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Note that you have a homework assignment due this Friday. Let's start today with a review of what we actually covered from Chapter 4 last time. Key questions for you:
Today we'll focus on: --why interference with market forces can prevent a move to equilibrium and thereby lower efficiency --what happens when other factors--such as income or technology--change, leading to shifts in supply or demand. This is covered in more detail in the notes that were posted for the last lecture (we didn't cover them, due to the snow day problems). Note that a rightward shift of supply tends to lower equilibrium price. But a rightward shift of demand tends to increase equilibrium price. Does an increase in income increase the demand for a good? If so, it's a "normal" good. Does an increase in increase decrease the demand for a good? If so, it's an "inferior" good. Two goods are substitutes if an increase in the price of one makes you more likely to buy the other.
Two goods are complements if an increase in the price of one makes you less likely to buy the other.
Chapter 5: Demand There are two key concepts in this chapter. One is the Rational Spending Rule for Two Goods, which stipulates that if you are getting more pleasure for the money from your last unit of consumption of good A than from your last unit of consumption of good B, you will consume more of good A. As you consume more of good A, however, the marginal utility you get will tend to decline. When it declines to the level of marginal utility you get from good B, your consumption of these two goods will be in equilibrium. Keep in mind that when economists say "utility" what they really mean is "pleasure." Not usefulness. In my list of optional discussion group presentations, number 3 is the "coke-popcorn" experiment. It might be helpful to actually go through this. The second key concept is elasticity. This concept is less obvious than the Rational Spending Rule, and has more applications to the real world. It is also more difficult. PRETEND YOU ARE A CAPITALIST. Your goal in life is to maximize profits. What are profits? Total revenues minus total costs. Let's leave the costs out of the picture right now, and focus on revenues. Revenues are the product of price and quantity. Take the following demand information:
WHAT PRICE DO YOU WANT TO CHARGE FOR YOUR PRODUCT? IF YOU RAISE THE PRICE, THE QUANTITY DEMANDED FALLS. BIG QUESTION FOR YOU: DOES THE EFFECT OF A DECREASE IN QUANTITY CANCEL OUT THE EFFECT OF AN INCREASE IN PRICE?
Let's focus on figure 5.8 (The Demand Curve for Movie Tickets).
Total expenditure is quantity times price. Note that you can think of it as the area of the rectangle defined by the quantity and price.
Elasticity is defined as the percentage change in quantity divided by the percentage change in price. Since the relationship between price and quantity on a demand curve is negative (when one goes up the other goes down), elasticity will always have a negative sign. We ignore this, since it's the absolute value that matters. If the percentage change in quantity is GREATER than the percentage change in price this ratio will be greater than one. In this situation, we say the demand is elastic--which is another way of saying that is it quite responsive to price. In this case, an increase in price will reduce total expenditure. We will go into more detail about formulas
for calculating elasticity in next class. |
