Supply and Demand:Section 9Finally getting into Microeconomics

Behind the CurvesFirst what can shift a supply curve?

ROTTE N

Second, what can shift a demand curve?TRIBE

esourcesther goodsechnologyaxesxpectations (producers)umber of producers

asteelated goodsncomeuyers (number of)xpectations

Substitutes and Complements

What is a substitute?How does this affect/relate demand for a good?

A complement?How does this affect/relate to demand for a good?

Elasticity ExplainedElastic

Consumers are very responsiveWill change purchasing behavior quickly

InelasticConsumers are NOT very responsive

Will not change purchasing behaviors quickly

Unit ElasticConsumer behavior changes directly proportional to price/quantity changes

Consumer ChoiceSubstitution Effect

Prices , DemandOpportunity costsWe substitute the cheaper good for the one we would have purchased = substitution effect

Consumer ChoiceSubstitution effect – has greatest bearing on goods that we rarely purchase

Examples?

Income effectChange in the quantity of a change in the purchasing power of a consumers income

Housing – prices go up, we buy smaller/cheaper housesOther examples?

Consumer ChoiceMost goods are NORMAL goods

Income , demandPeople start to buy inferior goods

Giffen GoodsTheory, never proven

Inferior goods = prices increaseEx: Irish and potatoes

Consumer ChoiceElasticity

Independent/dependent variables and price What else affects a good’s price?

Substitutes and complimentsQuestion to ask:

NOT IF a dependent good (compliment) will change due to price increases BUT how much will the quantity demanded decrease/increase?

Elasticity – measure how responsive the quantity demanded is to a change in price

Consumer ChoicePrice elasticity of demand

Flu shot vaccine example

Time to do research!

Consumer ChoiceMagic number with Elasticity is 1

Below 1 – inelasticDemand will change a relatively small amount when price changes

Examples:GasHealth careFlu shotsCrack rocks?

Above 1 – elasticDemand will change in greater amounts if price changes

Examples:Restaurant mealsHousingForeign Travel

1 = unit elastics

Consumer ChoiceInterpreting Price Elasticity of Demand

How elastic IS elastic?Perfectly inelastic

No matter the price of a good, the quantity demand stays

Consumer GoodsPerfectly elastic

A tiny price change will cause the quantity demanded to change

Consumer ChoiceWhy does the elasticity of a good matter?

Crucial to know how price changes affect TOTAL REVENUE = P x Q sold

Consumer ChoiceBesides rare cases of perfectly inelastic or perfectly elastic goods, two effects are important and can be found using elasticity

Price effect – Price = price, raises revenueQuantity Effect – Price = products sold, lowers revenue

Consumer ChoicePrice elasticity of demand tells us what happens when price changes, and the size of that effect

Unit-elastic (price elasticity of d = 1)Increase in price does not change total revenue

Inelastic (price elasticity of d < 1)Higher price increases total revenuePrice effect is stronger than quantity effect

Elastic (price elasticity of d > 1)Increase in price reduces revenueQuantity effect is stronger than price effect

Consumer ChoiceWhat factors determine the price elasticity of demand?

Are close substitutes available?Ex: difference between Pepsi and Coke

Is the good a necessity or luxury?Ex: Ferrari

What share of income is spent on the good?Ex: Starbucks

TimeEx: Gas crisis in the 1970s

Thinking about what we know about economics so far…

Should price elasticity affect a person’s choice of college?

Consumer ChoiceFurther Elasticities of Demand (and Supply)

Demand for a good is often affected by the price of other, related goods

If a price changes for hot dogs, how much does this affect demand for hamburgers?

Cross-Price Elasticity for Demand = %∆ Qd for Good A%∆ in Price of B

o When two goods are substitutes, Cross-Price Elasticity is Positive (shift demand curve of Good B to the right)

o When goods are compliments, hot dogs and hot dog bunds, CPE is negative (shift left of Good B)

**The (+) or (-) sign matters here**

Consumer ChoiceIncome Elasticity of Demand

Changes in income affect a good = %∆ in Qd %∆ in income

o Income Elasticity is (+) – Normal goodo Income Elasticity is (-) – Inferior good

o Income Elasticity (normal goods)o Income – elastic (>1)

o If income rises, the demand for a good rises FASTER than rise in income

o Income – inelastic (<1 but >0)o When income rises, the demand for a good is SLOWER

than rise in income

Consumer ChoicePrice Elasticity of Supply

The response of producers to price changesExamples – produce more products, reduce production

Price Elasticity of Supply = %∆ in Qs %∆ in price

o Same rules as Demand Elasticities, just along the supply curve

Consumer Choice

Consumer ChoiceWhat factors determine the Price Elasticity of Supply?

Availability of inputsToo few inputs means higher cost of production

TimeResponse of producers to inputs, prices

Ex – Fish supply, pizza, cell phone radio spectrum