Principles of Business I Supply and Demand Review Price Elasticity of Demand

1. Principles of Business I: Week 2Supply and DemandReview Price Elasticity of Demand Professor Whitaker September 14, 2011 Sotheby’s Institute of Art © Amy Whitaker – a.whitaker@sothebysinstitute.com

2. supply and demand © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) D (Demand) Q (Quantity)

3. The relationship of price and quantity © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) Change in price moves you along the curve. D (Demand) Change in anything else shifts the curve. Q (Quantity)

4. shifts in supply and demand © Amy Whitaker - a.whitaker@sothebysinstitute.com

5. cigarette tax © Amy Whitaker - a.whitaker@sothebysinstitute.com S2 S (Supply) P (Price) 2: like adding $2 to cost $8 1: the government adds $2 to every pack $6 D (Demand) Q (Quantity)

6. Airline fuel more expensive? © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) D (Demand) Q (Quantity)

7. Airline fuel more expensive? © Amy Whitaker - a.whitaker@sothebysinstitute.com S2 S (Supply) P (Price) $250 $240 D (Demand) Q (Quantity)

8. Your income goes up. . . © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) D (Demand) Q (Quantity)

9. Your income goes up. . . © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) D2 D (Demand) Q (Quantity)

10. Consumer and Producer Surplus © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) D (Demand) Q (Quantity)

11. Price Discrimination © Amy Whitaker - a.whitaker@sothebysinstitute.com S (Supply) P (Price) D (Demand) Q (Quantity)

23. How do people respond to changes in price? © Amy Whitaker - awhitaker@cca.edu

24. What if the price of chicken goes down? © Amy Whitaker - awhitaker@cca.edu 1. You have more purchasing power, so you buy more chicken. This is an income effect. 2. Chicken starts to look better than pork. This is a substitution effect.

25. Indifference curves © Amy Whitaker - awhitaker@cca.edu Museum visits Imelda doesn’t have a lot of money, and she likes museums but she also likes to go see movies. How does an economist model this? An indifference curve represents the relationship of utility given by one item and utility given by another. Movie tickets

26. The budget line © Amy Whitaker - awhitaker@cca.edu Museum visits A budget line shows the constraint on the indifference curves. The line connects the point where you spend all your income on movies with the point where you spend all your money on museum visits. The circle shows the most total utility you can afford. $120 / 15 = 8 visits $120 / 10 = 12 visits Movie tickets Imelda has $120 to spend. Museum visits cost $15. Movies cost $10.

27. Utility © Amy Whitaker - awhitaker@cca.edu

28. Price Elasticity of Demand % change in the quantity Elasticity = % change in the price

29. Determinants of Price Elasticity Availability of substitutes Proportion of your income Luxury vs. necessity Time horizon © Amy Whitaker - awhitaker@cca.edu

30. price elasticity and total revenue © Amy Whitaker - awhitaker@cca.edu E < 1, inelastic E > 1, elastic 1 Unit elastic (unitary elastic)

31. some everyday elasticities © Amy Whitaker - awhitaker@cca.edu

32. Calculating elasticity The price of a latte goes up from $4 to $5. 30 people buy at $4, and 20 people buy at $5. © Amy Whitaker - awhitaker@cca.edu % change in the quantity Elasticity = % change in the price 1/3 (30-20) / 30 4/3 = 1.3 = = Elasticity = 1/4 (5-4)/4

33. Calculating elasticity 2. The price of a latte goes down from $5 to $4. © Amy Whitaker - awhitaker@cca.edu % change in the quantity Elasticity = % change in the price 1/2 (30-20) / 20 5/2 = 2.5 = = Elasticity = 1/5 (5-4)/5

34. Arc or Midpoint Elasticity © Amy Whitaker - awhitaker@cca.edu Q1 – Q2 Elasticity = Q1 + Q2 2 P1 – P2 P1 + P2 2

35. Calculating elasticity This elasticity shows a change in either direction the same way. © Amy Whitaker - awhitaker@cca.edu Q1 – Q2 Elasticity = Q1 + Q2 2 P1 – P2 P1 + P2 2 (30-20) / (20 + 30)/2 10/25 0.4 / 0.22 = 1.81 = Elasticity = = 1 / 4.5 (5-4)/(5 +4)/2

36. Example: Pasta Bar Italia restaurant is famous in Boise for its spaghetti dinner. Maria, the chef, may be the only purveyor of fifth generation Tuscan recipes in the state of Idaho. Maria prices the dish at $12, and 100 people order it each night. Every Tuesday, she hosts ‘student night’ and the dish is $8. On Tuesdays, 200 people order it. What is the price elasticity of demand for Maria’s spaghetti? © Amy Whitaker - awhitaker@cca.edu