1. ECON 308 Week 5.R1 February 22-24, 2011 Chapter 4

2. Review Markets are the interaction of buyers and sellers. Focus on buyers and sellers separately. Ceteris paribus: look at one thing at a time; All other things held equal.

3. $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 Demand x Demand shows the amounts purchased at alternative prices (horizontal distances at each price) Qty x /T DxDx DxDx Demand for X

4. Supply Curve $Price $10 8 6 4 2 2 4 6 8 10 12 14 16 Qty x/ T

5. $Price $ 4 3 2.50 2.00 1.50 1.00.50.25 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T Demand Supply Surplus at this $ Price

6. $Price $ 4 3 2.50 2.00 1.50 1.00.50.25 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T Demand Supply Shortage at this $ Price

7. $Price 4 3 2.50 2.00 1.50 Pe Pe 1.00.50.25 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T Qe DemandSupply Market Equilibrium Qty D = Qty S

8. $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T Supply Do DoDo SxSx Effects of Increase in Demand on Price and Quantity Increases Price and Quantity Pe Qe D1D1 D1D1

9. $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T Demand DxDx S0S0 Effects of an Increase in Supply on Price and Quantity Price decreases and Quantity increases Pe Qe S0S0 S1S1 S1S1

10. $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T Supply Demand DxDx Pe Qe Total Revenue = P X Q $6x5 = $30

11. AB PxPx PxPx Q x /T P0P0 Q0Q0 P0P0 Q0Q0 Slope of Supply Shows responsiveness of quantity to a change in Price P1P1 Q1Q1 P1P1 Q1Q1

12. Slope Shows Responsiveness of Quantity to a Change in Price A B PxPx PxPx Q x /T P0P0 P0P0 DxDx DxDx Q0Q1Q0Q1 Q0Q0 P1P1 P1P1 Q 1

13. Elasticity: a Measure of responsiveness of Quantity to a Change in Price E d = % Δ Q d / % Δ price E s = %  Q s / %  price

14. Measures of Elasticity ElasticDemand is Elastic : %Δ Q d > %Δ P; ie |E d | >1. A decrease in Price  an increase in Total Revenue. Unitary ElasticDemand is Unitary Elastic: %ΔQ d = %ΔP; ie |E d | = 1. A Change in price  no change in Total Revenue. InelasticDemand is Inelastic: %ΔQ d < %ΔP; i.e. |Ed| < 1. An increase in Price  an increase in Total Revenue.

15. Elasticity, Price Change & Total Revenue $Px Elastic Inelastic Q1Q1 Qty/T P0P0 P1P1 Q0Q0 P1P1 P0P0 Q0Q0 Q1Q1

16. Increased Demand with elastic Supply $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T SxSx DxDx DxDx SxSx Pe Qe Dx` Qe` Pe`

17. $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T SxSx DxDx DxDx SxSx Pe Qe Dx’ Qe’ Pe’ Increased Demand, Inelastic Supply

18. Decrease in Supply, Elastic Demand $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T SxSx DxDx DxDx S x’ Pe QeQe` Pe`

19. $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 1 2 3 4 5 6 7 8 9 10 11 12 Qty x /T SxSx DxDx DxDx Sx’Sx’ Pe QeQe’ Pe’ Decrease in Supply, Inelastic Demand

20. Determinants of Price Elasticity of Demand Number & Closeness of Substitutes. Information about price change and availability of substitutes. Percentage of Income Spent on good. Second Law of DemandPeriod of time: Second Law of Demand: Demand is more elastic over a longer period of time.

21. Other Elasticity's A Measure of responsiveness of Quantity to a Change in some other factor

22. Income Elasticity: Measure of responsiveness of Quantity to a Change in Income E dI = % Δ Q d / % Δ income E dI = 100 * ΔQ/Q = I * ΔQ 100 * ΔI/I Q * ΔI Normal Goods: Positive Clothing:.95: 10%  income → 9.5%  Stereo: 27.2: 10%  income → 27.2%  Increase may be Quantity or Quality Inferior Goods: Negative

23. Cross Price Elasticity: Measure of responsiveness of Quantity to a Change Price of other good E xy = % Δ Q x / % Δ P y E dI = 100 * ΔQ x /Q x = P y * ΔQ x 100 * ΔP y /P y Q x * ΔP y Substitutes: Positive Complements: Negative

24. Uses of Cross Price Elasticity Magnitude of cross price elasticity reflects closeness of substitutes or complements Able to identify your closest competitors Courts use cross-price to measure monopoly power

25. Review Markets are the interaction of buyers and sellers. Focus on buyers and sellers separately. Ceteris paribus: look at one thing at a time; All other things held equal.

26. Other Elasticity's A Measure of responsiveness of Quantity to a Change in some other factor

27. Income Elasticity: Measure of responsiveness of Quantity to a Change in Income E dI = % Δ Q d / % Δ income E dI = 100 * ΔQ/Q = I * ΔQ 100 * ΔI/I Q * ΔI Normal Goods: Positive Clothing:.95: 10%  income → 9.5%  Stereo: 27.2: 10%  income → 27.2%  Increase may be Quantity or Quality Inferior Goods: Negative

28. Cross Price Elasticity Measure of responsiveness of Quantity to a Change Price of other good E xy = % Δ Q x / % Δ P y E dI = 100 * ΔQ x /Q x = P y * ΔQ x 100 * ΔP y /P y Q x * ΔP y Substitutes: Positive Complements: Negative

29. Uses of Cross Price Elasticity Magnitude of cross price elasticity reflects closeness of substitutes or complements Able to identify your closest competitors Courts use cross-price to measure monopoly power

30. Network Effects Demand for a good increases as the number of users of the good increases –fax machines –High Definition DVD versus Blu-Ray 4-30

31. Product Attributes Managers must understand consumer demand What product attributes are important to consumers? –price –product design –packaging –promotion 4-31

32. Product Life Cycle Time Industry quantity of output Introduction Product life cycle MaturityDeclineGrowth T Q 4-32

33. Demand Estimation Three general techniques –interviews surveys, focus groups, questionnaires –price experimentation track changes in sales when prices change –statistical analysis must account for omitted variables and other issues 4-33

34. Omitted Variables Problem 200620072008 Income (I)$3,000$4,000$3,500 Advertising (A)232.5 Price (P)10 Sales (S)236284260 True demandS=120-2P+8A+0.04I Estimated demand S=140+48A 4-34

35. Estimating Demand T he Identification Problem Price (in dollars) Quantity Estimated demand $ Q S1S1 S2S2 S3S3 D1D1 D2D2 D3D3 Q1Q1 Q2Q2 Q3Q3 P1P1 P2P2 P3P3 Three different equilibriums are not mapping out the demand curve 4-35

36. Transaction Costs of Exchange Information Costs –Search Costs –Quality Identification Cost Negotiating Costs: Cost of agreeing on what and how much will be exchanged Transportation Costs: Cost of moving goods between parties 36