingprice of $19.30. Did Jack save $10.00? Is the radio sta-tion doing its listeners a favor by offering this promo-tion? Briefly explain.

4.6 You have tickets to see Bruce Springsteen in concertat a stadium 50 miles away. A severe thunderstorm onthe night of the concert makes driving hazardous.Will your decision to attend the concert be different ifyou paid $70 for the tickets than if you received thetickets for free? Explain your answer.

4.7 Rob Neyer is a baseball writer for ESPN.com. Hedescribed attending a Red Sox game at Fenway Park inBoston and having a seat in the sun on a hot, humidday: “Granted, I could have moved under the over-hang and enjoyed today’s contest from a nice, cool,shady seat. But when you paid forty-five dollars for aticket in the fourth row, it’s tough to move back to thetwenty-fourth [row].” Evaluate Neyer’s reasoning.

Source: Rob Neyer, Feeding the Green Monster, New York: iPublish.com,2001, p. 50.

4.8 After owning a used car for two years, you starthaving problems with it. You take it into the shop,and a mechanic tells you that repairs will cost$4,000. What factors will you take into account indeciding whether to have the repairs done or tojunk the car and buy another one? Will the priceyou paid for the car be one of those factors? Brieflyexplain.

4.9 The following excerpt is from a letter sent to a finan-cial advice columnist: “My wife and I are trying todecide how to invest a $250,000 windfall. She wantsto pay off our $114,000 mortgage, but I’m not eagerto do that because we refinanced only nine monthsago, paying $3,000 in fees and costs.” Briefly discusswhat effect the $3,000 refinancing cost should haveon this couple’s investment decision.

Source: Liz Pulliam, Los Angeles Times advice column, March 24, 2004.

4.10 [Related to the Making the Connection onpage xxx] Consumers tend to ignore the prices of“add-on” goods like ATM fees for checking accounts.Does this mean that if the government were to banATM fees that consumers would benefit?

4.11 In an article in the Quarterly Journal of Economics,Ted O’Donoghue and Matthew Rabin make the fol-lowing observation: “People have self-control prob-lems caused by a tendency to pursue immediate grat-ification in a way that their ‘long-run selves’ do notappreciate.” What do they mean by a person’s “long-run self ”? Give two examples of people pursuingimmediate gratification that their long-run selveswould not appreciate.

Source: Ted O’Donoghue and Matthew Rabin, “Choice andProcrastination,” Quarterly Journal of Economics, February 2001,pp. 125–126.

4.12 Data from health clubs show that members whochoose a contract with a flat monthly fee over $70attend, on average, 4.8 times per month. They pay aprice per expected visit of more than $14, eventhough a $10-per-visit fee is also available. Whywould these consumers choose a monthly contractwhen they lose money on it?

4.13 [Related to the Making the Connection onpage xxx] Briefly explain whether you agree ordisagree with the following statement: “If people weremore realistic about their future behavior, thedemand curve for potato chips would shift to theleft.”



6.5 LEARNING OBJECTIVE 6.5 | Define the price elasticity of demand and understand how to measure it,

pages xxx–xxx.

The Price Elasticity of Demand and Its Measurement

Summary

Elasticity measures how much one economic variableresponds to changes in another economic variable. Theprice elasticity of demand measures how responsive quan-tity demanded is to changes in price. The price elasticity ofdemand is equal to the percentage change in quantitydemanded divided by the percentage change in price. If thequantity demanded changes more than proportionallywhen price changes, the price elasticity of demand isgreater than 1 in absolute value, and demand is elastic. Ifthe quantity demanded changes less than proportionallywhen price changes, the price elasticity of demand is lessthan 1 in absolute value, and demand is inelastic. If thequantity demanded changes proportionally when pricechanges, the price elasticity of demand is equal to 1 inabsolute value, and demand is unit elastic. Perfectlyinelastic demand curves are vertical lines, and perfectlyelastic demand curves are horizontal lines. Relatively fewproducts have perfectly elastic or perfectly inelasticdemand curves.


Review Questions

5.1 Write the formula for the price elasticity of demand.Why isn’t elasticity just measured by the slope of thedemand curve?

5.2 If a 10 percent increase in the price of Cap’n Crunchcereal causes a 25 percent reduction in the number ofboxes of cereal demanded, what is the price elasticityof demand for Cap’n Crunch cereal? Is demand forCap’n Crunch elastic or inelastic?

5.3 What is the midpoint method for calculating priceelasticity of demand? How else can you calculate the

price elasticity of demand? What is the advantage ofthe midpoint method?

5.4 Draw a graph of a perfectly inelastic demand curve.Think of a product that would have a perfectly inelas-tic demand curve. Explain why demand for this prod-uct would be perfectly inelastic.


5.5 Suppose the following table gives data on the price ofrye and the number of bushels of rye sold in 2008and 2009.

PRICE (DOLLARS PER QUANTITYYEAR BUSHEL) (BUSHELS)

2008 $3.00 8 million

2009 2.00 12 million

a. Calculate the change in the quantity of ryedemanded divided by the change in the price ofrye. Measure the quantity of rye in bushels.

b. Calculate the change in the quantity of ryedemanded divided by the change in the price ofrye, but this time measure the quantity of rye inmillions of bushels. Compare your answer to theone you computed in a.

c. Finally, assuming that the demand curve for ryedid not shift between 2008 and 2009, use theinformation in the table to calculate the price elas-ticity of demand for rye. Use the midpoint for-mula in your calculation. Compare the value forthe price elasticity of demand to the values youcalculated in a and b.

5.6 [Related to Solved Problem 6-4 on pagexxx] You own a hot dog stand that you set up outsidethe student union every day at lunch time. Currently,


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$3

2

0

Price(dollars

perhot dog)

Quantity(hot dogs per day)

40 6030

D1

BC

A

D2



5.7 In fall 2006, Pace University in New York raised itsannual tuition from $24,751 to $29,454. Freshmanenrollment declined from 1,469 in fall 2005 to 1,131in fall 2006. Assuming that the demand curve forplaces in the freshmen class at Pace did not shiftbetween 2005 and 2006, use this information to cal-culate the price elasticity of demand. Use the mid-point formula in your calculation. Is the demandfor places in Pace’s freshmen class elastic or inelas-tic? Did the total amount of tuition Pace receivedfrom its freshman class rise or fall in 2006 com-pared with 2005?

Source: Karen W.Arenson,“At Universities,Plum Post at Top Is Now Shaky,”New York Times, January 9, 2007.

5.8 Consider the following excerpt from a newspaperstory on increases in college tuition:

Facing stiff competition, Hendrix College,a small liberal arts institution in Conway,Ark., decided two years ago to bolster itsacademic offerings, promising studentsat least three hands-on experiences

outside the classroom, including research,internships and service projects. It alsoraised tuition and fees 29 percent, to$21,636. . . . As a result, 409 studentsenrolled in the freshman class this year,a 37 percent increase. “What worked wasthe buzz,” said J. Timothy Cloyd, theHendrix president. “Students saw thatthey were going to get an experiencethat had value, and the price position-ing conveyed to them the value of theexperience.”

Does this excerpt provide enough information to cal-culate the price elasticity of demand for places inHendrix College’s freshman class? Briefly explain.

Source: Jonathan D. Glater and Alan Finder, “In New Twist on TuitionGame, Popularity Rises with the Price,” New York Times, December 12,2006.

5.9 In summer 2007, Sony decided to cut the price of itsPlayStation 3 video game console from $600 to$500. One industry analyst forecast that the pricecut would increase sales from 80,000 units permonth to 120,000 units per month. Assuming theanalyst’s forecast is correct, use the midpoint for-mula to calculate the price elasticity of demand forPlayStation 3.

Source: “Sony Cuts Price on PlayStation 3 by $100,” New York Times, July 9,2007.

5.10 In 1916, the Ford Motor Company sold 500,000Model T Fords at a price of $440 each. Henry Fordbelieved that he could increase sales of the Model Tby 1,000 cars for every dollar he cut the price. Use thisinformation to calculate the price elasticity ofdemand for Model T Fords. Use the midpoint for-mula in your calculation.

5.11 [Related to the Don’t Let This Happen to You!on page xxx] The publisher of a magazine gives hisstaff the following information:

Current price $2.00 per issue

Current sales 150,000 copies per month

Current total costs $450,000 per month

He tells the staff, “Our costs are currently $150,000more than our revenues each month. I propose toeliminate this problem by raising the price of themagazine to $3.00 per issue. This will result in ourrevenue being exactly equal to our cost.” Do you agreewith the publisher’s analysis? Explain. (Hint:Remember that a firm’s revenue is equal to the priceof the product multiplied by the quantity sold.)

you are selling hot dogs for a price of $3, and you sell30 hot dogs a day. You are considering cutting theprice to $2. The following graph shows two possibleincreases in the quantity sold as a result of your pricecut. Use the information in the graph to calculate theprice elasticity between these two prices on each ofthe demand curves. Use the midpoint formula to cal-culate the price elasticities.





Summary

The main determinants of the price elasticity of demand fora product are the availability of close substitutes, the passageof time, whether the good is a necessity or a luxury, hownarrowly the market for the good is defined, and the share ofthe good in the consumer’s budget.


Review Questions

6.1 Is the demand for most agricultural products elasticor inelastic? Why?

6.2 What are the key determinants of the price elasticityof demand for a product? Which determinant is themost important?


6.3 Briefly explain whether the demand for each of thefollowing products is likely to be elastic or inelastic.

a. Milkb. Frozen cheese pizzac. Colad. Prescription medicine

6.4 [Related to the Making the Connection onpage xxx] A study of the price elasticities of productssold in supermarkets contained the following data:

PRODUCT PRICE ELASTICITY OF DEMAND

Soft drinks −3.18

Canned soup −1.62

Cheese −0.72

Toothpaste −0.45

a. For which products is the demand inelastic?Discuss reasons why the demand for each productis either elastic or inelastic.

b. Use the information in the table to predict thechange in the quantity demanded for each prod-uct following a 10 percent price increase.

Source: Stephen J. Hoch, Byung-do Kim, Alan L. Montgomery, and Peter E.Rossi, “Determinants of Store-Level Price Elasticity,” Journal of MarketingResearch,Vol. 32, February 1995, pp. 17–29.

6.7 LEARNING OBJECTIVE 6.7 | Understand the relationship between the price elasticity of demand

and total revenue, pages xxx–xxx.

The Relationship between Price Elasticity of Demand and Total Revenue

Summary

Total revenue is the total amount of funds received by aseller of a good or service. When demand is inelastic, adecrease in price reduces total revenue, and an increase inprice increases total revenue. When demand is elastic, adecrease in price increases total revenue, and an increase inprice decreases total revenue. When demand is unit elastic,an increase or a decrease in price leaves total revenueunchanged.


Review Questions

7.1 If the demand for orange juice is inelastic, will anincrease in the price of orange juice increase ordecrease the revenue received by orange juice sellers?

7.2 The price of organic apples falls and apple growersfind that their revenue increases. Is the demand fororganic apples elastic or inelastic?


7.3 A newspaper story on the effect of higher milk priceson the market for ice cream contained the following:“As a result [of the increase in milk prices], retail pricesfor ice cream are up 4 percent from last year. . . . Andice cream consumption is down 3 percent.” Given thisinformation, compute the price elasticity of demandfor ice cream. Will the revenue received by ice creamsuppliers have increased or decreased following theprice increase? Briefly explain.

Source: John Curran,“Ice Cream,They Scream: Milk Fat Costs Drive Up IceCream Prices,”Associated Press, July 23, 2001.

6.6 LEARNING OBJECTIVE 6.6 | Understand the determinants of the price elasticity of demand, pages xxx–xxx.

The Determinants of the Price Elasticity of Demand


7.4 Use the following graph for Yolanda’s Frozen YogurtStand to answer the questions that follow.

a. Use the midpoint formula to calculate the priceelasticity of demand for D1 between point A andpoint C and the price elasticity of demand for D2between point A and point B. Which demandcurve is more elastic, D1 or D2? Briefly explain.

b. Suppose Yolanda is initially selling 200 cones perday at a price of $3.00 per cone. If she cuts her priceto $2.50 per cone and her demand curve is D1, whatwill be the change in her revenue? What will be thechange in her revenue if her demand curve is D2?

7.5 An article in the Wall Street Journal noted the following:

Instead of relying on a full-coach, round-trip unrestricted fare of about $2,000between Cleveland and Los Angeles . . .Continental [Airlines] since June hasoffered a $716 unrestricted fare in thatmarket. . . . Through October, the testresulted in about the same revenue thatContinental thinks it would have col-lected with its higher fare.

What is the value of the price elasticity of demand onthis airline route? Is Continental likely to be better offcharging the low fare or the high fare? Briefly explain.

Source: Scott McCartney, “Airlines Try Cutting Business Fares, Find TheyDon’t Lose Revenue,”Wall Street Journal, November 22, 2002.

7.6 [Related to Solved Problem 6-6 on pagexxx] Briefly explain whether you agree or disagreewith Manager 2’s reasoning:

Manager 1: “The only way we can increase the rev-enue we receive from selling our frozen pizzas is bycutting the price.”

Manager 2: “Cutting the price of a product neverincreases the amount of revenue you receive. If wewant to increase revenue, we have to increase price.”

7.7 [Related to the Chapter Opener on pagexxx] Consider the following description of a pricingdecision by academic book publishers:

A publisher may have issued a monographseveral years ago, when both costs andbook prices were lower, and priced it at$14.95. The book is still selling reasonablywell and would continue to do so at$19.95. Why not, then, raise the price? Theonly danger is miscalculation: By raisingthe price you may reduce sales to the pointwhere you make less money overall, evenwhile making more per copy.

Assume that the situation described in the last sen-tence happens. What does this tell us about the priceelasticity of demand for that book? Briefly explain.

Source: Beth Luey, Handbook for Academic Authors, 4th ed., Cambridge,UK: Cambridge University Press, 2002, p. 250.

7.8 Each summer, the city of Bethlehem, Pennsylvania,holds Musikfest, an outdoor music festival. The cityhad been charging $7 per day to park in city parkinglots. One year it raised the fee to $10 per day.According to an article in a local newspaper, “Fewerparkers used city lots, but this year’s parking rateincrease [from $7 to $10] gave the [parking] authorityrecord [parking] lot revenues for the annual festival.”Use the information in the following table to calculatethe price elasticity of demand for parking spaces inBethlehem city parking lots during Musikfest; use themidpoint price elasticity of demand formula. Assumethat nothing happened to shift the demand curve forparking places. Be sure to state whether demand iselastic or inelastic.

MUSIKFEST PARKING RATE REVENUE

YEAR RATE REVENUE

1999 $10 $83,760

1998 7 77,791

Source: Matt Assad, “Grinch Alive and Well in Bethlehem ParkingAuthority,” (Allentown, Pennsylvania) Morning Call, September 29, 1999,page B4.

7.9 An article about the newspaper industry that appearedin the Wall Street Journal noted the following:“Decliningcirculation hasn’t stopped Knight Ridder papers fromraising subscription prices. Such increases, while boost-ing revenue per copy, almost always trigger a readershipdecline.”a. What is a newspaper’s “circulation”?b. To what is “revenue per copy” equal?c. Why would a newspaper’s management increase

its subscription price if the result was a decline inthe quantity of newspapers sold?

Source: Patricia Callahan and Kevin Helliker, “Subscriptions Fall, butKnight Ridder Lifts Advertising Rates,”Wall Street Journal, June 18, 2001.

$3.00

2.50

0

Price(dollars

percone)

Quantity(cones per day)

225 300200

D1

B C

A

D2





7.10 [Related to the Chapter Opener on pagexxx] Look again at the quote from Stephen Rubin ofDoubleday at the beginning of this chapter. Doubledayis selling John Grisham’s book The Innocent Man at aprice of $28.95.a. Assume that the demand for this book is perfectly

inelastic. Draw a demand curve showing the effecton the quantity demanded of raising the pricefrom $28.95 to $39.95. Assume that sales are500,000 at a price of $28.95. What is the change inrevenue as a result of the price change?

b. Now assume that the price elasticity of demand is−2. Draw another demand curve showing the effectof raising the price from $28.95 to $39.95. Be sureto show the quantity demanded at each price. Nowwhat is the change in revenue as a result of theprice change?

7.11 The Delaware River Joint Toll Bridge Commissionincreased the toll on the bridges on Route 22 andInterstate 78 from New Jersey to Pennsylvania from$0.50 to $1.00. Use the information in the table toanswer the questions. (Assume that nothing otherthan the toll change occurred during the months thatwould affect consumer demand.)

NUMBER OF VEHICLES CROSSING THE BRIDGE

ROUTE 22 INTERSTATE 78MONTH TOLL BRIDGE BRIDGE

November $0.50 519,337 728,022

December 1.00 433,691 656,257

a. Calculate the price elasticity of demand for eachbridge, using the midpoint formula.

b. How much total revenue did the commission col-lect from these bridges in November? How muchdid it collect in December? Relate your answer toyour answer in part a.

Source: Garrett Therolf, “Frugal Drivers Flood Free Bridge,” (Allentown,Pennsylvania) Morning Call, January 20, 2003.

7.12 Suppose you check out the prices of two products onAmazon.com: Conventional DVD players and Blu-Ray DVD players. For which type of players wouldyou expect manufacturers to be offering similar play-ers at about the same prices and for which type ofplayers would you expect prices to be more spreadout? Briefly explain.


hubbard obrien macroeconomics 2nd edition chapter 6

Economy & Finance

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