Unit 2: Supply, Demand, and Consumer Choice

Unit 2: Supply, Demand, and Consumer Choice

Connection to Circular Flow Model
Do individuals supply or demand? Do business supply or demand? Who demands in the product market? Who supplies in the product market?

DEMAND DEFINED What is Demand? What is the Law of Demand?
Demand is the different quantities of goods that consumers are willing and able to buy at different prices. (Ex: Bill Gates is able to purchase a Ferrari, but if he isn’t willing he has NO demand for one) What is the Law of Demand? There is an INVERSE relationship between price and quantity demanded

LAW OF DEMAND As Price Falls… …Quantity Demanded Rises As Price Rises… …Quantity Demanded Falls Quantity Demanded Price

Example of Demand I am willing to sell several A’s in AP Economics. How much will you pay? Price Quantity Demanded Demand Schedule

Why does the Law of Demand occur?
The law of demand is the result of three separate behavior patterns that overlap: The Substitution effect The Income effect The Law of Diminishing Marginal Utility We will define and explain each…

1. The Substitution Effect If the price goes up for a product, consumer buy less of that product and more of another substitute product (and vice versa) 2. The Income Effect If the price goes down for a product, the purchasing power increases for consumers -allowing them to purchase more.

3. Law of Diminishing Marginal Utility U- TIL- IT- Y Utility = Satisfaction We buy goods because we get utility from them The law of diminishing marginal utility states that as you consume more units of any good, the additional satisfaction from each additional unit will eventually start to decrease In other words, the more you buy of ANY GOOD the less satisfaction you get from each new unit. Discussion Questions: What does this have to do with the Law of Demand? How does this effect the pricing of businesses?

Can you see the Law of Diminishing Marginal Utility in Disneyland’s pricing strategy?
Change N/A $54 $33 $15 $10 $5

The Law of Diminishing Marginal Utility

Graphing Demand

Let’s draw a new demand curve for cereal…
The Demand Curve A demand curve is a graphical representation of a demand schedule. The demand curve is downward sloping showing the inverse relationship between price (on the y-axis) and quantity demanded (on the x-axis) When reading a demand curve, assume all outside factors, such as income, are held constant. (This is called ceteris paribus) Let’s draw a new demand curve for cereal…

GRAPHING DEMAND Draw this large in your notes Demand Schedule
Price of Cereal Draw this large in your notes $5 4 3 2 1 Price Quantity Demanded $5 10 $4 20 $3 30 $2 50 $1 80 o Q Quantity of Cereal

GRAPHING DEMAND Demand Schedule Price of Cereal $5 10 $4 20 $3 30 $2
Quantity Demanded $5 10 $4 20 $3 30 $2 50 $1 80 Demand o Q Quantity of Cereal 15

Where do you get the Market Demand?
Billy Jean Other Individuals Market Price Q Demd $5 1 $4 2 $3 3 $2 5 $1 7 Price Q Demd $5 $4 1 $3 2 $2 3 $1 5 Price Q Demd $5 9 $4 17 $3 25 $2 42 $1 68 Price Q Demd $5 10 $4 20 $3 30 $2 50 $1 80 P P P P $3 $3 $3 $3 D D D D Q Q Q Q 3 2 25 30

Review with your neighbor…
What are the two key aspects of the definition of demand? What is the Law of Demand? Give an example of the substitution effect Give an example of the income effect Give an example of the law of diminishing marginal utility Explain how the law of diminishing marginal utility causes the law of demand How do you determine the MARKET demand for a particular good? Name 10 fast food places

This is a change in demand, not a change in quantity demanded
Shifts in Demand CHANGES IN DEMAND Ceteris paribus-“all other things held constant.” When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts. A shift means that at the same prices, more people are willing and able to purchase that good. This is a change in demand, not a change in quantity demanded Changes in price DON’T shift the curve!

What if cereal makes you smarter?
Change in Demand Demand Schedule What if cereal makes you smarter? Price of Cereal $5 4 3 2 1 Price Quantity Demanded $5 10 $4 20 $3 30 $2 50 $1 80 Demand o Q Quantity of Cereal 19

Change in Demand Demand Schedule Price of Cereal $5 10 $4 20 $3 30 $2

1 Price Quantity Demanded $5 30 $4 40 $3 50 $2 70 $1 Demand o Q Quantity of Cereal 22

Prices didn’t change but people want MORE cereal
Change in Demand Demand Schedule Price of Cereal Increase in Demand Prices didn’t change but people want MORE cereal $5 4 3 2 1 Price Quantity Demanded $5 30 $4 40 $3 50 $2 70 $1 D1 Demand o Q Quantity of Cereal 23

What if cereal causes baldness?
Change in Demand Demand Schedule What if cereal causes baldness? Price of Cereal $5 4 3 2 1 Price Quantity Demanded $5 10 $4 20 $3 30 $2 50 $1 80 Demand o Q Quantity of Cereal 24

Change in Demand Demand Schedule Price of Cereal $5 $4 5 $3 20 $2 30
1 Price Quantity Demanded $5 $4 5 $3 20 $2 30 $1 80 60 Demand o Q Quantity of Cereal 27

Prices didn’t change but people want LESS cereal
Change in Demand Demand Schedule Price of Cereal $5 4 3 2 1 Decrease in Demand Prices didn’t change but people want LESS cereal Price Quantity Demanded $5 $4 5 $3 20 $2 30 $1 80 60 D2 Demand o Q Quantity of Cereal 28

What if the price of MILK goes up?
Change in Demand Demand Schedule What if the price of MILK goes up? Price of Cereal $5 4 3 2 1 Price Quantity Demanded $5 10 $4 20 $3 30 $2 50 $1 80 Demand o Q Quantity of Cereal 29

What Causes a Shift in Demand?
5 Shifters (Determinates) of Demand: Tastes and Preferences Number of Consumers Price of Related Goods Income Future Expectations Changes in PRICE don’t shift the curve. It only causes movement along the curve.

Prices of Related Goods
The demand curve for one good can be affected by a change in the price of ANOTHER related good. Substitutes are goods used in place of one another. If the price of one increases, the demand for the other will increase (or vice versa) Ex: If price of Pepsi falls, demand for coke will… 2. Complements are two goods that are bought and used together. If the price of one increase, the demand for the other will fall. (or vice versa) Ex: If price of skis falls, demand for ski boots will...

Substitutes 32 32

Substitutes 33 33

Substitutes 34 34

Substitutes 35 35

Substitutes 36 36

Substitutes 37 37

Substitutes 38 38

Complements 39 39

Income The incomes of consumer change the demand, but how depends on the type of good. Normal Goods As income increases, demand increases As income falls, demand falls Ex: Luxury cars, Sea Food, jewelry, homes 2. Inferior Goods As income increases, demand falls As income falls, demand increases Ex: Top Ramen, used cars, used clothes, Spam-Inferior Yachts- Normal Off Brand Cereal-Inferior McDonald’s-Inferior Toilet Paper- Probably no connection to income (The point-some products are very reliant on income and others are not)

Inferior Goods 41 41

Change in Qd vs. Change in Demand
There are two ways to increase quantity from 10 to 20 Price of Cereal P A to B is a change in quantity demand (due to a change in price) A to C is a change in demand (shift in the curve) A C $3 $2 B D2 D1 o Q Cereal Quantity of Cereal

Practice First, identify the determinant (shifter) then decide if demand will increase or decrease Shifter Increase or Decrease Left or Right 1 2 3 4 5 6 7 8 Number of consumers, increase. Income, decrease. Substitutes, decrease. Price doesn’t shift curve, no change. Tastes and preferences, decrease. Expectations, increase. Complements, decrease.

Hamburgers (a normal good)
Practice First identify the determinant (Shifter). Then decide if demand will increase or decrease Hamburgers (a normal good) Population boom Incomes fall due to recession Price for chicken sandwiches falls to $1 Price increases to $5 for hamburgers New health craze- “No ground beef” Hamburger restaurants announce that they will significantly increase prices NEXT month Government heavily taxes shake and fries causing their prices to quadruple. Restaurants lower price of burgers to $.50 Number of consumers, increase. Income, decrease. Substitutes, decrease. Price doesn’t shift curve, no change. Tastes and preferences, decrease. Expectations, increase. Complements, decrease. 44 44

Can you see me?

Supply

Supply Defined EXAMPLE: Mowing Lawns
What is supply? Supply is the different quantities of a good that sellers are willing and able to sell (produce) at different prices. What is the Law of Supply? There is a DIRECT (or positive) relationship between price and quantity supplied. As price increases, the quantity producers make increases As price falls, the quantity producers make falls. Why? Because, at higher prices profit seeking firms have an incentive to produce more. EXAMPLE: Mowing Lawns

Example of Supply You own an lawn mower and you are willing to mow lawns. How many lawns will you mow at these prices? Price per lawn mowed Quantity Supplied Supply Schedule $1 $5 $20 $50 $100 $1000 48

GRAPHING SUPPLY Draw this large in your notes Supply Schedule
Price of Cereal Draw this large in your notes $5 4 3 2 1 Price Quantity Supplied $5 50 $4 40 $3 30 $2 20 $1 10 o Q Quantity of Cereal 49

GRAPHING SUPPLY Supply Schedule Price of Cereal Supply $5 50 $4 40 $3
2 1 Price Quantity Supplied $5 50 $4 40 $3 30 $2 20 $1 10 o Q Quantity of Cereal 50

companies start making
GRAPHING SUPPLY Supply Schedule What if new companies start making cereal? Price of Cereal Supply $5 4 3 2 1 Price Quantity Supplied $5 50 $4 40 $3 30 $2 20 $1 10 o Q Quantity of Cereal 51

Change in Supply Supply Schedule Price of Cereal Supply $5 50 $4 40 $3

2 1 Price Quantity Supplied $5 70 $4 60 $3 50 $2 40 $1 10 30 o Q Quantity of Cereal 54

Prices didn’t change but there is MORE cereal produced
Change in Supply Supply Schedule Price of Cereal Supply S2 $5 4 3 2 1 Price Quantity Supplied $5 70 $4 60 $3 50 $2 40 $1 10 30 Increase in Supply Prices didn’t change but there is MORE cereal produced o Q Quantity of Cereal 55

destroys corn and wheat
Change in Supply Supply Schedule What if a drought destroys corn and wheat crops? Price of Cereal Supply $5 4 3 2 1 Price Quantity Supplied $5 50 $4 40 $3 30 $2 20 $1 10 o Q Quantity of Cereal 56

1 Price Quantity Supplied $5 30 $4 20 $3 10 $2 1 $1 10 0 o Q Quantity of Cereal 59

Prices didn’t change but there is LESS cereal produced
Change in Supply Supply Schedule Price of Cereal Supply S2 $5 4 3 2 1 Price Quantity Supplied $5 30 $4 20 $3 10 $2 1 $1 10 0 Decrease in Supply Prices didn’t change but there is LESS cereal produced o Q Quantity of Cereal 60

What if cereal companies find a quicker way to make
Change in Supply Supply Schedule What if cereal companies find a quicker way to make cereal? Price of Cereal Supply $5 4 3 2 1 Price Quantity Supplied $5 50 $4 40 $3 30 $2 20 $1 10 o Q Quantity of Cereal 61

6 Shifters (Determinants) of Supply
Prices/Availability of inputs (resources) Number of Sellers Technology Government Action: Taxes & Subsidies 5. Opportunity Cost of Alternative Production 6. Expectations of Future Profit Changes in PRICE don’t shift the curve. It only causes movement along the curve.

Supply Practice First, identify the determinant (shifter) then decide if supply will increase or decrease Shifter Increase or Decrease Left or Right 1 2 3 4 5 6 63 63

Supply Practice Hamburgers Mad cow disease kills 20% of cows
Which determinant (SHIFTER)? Increase or decrease? Which direction will curve shift? Hamburgers Mad cow disease kills 20% of cows Price of hamburgers increase 30% Government taxes burger producers Restaurants can produce burgers and/or tacos. A demand increase causes the price for tacos to increase 500% New bun baking technology cuts production time in half Minimum wage increases to $20 Decrease in availability of resources, decrease. Price doesn’t shift curve, no shift. Government action, decrease. Opportunity cost of alternative production, decrease. Technology, increase. Price of resources, decrease.

Putting Supply and Demand Together!!!

Supply and Demand are put together to determine equilibrium price and equilibrium quantity
Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 D o Q 66

Equilibrium Price = $3 (Qd=Qs) Equilibrium Quantity is 30
Supply and Demand are put together to determine equilibrium price and equilibrium quantity P Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 Equilibrium Price = $3 (Qd=Qs) D o Q Equilibrium Quantity is 30 67

What if the price increases to $4?
Supply and Demand are put together to determine equilibrium price and equilibrium quantity What if the price increases to $4? P Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 D o Q 68

How much is the surplus at $4?
At $4, there is disequilibrium. The quantity demanded is less than quantity supplied. P Supply Schedule Demand Schedule S $5 4 3 2 1 Surplus (Qd<Qs) P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 How much is the surplus at $4? Answer: 20 D o Q 69

How much is the surplus if the price is $5?
What if the price decreases to $2? P Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 Answer: 40 D o Q 70

How much is the shortage at $2?
At $2, there is disequilibrium. The quantity demanded is greater than quantity supplied. P Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 How much is the shortage at $2? Answer: 30 Shortage (Qd>Qs) D o Q 71

How much is the shortage if the price is $1?
Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 Answer: 70 D o Q 72

The FREE MARKET system automatically pushes the price toward equilibrium.
Supply Schedule Demand Schedule S $5 4 3 2 1 When there is a surplus, producers lower prices P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 When there is a shortage, producers raise prices D o Q 73

Review with your neighbor…
Explain the Law of Demand Explain the Law of Supply Identify the 5 shifters of demand Identify the 6 shifters of supply Define Subsidy Explain why price DOESN’T shift the curve Define Equilibrium Define Shortage Define Surplus Identify 10 stores in the mall

Shifting Supply and Demand

Assume shifts in supply or demand change equilibrium P and Q instantaneously
76

Supply and Demand Analysis
Easy as 1, 2, 3 Before the change: Draw supply and demand Label original equilibrium price and quantity The change: Did it affect supply or demand first? Which determinant caused the shift? Draw increase or decrease After change: Label new equilibrium? What happens to Price? (increase or decrease) What happens to Quantity? (increase or decrease) Let’s Practice!

S&D Analysis Practice Analyze Hamburgers
Before Change (Draw equilibrium) The Change (S or D, Identify Shifter) After Change (Price and Quantity After) Analyze Hamburgers New grilling technology cuts production time in half Price of chicken sandwiches (a substitute) increases Price for ground beef triples Human fingers found in multiple burger restaurants. Price of burgers falls from $3 to $1. 1. Supply Increases 2. Demand Increases 3. Supply Decreases 4. Demand Decreases 5. No shift

Voluntary Exchange In the free-market, buyers and sellers voluntarily come together to seek mutual benefits.

Example of Voluntary Exchange
Ex: You want to buy a truck so you go to the local dealership. You are willing to spend up to $20,000 for a new 4x4. The seller is willing to sell this truck for no less than $15,000. After some negotiation you buy the truck for $18,000. Analysis: Buyer’ Maximum- Sellers Minimum- Price- Consumer’s Surplus- Producer’s Surplus- $20,000 $15,000 $18,000 $2,000 $3,000

Voluntary Exchange Terms
Consumer Surplus is the difference between what you are willing to pay and what you actually pay. CS = Buyer’s Maximum – Price Producer’s Surplus is the difference between the price the seller received and how much they were willing to sell it for. PS = Price – Seller’s Minimum

Pearl Exchange Activity
85

The Pearl Exchange There will be four trading sessions.
In each session, you can only buy or sell ONCE. When you make a deal, shake hands and come to the board to record your negotiated price. Then go back to your seat and record your surplus in the table. If you do not make a sale or purchase, you take the entire minimum or maximum price for a LOSS. Are you the best negotiator in the class? Let’s find out. Good Luck!

Voluntary Exchange Activity
87

Consumer and Producer’s Surplus
Calculate the area of: Consumer Surplus Producer Surplus Total Surplus P $10 8 6 $5 4 2 1 S CS CS= $25 PS= $20 Total= $45 PS 1: $25 2: $20 3: $45 D 10 Q

Double Shifts Suppose the demand for sports cars fell at the same time as production technology improved. Use S&D Analysis to show what will happen to PRICE and QUANTITY. If TWO curves shift at the same time, EITHER price or quantity will be indeterminate.

On graph for Hamburgers (a normal good), draw…
Double Shift Practice On graph for Hamburgers (a normal good), draw… A population boom combined with an increase in the price of ground beef. A decrease in incomes combined with an improvement in bun making technology A report released that states that beef will give you a second head at the same time that two major burger producers stop burger production

Use a S&D to explain this double shift
91

Government Involvement
#1-Price Controls: Floors and Ceilings #2-Quotas #3-Subsidies #4-Excise Taxes

#1-PRICE CONTROLS Who likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon?

To have an effect, a price ceiling must be below equilibrium
Maximum legal price a seller can charge for a product. Goal: Make affordable by keeping price from reaching Eq. To have an effect, a price ceiling must be below equilibrium P Gasoline S $5 4 3 2 1 Does this policy help consumers? Result: BLACK MARKETS Price Ceiling Shortage (Qd>Qs) D o Q 95

To have an effect, a price floor must be above equilibrium
Minimum legal price a seller can sell a product. Goal: Keep price high by keeping price from falling to Eq. To have an effect, a price floor must be above equilibrium P Corn S $ 4 3 2 1 Surplus (Qd<Qs) Price Floor Does this policy help corn producers? D o Q 96

Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and producers surplus P S CS Pc PS D Qe Q

Are Price Controls Good or Bad? DEADWEIGHT LOSS The Lost CS and PS.
To be “efficient” a market must maximize consumers and producers surplus P S CS Price FLOOR DEADWEIGHT LOSS The Lost CS and PS. INEFFICIENT! Pc PS D Qfloor Qe Q

Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and producers surplus P S CS Pc PS D Qe Q

Are Price Controls Good or Bad? DEADWEIGHT LOSS The Lost CS and PS.
To be “efficient” a market must maximize consumers and producers surplus P S DEADWEIGHT LOSS The Lost CS and PS. INEFFICIENT! CS Pc Price CEILING PS D Qceiling Qe Q

#2 Import Quotas A quota is a limit on number of imports.
The government sets the maximum amount that can come in the country. Purpose: To protect domestic producers from a cheaper world price. To prevent domestic unemployment

Quotas in General Quotas limit quantity, so imagine a vertical line at a set amount of a product—that vertical line limits the supply! Quotas DO NOT allow enough to be consumed, resulting in DWL

World Prices Sometimes people can get products for cheaper by purchasing them from another country at a world price. Examples: Cars, TVs, shoes, etc. BUT, by making goods available at a world price, domestic producers are hurt!

International Trade and Quotas
Identify the following: CS with no trade PS with no trade CS if we trade at world price (PW) PS if we trade at world price (PW) Amount we import at world price (PW) If the government sets a quota on imports of Q4 - Q2, what happens to CS and PS? 1.H 2.TLI 3.HIJKLMNRS 4.T 5.Q5-Q1 6. CS gets smaller and PS gets bigger This graphs show the domestic supply and demand for grain. The letters represent area.

i. P2 ii. Q2 Q3-Q1 i. P2, G, K ii. Pw, K, H i. P2, G, P1 ii. P1, J. Pw

#3 Subsidies The government just gives producers money.
The goal is for them to make more of the goods that the government thinks are important. Ex: Agriculture (to prevent famine) Pharmaceutical Companies Environmentally Safe Vehicles FAFSA

Result of Subsidies to Corn Producers
Price of Corn S SSubsidy Price Down Quantity Up Everyone Wins, Right? Pe P1 D o Qe Q1 Q Quantity of Corn 107

Excise Tax = A per unit tax on producers
#4 Excise Taxes Excise Tax = A per unit tax on producers For every unit made, the producer must pay $ NOT a Lump Sum (one time only)Tax The goal is for them to make less of the goods that the government deems dangerous or unwanted. Ex: Cigarettes “sin tax” Alcohol “sin tax” Tariffs on imported goods Environmentally Unsafe Products 108

Government sets a $2 per unit tax on Cigarettes
Excise Taxes Supply Schedule Government sets a $2 per unit tax on Cigarettes P P Qs $5 140 $4 120 $3 100 $2 80 $1 60 S $5 4 3 2 1 D o Q 109

Government sets a $2 per unit tax on Cigarettes
Excise Taxes Supply Schedule Government sets a $2 per unit tax on Cigarettes P P Qs $5 $7 140 $4 $6 120 $3 $5 100 $2 $4 80 $1 $3 60 S $5 4 3 2 1 D o Q 110

Tax is the vertical distance between supply curves
Excise Taxes STax Supply Schedule P P Qs $5 $7 140 $4 $6 120 $3 $5 100 $2 $4 80 $1 $3 60 S $5 4 3 2 1 Tax is the vertical distance between supply curves D o Q 111

Identify the following:
Excise Taxes Stax Identify the following: Price before tax Price consumers pay after tax Price producers get after tax Total tax revenue for the government before tax Total tax revenue for the government after tax P S $5 4 3 2 1 1.$3 2.$4 3.$2 4.$0 5.$160 D o Q 112

Tax Practice CS Before Tax PS Before Tax CS After Tax PS After Tax
Tax Revenue for Gov. Dead Weight Loss due to tax Amount of tax revenue producers pay 1.ABCD 2.HFEG 3.A 4.G 5.BCHF 6.DE 7.HF 113

Excise Tax P $14 12 11 8 S D 10 12 Q

Excise Tax 12 P Stax $14 11 8 S Pc Pp D 10 10 12 Q Calculate
Tax Per Unit Total Tax Revenue Amount of Tax paid by consumers Amount of Tax paid by producers Total Expenditures Total Revenue for firms P Stax $14 12 11 8 S Pc Pp $3 $30 $2 $1 $140 $110 D 10 10 12 Q

Excise Tax P Stax $8 S $6 $5 $4 $2 D 6 Q 9 Calculate CS Before Tax
PS Before Tax Total Surplus Before Tax CS After Tax PS After Tax Tax Revenue to the Government P Stax $8 $6 $5 $4 $2 S $13.5 $27 $6 $12 D 6 9 Q

EXCISE TAX ON CIGARETTES
P S1 $10 8 7 6 5 4 2 S CS After Pconsumers = $7 Tax per Unit? Total Tax Revenue? Tax paid by consumers? Tax paid by producers? Total spending? Revenue for businesses? Pproducers = $4 Tax per Unit = $3 Total Tax Revenue = $60 Tax Paid by Consumers = $40 Tax Paid by Producers = $20 Total Spending = $140 Revenue for Businesses=$80 D 20 30 Q 117

Supply and Demand Review
Define the Law of Demand Define the Law of Supply What is the difference between a change in demand and a change in quantity demanded? What happens if price is above equilibrium? What happens if price is below equilibrium? Define Consumer’s and Producer’s Surplus Identify the rule for double shifts in S&D Explain the results of an excise tax Define Dead Weight Loss Name 10 musical instruments

Consumers will buy more when prices go down and less when prices go up
THE LAW OF DEMAND SAYS... Consumers will buy more when prices go down and less when prices go up HOW MUCH MORE OR LESS? DOES IT MATTER?

Elasticity shows how sensitive quantity is to a change in price.

1. Elasticity of Demand Elasticity of Demand-
Measurement of consumers responsiveness to a change in price. What will happen if price increase? How much will it effect Quantity Demanded Who cares? Used by firms to help determine prices and sales Used by the government to decide how to tax

Inelastic Demand

Inelastic Demand INelastic = Quantity is INsensitive to a change in price. If price increases, quantity demanded will fall a little If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 20% 5% A INELASTIC demand curve is steep! (looks like an “I”) Examples: Gasoline Milk Diapers Medical Care Toilet paper

General Characteristics of INelastic Goods:
Inelastic Demand General Characteristics of INelastic Goods: Few Substitutes Necessities Small portion of income Required now, rather than later Elasticity coefficient less than 1 20% 5%

Elastic Demand

Elastic Demand An ELASTIC demand curve is flat!
Elastic = Quantity is sensitive to a change in price. If price increases, quantity demanded will fall a lot If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. An ELASTIC demand curve is flat! Examples: Soda Boats Beef Real Estate Pizza Gold

General Characteristics of Elastic Goods:
Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxuries Large portion of income Plenty of time to decide Elasticity coefficient greater than 1

Elastic or Inelastic? What about the demand for insulin for diabetics?
Beef- Gasoline- Real Estate- Medical Care- Electricity- Gold- Elastic- 1.27 INelastic - .20 Elastic- 1.60 INelastic - .31 INelastic - .13 Elastic - 2.6 What if % change in quantity demanded equals % change in price? Perfectly INELASTIC (Coefficient = 0) Unit Elastic (Coefficient =1)

Total Revenue Test Uses elasticity to show how changes in price will affect total revenue (TR). (TR = Price x Quantity) Elastic Demand- Price increase causes TR to decrease Price decrease causes TR to increase Inelastic Demand- Price increase causes TR to increase Price decrease causes TR to decrease Unit Elastic- Price changes and TR remains unchanged Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic?
10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue A Price decreased and TR increased, so… Demand is ELASTIC 50% B 125%

2. Price Elasticity of Supply
Elasticity of supply shows how sensitive producers are to a change in price. Elasticity of supply is based on time limitations. Producers need time to produce more. INelastic = Insensitive to a change in price (Steep curve) Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price (Flat curve) Most goods have elastic supply in the long-run Perfectly Inelastic = Q doesn’t change (Vertical line) Set quantity supplied

3. Cross-Price Elasticity of Demand
Cross-Price elasticity shows how sensitive a product is to a change in price of another good It shows if two goods are substitutes or complements % change in quantity of product “b” % change in price of product “a” P increases 20% Q decreases 15% If coefficient is negative (shows inverse relationship) then the goods are complements If coefficient is positive (shows direct relationship) then the goods are substitutes

4. Income-Elasticity of Demand
Income elasticity shows how sensitive a product is to a change in INCOME It shows if goods are normal or inferior % change in quantity % change in income Income increases 20%, and quantity decreases 15% then the good is a… INFERIOR GOOD If coefficient is negative (shows inverse relationship) then the good is inferior If coefficient is positive (shows direct relationship) then the good is normal Ex: If income falls 10% and quantity falls 20%…

Password Demand Substitute Inferior Good Elastic Total Revenue Test

Password Subsidy Supply Excise Tax Inelastic Elasticity Coefficient

Elasticity Practice 138

(i)The price of tickets (ii)The quantity of tickets sold
1996 Micro FRQ #2 The Toledo arena holds a maximum of 40,000 people. Each year the circus performs in front of a sold out crowd. (a) Analyze the effect on each of the following of the addition of a fantastic new death-defying trapeze act that increases the demand for tickets. (i)The price of tickets (ii)The quantity of tickets sold (b) The city of Toledo institutes an effective price ceiling on tickets. Explain where the price ceiling would be set. Explain the impact of the ceiling on each of the following. (i) The quantity of tickets demanded (ii) The quantity of tickets supplied 140

Consumer Choice and Utility Maximization

The Law of Diminishing “ADDITIONAL” “SATISFACTION”

Would you see the movie three times?
Thinking at the Margin # Times Watching Movie Marginal Utility Price 1st $30 $10 2nd $15 3rd $5 Total $50 Would you see the movie three times? Notice that the total benefit is more than the total cost but you would NOT watch the movie the 3rd time.

Calculate Marginal Utility
# of Slices of Pizza Total Utility (in utils) Marginal Utility/Benefit 1 8 2 14 3 19 4 23 5 25 6 26 7 24 How many slices would you buy if the price per slice was $2?

# of Slices of Pizza Total Utility (in dollars) Marginal Utility/Benefit 1 8 2 14 6 3 19 5 4 23 25 26 7 24 -2 Marginal Cost $2 How many pizzas would you buy if the price per slice was $2?

# of Slices of Pizza Total Utility (in dollars) Marginal Utility/Benefit 1 8 2 14 6 3 19 5 4 23 25 26 7 24 -2 Marginal Cost 2 You will continue to consume until Marginal Benefit = Marginal Cost How many pizzas would you buy if the price per slice was $2?

Marginal Utility Per Dollar
CONSUMER BEHAVIOR You plan to take a vacation and want to maximize your utility. Based on the info below, which should you choose? Destination Marginal Utility (In Utils) Price Tahiti 3000 $3,000 Chicago 1000 $500 Marginal Utility Per Dollar 1 Util 2 Utils

Marginal Utility Per Dollar
CONSUMER BEHAVIOR You plan to take a vacation and want to maximize your utility. Based on the info below, which should you choose? Destination Marginal Utility (In Utils) Price Tahiti 3000 $3,000 Chicago 1000 $500 Marginal Utility Per Dollar 1 Util 2 Utils Calculating Marginal Utility Per Dollar allows you to compare products with different prices.

Utility Maximization $10 $5
# Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 10 2nd 20 5 3rd 2 4th 1 If you only have $25, what combination of movies and go carts maximizes your utility?

# Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 3 10 $2 2nd 20 5 $1 3rd 2 $.40 4th $.50 1 $.20 If you only have $25, what combination of movies and go carts maximizes your utility?

# Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 3 10 2 2nd 20 $2 5 $1 3rd $.40 4th $.50 1 $.20 If you only have $25, what combination of movies and go carts maximizes your utility?

# Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 3 10 2 2nd 20 5 1 3rd .40 4th .50 .20 If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximizing Rule
The consumer’s money should be spent so that the marginal utility per dollar of each good equal each other. 3 apples and 2 oranges Assume apples cost $1 each and oranges cost $2 each. If the consumer has $7, identify the combination that maximizes utility.

Utility Maximizing Rule
The utility maximizing rule assumes that you always consume where MU/P for each product is equal 154

Unit 2: Supply, Demand, and Consumer Choice

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Unit 2: Supply, Demand, and Consumer Choice

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Presentation on theme: "Unit 2: Supply, Demand, and Consumer Choice"— Presentation transcript:

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