Transcript Ch6

chapter
six
Consumer Choice and Elasticity
Prepared by: Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
Can LeBron James Get You to Drink Powerade?
After studying this chapter, you should be
able to:
Firms must understand
consumer behavior to
determine whether
strategies such as using
celebrities in their
advertising are likely to
be effective.
LEARNING OBJECTIVES
CHAPTER 6: Consumer Choice and
Elasticity
1
2
3
Define utility and explain how
consumers choose goods and
services to maximize their utility.
Explain how social influences can
affect consumption choices.
Describe how people can improve
their decision making by taking into
account nonmonetary opportunity
costs, ignoring sunk costs, and being
more realistic about their future
behavior.
4
Define the price elasticity of demand
and understand how to calculate it.
5
Understand the determinants of the
price elasticity of demand.
6
Understand the relationship between
the price elasticity of demand and
total revenue.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
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CHAPTER 6: Consumer Choice and
Elasticity
Consumer Choice and Elasticity
Elasticity A measure of how
much one economic variable
responds to changes in another
economic variable.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
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1 LEARNING OBJECTIVE
CHAPTER 6: Consumer Choice and
Elasticity
Utility and Consumer Decision Making
The Economic Model of Consumer Behavior in a
Nutshell
Utility
Utility The enjoyment or satisfaction that people receive from
consuming goods and services.
The Principle of Diminishing Marginal Utility
Marginal utility The additional utility a person receives from
consuming one additional unit of a good or service.
Law of diminishing marginal utility Consumers
experience diminishing additional satisfaction as they consume
more of a good or service during a given period of time.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
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Utility and Consumer Decision Making
CHAPTER 6: Consumer Choice and
Elasticity
6-1
Total and Marginal Utility from
Eating Pizza on Super Bowl
Sunday
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Utility and Consumer Decision Making
CHAPTER 6: Consumer Choice and
Elasticity
The Rule of Equal Marginal Utility per Dollar Spent
Budget constraint The limited amount of income available
to consumers to spend on goods and services.
6–1
Total Utility and Marginal Utility
from Eating Pizza and Drinking
Coke
NUMBER OF TOTAL UTILITY
SLICES OF FROM EATING
PIZZA
PIZZA
0
1
2
3
4
5
6
0
20
36
46
52
54
51
MARGINAL
UTILITY
FROM THE
LAST SLICE
20
16
10
6
2
3
NUMBER OF
CUPS OF
COKE
TOTAL UTILITY
FROM
DRINKING
COKE
MARGINAL
UTILITY
FROM THE
LAST CUP
0
1
2
3
4
5
6
0
20
35
45
50
53
52
20
15
10
5
3
1
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
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Utility and Consumer Decision Making
The Rule of Equal Marginal Utility per Dollar Spent
CHAPTER 6: Consumer Choice and
Elasticity
6–2
Converting Marginal Utility to
Marginal Utility per Dollar
(1)
Slices
of Pizza
(2)
Marginal Utility
(MUPizza)
1
(3)
Marginal Utility
per Dollar
(6)
Marginal Utility
per Dollar
 MU Pizza 


P
 Pizza 
(4)
Cups
of Coke
(5)
Marginal Utility
(MUCoke)
20
10
1
20
20
2
16
8
2
15
15
3
10
5
3
10
10
4
6
3
4
5
5
5
2
1
5
3
3
6
3
--
6
1
--
 MU Coke 


P
 Coke 
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
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Utility and Consumer Decision Making
The Rule of Equal Marginal Utility per Dollar Spent
CHAPTER 6: Consumer Choice and
Elasticity
6–3
Equalizing Marginal Utility per
Dollar Spent
Combinations of Pizza and Coke with Marginal Utility per Dollar
Equal Marginal Utilities per Dollar
(Marginal Utility/Price)
Total Spending
Total Utility
1 Slice of Pizza and 3 Cups of Coke
10
$2 + $3 = $5
20 + 45 = 65
3 Slices of Pizza and 4 Cups of Coke
5
$6 + $4 = $10
46 + 50 = 96
4 Slices of Pizza and 5 Cups of Coke
3
$8 + $5 = $13
52 + 53 = 105
We can compactly summarize the two conditions for maximizing
utility as follows:
MU Pizza MU Coke

1.
PPizza PCoke
2. Spending on pizza + Spending on Coke = Amount available to be
spent
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien
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6-1
1 LEARNING OBJECTIVE
CHAPTER 6: Consumer Choice and
Elasticity
Finding the Optimal Level of Consumption
Number of
Ice Cream
Cones
Number of
Total Utility from Marginal Utility Cans of Lime Total Utility from Marginal Utility
Ice Cream Cones from Last Cone
Fizz
Cans of Lime Fizz from Last Can
0
0
0
0
1
30
30
1
40
40
2
55
25
2
75
35
3
75
20
3
101
26
4
90
15
4
119
18
5
100
10
5
134
15
6
105
5
6
141
7
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6-1
1 LEARNING OBJECTIVE
CHAPTER 6: Consumer Choice and
Elasticity
Finding the Optimal Level of Consumption (continued)
Ice Cream Cones
MU
P
Cans of Lime Fizz
MU
MU
P
15
40
40
25
12.5
35
35
3
20
10
26
26
4
15
7.5
18
18
5
10
5
15
15
6
5
2.5
7
7
Quantity
MU
1
30
2
What if the Rule of Equal Marginal Utility per Dollar Does Not Hold?
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 10 of 36
Utility and Consumer Decision Making
CHAPTER 6: Consumer Choice and
Elasticity
Where Demand Curves Come From
Income effect The change in the quantity demanded of a
good that results from the effect of a change in price on
consumer purchasing power, holding all other factors constant.
Substitution effect The change in the quantity demanded of
a good that results from a change in price making the good
more or less expensive relative to other goods, holding constant
the effect of the price change on consumer purchasing power.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 11 of 36
Utility and Consumer Decision Making
CHAPTER 6: Consumer Choice and
Elasticity
6-2
Deriving the Demand Curve for
Pizza
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 12 of 36
2 LEARNING OBJECTIVE
CHAPTER 6: Consumer Choice and
Elasticity
Social Influences on Decision Making
The Effects of Celebrity Endorsements
Network Externalities
Network externalities Network
externalities exist when the usefulness of
a product increases with the number of
consumers who use it.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 13 of 36
6-1
CHAPTER 6: Consumer Choice and
Elasticity
Why Do Firms Pay Tiger Woods to
Endorse Their Products?
When consumers buy the same
products as celebrities they feel
fashionable and closer to the
celebrities.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 14 of 36
Social Influences on Decision Making
CHAPTER 6: Consumer Choice and
Elasticity
Does Fairness Matter?
BUSINESS IMPLICATIONS OF FAIRNESS
6-3
The Market for Tickets to the
Producers
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 15 of 36
6-2
CHAPTER 6: Consumer Choice and
Elasticity
Professor Krueger Goes to the Super Bowl
Should the NFL charge the highest
price it can for Super Bowl tickets?
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 16 of 36
The Price Elasticity of Demand and Its Measurement
Elasticity
CHAPTER 6: Consumer Choice and
4 LEARNING OBJECTIVE
Price elasticity of demand The responsiveness of
the quantity demanded to a change in price, measured
by dividing the percentage change in the quantity
demanded of a product by the percentage change in the
product’s price.
Measuring the Price Elasticity of Demand
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 17 of 36
Elastic Demand and Inelastic Demand
Elasticity
CHAPTER 6: Consumer Choice and
The Price Elasticity of Demand and Its Measurement
Elastic demand Demand is elastic when the percentage
change in quantity demanded is greater than the percentage
change in price, so the price elasticity is greater than 1 in
absolute value.
Inelastic demand Demand is inelastic when the percentage
change in quantity demanded is less than the percentage change
in price, so the price elasticity is less than 1 in absolute value.
Unit-elastic demand Demand is unit-elastic when the
percentage change in quantity demanded is equal to the
percentage change in price, so the price elasticity is equal to –1.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 18 of 36
An Example of Computing Price Elasticities
6-4
Elastic and Inelastic Demand
Curves
Elasticity
CHAPTER 6: Consumer Choice and
The Price Elasticity of Demand and Its Measurement
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 19 of 36
The Midpoint Formula
Elasticity
CHAPTER 6: Consumer Choice and
The Price Elasticity of Demand and Its Measurement
Price elasticity of demand =
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 20 of 36
When Demand Curves Intersect, the Flatter Curve is
More Elastic
Elasticity
CHAPTER 6: Consumer Choice and
The Price Elasticity of Demand and Its Measurement
Don’t Confuse Inelastic with Perfectly Inelastic
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 21 of 36
Polar Cases of Perfectly Elastic and Perfectly
Inelastic Demand
Elasticity
CHAPTER 6: Consumer Choice and
The Price Elasticity of Demand and Its Measurement
Perfectly inelastic demand
Demand is perfectly inelastic when a
change in price results in no change in
quantity demanded.
Perfectly elastic demand Demand
is perfectly elastic when a change in
price results in an infinite change in
quantity demanded.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 22 of 36
What Determines the Price Elasticity of Demand for a Product?
The key determinants of price elasticity of
demand are as follows:
 Availability of close substitutes
Elasticity
CHAPTER 6: Consumer Choice and
5 LEARNING OBJECTIVE
 Passage of time
 Necessities versus luxuries
 Definition of the market
 Share of good in the consumer’s budget
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6–4
Summary of the Price Elasticities of Demand
Elasticity
CHAPTER 6: Consumer Choice and
What Determines the Price Elasticity of Demand for a Product?
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 24 of 36
6 – 4 (continued)
The Price Elasticity of Demand
Elasticity
CHAPTER 6: Consumer Choice and
What Determines the Price Elasticity of Demand for a Product?
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 25 of 36
The Price Elasticity of Demand for Breakfast
Cereal
Elasticity
CHAPTER 6: Consumer Choice and
6-4
CEREAL
What happens when the
price of cereal rises?
PRICE ELASTICITY
OF DEMAND
Post Raisin Bran
-2.5
All family breakfast cereals
-1.8
All types of breakfast cereals
-0.9
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 26 of 36
The Relationship Between Price Elasticity and Total Revenue
6-5
The Relationship Between Price
Elasticity and Total Revenue
Total revenue The total amount of funds
received by a seller of a good or service,
calculated by multiplying price per unit by
the number of units sold.
Elasticity
CHAPTER 6: Consumer Choice and
6 LEARNING OBJECTIVE
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 27 of 36
Elasticity and Revenue with a Linear Demand Curve
6–5
The Relationship between Price
Elasticity and Revenue
Elasticity
CHAPTER 6: Consumer Choice and
The Relationship Between Price Elasticity and Total Revenue
IF DEMAND IS . . .
THEN . . .
BECAUSE . . .
elastic
an increase in price reduces
revenue
the decrease in quantity demanded is
proportionally greater than the increase in price.
elastic
a decrease in price increases
revenue
the increase in quantity demanded is
proportionally greater than the decrease in price.
inelastic
an increase in price increases
revenue
the decrease in quantity demanded is
proportionally smaller than the increase in price.
inelastic
a decrease in price reduces
revenue
the increase in quantity demanded is
proportionally smaller than the decrease in price.
unit-elastic
an increase in price does not
affect revenue
the decrease in quantity demanded is
proportionally the same as the increase in price.
unit-elastic
a decrease in price does not
affect revenue
the increase in quantity demanded is
proportionally the same as the decrease in price.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 28 of 36
6-6
3
Elasticity is Not Constant Along a
Linear Demand Curve
Elasticity
CHAPTER 6: Consumer Choice and
The Relationship Between Price Elasticity and Total Revenue
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 29 of 36
6 LEARNING OBJECTIVE
Price and Revenue Don’t Always Move in the Same Direction
Elasticity
CHAPTER 6: Consumer Choice and
6-2
Verify that increasing a product’s price is not the
only way to increase the revenue from selling
a product.
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 30 of 36
CHAPTER 6: Consumer Choice and
Elasticity
A Celebrity Endorser Who Doesn't Offend? Slim Chance
© 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien 31 of 36
CHAPTER 6: Consumer Choice and
Elasticity
Behavioral economics
Budget constraint
Elastic demand
Elasticity
Endowment effect
Income effect
Inelastic demand
Law of diminishing marginal
utility
Marginal utility (MU)
Network externalities
Opportunity cost
Perfectly elastic demand
Perfectly inelastic demand
Price elasticity of demand
Substitution effect
Sunk cost
Total revenue
Unit-elastic demand
Utility
© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien 32 of 36