chapteranswersthefollowingquestions:
1.onsumption.The Chapter5ConsumerDemand
WHATISTHISCHAPTERALLABOUT?
Thechapterintroducestheanalysisofconsumerbehavior.Theemphasisisontheinfluenceof
tastes,prices,income,expectationsandtheavailabilityofdifferentgoodsonc Howdowedecidehowmuchofanygoodtobuy?
2. Howdoesachangeinaproductspriceaffectthequantitywepurchaseorthe
amountofmoneywespendonit?
3. Whydowebuycertaingoodsandnotothers?
LEARNINGOBJECTIVES:Afterreadingthechapter,thestudentshouldbeableto:
1. ExplainthebasisfortheLawofDemand
2. Discusswhatpriceandincomeelasticitiesofdemandmeasure
3. Describehowconsumersmaximizeutility
NEWTOTHISEDITION
Thechangestothischapterinclude:
NewNEWSonimpactof2009cigarettetaxhike
NewNEWSonsalesimpactofPlayStation3pricecuts
NewNEWSonlotteryticketsasinferiorgood
NewNEWSonmusicdownloadsandalbumsassubstitutegoods
NewNEWSonLeBronsendorsementvalue
Revised2DiscussionQuestions
3newProblems
Revised6Problems
Revised4Problems
LECTURELAUNCHERS
Howlongwillthischaptertake?Two75minuteclassperiods.
Whereshouldyoustart?
1.
Thebeginningofthischapterisapartialreviewofchapter3,SupplyandDemand.This
chapterfocusesonthedemandsideofthemarket.Startyourlecturebyreemphasizing
thedeterminantsofdemand.
Itisalwaysusefultoreviewwhatyouhavealreadycoveredinanearlierlecture.Doing
sohelpsthestudentsrecallwhattheyhavecoveredinthepastandhelpsyourelatethat
towhatyouwillcovernow.Italsogivesthestudentstheopportunitygaugehowwell
theyunderstandthematerialcovereduptothispointinthesemester.Askstudentsto
citeexamplesofdeterminantsfromtheirownlivesandwritetheseexamplesintheir
notes.Forexample,theymightnameanitemthatwouldbeanormalgoodforthem.
Theymightalsonametwoitemsthataresubstitutesforthem.Inthismaterial,themore
yourexamplesrelatetothestudentseverydaylife,themorelikelytheywillunderstand
thematerial.
Thiswouldbeagoodopportunitytousea35minutewritingexerciseatthebeginning
ofclass.
2.
Agreatlaunchingpointforthelecturesonthedemandforgoodsistotalkabouthow
peoplespendtheirmoney.Figure20.1isalsoagreatplacetobeginyourdiscussionon
TheDemandforGoods.
3.
Askstudentswhathappenstothesatisfactiontheygetfromeachsliceofpizzaastheyeat
moreandmorepizzainasinglenight.
Allstudentswilladmitthateventuallytheadditionalsatisfactionfromeachslice
diminishes.Thisisagreatwaytointroducetheconceptofutilityandmarginalutility.
4.
Themostdifficulttopicwithinthischapteristhatofelasticities.Tostartstudents
thinkingabouttheirresponsivenesstoapricechange(priceelasticityofdemand),
consideraskingthesequestions.
a.
Askstudentswhattheywoulddoiftuitionincreased.Wouldtheystayin
school?
b.
Ifthepriceoftextbooksrequiredforclassesincreased,whatwouldtheydo?
Dideveryoneintheclasspurchasethetext?Thesupplements?Whynot?If
thepricewashigherorlower,wouldthisaffecthowmanytextsor
supplementsarepurchased?
c.
Dostudentsgotonewmoviereleasesorwaitforthevideo?Dostudentsgoto
thediscountmatineeshowordotheygotoseetheshowatnightwhenthe
theaterchargesfullprice?
d.
Thepriceofcigaretteshasincreaseddramaticallyinthelastfewyears.How
hasstudentsconsumptionofcigaretteschangedgiventhesepricechanges?
UsetheIntheNews,ProfessorBeckerCorrectsPresidentsMathtoillustrate
thisexample.
Paycarefulattentiontothesectionsonelasticities(beginningwithPriceElasticity).
Studentstendtohaveanaturalfeelfortheconceptofelasticities Bespeciallywhenexamples
suchascigarettesorhighstatusclothingaregivenasexamplesofproductswithinelastic
demandcurves.Studentsalsohaveafeelforproductswithrelativelyelasticdemand.For
example,manystudentswillquicklyswitchconsumptionawayfromPepsiifCoke,a
substituteinconsumption,isonsale.
EstimatesofelasticityforvariousgoodsandservicesareshowninTable5.1.
COMMONSTUDENTERRORS
Studentsoftenbelievethefollowingstatementsaretrue.Thecorrectanswerisexplainedafter
theincorrectstatementispresented.
1. Thelawofdemandandthelawofdiminishingmarginalutilityarethesame .Studentsoften
confuseutilityanddemand.Utilityrefersonlytoexpectedsatisfaction.Demandrefersto
bothpreferencesandabilitytopay.
2. Theformulaforthepriceelasticityofdemandis(changeinprice)/(changeinquantity). The
trueformulais(percentagechangeinquantity)/(percentagechangeinprice).Theconcept
ofelasticityallowsustocomparerelativechangesinquantityandpricewithouthavingto
worryabouttheunitsinwhichtheyaremeasured.Inordertodothis,wecompute
percentagechangesofbothpriceandquantity.Achangeinpricecausespeopletochange
thequantitytheydemandinagiventimeperiod.Byputtingthequantitychangesinthe
numerator,wecanseethatifthequantityresponseisverylargeinrelationtoapricechange,
theelasticitywillalsobeverylarge.Ifthequantityresponseissmallinrelationtoaprice
change,thendemandispriceinelastic(elasticityissmall)
3. Aflatdemandcurvehasanelasticityofzero.Whenpriceremainsconstantevenwhen
quantitychanges,theelasticityformularequiresustodividebyazeropricechange.Infact,
asdemandcurvesapproachflatness,theelasticitybecomeslargerandlarger.Byagreement,
wesayitisinfinite.
4. Thepersonforwhomagoodorservicehasthegreatestutilityhasthegreatestdesireformoreof
it.Utilitiesofonegoodformanypeoplecannotbecompared.Utilitiesofvariousgoodsfor
onepersoncanbecompared.Marginalutilitywithrespecttoprice,nottotalutility,isthe
bestindicatorofhowtomakeachoice.
5. Anexpectedpricechangehasthesameeffectasachangeinthecurrentprice. Ifpricesare
expectedtoriseinthenearfuture,peoplewilldemandmoreofthecommoditytodayin
ordertobeattheriseinprice.Demandincreasesandthequantitydemandedwillrise.
However,ifthepricerisestoday,bythelawofdemandpeoplereducethequantity
demanded.Furthermore,demanditselfdoesnotchange.Acurrentpricechangeandan
expectedpricechangehaveverydifferenteffects.
6. Whenabuyerbuysagood,thedemandforthegooddecreases .Demandrefersonlytothe
willingnessandabilityofabuyertobuy.Thepotentialforpurchase,nottheactualpurchase,
isthefocusofdemand.Demandisdefinedoveragivenperiodoftime.Ifabuyerbuysa
goodduringtheperiodoftime,heorsheisstillcountedasdemandingthegoodevenafterit
ispurchased.
7. Bothincomeandcrosspriceelasticitiesmustbeinterpretedusingabsolutevalues .Thelawof
demandguaranteesthatthepriceelasticityofdemandwouldalwayshaveanegativesign.
However,theincomeandcrosspriceelasticitiesmaybeeitherpositiveornegative,andthe
signprovidesimportantinformationaboutthedemandforagood.Thesignoftheincome
elasticityindicatesifagoodisanormalgoodoraninferiorgood.Thesignonthecrossprice
elasticityindicateswhetheragoodisasubstituteoracomplement.
ANNOTATEDOUTLINE
I. Introduction
A. Amajorconcernofmicroeconomicsistoanswerthefollowingquestions:
1. Howdowedecidehowmuchofanygoodtobuy?
2. Howdoesachangeinaproductspriceaffectthequantitywepurchaseorthe
amountofmoneywespendonit?
3. Whydowebuycertaingoodsbutnotothers?
2. DeterminantsofDemand
A. TheSociopsychiatricExplanation(Figure5.1)
1. InFreudsview,itistheconstantinterplayoftheid,egoandsuperegothatdrives
ustobuy,buy,buy.
2. Notallconsumptionismotivatedbyegoorstatusconcerns.Therearealways
basicneeds(food,clothes,shelter)thatareanecessity.
3. InTheNews:Menvs.Women:HowTheySpend
Thisarticleexaminesthedifferencesinspendingbetweenmenandwomen.
Womenspendmorethantwiceasmuchasmenonclothing,personalcareitems
andtheirpets.Menspendmoreonentertainment,food,anddrink.
B. TheEconomicExplanation
1. Atbest,sociopsychiatrictheoriestelluswhywedesirecertaingoodsnotwhat
goodswillactuallybepurchased.
2. Inexplainingconsumerbehavior,economistsfocusonthedemandforgoodsand
services.(Figure5.1)
3. Definition:
DemandThewillingnessandabilitytobuyspecificquantitiesof
agoodatalternativepricesinagiventimeperiod,ceterisparibus.
4. Anindividualsdemandforaspecificproductisdeterminedby:
Tastes(desireforthisandothergoods)
Income(oftheconsumer)
Expectations(forincome,prices,tastes)
Othergoods(theiravailabilityandprices)
3. TheDemandCurve
A. UtilityTheory
1. Economistsassumethehigherthesatisfactionagoodorserviceprovides,the
moreaconsumerwillpay.
2. Totalvs.MarginalUtility(Figure5.2)
Definition:
UtilityThepleasureorsatisfactionobtainedfromagood
orservice.
Thereisanimportantdistinctionbetweentotalutilityandmarginalutility:
Definition:
TotalutilityTheamountofsatisfactionobtainedfrom
entireconsumptionofaproduct.
Definition:
MarginalutilityThechangeintotalutilityobtainedby
consumingoneadditional(marginal)unitofagoodorservice.
Formula:
Marginal Utility =
Change inTotal Utility
Change in Quantity
3. DiminishingMarginalUtility
Definition:
LawofdiminishingmarginalutilityThemarginal
utilityofagooddeclinesasmoreofitisconsumedinagiventimeperiod.
Thelawofdiminishingutilityappliestoshorttimeperiods.
Aslongasmarginalutilityispositive,totalutilitymustbeincreasing.
Additionalquantitiesofagoodeventuallyyieldincreasinglysmaller
incrementsofsatisfaction.
B. PriceandQuantity(Figure5.3)
1. Howmuchofaproductwerewillingtobuyatanyparticularpricedependsnot
onlyonitsmarginalutility(ameasureofourtaste)butalsoonourincome,our Whenwefocusontherelationshipbetweenthepriceofthegoodandtheamount
ofitwerewillingtobuy,wemustmaketheceterisparibusassumption.
3.
expectations,andthepricesofalternativegoodsandservices.
2. Definition:
CeterisParibusTheassumptionofnothingelsechanging.
4. Withgivenincome,tastes,expectations,andpricesofothergoodsandservices,
peoplearewillingtobuyadditionalquantitiesofagoodonlyifitspricefalls.
5. Inotherwords,asthemarginalutilityofagooddiminishes,sodoesour
willingnesstopay.
6. Definition:
LawofDemandThequantityofagooddemandedinagiven
timeperiodincreasesasitspricefalls,ceterisparibus.
7. Definition:
DemandCurveAcurvedescribingthequantitiesofagooda
consumeriswillingandabletobuyatalternativepricesinagivenperiod, ceteris
paribus.
IV.PriceElasticity
A. Theresponseofconsumerstoachangeinpriceismeasuredbythepriceelasticityof
demand.
1. Definition:
PriceelasticityofdemandThepercentagechangeinquantity
demandeddividedbythepercentagechangeinprice.
Formula
Price elasticity (E) =
Percentage Change in Quantity Demanded
Percentage Change in Price
2. Thelawofdemandimpliesthatthepriceelasticityofdemandwillalwaysbe
greaterthanzero.
3. Sincequantitydemandeddecreaseswhenpricesincrease(lawofdemand),Eis
alwaysnegative.
B. ComputingPriceElasticity
1. Toensureconsistency,theaveragequantity(beforeandafter)isusedinthe
calculation.
Formula
Percentage Change in Quantity Demanded =
Change in Quantity
Average Quantity
Formula
Percentage Change in Price =
Change in Price
Average Price
2. Alargepriceelasticitymeansthatasmallchangeinpricewillbringaboutalarge
changeinquantitydemanded.
C. Elasticvs.Inelastic.
1. IfEislargerthan1,demandiscalledelasticintheimmediatepricerange.IfEis
lessthan1,demandiscalledinelastic.(Note:Numbersareinabsolutevalue.)
2. ElasticityEstimates(SeeTable5.1)Thisillustratestheelasticityofavarietyof
goodsandservices.
3. ElasticityExtremes(Figure5.4)
Ahorizontaldemandcurvemeansthatdemandisperfectlyelastic.Any
priceincreasewouldcausedemandtofalltozero.
Averticaldemandcurvemeansthatdemandiscompletelyinelastic.
Demandwillnotchangeregardlessofanychangeinprice.
IntheNews:FederalCigaretteTaxGoingUpPresidentBarack
ObamasignedlegislationWednesdaytomorethandoublethefederal
cigarette[tax]topayforanexpansionofhealthinsuranceforpoor
children.
D. DeterminantsofElasticity.
1. Theelasticityofdemandiscomputedbetweenpointsonagivendemandcurve.
Hence,thepriceelasticityofdemandisinfluencedbyallofthedeterminantsof
demand.
2. Fourfactorsareparticularlyworthnoting:
Necessitiesvs.Luxuries
Demandfornecessities,goodsthatarecriticaltooureverydaylife,
isrelativelyinelastic.
Demandforluxurygoods,goodswewouldliketohavebutarenot
likelytobuyunlessourincomejumpsorthepricedeclinessharply,
isrelativelyelastic.
AvailabilityofSubstitutes
Thegreatertheavailabilityofsubstitutes,thehighertheprice
elasticityofdemand.
Thelesssubstitutesavailable,themorepriceinelasticthedemand.
IntheNews:PlayStation3SalesMoreThanDoubleafter
PriceCutU.S.salesofthePlayStation3morethandoubledinthe
weeksafterthecompanyslashedthevideogameconsolesprice
$100andlaunchedalowendmodel
RelativePrice:
Thehigherthepriceinrelationtoaconsumersincome,thehigher
theelasticityofdemand.
Asarule,thepriceelasticityofdemanddeclinesaspricemoves
downthedemandcurve.
Time
Thelongrunpriceelasticityofdemandishigherthantheshort
runelasticity.Thisisduetoconsumersmakingchangesoverthe
longrunthattheycouldntintheshortrun.
InTheNews:ProfessorBeckerCorrectsPresidentsMath
PresidentClinton,in1994,assumedcigarettesaleswoulddropby
4percentforevery10percentincreaseinpriceresultingfroman
excisetaxincrease.Beckernotedthata10%cigarette
consumptiontaxwilllikelydecreasesalesby4%intheshortrun
and8%inthelongrun.Ittakestimeforpeopletoadjusttheir
behaviortochangedprices.Hence,theshortrunpriceelasticityof
demandislowerthanthelongrunelasticity.
E. PriceElasticityandTotalRevenue(Table5.2)
1. Definition:
TotalrevenueThepriceofaproductmultipliedbythequantity
soldinagiventimeperiod:pxq.
Formula:
Total Revenue = (Price) X (Quantity Sold)
2. Pricechangesaffecttotalrevenueaccordingto:
Apricehikeincreasestotalrevenueonlyifdemandisinelastic(E<1).
Apricehikereducestotalrevenueifdemandiselastic(E>1).
Apricehikedoesnotchangetotalrevenueifdemandisunitaryelastic
(E=1).
3. Thereverseappliesforpricedecreases.
4. Thekeyisthattheimpactofapricechangeontotalrevenuedependsonthe
(changing)priceelasticityofdemand.(SeeFigure5.6)
V.OtherElasticities
1. Shiftsvs.Movements
1. Whenthepricechanges,ceterisparibus,theoutcomeisamovementalongthe
demandcurve.
2. Whentheunderlyingdeterminantsofdemandchange,theentiredemandcurve
shifts.
B. IncomeElasticity(Figure5.7)
1. Anincreaseinconsumerincomewillcausearightwardshiftindemand.
Consumerswillnowpurchasemoreatanypricethantheydidpriortothe
increaseinincome.
2. Definition:
ShiftinDemandAchangeinthequantitydemandedatany
(every)givenprice.
3. Definition:
IncomeelasticityofdemandPercentagechangeinquantity
demandeddividedbypercentagechangeinincome.
4. Formula
Income Elasticity of Demand =
Percentage change in Quantity Demanded
Percentage Change in Income
C. ComputingIncomeElasticityAswithpriceelasticity,incomeelasticityiscomputed
usingaveragevaluesforthechangesinquantityandincome.
D. Normalvs.InferiorGoods
1. Definition:
NormalgoodGoodforwhichdemandriseswhenincomerises.
2. Anormalgoodhasanincomeelasticityofdemandgreaterthanzero.
3. Definition:
InferiorgoodGoodforwhichdemanddecreaseswhenincome
rises.
4. Aninferiorgoodhasanincomeelasticityofdemandlessthanzero.
5. IntheNews:ManyLotterySalesUpduringRecessionInthesetoughtimes,
manypeopleappearwillingtogambleafewpreciousdollarsinthehopeof
winninginstantdeliverancefromtheireconomicwoes.Twentyfiveof42states
withlotterieshaveexperiencedhighersalesofscratchoffanddailylotterygames.
E. CrossPriceElasticity(Figure5.8)
1. Definition:
SubstitutegoodsGoodsthatsubstituteforeachother;whenthe
priceofgoodXrises,thedemandforgoodYincreases,ceterisparibus.
2. Definition:
ComplementarygoodsGoodsfrequentlyconsumedin
combination;whenthepriceofgoodXrises,thedemandforcomplementarygood
Yfalls,ceterisparibus.
3. Definition:CrosspriceelasticityofdemandPercentagechangeinthe
quantitydemandedofXdividedbypercentageinpriceofY.
4. Achangeinthepriceofonegoodaffectsthedemandforanothergood.
5. CalculatingCrossPriceElasticity
Formula
Cross - Price Elasticity of Demand =
Percentage Change in Quantity Demanded of Good X
Percentage Change in Price of Good Y
Whenthecrosspriceelasticityofdemandhasanegativesignthetwogoods
arecomplementarygoods
Whenthecrosspriceelasticityofdemandhasapositivesignthetwogoods
aresubstitutegoods.
IntheNews:DownloadsDisplacingCDs:
ThisarticleillustratesthechangeindemandforalbumsandCDsastheprice
fortheirsubstitutes(downloads)changed.
VI.ChoosingAmongProducts
A. Thepurchaseofanyonesinglegoodmeansgivinguptheopportunitytobuymoreof
othergoods.Thismeansthatthepurchaseofanygoodentailsadistinctopportunity
cost.
B. Definition:
OpportunityCostsThemostdesiredgoodsorservicesthatareforgone
inordertoobtainsomethingelse.
C. MarginalUtilityvs.Price.
1. Rationalbehaviorrequiresonetocomparetheanticipatedutilityofeach
expenditurewithitscost.
2. Tomaximizeutility,theconsumershouldchoosethatgoodwhichdeliversthe
mostmarginalutilityperdollar.
D. UtilityMaximization(Table5.3)
1. Consumerschoosetheoptimalconsumptionthemixofconsumerpurchasesthat
maximizestheutilityattainablefromavailableincome.
2. Definition:
OptimalConsumptionThemixofconsumerpurchases
thatmaximizestheutilityattainablefrom
availableincome.
E. UtilityMaximizingRule
1. Optimalconsumptionreferstothemixofoutputthatmaximizestotalutilityfor
thelimitedamountofincomeyouhavetospend.
2. Formula
Utility - Maximizing Rule :
MU X MU Y
=
PX
PY
3. IfapersoncouldgetmoreutilityperdollarbybuyinggoodX,thentheyshould
continuetobuygoodXuntiltheratiosareequal.Onlythenwillutilitybe
maximized.
F. EquilibriumOutcomes
1. Consumersdontalwaysbuytheoptimalmixofgoodsandserviceswiththeir
limitedincome.Butaftersometrialanderror,consumersadjusttheirbehavior.
Whateconomictheorypredictsisthatthefinalchoicestheequilibrium
outcomeswillbethepredictedoptimalones.
VII.TheEconomyTomorrow:CaveatEmptor
A. Asuccessfuladvertisingcampaignisonethatshiftsthedemandcurvetotheright
(Figure5.9).
B. InTheNews:WinorLose,LeBronsStarisSoaring
BasketballstarLeBronJamesgainedanewendorsementsraisinghistotalsponsorship
dealstonearly$157million.Thisillustratesonemethodproducersusetoincrease
demand.
C. AreWantsCreated?
1. Asuccessfuladvertisingcampaignisonethatshiftsthedemandcurvetotheright
andmakesitlesselastic.
2. WorldView:WherethePitchIsLoudest
ThisWorldViewshowscountrieswhereadvertisersspendthemostmoneyper
person.TheU.S.spendsthemostperpersonfollowedbyJapanandtheUnited
Kingdom.Theworldaverageis$79perperson