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Demand Curves • Deriving Demand Curves from Indifference Curves • Law of Demand • Ceteris Paribus Assumption • Shifts in Demand Curves – A Change in Demand • Movements along a Demand Curve – A Change in Quantity Demanded • Elasticity – Price – Income – Cross Price • Market Demand Curves • Consumer Surplus Deriving a Demand Curve Price Consumption Curve (or Price Expansion Path) E* E3 E4 E1 E2 Good X We can show the effects of changing prices on the consumption of good X (and also Y). We can trace the consumption path as shown above. The Price Consumption Curve is consistent with a Demand Curve for various Prices Demand Curves Price of X E E1 E2 E3 E4 D Quantity of X Shifts and Movements in Demand Curves Price of Good X P1 A C P2 B D2 D1 Quantity of X Q1 Q 2 Q 2’ • What is A to B? • What is A to C? • What causes each? Elasticity: Measuring Consumer Responses to Change • Elasticity is a means of measuring consumer response to changes in relevant variables. We focus on elasticity measures which give information about the response of demand to changes. • The formulation of elasticity is a unitless measure. We calculate it as the ratio of proportions. • Price Elasticity of Demand is: D %Qd %P Elasticity of Demand • Elasticity is the Percentage Change in Quantity Demanded divided by the Percentage Change in Price • In use we can calculate this is two different forms: • Arc Elasticity--the response of demand over a range of prices. The basic formula is adapted to consider the two price-quantity combinations. This is called the mid-point formula. Q1 Q2 Q1 Q 2 d 2 P P 1 2 P P2 1 2 Elasticity of Demand • Point Price Elasticity--This second form is based upon the response to changes in (and around) a single price-quantity combination. • This is calculated from rearranging the basic elasticity formula: Q P d Q P •The first part is the slope of the demand function (i.e., Q=a+bP, this is b). The second is simply the price and quantity. Elasticity of Demand: An Example • Consider the following example: • Q = 100 - 4P • For this demand function, find the elasticity of demand at: – P= 10 – P= 20 – between P= 10 and 20 Elasticity Relationships Price of Good X P1 A P2 B D1 Quantity of X Q1 Q2 Elasticity Relationships Price of Good X What can we say about the value of elasticity along a (linear) demand curve? E P D1 Quantity of X Q Elasticity Relationships Price of Good X How does elasticity vary as we change price (and Q)? P E D1 Revenue Quantity of X Q Total Revenue Quantity of X Elasticity and Pricing • How can the elasticity value be used to help in setting the appropriate price? • Firms wishing to maximize profit determine price by producing the output where MR=MC • The relationship between MR and Price is determined by the expression • MR = P(1 + 1/) • Thus, we can just substitute MC for MR or • MC = P(1 + 1/) Other Demand Elasticity Measures • Income Elasticity – Formula – Use of income elasticity to classify goods • Cross Price Elasticity – Formula – Use of cross elasticity to classify goods %Qd % Q x I xy d %I % Py Using Price Elasticity • How can this information be used? • Help determine what will happen based upon a given change in the price of a good • Useful in knowing about the effects of other events (e.g., macroeconomic factors) on demand in a market [Income elasticity would be useful here, too] • Pricing relationships • What are the determinants of price elasticity? – Degree of necessity – proportion of budget spent on good [relation to income] – ability to find suitable substitutes • Relationship between these ideas and the demand function

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posted: | 2/9/2012 |

language: | English |

pages: | 14 |

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