Microeconomics

Chapter 20: Elasticities of Demand and Supply

Chapter 21: Consumer Behavior and Utility Maximization

Demand - willingness and ability to pay for goods and services

An individual's demand for a specific product is determined by these four factors:

* Tastes (desire for this and other goods)

* Income (of the consumer)

* Expectations (for income, prices, tastes)

* Other goods (their availability and prices)

The more pleasure a product gives us, the higher the price we'd be willing to pay for it

Utility  expected pleasure or satisfaction

Total utility - amount of satisfaction obtained from your entire consumption of a product

Marginal utility - amount of satisfaction you get from consuming the last (marginal) unit of a product.

Marginal Utility = Change in total utility

Change in quality

MU is +  TU 

Law of Diminishing Utility = each successive unit of a good consumed yields less additional utility (satisfaction)

Thrill diminishes with each mouthful

With given income, tastes, expectations, and prices of other goods & services, people are willing to buy additional quantities of a good only if its price falls.

As MU diminishes  so does our willingness to pay

LAW OF DEMAND (page 374, Figure 21.1)

Price Elasticity - (by how much the quantity demanded would fall if the price were raised)

* The response of consumers to a change in price

* %change in quantity demanded / % change in price

Price Elasticity = % change in Qd

E % change in P

1. Emphasis: The percentages changes are compared, not the absolute changes.

a. Absolute changes depend on choice of units. For example, a change in the price of a $10,000 car by $1 and is very different than a change in the price a of $1 can of beer by $1. The auto's price is rising by a fraction of a percent while the beer price is rising 100 percent.

b. Percentages also make it possible to compare elasticities of demand for different products.

Elasticity (page 362, Table 20.2)

* E > 1  demand is elastic

* Consumers are very responsive to changes in prices

* WHY?

1. Luxuries

2. Availability of Substitutes (more substitutes  elasticity)

3. "Big Ticket" items - Relative price to income

4. Long Run is more elastic than short run

* Examples: fast food, airline travel,

* E < 1 &#61664; demand is inelastic

* Consumers are not responsive to changes in prices

* WHY?

1. Necessities (toothpaste)

2. No available substitutes

3. Cheaper goods

4. Short run is more inelastic than long run

* Examples: cigarettes, coffee, gasoline, electricity

Because the price of a good affects E, the value of E changes along a demand curve*

Total Revenue

Amount of money received from product sales and is determined by Quantity Sold & Price

Total Revenue = Price X Quantity Sold

* Price hike increases TR only if demand is inelastic (E1)

* Price hike does not change TR if demand is unitary-elastic (E=1)

*

Impact of a price change on TR depends on the (changing) price elasticity of demand*

When the determinants of demand change (income, tastes, expectations, and other goods), the entire demand curve shifts.

Movement along the demand curve represents consumer response to a change in PRICE &#61664; the magnitude of the movement is expressed in price elasticity.

Other Elasticities: (page 368, Table 20.4)

1. Income Elasticity

Measure of consumer responses to changes in income

Income elasticity = %change in Qd

% change in income

* Normal goods - consumers purchase more as income rises

* Inferior goods - quantity demanded falls when income rises

1. A positive income elasticity indicates a normal or superior good.