10Lecture

# 10Lecture - LECTURE 10 ELASTICITY OF DEMAND Suppose there...

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LECTURE 10 ELASTICITY OF DEMAND Suppose there are two stores in a shopping center near campus. 1 One sells haircuts, and the other sells CD's. (Not certificates of deposit, from Wells Fargo Bank; I'm talking Welcome Home , by King Diamond.) Suppose the barber shop charges \$20 for a haircut, and the music store charges \$20 for the King Diamond CD. 2 Figure 10-1 shows the first point on each of the demand curves for each firm's product. Demand curve D HC shows the demand curve for haircuts, while demand curve D CD shows the demand curve for CD's. Note that at a price of \$20, each store sells 10 units of its unique product per day. Let each store drop the price of its product from \$20 each to \$5 each. What do we know for certain? We know there will be a larger quantity demanded of each economic good. 3 Both demand curves reflect the Law of Demand: at a lower price, all other things equal, there will be a larger quantity demanded. This is reflected in the downward slope of both curves in Figure 10-1. But note the difference in the two demand curves. When the price of haircuts is cut from \$20 each to \$5 each, the quantity demanded increases from 10 haircuts per day to 20 haircuts per day. When the price of CD's is cut from \$20 each to \$5 each, the quantity demanded increases from 10 CD's per day to 80 CD's per day. The response in quantity demanded to a given change in price is much greater for CD's than for haircuts. This phenomenon gives rise to the all-important economic concept called elasticity of demand . The greater the response in quantity demanded to a given change in price, the greater the elasticity of demand for the product. We can formalize this argument in order to derive some interesting and important results. First, who made a mistake in cutting their price from \$20 per unit to \$5 per unit. Clearly, the barber made a serious mistake. Why? Examine the outcome closely. Remember the concept called total revenue . The total revenue of a firm is the total number of dollars taken in by the firm each period from producing 1 There are, just off Rural. 2 When I first created this example two years ago, I used the barber shop and Hoodlum's in the Memorial Union. Unfortunately, Hoodlum's is no more. It doesn't matter. What matters is you can still get Welcome Home by King Diamond. If you ain't heard it, you haven't lived. 3 Note that both haircuts and CD's are economic goods . However, a CD is a good , and a haircut is a service . Goods and services make up all economic goods; goods are tangible and services are intangible.

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and selling the firm's product. 4 When the price of haircuts is \$20 each, the barber sells 10 haircuts per day. The total revenue of the barber shop from producing and selling haircuts is \$20 x 10 = \$200 per day. When the barber cuts his price to \$5 per haircut, he sells 20 per day. Note that when he lowers his price, his daily total revenue falls . \$5 x 20 = \$100 per day. Clearly, cutting his price was a mistake.
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## This note was uploaded on 03/23/2011 for the course ECN 212 taught by Professor Nancy during the Spring '07 term at ASU.

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10Lecture - LECTURE 10 ELASTICITY OF DEMAND Suppose there...

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