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ECN 203 (4), Product Market Demand

# ECN 203 (4), Product Market Demand - Chapter 4 Product...

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Chapter 4 – Product Market Demand This chapter examines the major causes of the Demand for a specific good – its own price, the prices of related goods, tastes, and consumer income. Also we distinguish between the qualitative (direction of change) versus the quantitative ( elasticity ) effects of a ceteris paribus change in each of these causes.

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Price and Quantity Demanded: Direction of Change Recall – the good’s own price (P) is a cause of quantity demanded of that good (Q). Qualitative Effect: P Q D . Qualitative Effect – measures direction of change.
Underlying Reason: Inverse Relationship Consumer maximizes utility subject to their budget constraint when MU 1 /P 1 = MU 2 /P 2 = … If P 1 , then consumer should rebalance by MU 1 to make the ratio equal across goods again. Given diminishing Marginal Utility, this is done by having Q 1 .

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Own Price Elasticity of Demand Own Price Elasticity of Demand ( ε ) – measures the magnitude of responsiveness of quantity demanded of a good to changes in its own price. In other words, the Quantitative Effect of a change in price on the quantity demanded of that good.
Own Price Elasticity of Demand ( ε ): A Formula ε = |Percentage Change in Q D | |Percentage Change in P| . Always has positive sign. Ratio of percentage changes instead of slope, makes it a unit-free measure.

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Price Inelastic Goods Price Inelastic Goods have ε < 1 . These goods are unresponsive to changes in their own price. Example – suppose that if the Price of Milk increases by 10%, Quantity Demanded of Milk goes down by 3%. Then, for Milk, ε = |-3%|/|10%| = 0.3 .
Elasticity Price Elastic Goods have ε > 1 . These goods are responsive to changes in their own price. Example – suppose that if the Price of Cars increase by 10%, Quantity Demanded of Cars goes down by 18%. Then, for Cars,

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ECN 203 (4), Product Market Demand - Chapter 4 Product...

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