1. Consumer Choice and Elasticity
Micro Chapter 7
Consumer Choice and Elasticity

2. This chapter is an extension of the first part of Chapter 3 on demand and consumer theory
Refer back to your Chapter 3 notes and mentally combine them with Chapter 7 notes

3. 6 Learning Goals
List the key factors influencing consumer behavior (repeat from Chapter 3)
Apply the concept of marginal utility to determine how a demand curve is derived (repeat from Chapter 3)
Define, calculate, and graph elasticity of demand
Relate demand elasticity to total revenue
Define and calculate income elasticity
Define and graph elasticity of supply

4. Elasticity of Demand

5. Law of demand states that if price rises (falls), quantity demanded falls (rises)
Elasticity gives us more information about the consumer
Price elasticity seeks to quantify how much quantity demanded falls (rises)

6. Class Activity: Draw two demand curves side by side
Class Activity: Draw two demand curves side by side. Increase price by the same amount in each graph. Draw the first demand curve illustrating a small reduction in quantity demanded. Draw the second demand curve illustrating a large reduction in quantity demanded.

7. Graphs:
Watch content video: Inelastic-Elastic demand curves

8. Other questions to consider:
By how much does price need to rise to decrease quantity demanded by X%?
By how much does price need to fall to increase quantity demanded by Y%?

9. Price elasticity of demand= percentage change in quantity demanded / percentage change in price
Elasticity = % Δ Qd
% Δ P

10. Values of price elasticity
If ε > 1, then elastic
Consumers change their behavior a lot
If ε < 1, then inelastic
Consumers change their behavior a little
If ε = 1, then unitary elastic
Consumers don’t change their behavior

11. Key point: Price elasticity is NOT the slope of the demand curve
A straight-line demand curve will have constant slope but a different elasticity at every point

12. I often do a survey of my students to see if their demand for places at the university responds to prices. The price of places at the university is the tuition charged. I offer students the possibility of zero tuition increase for next year, a 5 percent increase for next year, and a 10 percent increase. Each student is then asked whether he or she will return next year. I recently got the following results: For a 5 percent tuition increase, the number of students returning would decrease by 2.2 percent, implying a price elasticity of demand equaling For a 10 percent tuition increase, however, the number returning would fall by 11.8 percent, implying an elasticity of The demand curve is surely downward sloping. Not only does the number of places demanded decline when tuition rises more; the responsiveness of demand- the price elasticity of demand- is greater in percentage terms when the university tries to raise tuition by higher amounts. That’s not surprising: Substitutes that suddenly become slightly cheaper don’t affect behavior proportionately as much as substitutes that suddenly become relatively a lot cheaper.
Q: Who is likely to be more inelastic, freshmen or juniors? Why?

13. Q7.1 If a large percentage increase in the price of a good results in a small percentage reduction in the quantity demanded of the good, demand is said to be
unitary elastic.
relatively inelastic.
relatively elastic.
perfectly elastic.

14. Q7.2 When economists say the demand for a good is highly inelastic, they mean that
even if the price rose substantially, suppliers would be unwilling to offer much more of the good.
the facilities utilized by producers of the good are inflexible; producers cannot easily expand their facilities, even in the long run.
consumers will respond to a change in the price of the good by purchasing substantially more of it.
a large (percentage) change in the price of a good will result in only a small (percentage) change in the quantity demanded.

15. What determines elasticity?
(1) Availability of substitutes
More substitutes, more elastic (more responsive)
(2) Share of budget
Greater share, more elastic
(3) Time
More time, more elastic

16. Q7.3 Members of Alpha fraternity have developed a strong liking for Coca-Cola. Beta fraternity members buy the same amount of Coke but believe Pepsi is just about as good. From this, we can infer that
Alpha members will not care what the price of Coke is.
compared to Alpha members, Betas will have a smaller price elasticity of demand for Coke.
compared to Alpha members, Betas will have a larger price elasticity of demand for Coke.
Alpha members will increase their purchases by a larger amount of Pepsi than Beta members in response to a "50 cents off" sale on a case of Pepsi.

17. How Demand Elasticity and Price Changes Affect Total Expenditures (or Revenues) on a Product

18. Impact of higher price on total consumer expenditures or a firm’s total revenue
Impact of lower price on total consumer expenditures or a firm’s total revenue
Elasticity coefficient (in absolute value)
Price elasticity of demand
1 to 
Elastic
decrease
increase
Unitary Elastic 1
-- unchanged --
-- unchanged --
Inelastic
0 to 1
increase
decrease

19. Don’t memorize this chart!
Use it as a tool
Think about what elasticity tells us and then apply it to total revenue

20. Total Revenue (TR) to the firm is Total Expenditure (TE) by the consumer. TR = TE = P x Q
If elastic and price falls: ↓ P x ↑Q = ↑TR
Lower price and lots more is bought, Q dominates equation
If elastic and price rises: ↑ P x↓Q = ↓TR
Raise price and lots less is bought, Q dominates equation
If inelastic and price falls:↓P x ↑ Q = ↓TR
Lower price and a little more is bought, P dominates equation
If inelastic and price rises: ↑ P x ↓ Q = ↑TR
Raise price and a little less is bought, P dominates equation

21. A different way to look at this:
4 graphs
Watch content video: Elasticity and TR

22. The local airport in Austin, Texas, opened in 1999 with on-site parking, priced from $18 per day for garage parking to $6 per day for distant uncovered parking. The lots were so crowded that soon the Airport Authority built an additional lot. By 2002, off-site parking places had opened up, offering covered parking for $8 per day, and some offering three-minute shuttle service to the terminal. Not surprisingly, this entry of new competitors into the parking market has left many on-site places empty, and the airport’s parking revenues this year have fallen from $22 million to $18 million. If the Airport Authority is smart, it would think about what its demand elasticity is, lower prices if it believes demand is elastic, not lower them, and maybe even raise them (especially on garage parking) if it believes demand is inelastic. The evidence suggests management believes that the demand is elastic for the garage parking, because in 2004 they lowered the price for garage parking to $15 per day.
Q: For which part of the airport parking areas is the demand likely to be more or less elastic, the garage parking or the uncovered distant parking? In light of your beliefs about this question, how would you alter prices?

23. Q7.4 Suppose ε = 0.52 and the firm raises price. What happens to TR?
TR rises
TR falls
TR remains constant

24. Q7.5 Suppose the firm wants to raise TR and it knows demand is elastic. What should the firm do?
Raise price
Lower price
Keep price the same

25. Q7.6 (MA) In which of the following cases will the total spending on a good decrease?
Demand is elastic, and price decreases.
Demand is elastic, and price increases.
Demand is inelastic, and price increases.
Demand is inelastic, and price decreases.

26. Income Elasticity

27. Price elasticity measures the change in consumer purchases when price changes
Income elasticity measures the change in consumer purchases when income changes
Income Elasticity = % Δ Qd
% Δ I

28. Values of income elasticity
If positive, consumers buy more when income rises
Normal good - a good that consumers will buy more of when income rises
If negative, consumers buy less when income rises
Inferior good - a good that consumers will buy less of when income rises

29. Price Elasticity of Supply

30. Price elasticity of supply measures the responsiveness of quantity supplied to price changes
How much does quantity supplied increase (or decrease) when price rises (or falls)?

31. Graphs:
Watch content video: Inelastic-Elastic supply curves

32. Question Answers: Q7.1 = 2 Q7.2 = 4 Q7.3 = 3 Q7.4 = 1 Q7.5 = 2