Supply and Demand:
Section 9
Finally getting into Microeconomics
Behind the Curves
First what can shift a supply curve?
R esources
O ther goods
T echnology
T axes
E xpectations (producers)
N umber of producers
Second, what can shift a demand curve?
T
R
I
B
E
aste
elated goods
ncome
uyers (number of)
xpectations
Substitutes and Complements
What is a substitute?
How does this affect/relate demand for a good?
A complement?
How does this affect/relate to demand for a good?
Elasticity Explained
Elastic
Consumers are very responsive
Will change purchasing behavior quickly
Inelastic
Consumers are NOT very responsive
Will not change purchasing behaviors quickly
Unit Elastic
Consumer behavior changes directly proportional to
price/quantity changes
Consumer Choice
Substitution Effect
Prices
, Demand
Opportunity costs
We substitute the cheaper good for the one we would
have purchased = substitution effect
Consumer Choice
Substitution effect – has greatest bearing on goods that
we rarely purchase
Examples?
Income effect
Change in the quantity of a change in the purchasing
power of a consumers income
Housing – prices go up, we buy smaller/cheaper houses
Other examples?
Consumer Choice
Most goods are NORMAL goods
Income
, demand
People start to buy inferior goods
Giffen Goods
Theory, never proven
Inferior goods = prices increase
Ex: Irish and potatoes
Consumer Choice
Elasticity
Independent/dependent variables and price
What else affects a good’s price?
Substitutes and compliments
Question to ask:
NOT IF a dependent good (compliment) will change due
to price increases BUT how much will the quantity
demanded decrease/increase?
Elasticity – measure how responsive the quantity demanded
is to a change in price
Consumer Choice
Price elasticity of demand
Flu shot vaccine example
Time to do
research!
Consumer Choice
Magic number with Elasticity is 1
Below 1 – inelastic
Demand will change a relatively small amount when price changes
Examples:
Gas
Health care
Flu shots
Crack rocks?
Above 1 – elastic
Demand will change in greater amounts if price changes
Examples:
Restaurant meals
Housing
Foreign Travel
1 = unit elastics
Consumer Choice
Interpreting Price Elasticity of Demand
How elastic IS elastic?
Perfectly inelastic
No matter the price of a good, the quantity demand stays
Consumer Goods
Perfectly elastic
A tiny price change will cause the quantity demanded to change
Consumer Choice
Why does the elasticity of a good matter?
Crucial to know how price changes affect
REVENUE = P x Q sold
TOTAL
Consumer Choice
Besides rare cases of perfectly inelastic or perfectly elastic goods, two
effects are important and can be found using elasticity
Price effect – Price
Quantity Effect – Price
=
=
price, raises revenue
products sold, lowers revenue
Consumer Choice
Price elasticity of demand tells us what happens when price
changes, and the size of that effect
Unit-elastic (price elasticity of d = 1)
Increase in price does not change total revenue
Inelastic (price elasticity of d < 1)
Higher price increases total revenue
Price effect is stronger than quantity effect
Elastic (price elasticity of d > 1)
Increase in price reduces revenue
Quantity effect is stronger than price effect
Consumer Choice
What factors determine the price elasticity of demand?
Are close substitutes available?
Ex: difference between Pepsi and Coke
Is the good a necessity or luxury?
Ex: Ferrari
What share of income is spent on the good?
Ex: Starbucks
Time
Ex: Gas crisis in the 1970s
Thinking about what we know about economics so far…
Should price elasticity affect a person’s choice of college?
Consumer Choice
Further Elasticities of Demand (and Supply)
Demand for a good is often affected by the price of other, related
goods
If a price changes for hot dogs, how much does this affect demand for
hamburgers?
Cross-Price Elasticity for Demand = %∆ Qd for Good A
%∆ in Price of B
o When two goods are substitutes, Cross-Price Elasticity is Positive (shift
demand curve of Good B to the right)
o When goods are compliments, hot dogs and hot dog bunds, CPE is
negative (shift left of Good B)
**The (+) or (-) sign matters here**
Consumer Choice
Income Elasticity of Demand
Changes in income affect a good = %∆ in Qd
%∆ in income
o
o
o
Income Elasticity is (+) – Normal good
Income Elasticity is (-) – Inferior good
Income Elasticity (normal goods)
o
Income – elastic (>1)
o If income rises, the demand for a good rises FASTER than rise in
income
o
Income – inelastic (<1 but >0)
o When income rises, the demand for a good is SLOWER than rise in
income
Consumer Choice
Price Elasticity of Supply
The response of producers to price changes
Examples – produce more products, reduce production
Price Elasticity of Supply = %∆ in Qs
%∆ in price
o Same rules as Demand Elasticities, just along the supply curve
Consumer Choice
Consumer Choice
What factors determine the Price Elasticity of Supply?
Availability of inputs
Too few inputs means higher cost of production
Time
Response of producers to inputs, prices
Ex – Fish supply, pizza, cell phone radio spectrum