rev2f04 - Review for Test 2 Some Key Concepts from Unit...

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Unformatted text preview: Review for Test 2 Some Key Concepts from Unit Two: Chapters 3-5 Supply and Demand Supply and Demand determine prices in individual markets. Price is the mechanism that brings supply and demand together. Law of Downward Sloping Demand When the price of a commodity is raised (and other things are held constant), buyers tend to buy less of the commodity. Similarly, when the price is lowered, other things being constant, quantity demanded increases. The downward slope in demand can be explained by decreasing marginal utility. Substitution Effect When the price of a good rises, I will substitute other similar goods for it. For example, if the price of beef rises, I will eat more chicken and pork. Income Effect As the price of a commodity rises, my income will not stretch as far as it used to. I am therefore poorer in a relative sense, than before the price increase. Market Demand Curve The market demand curve adds up all the quantities demanded by individual consumers at a given price. It shows the total amount of a quantity consumers are willing and able to buy at a given price. The Demand Curve D Q P Elasticity of demand refers to movements along the curve. Moving Along Demand If the price of a product changes, consumers move along the demand curve to a new quantity. If price rises, quantity demanded falls. If price falls, quantity demanded rises. The curve itself DOES NOT MOVE. The movement is from one point to another ON THE ORIGINAL CURVE, Elasticity of Demand The elasticity of demand tells us the relationship between the percentage change in quantity and the percentage change in price as we move along a demand curve. Demand for Pretzels D Q P A $10 3 At a price of $10, 3 pretzels will be sold in this market. Point A on the demand curve shows this relationship. Total Revenue Total Revenue is price times quantity. In this case, total revenue would be $30 ($10x3). Demand for Pretzels D Q P $5 9 At a price of $5, 9 pretzels will be sold in this market. Point B on the demand curve shows this relationship. B Moving from A to B In moving from point A to point B, we have gone down the original demand curve. As the price of pretzels fell, the quantity demanded increased. Price and quantity move in opposite directions on a demand curve. Total Revenue at Point B Total Revenue at point B is $45. ($5x9) Total Revenue got larger as we moved from point A to point B because the increase in quantity was larger, in relative terms, than the decrease in price. Price fell by 1/2 ($10 to $5), but quantity tripled (3 to 9). The increase in quantity more than offset the decrease in price. We can calculate this elasticity Price Q 10 3 5 9 % change in price is 5/7.5*100% = 66.67 % change in q is 6/6*100% = 100% Ed = 100%/66.67% = 1.5 Elastic demand To find out what happens to TR To find out what happens to TR as we move along a demand curve we have to know which change is proportionately bigger, the change in quantity or the change in price....
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This note was uploaded on 11/15/2011 for the course AGEC 7100 taught by Professor Duffy,p during the Fall '08 term at Auburn University.

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rev2f04 - Review for Test 2 Some Key Concepts from Unit...

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