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ECON 308 Week 3 September 14, 2012 Chapter 4

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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.

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

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Supply Curve $Price $ Qty x/ T

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$Price $ Q x/ T Demand Supply Surplus at this $ Price

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$Price $ Q x/ T Demand Supply Shortage at this $ Price

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$Price Pe Pe Q x/ T Qe DemandSupply Market Equilibrium Qty D = Qty S

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

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$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 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

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

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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

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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

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

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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.

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

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

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$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T SxSx DxDx DxDx SxSx Pe Qe Dx Qe Pe Increased Demand, Inelastic Supply

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Decrease in Supply, Elastic Demand $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T SxSx DxDx DxDx S x Pe QeQe` Pe`

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$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T SxSx DxDx DxDx S x Pe Qe Pe Decrease in Supply, Inelastic Demand

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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.

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

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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

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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

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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

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Network Effects Bandwagon: Demand for a good increases as the number of users of the good increases –fax machines –High Definition DVD versus Blu-Ray Snob: Demand for a good decreases as the number of users of the good increases 4-25

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Product Attributes Managers must understand consumer demand What product attributes are important to consumers? –price –product design –packaging –promotion 4-26

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Product Life Cycle Time Industry quantity of output Introduction Product life cycle MaturityDeclineGrowth T Q 4-27

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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 4-28

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Omitted Variables Problem Income (I)$3,000$4,000$3,500 Advertising (A)232.5 Price (P)10 Sales (S) True demandS=120-2P+8A+0.04I Estimated demand S=140+48A 4-29

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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 4-30

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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 31

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