You are on page 1of 16

Law L of f Demand D d

‹Law of Demand
‹People do less of what they want to do as the cost of doing it rises

‹Recall the Cost-Benefit Principle
‹Pursue an action if and only if its benefits are at least as great as its costs

‹Recall R ll the h Reservation R i Price P i
‹The highest price we’d be willing to pay
1

T Total lE Expenditure di ‹Total Expenditure equals ‹The number of units sold multiplied by the price of the good ‹Total Expenditure = Total Revenue ‹The dollar amount that consumers spend on a product o p oduct is s equal equa to the t e dollar do a amount a ou t that sellers receive 2 .

The Law of Demand and T Total lE Expenditure di ‹“Will consumers spend more on my product if I sell more units at a lower price or fewer units at a higher price?” ‹Depends upon price elasticity of demand ‹When price rises. decrease. total expenditure may ‹increase. quantity demanded rises 3 . or stay the same ‹This is due to the Law of Demand ‹As price rises. quantity demanded falls ‹As price falls.

5.Fig.7 The Demand Curve for Movie Tickets 4 .

Fig. g 5.8 The Demand Curve for Movie Tickets 5 .

10 Total Expenditure as a Function of Price 6 .Fig. 5.

Price P i El Elasticity i i of f Demand D d ‹In order to predict what will happen to total expenditures. ‹We must know how much quantity will change when the price changes ‹Price elasticity of demand is ‹the percentage change in the quantity demanded that results from a one-percent one percent change in its price 7 .

Price P i El Elasticity i i of f Demand D d = εP D %Δ Q %ΔP D 8 .

demand you will always get a negative.WHY? ‹For convenience we will take the absolute value 9 .P i El Price Elasticity i i ‹Elastic – q quantity y changes g by y a lot when price changes even a little ‹price elasticity is greater than one ‹Inelastic – quantity changes by a little when price changes even a lot ‹price elasticity is less than one ‹Unit elastic – quantity change = price change ‹price elasticity equals one ‹When calculating price elasticity of demand.

11 Elastic and Inelastic Demand 10 . 5.Fig.

Price Elasticity and Expenditures ‹For an elastic product ‹Quantity demanded is highly responsive ‹Percentage change in quantity dominates ‹An A i increase in i price i will ill reduce d total t t l expenditure dit ‹A decrease in price will increase total expenditure ‹For an inelastic product ‹Quantity demanded is not responsive ‹Percentage change in price dominates ‹An increase in price will increase total expenditure ‹A decrease in price will decrease total expenditure 11 .

price elasticity will be higher in the long run than in the short run 12 .D Determinants i of f El Elasticity i i ‹Substitution possibilities ‹Price elasticity of demand will be relatively high if it is easy to substitute between products – Why? ‹Budget share ‹The larger the share of the budget the good uses tends to have higher price elasticities of demand – Why? ‹Time ‹Because substitution takes time.

E Examples l ‹What are some goods that will have very y elastic demand? ‹What are some goods that will have very inelastic i l i demand? d d? 13 .

C l l i Price Calculating P i El Elasticity i i ‹Proportion by which quantity demanded changes divided by the proportion by which price changes %ΔQ = ε= %ΔP ΔQ Q P = ΔP P Q 1 slope 14 .

12 Graphical Interpretation of Price Elasticity of Demand 15 .Fig. 5.

Other Elasticities of Demand ‹Income Elasticity of Demand ‹The amount by which the quantity demanded changes in response to a onepercent change in income ‹Positive for normal goods g for inferior goods g ‹Negative 16 .