1. Law of Demand Law of Demand Recall the Cost-Benefit Principle
People do less of what they want to do as the cost of doing it rises
Recall the Cost-Benefit Principle
Pursue an action if and only if its benefits are at least as great as its costs
Recall the Reservation Price
The highest price we’d be willing to pay

2. Total Expenditure Total Expenditure equals
The number of units sold multiplied by the price of the good
Total Expenditure = Total Revenue
The dollar amount that consumers spend on a product is equal to the dollar amount that sellers receive

3. The Law of Demand and Total Expenditure
“Will consumers spend more on my product if I sell more units at a lower price or fewer units at a higher price?”
Depends upon price elasticity of demand
When price rises, total expenditure may
increase, decrease, or stay the same
This is due to the Law of Demand
As price rises, quantity demanded falls
As price falls, quantity demanded rises

4. Fig. 5.7 The Demand Curve for Movie Tickets

5. Fig. 5.8 The Demand Curve for Movie Tickets

6. Fig. 5.10 Total Expenditure as a Function of Price

7. Price Elasticity of Demand
In order to predict what will happen to total expenditures,
We must know how much quantity will change when the price changes
Price elasticity of demand is
the percentage change in the quantity demanded that results from a one-percent change in its price

8. Price Elasticity of Demand

9. Price Elasticity
Elastic – quantity changes by a lot when price changes even a little
price elasticity is greater than one
Inelastic – quantity changes by a little when price changes even a lot
price elasticity is less than one
Unit elastic – quantity change = price change
price elasticity equals one
When calculating price elasticity of demand, you will always get a negative- WHY?
For convenience we will take the absolute value

10. Fig. 5.11 Elastic and Inelastic Demand

11. Price Elasticity and Expenditures
For an elastic product
Quantity demanded is highly responsive
Percentage change in quantity dominates
An increase in price will reduce total expenditure
A decrease in price will increase total expenditure
For an inelastic product
Quantity demanded is not responsive
Percentage change in price dominates
An increase in price will increase total expenditure
A decrease in price will decrease total expenditure

12. Determinants of Elasticity
Substitution possibilities
Price elasticity of demand will be relatively high if it is easy to substitute between products – Why?
Budget share
The larger the share of the budget the good uses tends to have higher price elasticities of demand – Why?
Time
Because substitution takes time, price elasticity will be higher in the long run than in the short run

13. Examples What are some goods that will have very elastic demand?
What are some goods that will have very inelastic demand?

14. Calculating Price Elasticity
Proportion by which quantity demanded changes divided by the proportion by which price changes

15. Fig. 5.12 Graphical Interpretation of Price Elasticity of Demand

16. Other Elasticities of Demand
Income Elasticity of Demand
The amount by which the quantity demanded changes in response to a one-percent change in income
Positive for normal goods
Negative for inferior goods

17. Other Elasticities of Demand
Cross Price Elasticity of Demand
The amount by which the quantity demanded of one good changes in response to a one-percent change in the price of another good
Positive for substitutes
Negative for complements

18. Perfect Elasticity Perfectly Elastic demand Perfectly Inelastic demand
Price elasticity of demand is infinite
Even the slightest change in price leads consumers to find substitutes
Perfectly Inelastic demand
Price elasticity of demand is zero
Consumers do not switch to substitutes even when price increases dramatically
Do goods like these exist?

19. Fig. 5.14 Perfectly Elastic and Perfectly Inelastic Demand Curves

20. Price Elasticity of Supply
The percentage change in the quantity supplied that will occur in response to a one-percent change in its price

21. Determinants of Supply Elasticity
The more easily additional units of inputs can be acquired, the higher the price elasticity (more elastic)
Flexibility of Inputs
Mobility of Inputs
Ability to Produce Substitute Inputs
Time
Unique and Essential Inputs

22. Perfect Elasticity Perfectly Inelastic Perfectly Elastic
Elasticity of supply is zero
Whether the price is high or low, the same amount is available
Perfectly Elastic
Elasticity of supply is infinite
When additional units can be produced using the same combination of inputs purchased at the same prices

23. Fig. 6.10 A Perfectly Inelastic Supply Curve

24. Fig. 6.11 A Perfectly Elastic Supply Curve

25. Elasticity of Supply
What determines whether the supply of a particular good will be elastic or inelastic?
Availability of resources used to produce the good – how quickly and easily can producers respond to a price change?
Eg of good with inelastic supply?
Eg of good with elastic supply?

26. Naturalist Questions
Why do you pay $5 for a beer in the airport when you can buy the same beer for less than $1 outside the airport?
Why do you get a discounted airfare when you stay over a Saturday night?
Why are there so many personalized license plates in Virginia vs. NC?