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Microeconomics
Lesson 2
Topics
1. Homework
2. Review Supply and Demand
3. Floors and Ceilings
4. Elasticity
5. Consumer Choice
Another S & D example
Price Q d Price Q s
60 0 60 500
50 100 50 400
40 200 40 300
30 300 30 200
20 400 20 100
10 500 10 0
Answer:
Price = $ Quantity =
What happens to price and quantity if the price of a substitute good increases?
What happens to price and quantity if the cost of production decreases?
Floors and Ceilings
See the examples on the board.
Price Elasticity of Demand
Measures the sensitivity or (responsiveness) of quantity consumers demand to changes in the price of a product
Equation for Coefficient of Elasticity of Demand
% change in quantity ÷ % change in price
The equation for determining the coefficient elasticity of demand is:
[(Q1-Q2)÷(Q1+Q2)]÷[(P1-P2)÷(P1+P2)]
Examples
1. Q1 = 250 Q2 = 300 P1=50 P2=40
Answer = ___ ( <1, inelastic)
2. Q1 = 250 Q2 = 500 P1 = $6 P2=$5
Answer = ___ (>1, elastic)
3. Q1 = 250 Q2 = 300 P1 = $6 P2=$5
Answer = __ (unit elastic)
More examples
4. Q1 = 500 Q2 = 500 P1 = $6 P2=$5
Answer = __ (perfectly inelastic)
5. Q1 = 500 Q2 = 600 P1 = $5 P2=$5
Answer = undefined (perfectly elastic)
Sesame Street School of Ed
A key to identifying elastic or inelastic demand is the shape of the Demand Curve:
The more the curve looks like a capital I, the more inelastic the demand, and the fewer the substitutes
The more the curve looks like a capital E, the more elastic the demand, and there must be many substitutes
Uses of Elasticity of Demand
We can use Elasticity of Demand to determine the price where we Maximize Total Revenue
Remember the equation for Total Revenue TR = Price x Quantity
Elasticity, Price, Total Revenue
If Ed > 1 then: an increase in price will cause TR to drop A decrease in price will cause TR to go up
If Ed < 1 then: An increase in price will cause TR to go up A decrease in price will cause TR to drop
If Ed = 1 then: TR is maximized!
Bill and his priceBill Gates called and he wants to know if he should raise the price of his Office software package.Currently, the package is $400 and they sell 10,000/day. Bill’s research shows that if they raise the price to $440 sales will drop to 8,000/day. What is the Ed of the Office software?Should Bill raise the price if he wants to maximize Total Revenue?
Bill’s Answer
Since Ed was ___ (greater than 1) then Bill should lower his price not raise if he wants to maximize revenue
Other uses for Ed
Tax incidence
Predict the change in quantity from a change in price
Evaluate the effectiveness of social policies
Circular Flow
Consumer Behavior
Utility Theory
Indifference Curves (the abbreviated version)
Satisfaction
What if there were some way to measure the satisfaction a person derived from consuming a certain quantity of a good?
sound
Utility Theory
The nearest we can come in Economics to measuring satisfaction is the UTIL.
The UTIL
Is an imaginary measure of satisfaction
Total utility measures the total UTILS of satisfaction the consumer enjoys
Marginal utility is the change in total utility from one additional unit of the good
UTILS and Mounds Bars
Mounds Bars
Total Utility
Marginal Utility
0 0
1 15 15.0 TU2-TU1/Q2-Q1
2 20 5.0 TU3-TU2/Q3-Q2
3 2 -18.0 TU4-TU3/Q4-Q3
Utility and Consumer Behavior
Choosing a diaper
Q Choice MU Price MU/P
49 Cloth 5 $2.00 2.5
49 Service 30 $6.25 4.8
49 Disposable 60 $8.25 7.5
Utility again
Choosing a windshield wiper
Choice MU Price MU/P
Good 8 $4.00 2.0
Better 24 $6.00 4.0
Best 30 $10.00 3.0
Maximizing Utility
Pick the affordable combination of consumer goods that makes the marginal utility per dollar of one good equal to the marginal utility per dollar spent on a second good.
Choosing a combination of two goods to maximize utility
See the example on the board
Indifference Curves
Indifference curves are like a topographic map of the “Hill of Happiness”
You want to consume that combination that gets you highest on the hill of happiness given your budget constraint.
Indifference Curves
The word to remember if this ever comes up again is TANGENT
The key is to choose that point on the budget constraint that is TANGENT to the highest indifference curve.
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