Transcript Law of Demand  Recall the Cost-Benefit Principle

Law of Demand
Law of Demand
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
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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
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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
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Fig. 5.7
The Demand Curve for Movie Tickets
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Fig. 5.8
The Demand Curve for Movie Tickets
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Fig. 5.10
Total Expenditure as a Function of Price
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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
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Price Elasticity of Demand

P
D
% Q
D
%P
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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
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Fig. 5.11
Elastic and Inelastic Demand
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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
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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
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Examples
What are some goods that will have
very elastic demand?
What are some goods that will have
very inelastic demand?
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Calculating Price Elasticity
Proportion by which quantity demanded
changes divided by the proportion by which
price changes
%Q


%P
Q
Q
P
Q
P
1
slope

P
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Fig. 5.12
Graphical Interpretation of Price
Elasticity of Demand
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Other Elasticities of
Demand
Income Elasticity of Demand
The amount by which the quantity
demanded changes in response to a onepercent change in income
Positive for normal goods
Negative for inferior goods
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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
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Perfect Elasticity
Perfectly Elastic 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?
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Fig. 5.14
Perfectly Elastic and Perfectly Inelastic
Demand Curves
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Price Elasticity of Supply
The percentage change in the quantity
supplied that will occur in response to a
one-percent change in its price

S
P

% Q
%P
S

Q
Q
P
P

P
Q
1
slope
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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
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Perfect Elasticity
Perfectly Inelastic
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
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Fig. 6.10
A Perfectly Inelastic Supply Curve
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Fig. 6.11
A Perfectly Elastic Supply Curve
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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?
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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?
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