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ECON 308
Week 3
September 14, 2012
Chapter 4
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.
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10
Demand x
Demand shows the amounts purchased at alternative prices (horizontal distances at each price)
Qtyx /T
Dx
Dx
Demand for X
Supply Curve$Price
$10
8
6
4
2
2 4 6 8 10 12 14 16 Qty x/ T
$Price
$ 4
3
2.50
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Demand
Supply
Surplus at this $ Price
$Price
$ 4
3
2.50
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Demand
Supply
Shortage at this $ Price
$Price
4
3
2.50
2.00
1.50
PePe 1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T QeQe
Demand Supply
Market EquilibriumMarket Equilibrium
Qty D = Qty S
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SupplyDo
Do
Sx
Effects of Increase in Demand on Price and Quantity
Increases Price and Quantity
Pe
Qe
D1
D1
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
Demand
DxS0
Effects of an Increase in Supply on Price and Quantity
Price decreases and Quantity increases
Pe
Qe
S0
S1
S1
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SupplyDemand
Dx
Pe
Qe
Total Revenue = P X Q
$6x5 = $30
A B
PxPx
Qx/T Qx/T
P0
Q0
P0
Q0
Slope of Supply Shows responsiveness of quantity to a change
in Price
P1
Q1
P1
Q1
Slope Shows Responsiveness of Quantity to a Change in Price
A B
Px Px
Qx/T Qx/T
P0 P0
Dx
Dx
Q0Q1 Q0
P1P1
Q1
Elasticity: a Measure of responsiveness of Quantity to a Change in Price
• Ed = % Δ Qd/ % Δ price
• Es = % Qs / % price
Measures of Elasticity
• Demand is ElasticElastic : %Δ Qd > %Δ P;
ie |Ed| >1. A decrease in Price an increase in Total Revenue.
• Demand is Unitary ElasticUnitary Elastic: %ΔQd = %ΔP;
ie |Ed| = 1. A Change in price no change in Total Revenue.
• Demand is InelasticInelastic: %ΔQd < %ΔP;i.e. |Ed| < 1. An increase in Price an increase in Total Revenue.
Elasticity, Price Change & Total Revenue
$Px $PxElastic
Inelastic
Q1Qty/T
P0
P1
Q0
P1
P0
Q0Q1
Increased Demand with elastic Supply$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
Sx
Dx
Dx
Sx
Pe
Qe
Dx`
Qe`
Pe`
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx
Pe
Qe
Dx’
Qe’
Pe’
Increased Demand , Inelastic Supply
Decrease in Supply, Elastic Demand$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx’
Pe
QeQe`
Pe`
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T
SxDx
Dx
Sx’
Pe
QeQe’
Pe’
Decrease in Supply, Inelastic Demand
Determinants of Price Elasticity of Demand
• Number & Closeness of Substitutes.
• Information about price change and availability of substitutes.
• Percentage of Income Spent on good.
• Period of time: Second Law of DemandSecond Law of Demand: Demand is more elastic over a longer period of time.
Other Elasticity's
A Measure of responsiveness of Quantity to a Change in some other factor
Income Elasticity: Measure of responsiveness of Quantity to a Change in Income
• EdI = % Δ Qd/ % Δ income
• EdI = 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
Cross Price Elasticity: Measure of responsiveness of Quantity to a Change Price of other good
• Exy = % Δ Qx/ % Δ Py
• EdI = 100 * ΔQx/Qx = Py * ΔQx
100 * ΔPy/Py Qx * ΔPy
• Substitutes: Positive
• Complements: Negative
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
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
Product Attributes
• Managers must understand consumer demand
• What product attributes are important to consumers?– price– product design– packaging– promotion
4-26
Product Life Cycle
Time
Indu
stry
qu
antit
y of
out
put
Introduction
Product life cycle
Maturity DeclineGrowth
T
Q
4-27
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
Omitted Variables Problem
2006 2007 2008
Income (I) $3,000 $4,000 $3,500
Advertising (A) 2 3 2.5
Price (P) 10 10 10
Sales (S) 236 284 260
True demand S=120-2P+8A+0.04I
Estimated demand S=140+48A
4-29
Estimating DemandThe Identification Problem
Pric
e (in
dol
lars
)
Quantity
Estimated demand
$
Q
S1
S2
S3
D1
D2
D3
Q1 Q2 Q3
P1
P2
P3
Three differentequilibriums are notmapping out the demand curve
4-30
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