Prices

1. Prices Lesson 9: Demand

2. Teaser #9: Which is more valuable:  a 2' X 2' X 2' box filled with 1-ounce Gold Eagle coins (worth about $430 each) or a 3' X 3' X 3' box filled with 1/4-ounce Gold Eagles (worth about $110 each)?

3. Solution:  The larger box holds far more gold, so it's more valuable.  (It doesn't matter that a 1-ounce coin is more valuable than a 1/4-ounce coin.  The 1/4-ounce coin is smaller so there are more of them per cubic foot.)

4. In the Chips

5. MARKET TALLY: In the Chips

6. Who made money? Who lost money? Who made the most money? Why were you successful? Why were you unsuccessful? What conditions made the market work well? What was the most frequent transaction price in each round? In which round was there the greatest spread in transaction prices? Why?

7. Why did the transaction prices become more clustered in the final rounds? Who determined the “market price” for computer chips - buyers or sellers? Where would you have set the price if you'd had the power to do so? Would you describe this as a competitive market? With whom were you in competition? How does opportunity cost explain a high price on a seller card? A low price on a buyer card?

8. Readings and Assignments • “Sex, Booze and Drugs” • Junior Achievement Chapter 3 • “Freedom to Shop Around” • “Chargin’ All the Traffic Will Bear!” • The Young Economist Chapter 11 • Economic Reasoning Chapter 4

9. Economic Reasoning Principle # 3: People respond to incentives in predictable ways. Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, behavior changes in predictable ways.

10. What's Wrong with this Picture? Human Actions and DMU

11. Law of Diminishing Marginal Utility (or benefit) It's not just the calories--a Big Mac with supersized fries has more.  The law of diminishing marginal utility says that as a person increases consumption of a good, holding consumption of other goods constant, the marginal utility he or she gets from each additional unit of that good declines.  This suggests that the marginal utility of the second egg will be smaller than that of the first, and the marginal utility of the third will be smaller still.  For most people, the marginal utility of the tenth egg would likely be negative.

12. Robinson Crusoe • What does he have? (Factors) • What does he want? (Goods) • Economizing, tradeoffs, opportunity costs • Expectations • Time Preferences

13. Study Questions • Does economics assume that people act in isolation from the rest of society? • What does it mean to say Crusoe creates goods with his “mind powers”? • Can leisure be more physically demanding than work? • Why does Crusoe need to worry about depreciation of his capital goods? • How do expectations affect someone’s decisions?

14. Consumers in Markets: Dissatisfaction with Now desire for a product willingness and ability to pay for it Demand = +

15. Frank Knight "Wants...not only are unstable, changeable in response to all sorts of influences, but it is their essential nature to change and grow; it is an inherent inner necessity in them. The chief thing which the common-sense individual actually wants is not satisfaction for the wants which he has, but more, and better wants."

16. $4.00 (1) Price per cassette (2) Alice’s demand (3) Bruce’s demand (2) Cathy’s demand (3) Market demand G 3.50 F 3.00 E A B C D E F G H $.0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 9 8 7 6 5 4 3 2 6 5 4 3 2 1 0 0 1 1 0 0 0 0 0 0 16 14 11 9 7 5 3 2 2.50 D 2.00 Price per cassette (in dollars) C 1.50 B 1.00 A 0.50 Cathy Bruce Alice 0 2 4 6 8 10 12 14 16 Quantity of cassettes demanded per week From Individual Demandsto a Market Demand Curve Market demand

17. The Law of Demand If P then QD and If P then QD Consumers substitute – and there are substitutes for everything (at the margin) Note: What causes the change in the consumers’ behavior ? (think: Prices)

18. A demand schedule shows how much of a good or service consumers will want to buy at different prices. Demand Schedule for Tickets Demand Schedule

19. A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price.

20. The quantity demanded is the actual amount consumers want to buy at some specific price. If the scalpers are charging $250 per ticket, 8,000 tickets will be purchased. 8,000 That is, 8,000 is the quantity demanded at a price of $250.

21. The Law of Demand says that a higher price for a good, other things equal, leads people to demand a smaller quantity of the good. If the price drops to $100, 20,000 fans want to buy tickets. At $250, only 8,000 tickets are demanded. The law of demand points to the inverse relationship between price and the quantity demanded. Note that the demand curve slopes downward. This reflects the general proposition that a higher price reduces the number of people willing to buy a good.

22. Law of Diminishing Marginal Utility • The Law of Demand does not go on for infinity.  • There are limits. • The last item consumed will be less satisfying than the one before. • This means at some point, no matter how low the price is, consumers will purchase less

23. $4.00 (1) Price per cassette (1) Price per cassette (1) Price per cassette (2) Alice’s demand (2) Alice’s demand (2) Alice’s demand (3) Bruce’s demand (3) Bruce’s demand (3) Bruce’s demand (2) Cathy’s demand (2) Cathy’s demand (2) Cathy’s demand (3) Market demand (3) Market demand (3) Market demand G 3.50 F 3.00 E A B C D E F G H A B C D E F G H A B C D E F G H $.0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 $.0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 $.0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 9 8 7 6 5 4 3 2 10 9 8 7 5 4 3 2 9 8 7 6 5 4 3 2 6 5 4 3 2 1 0 0 7 6 4 3 2 1 0 0 6 5 4 3 2 1 0 0 1 1 0 0 0 0 0 0 1 1 0 0 0 0 0 0 2 2 1 0 0 0 0 0 19 17 13 10 7 5 3 2 16 14 11 9 7 5 3 2 16 14 11 9 7 5 3 2 2.50 D 2.00 Price per cassette (in dollars) C 1.50 B 1.00 A 0.50 Cathy Bruce Alice 0 2 4 6 8 10 12 14 16 Quantity of cassettes demanded per week What If “Everything Else” DOESN’T Stay the Same? Demand for CDs AFTER Something has changed: Your pay at your job doubles, for example. New Market Demand Market demand

24. Shifts of the Demand Curve A change in the quantity demanded at any given price, represented by the replacement of the original demand curve with a new demand curve. Gretzky is retiring!!! Announcement of Gretzky’s retirement generates an increase in demand, an increase in the quantity demanded at any given price. The increase in demand shifts the demand curve to the right. • This event is represented by the two demand schedules: • Demand before the announcement • Demand after the announcement

25. “Movement Along” vs. “Shift” of the Demand Curve A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price. from point A to point B: increase in quantity demanded reflects a movement along the demand curve it is the result of a fall in the price of the good. from point A to point C: increase in quantity demanded reflects a shift of the demand curve • It is the result of an increase in the quantity demanded at any given price.

26. What's Wrong with this Picture?

27. Concepts:  opportunity cost, substitutes, demand  People offer this service in less developed countries, but they don't in richer countries.  Most Americans have scales at home (a substitute for public scales), so the demand for this service is small.  It's unlikely that this man would get enough customers to cover the opportunity cost of his time.

28. Shifts of the Demand Curve (continued) • an “increase in demand”, means a rightward shift of the demand curve: • at any given price, consumers demand a larger quantity than before. (D1 D2) • A decrease in demand means a leftward shift of the demand curve. • At any given price, consumers demand a smaller quantity than before. (D1D3)

29. Demand shifters: examples What will happen to the demand for hotdogs if the price of hotdog buns increases? What will happen to the demand for hamburger if the price of hotdogs increases?

30. What causes a demand curve to shift? • Changes in the Prices of Related Goods • Substitutes: muffins and donuts, coffee and tea. • Complements: squash balls and squash racquets, or peanut butter and jelly. • Changes in Income • Normal Goods • Inferior Goods • Tastes and preferences • Numbers of consumers • Expectations of future prices • Taxes or subsidies to consumers

31. Income Restraint

32. Consumer Surplus

33. Laugher Curve Q. What’s the difference between an economist and a befuddled old man with Alzheimer’s? A. The economist is the one with a calculator.

34. Supposed exceptions to the Law of Demand (4) • A paradoxical demand curve (Giffen Good, “Bread,” Inferior Goods) • Personalization fallacy • Time-period misunderstanding • Prestige purchases (Veblen Good, Conspicuous Consumption)

35. Demand Suppose that you read in the paper that the price of gasoline had gone up from $1.90 in April to $2.00 in June, and that gasoline sales had also gone up, from 120 million gallons a day in April to 140 million gallons a day in June.  Does this violate the Law of Demand?

36. Don’t forget about Shifts No.  This could be explained by a rightward shift of the demand curve.

37. Elasticity • Elasticity describes the responsiveness (in percentage terms) of the quantity demanded to changes in price.  Knowing how sensitive a product is to a change in price is important in pricing goods and services.  • There are five categories of price elasticity.  • There are really only three types in the real world.

38. Inelastic and Elastic Demands

39. Unit Elastic

40. The Ideals??

42. Characteristics that Affect Elasticity • Nature of the product • Durability of the product • Size of the expenditure • Substitute goods  • Complementary goods  • Time

43. Characteristics of Elastic and Inelastic Goods ElasticInelastic Durable                                  Non-durable      Expensive                              Inexpensive       Luxuries                                 Necessities    Substitute goods                  Complementary goods

44. Elasticity, Total Revenue, and Demand • The elasticity of demand tells suppliers how their total revenue will change if their price changes. • Total revenue equals total quantity sold multiplied by price of good.

45. Total Revenue Test

46. Elasticity and Total Revenue $10 8 F Gained revenue 6 Price Lost revenue 4 2 0 1 2 3 4 5 6 7 8 9 Quantity Unit Elastic Demand E = 1 TRE= $4x6=$24 TRF= $6x4=$24 TR constant C E A B

47. Elasticity and Total Revenue Gained revenue Lost revenue Inelastic Demand E < 1 $10 TR rises if price increases 8 TRG = $1 x 9 = $9 TRH = $2 x 8 = $16 6 Price 4 H 2 G C A B 0 8 1 2 3 4 5 6 7 9 Quantity

48. Elasticity and Total Revenue Gained revenue J K Lost revenue B Elastic Demand E > 1 $10 C TR falls if price increases. 8 TRJ = $8 x 2 = $16 TRK = $9 x 1 = $9 6 A Price 4 2 0 1 2 3 4 5 6 7 8 9 Quantity

49. Total Revenue Along a Demand Curve • With elastic demand – a rise in price lowers total revenue. • With inelastic demand – a rise in price increases total revenue.

50. Total Revenue Along a Demand Curve Q0 Price 0 Quantity Q0 Elastic ED > 1 ED = 1 Inelastic ED< 1 Total revenue 0 Quantity