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Microeconomics

Microeconomics. Lesson 2. Topics. 1. Homework 2. Review Supply and Demand 3. Floors and Ceilings 4. Elasticity 5. Consumer Choice. Another S & D example. Answer:. Price = $ Quantity = What happens to price and quantity if the price of a substitute good increases?

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Microeconomics

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  1. Microeconomics Lesson 2

  2. Topics • 1.Homework • 2. Review Supply and Demand • 3. Floors and Ceilings • 4. Elasticity • 5. Consumer Choice

  3. Another S & D example

  4. Answer: • Price = $ Quantity = • What happens to price and quantity if the price of a substitute good increases? • What happens to price and quantity if the cost of production decreases?

  5. Floors and Ceilings • See the examples on the board.

  6. Price Elasticity of Demand • Measures the sensitivity or (responsiveness) of quantity consumers demand to changes in the price of a product

  7. Equation for Coefficient of Elasticity of Demand • % change in quantity ÷ % change in price • The equation for determining the coefficient elasticity of demand is: • [(Q1-Q2)÷(Q1+Q2)]÷[(P1-P2)÷(P1+P2)]

  8. Examples • 1. Q1 = 250 Q2 = 300 P1=50 P2=40 • Answer = ___ ( <1, inelastic) • 2. Q1 = 250 Q2 = 500 P1 = $6 P2=$5 • Answer = ___ (>1, elastic) • 3. Q1 = 250 Q2 = 300 P1 = $6 P2=$5 • Answer = __ (unit elastic)

  9. More examples • 4. Q1 = 500 Q2 = 500 P1 = $6 P2=$5 • Answer = __ (perfectly inelastic) • 5. Q1 = 500 Q2 = 600 P1 = $5 P2=$5 • Answer = undefined (perfectly elastic)

  10. Sesame Street School of Ed • A key to identifying elastic or inelastic demand is the shape of the Demand Curve: • The more the curve looks like a capital I, the more inelastic the demand, and the fewer the substitutes • The more the curve looks like a capital E, the more elastic the demand, and there must be many substitutes

  11. Uses of Elasticity of Demand • We can use Elasticity of Demand to determine the price where we Maximize Total Revenue • Remember the equation for Total Revenue TR = Price x Quantity

  12. Elasticity, Price, Total Revenue • If Ed > 1 then: • an increase in price will cause TR to drop • A decrease in price will cause TR to go up • If Ed < 1 then: • An increase in price will cause TR to go up • A decrease in price will cause TR to drop • If Ed = 1 then: TR is maximized!

  13. Bill and his price • Bill Gates called and he wants to know if he should raise the price of his Office software package. • Currently, the package is $400 and they sell 10,000/day. Bill’s research shows that if they raise the price to $440 sales will drop to 8,000/day. • What is the Ed of the Office software? • Should Bill raise the price if he wants to maximize Total Revenue?

  14. Bill’s Answer • Since Ed was ___ (greater than 1) then Bill should lower his price not raise if he wants to maximize revenue

  15. Other uses for Ed • Tax incidence • Predict the change in quantity from a change in price • Evaluate the effectiveness of social policies

  16. Circular Flow

  17. Consumer Behavior • Utility Theory • Indifference Curves (the abbreviated version)

  18. Satisfaction • What if there were some way to measure the satisfaction a person derived from consuming a certain quantity of a good? sound

  19. Utility Theory • The nearest we can come in Economics to measuring satisfaction is the UTIL.

  20. The UTIL • Is an imaginary measure of satisfaction • Total utility measures the total UTILS of satisfaction the consumer enjoys • Marginal utility is the change in total utility from one additional unit of the good

  21. UTILS and Mounds Bars

  22. Utility and Consumer Behavior Choosing a diaper

  23. Utility again • Choosing a windshield wiper

  24. Maximizing Utility • Pick the affordable combination of consumer goods that makes the marginal utility per dollar of one good equal to the marginal utility per dollar spent on a second good.

  25. Choosing a combination of two goods to maximize utility • See the example on the board

  26. Indifference Curves • Indifference curves are like a topographic map of the “Hill of Happiness” • You want to consume that combination that gets you highest on the hill of happiness given your budget constraint.

  27. Indifference Curves • The word to remember if this ever comes up again is TANGENT • The key is to choose that point on the budget constraint that is TANGENT to the highest indifference curve.

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