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Consumer Choice

Consumer Choice. 1. Limited Incomes. requires choices be made. 2. Rational. same cost - greater benefit. same benefit - least cost. 3. Substitutes Available. 4. Limited Information. 5. Diminishing Marginal Utility. Consumer Demand. Why the Demand Curve slopes down. One Reason:.

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Consumer Choice

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  1. Consumer Choice 1. Limited Incomes requires choices be made 2. Rational same cost - greater benefit same benefit - least cost 3. Substitutes Available 4. Limited Information 5. Diminishing Marginal Utility

  2. Consumer Demand Why the Demand Curve slopes down One Reason: Substitution Effect At a lower price consumers can switch to the cheaper good, substituting the cheaper for the more expensive.

  3. Consumer Demand Why the Demand Curves slopes down A Second Reason: Income Effect A lower price of a good will increase purchasing power of the consumer. They can buy more than before.

  4. Consumer Demand Why the Demand Curves slopes down A Third Reason: Diminishing Utility Consumers get less satisfaction as they buy more of a good. For the consumer to buy more the price must be reduced.

  5. John’sdemand curvefor frozen pizza MB1 MB2 MB3 Price = $2.50 MB4 d = MB < < < MB4 MB3 MB2 MB1 because < < < MU4 MU3 MU2 MU1 The Pizza Demand Curve • The demand for frozen pizzas reflects the law of diminishing marginal utility. Price • Because marginal utility (MU) falls with increased consumption, so does a consumer’s maximum willingness to pay -- marginal benefit (MB). $3.50 $3.00 $2.50 • A consumer will purchase untilMB =Price. . . $2.00 so at $2.50 they would purchase 3 frozen pizzas and receive a consumer surplus shown by the shaded area (above the price line and below the demand curve). Frozen pizzasper week 1 2 4 3

  6. Two Goods Available Marginal Utility per $ Domestic $1 MU Imported $2 MU With Constraint Number Bought Domestic MU/$ Imported MU/$ 24 20 18 16 12 6 4 10 8 7 6 5 4 3 ____ ____ 1 2 3 4 5 6 7 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ Without Income Constraint? With $12?

  7. MUB MUN MUA PB PN PA Consumer Response to Changes in Price = = . . . = Choices are based on Comparisons of MU per $ spent on each good

  8. Total Value vs Marginal Value Which is more valuable water or diamonds? “Why are you going out? Are your friends more important to you than me?” High Total Value, but Smaller Marginal Value

  9. D d d Individual and Market Demand Curves • ConsiderJones’s demand for frozen pizza. At $3.50Jonesdemands 1 pizza … and so on … at $2.50 3 pizzas … • ConsiderSmith’sdemand for frozen pizza. At $3.50Smithdemands 2 pizzas … and so on … at $2.50 3 pizzas … • Themarket demand curveis merely the horizontal sum of the individual demand curves (hereJonesandSmith). • Themarket demand curvewill slope downward to the right, just as the individual demand curves do. Jones Smith 2-Person market Price Price Price $3.50 $3.50 $3.50 $2.50 $2.50 $2.50 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Weekly frozen pizza consumption

  10. Price Elasticityof demand = = % Change inquantity demanded % Q % P % Change in Price Elasticity again the responsiveness of the amount purchased to a change in price. - or put more simply - - - - ( Q Q ) ( P P ) ( Q Q ) P = = 0 1 0 1 0 1 0 X - P ) ( P P Q Q 1 0 0 0 0 PED > 1 Elastic < 1 Inelastic = 1 Unit Elastic

  11. For Example: Quan 1 100 20 12 150 45 32 Price 1 5 8 3 12 6 24 Quan 2 120 25 16 200 45 40 Price 2 3 7 0 10 8 2 Ch in Q Q1 ___ ___ ___ ___ ___ ___ P1 Ch inP ___ ___ ___ ___ ___ ___ X X X X X X ___ ___ ___ ___ ___ ___ = = = = =

  12. Elasticity and Total Revenue ___ ___ ___ ___ ___ ___ ___ ___ Quan 1 2 3 4 5 6 7 8 Price 8 7 6 5 4 3 2 1 Elasticity ___ ___ ___ ___ ___ ___ ___ X X X X X X X X = = = = = = =

  13. Calculate the Price Elasticity of the following: 1. The number of cans demanded of a soft drink increases by 30 % after its price decreases by 40% 2. The number of available apartments increases by 8% following a 6 % increase in rents 3. The number of Caesar salads demanded at a restaurant increases from 60 to 80 per week when the price falls from $5.00 to $4.50 4. At a price of $200, 10,000 treadmills were supplied each month. Since the price increased to $250, 14,000 are supplied each month. 5. The number of DVDs demanded each weekend from Blockbuster falls from 500 to 400 following an increase in the rental charge from $2.00 to $2.40

  14. Price Elasticityof demand = = % Change inquantity demanded % Q = % P % Change in Price = Elasticity Mid Points Formula - But use average Q and average P -

  15. Elasticity What affects Elasticity??? 1. Available Substitutes 2. Necessity vs Luxury 3. Proportion of Income 4. Time to shop around

  16. Price • Perfectly inelastic:An increase in Price results in no change in Quantity Mythicaldemandcurve Quantity/time (a) Price • Relatively inelastic: A percent increase in Price results in a smaller % reduction in Quantity Demand for Cigarettes Quantity/time (b) Different Elasticities

  17. Price • Unitary elasticity: The percent change in quantity demanded due to an increase in price is equal to the % change in price. Demand curve of unitary elasticity Quantity/time (c)

  18. Relatively elastic: A % increase in Price leads to a larger % reduction in Quantity. Price Demand for Granny Smith Apples Quantity/time (d) Price • Perfectly elastic: Consumers will buy all of Farmer Hollings’s wheat at the market price, but none will be sold above the market price. Demand for Farmer Hollings’s wheat Quantity/time (e) Elasticity of Demand

  19. Examples Inelastic Approximately Unitary Elasticity Movies 0.9 Salt 0.1 Homes, owner occupied (long run) 1.2 Matches 0.1 Shellfish (consumed at home) 0.9 Toothpicks 0.1 Oysters (consumed at home) 1.1 Airline travel (short run) 0.1 Private education 1.1 Gasoline (short run) 0.2 Tires (short run 0.9 Gasoline (long run) 0.7 Tires (long run) 1.2 Natural gas, home (short run) 0.1 Radio and television receivers 1.2 Natural gas, home (long run) 0.5 Coffee 0.3 Fish (cod), at home 0.5 Elastic Tobacco products (short run) 0.5 Legal services (short run) 0.4 Restaurant meals 2.3 Physician services 0.6 Foreign travel (long run) 4.0 Taxi (short run) 0.6 Airline travel (long run) 2.4 Automobiles (long run) 0.2 Fresh green peas 2.8 Automobiles (short run 1.4 Chevrolet automobiles 4.0 Fresh tomatoes 4.6

  20. Income Elasticityof demand = % Change inquantity demanded % Change inIncome Income Elasticity • the responsiveness of a product’s demand to a change in income. • A normal goodhas a positive income elasticity of demand. • As income increases, the demand for normal goods increases. • Goods with a negative income elasticity are inferior goods. • As income expands, the demand for inferior goods will decline.

  21. Low Income Elasticity High Income Elasticity Margarine - 0.20 Private education 2.46 Fuel 0.38 New Cars 2.45 Electricity 0.20 Recreation and amusements 1.57 Fish (haddock) 0.46 Alcohol 1.54 Food 0.51 Tobacco 0.64 Hospital care 0.69 Income Elasticity of Demand

  22. Cross Price Elasticity = % Change inQx % Change inPy Cross Price Elasticity • the responsiveness of a product’s demand to a change in the price of another good. • A complementhas a negative cross price elasticity. • As Py increases, the demand for Y decreases, and demand for goods that are consumed with Y also decreases. • A substitute has a positive cross price elasticity • As Py increases, the demand for Y decreases, and demand for goods that can be consumed instead of Y also decreases.

  23. 1. If sleeping is required for good health and survival and attending Economics class is not, why is it more important to attend class rather than sleeping in? (The answer may appear on page 455)

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