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Lecture Notes: Sept. 30 |
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Econ. 103, Fall 2002, Prof. Nancy Folbre |
At least this song has something to do with the demand side. Commercials are an effort to shift the demand curve. Which way? To the right or the left? Just draw the picture, see which direction tends to increase price. A shift to the right. Some are more successful than others. This song reminds me of the Bruce Springsteen classic, "57 channels and nothing on" It does not, however, increase my demand for a Paleface CD's? I prefer the romantic solidarity of Billy Bragg.
Logistics: The pace quickens... Homework on Ch. 3 due this week. Homework on Ch. 4 and 5 next week. I have discovered that there is an official website for our textbook that has some quite interesting stuff on it. The URL is http://www.mhhe.com/economics/frankb/student_index.mhtml It includes a summary of key points, a list of definitions, some short sample multiple choice tests, and copies of all the Powerpoint slides that I have access to. Henceforth we can put links to the Powerpoint slides used in class in these notes, which should be cool. Let's start today with a review of Chapter 4, focusing on Figure 4.16. Note that a rightward shift of supply tends to lower equilibrium price. But a rightward shift of demand tends to increase equilibrium price. An application to the real world: Deregulation of electric utility generation lead to an energy crisis in California last year–prices went way up and there were rolling blackouts. There was much debate at the time over the causes–was it just bad weather? An increase in the demand for electricity as a result of unusually weather? (high temperatures leading to more use of air-conditioning, which is very electricity intensive) Or a decrease in supply due to the weather (drought, less water, less ability to generate electricity using hydroelectric power). Or was it due to a decrease in supply due to energy companies restricting supply? This is not something they could do in a truly competitive market, but that market is NOT very competitive–judicial hearings (and the implosion of Enron) have revealed that individual companies did try to drive prices up by taking generating capacity "off-line" –Enron had cute little names for their manipulative strategies, including "Get Shorty" and "Dark Star" Chapter 5: Demand (Powerpoint slides) There are two key concepts in this chapter. One is the Rational Spending Rule for Two Goods, which stipulates that if you are getting more pleasure for the money from your last unit of consumption of good A than from your last unit of consumption of good B, you will consume more of good A. As you consume more of good A, however, the marginal utility you get will tend to decline. When it declines to the level of marginal utility you get from good B, your consumption of these two goods will be in equilibrium. Keep in mind that when economists say "utility" what they really mean is "pleasure." Not usefulness. In my list of optional discussion group presentations, number 3 is the "coke-popcorn" experiment. It might be helpful to actually go through this. The second key concept is elasticity. This concept is less obvious than the Rational Spending Rule, and has more applications to the real world. It is also more difficult. That's why I am going to spend most of this class discussing it. Go back to the demand curve and look at it in more detail. Since the market demand for a good is simply the sum of all individual demand curves, the two look the same (only the quantities are different, larger for the market as a whole...) Let's focus on figure 5.8. What is the change in price associated with a change of one unit of quantity? When price falls from 10 to 6 what is the change in price? What is the change in quantity associated with that change in price? Note how total expenditure varies with price. Total expenditure is quantity times price. Note that you can think of it as the area of the rectangle defined by the quantity and price. What is the total expenditures at a price of 10? At a price of 4? Note that total expenditure reaches a maximum at the midpoint of the curve. What is total expenditure for the consumer is total revenue for the producer. Elasticity is defined as the percentage change in quantity divided by the percentage change in price. Since the relationship between price and quantity on a demand curve is negative (when one goes up the other goes down), elasticity will always have a negative sign. We ignore this, since it's the absolute value that matters. If the percentage change in quantity is GREATER than the percentage change in price this ratio will be greater than one. In this situation, we say the demand is elastic–which is another way of saying that is it quite responsive to price. In this case, an increase in price will reduce total expenditure. If the percentage change in quantity is LESS than the percentage change in price, this ratio will be less than one, or inelastic. In this case, an increase in price will increase total expenditure. If the percentage change in quantity is equal to the percentage change in price, the elasticity is equal to 1, or "unitary" In this case, an increase in price will leave total expenditure unchanged. What kinds of things determine elasticity? Possibilities for substitution, the relative budget share of the good, the length of time, and how "addictive" something is.... Since the slope of a line is the rise over the run, or the change in price divided by the change in quantity, and this is a key element in the formula above, we can also express elasticity in terms of the slope of a line. Focus on Figure 5.12 from the text. Note that P/Q declines as we move from left to right over the demand curve, while the slope remains constant. This means that the elasticity of demand declines as we move down a straight-line demand curve. Some elaborations of elasticity:
Extreme cases:
These concepts of elasticity also apply to supply curves, the topic of the next chapter. |