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UMass Amherst ECON 103 - Class 11 Elasticity of demand and surplus Fall 2014

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Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15High and low demand elasticitySlide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 3110:47:41Baby chicks10:47:41Bentley the hedgehogThe Elasticity of Demand and Consumer SurplusWhy life is worth living.Or is it?Big ideas •Consumer surplus is the extra pleasure you get over-and-above the price of commodities. It makes life worth living•The elasticity of demand reflects how much consumption falls if prices rise, or vice versa.•The elasticity of demand reflects both need and how easy it is to replace a product.•Capitalists try to turn consumer surplus into profits by raising prices without losing sales. They need to reduce demand elasticity.Puppies make us happyI like dogs because they give me more pleasure than I lose by paying for them.Consumer surplus: the extra pleasure we get from consuming.No surplus on the last, or marginal purchase. Last unit price = MUWe pay just as much as our pleasure.Surplus only from inframarginal purchases, before the marginal purchase.Buy until MU=priceYou get no net pleasure from the last unit because MU=price!MU diminishes. Therefore before the last, MU>price for previous (inframarginal) items. This is surplus!It is the inframarginal that makes you happy!You get consumer surplus from every purchase up to the final oneBeer MU Price Surplus (MU-price) Cumulative Surplus1 15 1.25 13.75 13.752 10 1.25 8.75 22.53 6 1.25 4.75 27.254 3 1.25 1.75 295 2 1.25 0.75 29.756 1.25 1.25 0 29.757 0.5 1.25 -0.75 298 0.25 1.25 -1 289 0 1.25 -1.25 26.75When I buy wine, I buy until the last glass is just worth the costThis means that until then, each gives me more pleasure than it cost.This is surplus.Surplus falls on additional purchasesBecause of diminishing marginal utility – of course! (You knew that!)10:47:42How much surplus will you get if the price of wine is $5/glass?Glass Your Marginal Utility1 $102 $53 $44 $25 $11.$102.$53.$04.I have no idea!How to find total surplusFirst figure out how many glasses you will buy. (Buy until MU=price, or 2 glasses.)Then figure out how much surplus on each glass you buy, or MU-price.On first glass, MU-price = $10-5=$5.On second glass, MU-price=$5-5=0.Total: $5+0=$5.The Elasticity of Demand is the relative change in quantity demanded for a change in priceThe elasticity is the percentage change in quantity divided by the percentage change in price.This tells you how responsive demand is to price changesSome people would keep their puppies at any priceThat is inelastic demand!Demand elasticity depends on two thingsCan you do without the service.(Could you live without puppy love?)Can you find another source if the price rises?(I need gas but I could get it from another gas station.)10:47:43High and low demand elasticityInelastic demand: large change in price, small change in quantityElastic demand: large change in quantity for a small change in priceQuantityPrice“Necessities” don’t necessarily have inelastic demandHighly elastic demand:It is easy to stop buying when prices rise.Consumers either do without or they find another way to get it.Inelastic demand:It is hard to stop buying even when prices rise.Consumers can’t do without and they can’t find another way to get it.It is not only about whether you need the productThe elasticity of demand for Dunkin Donuts may be low even though you don’t need donuts because almost no one else makes good donuts.The elasticity of demand for penicillin from Merck is high even though it may save your life because others make penicillin and there are other antibioticsHenions in downtown Amherst has the best donutsFresh baked every morning – go there after class!Which is better for you?1. Puppies2. Penicillin3. DonutsThis is very sillyCompanies want inelastic demandThen they can raise prices and increase profits without losing salesThey try to make you think you need their product, and to distinguish theirs from their rivals.Some things come in inelastic demand because they are distinct, even uniqueDemand elasticity depends on how important things are.And whether you can substitute for them.Essential: Will keep buying even at higher prices.Dispensable: Will buy something else at higher prices.Two ways to reduce elasticity of demandMake people think that life without the product is not worth living.Reduce alternative sources of supply.Harass and destroy the competition.Advertising is about persuading you that you need things10:47:44They would have you think that their product, and only their product, will make you sexy and happySometimes they have it wrong10:47:44Created scarcity is the key to power and profitMake your product special, unique, and you reduce the elasticity of demand, allowing you to raise prices and profit.Ways to create scarcity:1. Branding: create a reputation for quality2. Control access to technology3. Control access to essential resourcesCapitalism is about profit, not use value. Companies want little monopolies with low elasticity of demandThey brand name, and grab resources, and technology to restrict consumer choices. Trademarks, patents, restrictive labor contracts, land-grabs.Microsoft, the RIAA, the drug companies: all do this to increase profits.EvilArtificial scarcity allows companies to “milk the consumer surplus”Consumer surplus makes life worth living.It is the extra value you get from consumption beyond what you pay.It is the value from your “inframarginal” purchases.By raising prices, artificial scarcity reduces consumer surplus and makes you less happyEven, unhappySo, down with artificial scarcity!Down with monopoly profits!Take-away points•Consumer surplus is the extra pleasure you get over-and-above the price of commodities.•The elasticity of demand tells how much you will reduce consumption if prices go up, or how much more you will buy if prices fall.•The elasticity of demand reflects how much you need the product, and how easy it is to find substitutes.•Capitalists try to turn surplus into profits by raising prices. To do this, they need to lower the elasticity of demand by reducing substitution and


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