ECON 308 Week 5 R1 February 22 24 2011 Chapter 4 Review Markets are the interaction of buyers and sellers Focus on buyers and sellers separately Ceteris paribus look at one thing at a time All other things held equal Demand for X Px 10 9 8 7 6 5 4 3 2 1 Dx Demand shows the amounts purchased at alternative prices horizontal distances at each price Demand x Dx 1 2 3 4 5 6 7 8 9 10 Qtyx T Supply Curve Price 10 8 6 4 2 2 T 4 6 8 10 12 14 16 Qty x Price 4 3 2 50 Demand Surplus at this Price Supply 2 00 1 50 1 00 50 25 100 200 300 400 500 600 700 800 900 1000 1100 Q x T Price 4 3 Demand 2 50 Supply 2 00 1 50 1 00 50 25 Shortage at this Price 100 200 300 400 500 600 700 800 900 1000 1100 Q x T Market Equilibrium Price 4 3 2 50 2 00 Demand Qty D Qty S Supply 1 50 Pe 1 00 50 25 100 200 300 400 500 600 700 800 900 1000 1100 Q x T Qe Px 10 9 8 7 Pe 6 5 4 3 2 1 Effects of Increase in Demand on Price and Quantity Do D1 Supply Increases Price and Quantity Sx D1 Do 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qtyx T Px 10 9 8 7 Pe 6 5 4 3 2 1 Effects of an Increase in Supply on Price and Quantity S0 Demand S1 Price decreases and Quantity increases S0 Dx S1 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qtyx T Px 10 9 8 7 Pe 6 5 4 3 2 1 Total Revenue P X Q Demand 6x5 30 Supply Dx 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qtyx T Slope of Supply Shows responsiveness of quantity to a change in Price A B Px Px P1 P1 P0 P0 Q0 Q1 Qx T Q0 Q1 Qx T Slope Shows Responsiveness of Quantity to a Change in Price B A Px Px P0 P0 P1 P1 Dx Dx Q0Q1 Qx T Q0 Q1 Qx T Elasticity a Measure of responsiveness of Quantity to a Change in Price Ed Qd price Es Qs price Measures of Elasticity Demand is Elastic Qd P ie Ed 1 A decrease in Price an increase in Total Revenue Demand is Unitary Elastic Elastic Qd P ie Ed 1 A Change in price no change in Total Revenue Demand is Inelastic Inelastic Qd P i e Ed 1 An increase in Price an increase in Total Revenue Elasticity Price Change Total Revenue Px Elasti c Px P1 P0 Inelasti c P0 P1 Q0 Q1 Q1 Q0 Qty T Increased Demand with elastic Supply Px 10 9 8 Pe 7 Pe 6 5 4 3 2 1 Dx Sx Sx Dx Dx 1 2 3 4 5 6 Qe 7 8 9 Qe 10 11 12 Qtyx T Increased Demand Inelastic Supply Px 10 9 8 Pe 7 6 Pe 5 4 3 2 1 Sx Dx Dx Sx Dx 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qe Qtyx T Px 10 9 8 Pe 7 Pe 6 5 4 3 2 1 Decrease in Supply Elastic Demand Dx Sx Sx Dx 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qe Qtyx T Px 10 9 8 Pe 7 6 Pe 5 4 3 2 1 Decrease in Supply Inelastic Demand Dx Sx Sx Dx 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qe Qtyx T Determinants of Price Elasticity of Demand Number Closeness of Substitutes Information about price change and availability of substitutes Percentage of Income Spent on good Period of time Second Law of Demand Demand Demand is more elastic over a longer period of time Other Elasticity s A Measure of responsiveness of Quantity to a Change in some other factor Income Elasticity Measure of responsiveness of Quantity to a Change in Income EdI Qd income EdI 100 Q Q I Q 100 I I Q I Normal Goods Positive Clothing 95 10 income 9 5 Stereo 27 2 10 income 27 2 Increase may be Quantity or Quality Inferior Goods Negative Cross Price Elasticity Measure of responsiveness of Quantity to a Change Price of other good Exy Qx Py EdI 100 Qx Qx Py Qx 100 Py Py Qx Py Substitutes Positive Complements Negative Uses of Cross Price Elasticity Magnitude of cross price elasticity reflects closeness of substitutes or complements Able to identify your closest competitors Courts use cross price to measure monopoly power Review Markets are the interaction of buyers and sellers Focus on buyers and sellers separately Ceteris paribus look at one thing at a time All other things held equal Other Elasticity s A Measure of responsiveness of Quantity to a Change in some other factor Income Elasticity Measure of responsiveness of Quantity to a Change in Income EdI Qd income EdI 100 Q Q I Q 100 I I Q I Normal Goods Positive Clothing 95 10 income 9 5 Stereo 27 2 10 income 27 2 Increase may be Quantity or Quality Inferior Goods Negative Cross Price Elasticity Measure of responsiveness of Quantity to a Change Price of other good Exy Qx Py EdI 100 Qx Qx Py Qx 100 Py Py Qx Py Substitutes Positive Complements Negative Uses of Cross Price Elasticity Magnitude of cross price elasticity reflects closeness of substitutes or complements Able to identify your closest competitors Courts use cross price to measure monopoly power Network Effects Demand for a good increases as the number of users of the good increases fax machines High Definition DVD versus Blu Ray 4 30 Product Attributes Managers must understand consumer demand What product attributes are important to consumers price product design packaging promotion 4 31 Product Life Cycle Industry quantity of output Q Introduction Growth Maturity Decline Product life cycle T Time 4 32 Demand Estimation Three general techniques interviews surveys focus groups questionnaires price experimentation track changes in sales when prices change statistical analysis must account for omitted variables and other issues 4 33 Omitted Variables Problem 2006 2007 2008 3 000 4 000 3 500 2 3 2 5 Price P 10 10 10 Sales S 236 284 260 Income I Advertising A True demand S 120 2P 8A 0 04I Estimated demand S 140 48A 4 34 Estimating Demand The Identification Problem Price in dollars Three different equilibriums are not mapping out the demand curve S1 P1 S2 D1 P2 D2 P3 S3 D3 Estimated demand Q 1 Q2 Q3 Quantity Q 4 35 Transaction Costs of Exchange Information Costs Search Costs Quality Identification Cost Negotiating Costs Cost of agreeing on what and how much will be exchanged Transportation Costs Cost of moving goods between parties 36