Demand and Elasticities Microeconomic Analysis 1-808-07 Tuesday September 8 th 2009.
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Transcript of Demand and Elasticities Microeconomic Analysis 1-808-07 Tuesday September 8 th 2009.
Demand and ElasticitiesMicroeconomic Analysis
1-808-07
Tuesday September 8th 2009
2
Recap
[email protected] (subject: “HEC”)
Office hoursMonday 14:00 -15:00Tuesday 15:30 – 16:30
First Quiz: Tuesday Sept 22nd
HWs: see syllabus for suggested exercises
3
In-class survey
Reason for choosing HEC: Top school, good reputation
Trilingual program
Cheap
International student body
Background in EconomicsNone
French Bacc
4
In-class survey
Grade objective: Average answer A
10 years from now: CEO Travel Sustainable development Intl organisation HR Consulting My own firm
5
In-class survey
Interesting about you:Many different origins (France, Columbia, Tahiti,
etc.)Small business ownerSkydiverDrum playerTouched a sharkSpeaks four languages…
6
Today
Review of last week
Demand
From MV(q) to qid(p)
Elasticities
7
So far…
ValuationV(q) vs. MV(q)Buyer’s decision: P ≤ MV(q)Seller’s decision: MC(q) ≤ P
Gains from trade Surplus
Efficiency / Pareto OptimalityMC(q) = MV(q)
DemandDemand
9
Goals
To go from the behavior of individuals to that of an entire population
To analyze the determining factors of an economy
Being able to understand and to react appropriately to various economic circumstances
p
Q
D
Individual demand
11
Recall: marginal valuation
q
1
2
3
4
Price
0 5 10
MV(q)
0 4
2,5 3
5 2
7,5 1
10 0
Quantity Marginal ValuationMV(q)
12
Recall: marginal valuation
0 4
2,5 3
5 2
7,5 1
10 0
q
How many units would this person buy for a price of $2.50?
MV(q) P < MV(q)?
13
Recall: marginal valuation
0 4 Yes Buy!
2,5 3 Yes Buy!
5 2 No Stop!
7,5 1 No
10 0 No
q
How many units would this person buy for a price of $2.50?
MV(q) P < MV(q)?
14
From MV(q) to qid(p)
For each price, correspond a quantity demanded by the consumer.
In the previous example, a price of $2.50 corresponds to a demand of 2 units.
expenses
Consumer behaviorAt a given unit price, the consumer will choose the quantity, q, which maximizes her surplus: MV(q) = P.
q
1
P = 2
3
4
Prix
0q = 5 10
MV(q)
surplus
Valuation and individual demand
MV(q) = P : the consumer’s demand curve coincides with her marginal valuation curve.
q
1
P = 2
3
4
Price
0q = 5 10
d = MV
Market demand
18
Market demand
The aggregate demand of an entire population.
Market quantity demanded is the sum of quantities demanded by all individuals:
i
di
d qQ
19
Market demand
0 10 __
1 7,5 __
2 5 __
3 2,5 __
4 0 __
Price Ind. quantity Market (4 identical consumers)($) (q) (Q = 4xq)
20
Market demand
0 10 40
1 7,5 30
2 5 20
3 2,5 10
4 0 0
Price Ind. quantity Market (4 identical consumers)($) (q) (Q = 4xq)
Market demand
1
2
3
4
Price
0
5
5 10 15 20 25 30
Draw the demand curve of a population made up of 4 consumers with individual market demand, d.
d
The market demand curve is the horizontal sum of individual demand curves…
4035
Quantitydemanded
22
Market demand
Quantitydemanded 1
2
3
4
Price
0
5
5 10 15 20 25 30
d
The market demand curve is the horizontal sum of individual demand curves…
4035
D
23
The demand function
Demand for Coca-Cola (undiluted syrup):
Qd = 26.17 - 3.98 Pc + 2.25 Pp + 2.60 Ac – 0.62 Ap + 9.58 S + 0.99
Y
With: Qd = quantity demanded of Coca-Cola syrup
Pc, Pp = prices of Coca-Cola and Pepsi syrups
Ac, Ap = advertisement expenditures of Coca-Cola and Pepsi
S = seasonal indicator (=1 if spring or summer, =0 otherwise)
Y = household income
Factors affecting demandQuantity demanded, Qd, generally depends on… :
…the price of the good (falls when the price rises)
…the price of other goods, Po: If Po ↑ Qd ↑, the goods are substitutes If Po ↑ Qd ↓, the goods are complements
… household income: If Y ↑ Qd ↑, the good is normal If Y ↑ Qd ↓, the good is inferior
…other factors. (Examples?)
25
Factors affecting demandQuantity demanded, Qd, generally depends on… :
Giffen goods
26
Exercise
Consider the demand for minivans in the U.S.:
Qd = 12 – 0,6 P + 0,2 Ps – 3 Pg + 0,2 Y
With: Qd = qty demanded (in hundreds of thousands)
P = price of a minivan (in thousand $)
Ps = price of a station wagon (in thousand $)
Pg = price of gasoline (in $ per gallon)
Y = household income (in thousand $ per year)
27
Exercise (cont.)
A. Draw the demand curve for
Ps = $16,000, Pg = $3/gal, and Y = $25,000/yr.
P
Qd
28
Exercise (cont.)
B. Are minivans a normal good?
They can be a normal good over a certain range of income (lower) and become an inferior after a certain range (higher), where rich people would substitute away from minivan once they start getting wealthy enough.
C. Are minivans and station wagons substitutes or complements?
D. Are minivans and gasoline substitutes or complements?
29
Exercise (end)
Effect of a fall in income (crisis):
Effect of an increase in the price of station wagons:
P
Qd
D
P
Qd
D
30
Exercise (end)
Effect of a fall in income (crisis):
Effect of an increase in the price of station wagons:
P
Qd
D
P
Qd
D
31
Summary
A change in the price of a good leads to a movement along the demand curve for that good.
A change in a factor other than the price of the good leads to a shift of the demand curve.
Elasticities
33
Price-elasticity of demand
Elasticity : A number representing the sensitivity of one variable (e.g., Qd) to changes in another variable (e.g., P).
Interpretation: The price-elasticity of demand is the percentage change in Qd when P changes by 1%.
% change in Qd ∆Qd/Qd
Ep = --------------------------- = ---------------- % change in P ∆P/P
34
Computation: local method
Hence, with Qd = 280 – 20P, we get ∆Qd/∆P = -20 everywhere.
At P = 3$, we get Qd = 220 and Ep = - 20 x 3/220 = - 0.27.
At P = 4$, we get Qd = 200 and Ep = - 20 x 4/200 = - 0.4.
Note: The value of the elasticity of demand depends on where we are on the demand curve.
dQ
P
P
QEp
d
35
Ep on a linear D:
We say that D is:
Ep = - ∞: perfectly elastic
Ep = 0: perfectly inelastic
Ep = -1: unit elastic
-∞ < Ep < -1: relatively elastic
-1 < Ep < 0: relatively inelastic
P
Q
__ < Ep< __
Ep < __
Ep = __
Ep= ___
Ep = __
dQ
PconstEp .
D
36
Special cases
Ep = ____
Examples?
P
Qd
D
Ep = ____
Examples?
P
Qd
D
37
Special cases
Ep = 0
Examples?
Drug
P
Qd
D
Ep = ∞
Examples?
Bottled water
P
Qd
D
38
Ep and producer revenue
R = p x Qd A price increase does not necessary lead to an increase in revenue.
Hence, the percentage change in revenue in response to a 1% change in price is:
Question: When is it profitable for a producer to raise prices?
% change in R ∆R/R----------------------------- = ---------------- = … = 1+Ep
% change in p ∆p/p
39
Ep and producer revenue
Graphically
Rectangles vs. squares
Concave revenue graphs
Maximizing a concave function
40
Other elasticities (1)
The income elasticity of demand is the relative change in Qd in response to a 1% change in income (Y).
If EY > 0, we say the good is ____________,
If EY < 0, the good is ______________.
Examples?
% change in Qd ∆Qd/Qd
EY = ------------------------- = ---------------- % change in Y ∆Y/Y
41
Other elasticities (1)
The income elasticity of demand is the relative change in Qd in response to a 1% change in income (Y).
If EY > 0, we say the good is normal
If EY < 0, the good is inferior.
Examples?
% change in Qd ∆Qd/Qd
EY = ------------------------- = ---------------- % change in Y ∆Y/Y
42
Other elasticities (2)
The cross-price elasticity is the percentage change in Qd of a good X in response to a 1% change in the price of another good, PY.
If EcXY < 0, the goods X and Y are ________________.
If EcXY > 0, they are ____________________________.
Examples?
% change in QdX ∆Qd
X /Qd
X
EcXY = ----------------------- = ---------------- % change in PY ∆PY/PY
43
Other elasticities (2)
The cross-price elasticity is the percentage change in Qd of a good X in response to a 1% change in the price of another good, PY.
If EcXY < 0, the goods X and Y are Substitutes
If EcXY > 0, they are Complements
Examples?
% change in QdX ∆Qd
X /Qd
X
EcXY = ----------------------- = ---------------- % change in PY ∆PY/PY
44
Conclusion
We now know:
How to derive the purchasing behavior of an individual and of a population
How demand is affected by economic circumstance
How to predict changes and react accordingly