Demand Analysis Demand Elasticity Supply Equilibrium

Behind the Demand Curve: Theory of Consumer Choice Balance preferences and spending power Weigh willingness to buy against ability to buy Match desire to buy and ability to buy

Utility Theory Goal of maximizing utility s.t. an income constraint –U = U(X, Y) –s.t. M = p x X + P y Y Consumers can rank preferences Consumers have income to spend There are goods to buy

Consumer Equilibrium Maximize utility s.t. income constraint Given limited budget and positive prices, reach highest level of utility Income and substitution effects Equilibrium implies: MU x /MU y = p x /p y

Consumer Choice Using Lagrangians Deriving the decision rule with mathematics

Basis for Demand Direct demand Derived demand

The Demand Function Determinants of demand Q d = Q d (P o |T, C, I, P n, R, E )

The Demand Curve The amount of a good consumers are willing to buy at various prices The maximum price consumers are willing to pay for a given amount of a good

The Concept of Elasticity Defined Formula Point v. arc elasticity The relationship between elasticity and slope

Nature of Elasticity Perfectly elastic Elastic Unit elastic Inelastic Perfectly Inelastic

Issues in Elasticity Elasticity-revenue relationship Optimal pricing Straight-line demand curves MR = P(1 + 1/e)

Determinants of Price Elasticity Substitutability Complementary goods Relative importance in budget Time

Income Elasticity of Demand Superior goods Normal goods Inferior goods Giffen goods

Cross Elasticity of Demand Substitutes Complements

Basis for Supply Supply decisions based on cost of production

Market Supply Determinants of supply Q s = Q s (P o |P r, K, M)

The Supply Curve The amount of a good suppliers are willing to provide at various prices The minimum price suppliers are willing to accept to make a given amount of a good available

Market Equilibrium Superimpose demand and supply If Q s = Q d, no tendency to change

Applications Excise tax Quotas and tariffs Agricultural policy