1. Elasticity Chapter 20

2. Why We Study Economics To understand the problem of scarcity: the problem of fulfilling the unlimited wants of humankind with limited and/or scarce resources.

3. Economizing Problem: Scarce Resources Because of scarcity, economies need to allocate their resources efficiently.

4. Utility Underlying the laws of demand and supply is the concept of utility,

5. Utility Represents the advantage or fulfillment a person receives from consuming a good or service. (not necessarily useful)

6. Utility Explains how individuals and economies aim to gain optimal satisfaction in dealing with scarcity

7. Measuring Utility Util: a measure of relative satisfaction. Utilitarianism: Society should aim to maximize the total utility of individuals, aiming for "the greatest happiness for the greatest number of people". John Stuart Mill (1806 -1873)

8. Average Utility = Total Utility # Units Consumed

9. Marginal Utility The additional satisfaction a consumer gains from consuming one more unit of a good or service. = Utility # Units Consumed

10. Maximizing Utility When Marginal Utility = 0 There is a point when marginal utility diminishes as more of a product is consumed.

11. Law of Diminishing Utility as a person increases consumption of a product - (while keeping consumption of other products constant) - there is a decline in the marginal utility that person derives from consuming each additional unit of that product. http://www.youtube.com/watch?v=qF_ypa CnDsg

12. Law of Diminishing Utility Diminishing marginal returns imply increasing marginal cost

13. Increasing Marginal Utility As more of a good/service is consumed more satisfaction is achieved. Goods/Services that are ‘relievers’ have this quality.

14. Example: Room Full of 10 Screaming Bieber Fans You’d only pay 1st to shut up $1, but with each additional quiet fan you’d pay more b/c more quiet is achieved. Last one is worth $10. http://www.youtube.com/watch?v=2C- R23d-zSc

15. How You Too Can Maximize Your Utility by Following this one simple easy Rule To maximize your overall utility all the goods/services you purchase should have the same Marginal Utility. Why? Because buying one more of one means less of another, if all are at same Marginal utility, nothing is gained! You were at your happy place! 4 slices of pizza and 3 milkshakes = $11. Total utility = (90 + 50) + (80 + 40) + (70 + 30) + 60 = 420 [the sum of the marginal utilities] The last items purchased have the same marginal utility per dollar spent (30)

16. What is the MU/P for Movies & Bowling? MU/P = MU divided by price

17. What is the Maximum Utility?

18. 2 movies + 1 bowling = 240 Utils 1 movie + 3 bowling = 230 Utils If our rule is to have the marginal utility per dollar spent on the last items be the same for all goods, we are unable to have that exactly but we try to get as close as possible. There is no other combination that would give us greater utility given our income.

19. Law of Demand as the price of a good or service increases, consumer demand for the good or service will decrease and vice versa, ceteris paribus. Ceteris paribus all other factors being equal.

20. Law of Supply The tendency of suppliers to offer more of a good at a higher price.

21. Price Elasticity of Demand measures the rate of response of quantity demanded due to a price change.

22. Elasticity of Demand Responsiveness of the Demand for a good or service to the increase or decrease in its price. i.e buyers’ responsiveness to price changes

23. Formula to determine elasticity. Elasticity = (% Change in Quantity Demanded) (% Change in Price)

24. Elastic Demand Coefficient: E d >1 Slight change in price leads to a sharp change in the quantity demanded. If elasticity is greater than 1, the curve is considered to be elastic. % change in quantity demanded > % change in price

25. Elastic Demand: E d >1 Less essential items or items with a wide range of substitutes, and are frequently considered luxuries. hamburgers, lamb chops, and jewelry

26. Inelasticity & Elasticity Newspaper.10 Electricity (household).13 Bread.15 Major league Baseball Tickets.23 Telephone Service.26 Sugar.30 Medical Care.31 Eggs.32 Legal Services.37 Auto Repair.40 Clothing.49 Gasoline.60 Milk.63 Household Appliances.63 Movies.87 Beer.91 Shoes.91 Motor Vehicles1.14 Beef1.27 China, glassware, tableware1.54 Restaurant Meals2.27 Lamb Mutton2.65 Fresh Peas2.83

27. Elastic vs Inelastic Expensive items that consume a large % of a person’s income are more elastic: houses & cars Inexpensive items that area small % of a person’s income are more inelastic: cup of coffee, scotch tape

28. Elastic Demand % increase in price will be smaller than % decrease in quantity demanded Ex: if price increases 10%, the decrease in quantity demanded will be greater than 10%

29. Inelastic Demand % increase in price will be greater than % decrease in quantity demanded. Ex: If E =.2 and price decreases 10%, how much will Quantity Demanded decrease?.2 = (Q 1 - Q 2 ) (1).1 (1) {We say P 1 and Q 1 = 1 to make life easy}.2 (.1) = Q.02 = change in Quantity demanded

30. Example E = 1.2; price change is 20%. How much has Quantity demanded decreased by? 1.2 = Q (1).2 (1) Why the 1s? 1.2 (.2) =.24 Quantity demanded will decrease by 24%, which is greater than 20% price increase.

31. Perfectly Elastic Demand A small decrease change in price would lead to an infinitely large increase in Demand. In perfectly competitive markets (such as, coal), if you can charge slightly less than your competitors, and still make a profit, you will find your customers will attempt to buy as much as you can produce.

32. Inelastic Demand: E d <1 A large movement in price will create very little change in quantity demanded. Inelastic is less than 1.

33. Inelastic Taxing goods/services with inelastic demand results in greater tax revenue.

34. Perfectly Inelastic Demand When a price change has no effect on the demand of a good or service. Quantity stays exactly the same regardless of Price.

35. Unitary Demand: E d =1 a percentage change in price results in an equal and opposite percentage change in demand.

36. 4 Types of Demand Curves

37. Total Revenue: Total revenue (TR) is calculated by multiplying price (P) per unit and quantity (Q) of the good sold. TR = P x Q Profits = Total Revenue - Total Cost

38. Total Revenue TR = rectangle defined by price x quantity

39. Total Revenue Test: Ed > 1, total revenue will decrease as price increases. Ed < 1, total revenue will increase as price increases. So if you supply a good with inelastic demand, as Price increases Total Revenue also increases

40. 4 determinants of elasticity of demand 1.Number of substitutes 2.Degree of necessity 3.Price of the good as a proportion of income 4.Time for adjustment in rate of purchase

41. Applications of price elasticity of Demand Pricing Taxing

42. Application of Price Elasticity Elastic Total Revenue decreases as Price increases Total Revenue increases as Price decreases Inelastic Total Revenue increases as Price increases Total Revenue decreases as Price decreases

43. Elasticity of Supply: measure of the responsiveness of the supply of a given good to a change in the price of that good. E s = ∆ Q x P ∆ P x Q

45. Factors that Affect Price Elasticity of Supply: (1) Spare production capacity (2) Stocks of finished products and components (3) The ease and cost of factor substitution * (4) Time period involved in the production process * Main determinant of Elasticity of Supply

46. Elasticity of Supply Elastic Supply: quantity is responsive to market price Examples: gas (short run); agricultural products (long run); houses Inelastic Supply: quantity is not very responsive to market price Examples: the supply of tickets for sports or musical venues, and the short run supply of agricultural products (where the yield is fixed at harvest time)

47. Elasticity of Supply In Long Run…. Supply is Elastic Because Time allows firms to adjust down or for new firms to enter the market

48. In The Short Run, Supply is S 3 In the short run, the firm may not be able to change its factor inputs. S 2 is intermediate market period S 1 is long run, elastic Supply

49. Perfect Elasticity of Supply Perfect Inelasticity of Supply Example: da Vinci painting of Mona LisaExample: air

50. Unitary Elasticity of Supply Es = 1 For an increased unit of price, one more unit supplied

51. how to calculate the price elasticity of demand using the midpoint method

52. Cross Elasticity of Demand: measures the responsiveness of the demand for a good to a change in the price of another good. XED = % change in QD good A % change in price good B

53. Cross Elasticity of Demand: The formula used to calculate the coefficient cross elasticity of demand is CPEoD = (% Change in Quantity Demand for Good X) (% Change in Price for Good Y)

54. Cross Elasticity of Demand Example: in response to a 10% increase in the price of fuel, the demand of new cars that are fuel inefficient decreased by 20%,

55. Cross Elasticity of Demand If the two goods are complements the cross elasticity of demand will be negative as the price of good Y rises, the demand for good X falls.

56. Cross Elasticity of Demand If the two goods are substitutes the cross elasticity of demand will be positive, As the price of good Y rises, the demand for good X rises

57. Cross Elasticity of Demand If two goods that are independent have a zero cross elasticity of demand: As the price of good Y rises, the demand for good X stays constant

58. Income Elasticity of Demand measures the responsiveness of the demand for a good to a change in the income of the people demanding the good, holding all prices constant. IEoD = (% Change in Quantity Demanded) (% Change in Income) Normal Good

59. Good for which demand increases as consumer income rises, but at a rate slower than the rate of increase in income.

60. Inferior Good Good for which demand declines as the level of income or real GDP in the economy increases.

61. Inferior Good As your income increases, you buy less of a good

62. Tax Incidence tax incidence is the analysis of the effect of a particular tax on the distribution of economic welfare. Example: Sin taxes that fund education

63. Theory of Tax Incidence The economic effect of tax does not necessarily fall at the point where it is legally levied. Example: a tax on employment paid by employers will impact on the employee, at least in the long run. The greatest share of the tax burden tends to fall on the most inelastic factor involved -

64. Not On test! Uber-luxury goods are Inelastic! Not only are they Inelastic, but they defy gravity. As price goes up, so does Demand. Examples: Birkins, Tanqueray Gin, Cristal Champagne, Maybach Landaulet http://www.google.com/images?um=1&hl=en&biw=745&bih=391&tbs=isch%3A1&sa=1&q=birkin+bag&aq=0&aqi=g10&aql=&oq=birkin&gs_rfaihttp://www.google.com/images?um=1&hl=en&biw=745&bih=391&tbs=isch%3A1&sa=1&q=birkin+bag&aq=0&aqi=g10&aql=&oq=birkin&gs_rfai= Price: $1,380,000