Download Unit 1 Lesson 2 Elasticity and Demand

Microeconomics
Lesson 2
Topics
1. Homework
2. Review Supply and Demand
3. Floors and Ceilings
4. Elasticity
5. Consumer Choice
Another S & D example
Price
60
50
40
30
20
10
Qd
0
100
200
300
400
500
Price
60
50
40
30
20
10
Qs
500
400
300
200
100
0
Answer:
Price = $ Quantity =
What happens to price and quantity if
the price of a substitute good
increases?
What happens to price and quantity if
the cost of production decreases?
Floors and Ceilings
See the examples on the board.
Price Elasticity of Demand
Measures the sensitivity or
(responsiveness) of quantity
consumers demand to changes
in the price of a product
Equation for Coefficient of
Elasticity of Demand
% change in quantity ÷ % change in price
The equation for determining the
coefficient elasticity of demand is:
[(Q1-Q2)÷(Q1+Q2)]÷[(P1-P2)÷(P1+P2)]
Examples
1. Q1 = 250 Q2 = 300 P1=50 P2=40
Answer = ___ ( <1, inelastic)
2. Q1 = 250 Q2 = 500 P1 = $6 P2=$5
Answer = ___ (>1, elastic)
3. Q1 = 250 Q2 = 300 P1 = $6 P2=$5
Answer = __ (unit elastic)
More examples
4. Q1 = 500 Q2 = 500 P1 = $6 P2=$5
Answer = __ (perfectly inelastic)
5. Q1 = 500 Q2 = 600 P1 = $5 P2=$5
Answer = undefined (perfectly elastic)
Sesame Street School of Ed
A key to identifying elastic or inelastic
demand is the shape of the Demand Curve:
The more the curve looks like a capital I, the
more inelastic the demand, and the fewer the
substitutes
The more the curve looks like a capital E, the
more elastic the demand, and there must be
many substitutes
Uses of Elasticity of Demand
We can use Elasticity of Demand to
determine the price where we Maximize
Total Revenue
Remember the equation for Total
Revenue TR = Price x Quantity
Elasticity, Price, Total
Revenue
If Ed > 1 then:


an increase in price will cause TR to drop
A decrease in price will cause TR to go up
If Ed < 1 then:


An increase in price will cause TR to go up
A decrease in price will cause TR to drop
If Ed = 1 then: TR is maximized!
Bill and his price
Bill Gates called and he wants to know
if he should raise the price of his Office
software package.
Currently, the package is $400 and they
sell 10,000/day. Bill’s research shows
that if they raise the price to $440 sales
will drop to 8,000/day.
What is the Ed of the Office software?
Should Bill raise the price if he wants to
maximize Total Revenue?
Bill’s Answer
Since Ed was ___ (greater than 1) then
Bill should lower his price not raise if he
wants to maximize revenue
Other uses for Ed
Tax incidence
Predict the change in quantity from a
change in price
Evaluate the effectiveness of social
policies
Circular Flow
Consumer Behavior
Utility Theory
Indifference Curves (the abbreviated
version)
Satisfaction
What if there were some
way to measure the
satisfaction a person
derived from consuming a
certain quantity of a good?
sound
Utility Theory
The nearest we can come in Economics
to measuring satisfaction is the UTIL.
The UTIL
Is an imaginary measure of satisfaction
Total utility measures the total UTILS of
satisfaction the consumer enjoys
Marginal utility is the change in total
utility from one additional unit of the
good
UTILS and Mounds Bars
Mounds
Bars
0
Total
Utility
0
Marginal
Utility
1
15
15.0
TU2-TU1/Q2-Q1
2
20
5.0
TU3-TU2/Q3-Q2
3
2
-18.0
TU4-TU3/Q4-Q3
Utility and Consumer Behavior
Choosing a diaper
Q
Choice
MU
Price
MU/P
49
Cloth
5
$2.00 2.5
49
Service
30
$6.25 4.8
49
Disposable 60
$8.25 7.5
Utility again
Choosing a windshield wiper
Choice
MU
Price
MU/P
Good
8
$4.00
2.0
Better
24
$6.00
4.0
Best
30
$10.00
3.0
Maximizing Utility
Pick the affordable combination of
consumer goods that makes the
marginal utility per dollar of one good
equal to the marginal utility per dollar
spent on a second good.
Choosing a combination of two
goods to maximize utility
See the example on the board
Indifference Curves
Indifference curves are like a
topographic map of the “Hill of
Happiness”
You want to consume that combination
that gets you highest on the hill of
happiness given your budget constraint.
Indifference Curves
The word to remember if this ever
comes up again is TANGENT
The key is to choose that point on the
budget constraint that is TANGENT to
the highest indifference curve.