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Microeconomics Lesson 2

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Topics 1. Homework 2. Review Supply and Demand 3. Floors and Ceilings 4. Elasticity 5. Consumer Choice

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Another S & D example PriceQ dPriceQ s

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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?

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Floors and Ceilings See the examples on the board.

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Price Elasticity of Demand Measures the sensitivity or (responsiveness) of quantity consumers demand to changes in the price of a product

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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)]

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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)

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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)

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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

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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

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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!

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Bill and his price Bill 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. Bills 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?

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Bills Answer Since Ed was ___ (greater than 1) then Bill should lower his price not raise if he wants to maximize revenue

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Other uses for Ed Tax incidence Predict the change in quantity from a change in price Evaluate the effectiveness of social policies

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Circular Flow

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Consumer Behavior Utility Theory Indifference Curves (the abbreviated version)

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Satisfaction What if there were some way to measure the satisfaction a person derived from consuming a certain quantity of a good? sound

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Utility Theory The nearest we can come in Economics to measuring satisfaction is the UTIL.

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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

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UTILS and Mounds Bars Mounds Bars Total Utility Marginal Utility TU2-TU1/Q2-Q TU3-TU2/Q3-Q TU4-TU3/Q4-Q3

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Utility and Consumer Behavior Choosing a diaper QChoiceMUPriceMU/P 49Cloth5$ Service30$ Disposable60$

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Utility again Choosing a windshield wiper ChoiceMUPriceMU/P Good8$ Better24$ Best30$

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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.

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Choosing a combination of two goods to maximize utility See the example on the board

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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.

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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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