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Economics 202: Intermediate Microeconomic Theory

Economics 202: Intermediate Microeconomic Theory. Please turn in Review #1 Please read Chapter 7 (most of it will be for Tue). Demand Elasticity. We assume all D-curves have a downward-slope, but how steep one is depends on the commodity.

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Economics 202: Intermediate Microeconomic Theory

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  1. Economics 202: Intermediate Microeconomic Theory • Please turn in Review #1 • Please read Chapter 7 (most of it will be for Tue)

  2. Demand Elasticity • We assume all D-curves have a downward-slope, but how steep one is depends on the commodity. • A reduction in the Pmilk may lead to a small increase in purchases, but a  in Pairline may lead to a big increase in purchases. • Own-Price Elasticity of Demand = X,Px = % QdX / % PX • Just how sensitive is qty demanded to a change in price? •  = (Q/Q)/(P/P) = (Q/P)*(P/Q) = (1/slope)*(P/Q) •  = (Q/ P)*(P/Q) • If  < -1 we say D for that good is elastic > -1 D is inelastic = -1 D is unit-elastic

  3. Demand Elasticity • Find the elasticity of a D-curve: Q = a - bP. • Properties of Price Elasticity of Demand when D-curve is linear • it is different at every point along the D-curve approaching - at vertical intercept, 0 at horizontal intercept • it is never positive (always negative, except one point) • it is inversely related to the slope of the linear D-curve • Two polar cases • slope of D-curve is much easier to calculate, so why bother with elasticity at all?

  4. More Demand Elasticities • Income elasticity of demand measures how responsive consumption of a good is to a change in income X,I |Px,Py= (QdX/QdX)/( I/I) If X,I > 0, then the good is normal. Luxury good, X,I > 1 (eat out = 1.4; dentist = 1.42) Necessity, 1 > X,I > 0 (food bought for home = 0.5; physician = 0.75) If X,I < 0, then the good is inferior. • Cross-price elasticity of demand measures how responsive consumption of good X is to a change in price of good Y. X,Py |Px,I = ( QdX/QdX)/( PY/PY) If X,Py > 0, then X and Y are substitutes. If X,Py < 0, then X and Y are complements. Often used in anti-trust cases to measure how competitive a market may be. Are there substitutes?

  5. Point vs. Arc Elasticity • Point Elasticity is what we just did  = ( Q/Q)/( P/P) = (Q/ P)*(P/Q) • Arc elasticity is the same thing except we use the average of the two prices and quantities (“mid-point method”) arc = ( Q/Qavg)/( P/Pavg) = ( Q/  P)*(Pavg/Qavg) • for point elasticity, when the changes are small, it doesn’t make a big difference for our result which point we choose • for arc elasticity, it would make a big difference if we chose 1 point, so we take the average

  6. Elasticity • Suppose that instead of a linear D-curve, Q = a – bP, we have Q = 1,200/P as the demand for zip drives. • This is a hyperbola. PQ = 1,200 regardless of the price. • Total Expenditure is constant! • In general, if demand takes the form Q = aPb (b < 0), the price elasticity of demand is constant and equal to b. • No need to worry about specifying the point at which elasticity is measured.

  7. Elasticity and Total Revenue • GGB toll = $1, then 100,000 trips. If  = -2, what happens to # trips when you toll by 10%? Total revenue? • When D is:Price and Total expenditure move in: elastic opposite directions inelastic the same direction unit-elastic TE doesn’t change as P changes D unit-elastic P D elastic D inelastic Q

  8. Estimates of some Elasticities Good or serviceOwn-Price Elasticity of Demand Green peas -2.8 Cars -1.5 Electricity -1.2 Beer -1.19 Movies -0.87 Foreign Air Travel -0.77 Shoes -0.70 Doctor’s services -0.60 Water -0.40 Theater, opera -0.18 • Determinants of Elasticity of Demand

  9. Using Elasticity • Doctors, through the AMA, restrict the supply of physicians. How does this affect the incomes of doctors as a group? • A labor union negotiates a higher wage. How does this affect the incomes of affected workers as a group? • UNC decides to raise the price of football tickets. How is income from the sale of tickets affected? • Airlines propose to raise fares by 10%. Will the boost increase revenues? • Davidson is considering raising tuition by 7%. Will the increase in tuition raise revenues of the college? • CATS is considering lowering bus fares. Will this decrease CATS’ total receipts?

  10. Probability • The probability of a repetitive event happening is the relative frequency with which it will occur • probability of obtaining a head on the fair-flip of a coin is 0.5 • If a lottery offers n distinct prizes and the probabilities of winning the prizes are i (i=1,n) then

  11. Expected Value • For a lottery (X) with prizes x1,x2,…,xn and the probabilities of winning 1,2,…n, the expected value of the lottery is • Theexpected value is a weighted sum of the outcomes • the weights are the respective probabilities

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