Short-Run Versus Long-Run Elasticity (pp )

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Eustace Parsons
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1 Short-Run Versus Long-Run Elasticity (pp ) Price elasticity varies with the amount of time consumers have to respond to a price Short-run demand and supply curves often look very different from their longrun counterparts Chapter 3 1

2 Short-Run vs. Long-Run Elasticity An Application (pp. 45-6) Why are coffee prices very volatile? Most of the world s coffee is produced in Brazil Many changing weather conditions affect the crop of coffee, thereby affecting price Price following bad weather conditions is usually short-lived In long run, prices come back to original levels, all else equal Chapter 3 2

3 Price of Brazilian Coffee (pp. 45-6) Chapter 3 3

4 Short-Run vs. Long-Run Elasticity An Application (pp. 45-6) Demand and supply are more elastic in the long run In the short run, supply is completely inelastic Weather may destroy part of the fixed supply, decreasing supply Demand is relatively inelastic as well Price increases significantly Chapter 3 4

5 Price An Application - Coffee (pp. 45-6) S S A freeze or drought decreases the supply of coffee P 1 Price increases significantly due to inelastic supply and demand P 0 D Q 1 Q 0 Quantity Chapter 3 5

6 An Application - Coffee (pp. 45-6) Price S S Intermediate-Run 1) Supply and demand are more elastic 2) Price falls back to P 2. P 2 P 0 D Q 2 Q 0 Quantity Chapter 3 6

7 An Application - Coffee (pp. 45-6) Price Long-Run 1) Supply is extremely elastic 2) Price falls back to P 0. 3) Quantity back to Q 0. P 0 S D Q 0 Quantity Chapter 3 7

8 Chapter 3 Consumer Behavior

9 Introduction (pp. 64-5) How are consumer preferences used to determine demand? It is very likely that your consumption pattern is different from any of your friends with more or less same income. How do consumers allocate income to the purchase of different goods? Do you spend your income only on phone bills? Chapter 3 9

10 Introduction (pp. 64-5) How do consumers with limited income decide what to buy? Do you think a family with no babies spend their income for baby s items? How can cost of living indexes measure the well-being of consumers? Chapter 3 10

11 Consumer Behavior (pp. 64-5) The theory of consumer behavior can be used to help answer these and many more questions Theory of consumer behavior The explanation of how consumers allocate income to the purchase of different goods and services, or theories behinds consumer demand curves, Q D =Q D (P, ) Chapter 3 11

12 Consumer Behavior (pp. 64-5) Example: Consumption patterns of Japanese Households (See the figures on my handouts. The figures are taken from Kakei Chosa (Family Income and Expenditure Survey, Ministry of Internal Affairs and Communications)) Chapter 3 12

13 Consumer Behavior (pp. 64-5) There are three steps involved in the study of consumer behavior 1. Consumer Preferences To describe how and why people prefer one good to another (You have preferences) 2. Budget Constraints People have limited incomes (Opportunities are limited) Chapter 3 13

14 Consumer Behavior (pp. 64-5) 3. Given preferences and limited incomes, what amount and type of goods will be purchased? What combination of goods will consumers buy to maximize their satisfaction? (Make a rational or optimal choice) Chapter 3 14

15 Consumer Preferences (pp ) How might a consumer compare different groups of items available for purchase? A market basket is a collection of one or more commodities Individuals can choose between market baskets containing different goods Chapter 3 15

16 Consumer Preferences Basic Assumptions (pp ) 1. Preferences are complete Consumers can rank market baskets 2. Preferences are transitive If they prefer A to B, and B to C, they must prefer A to C 3. Consumers always prefer more of any good to less The more, the better Chapter 3 16

17 Consumer Preferences (pp ) Consumer preferences can be represented graphically using indifference curves (for the case of 2 goods) Indifference curves represent all combinations of market baskets that the person is indifferent to A person will be equally satisfied with either choice Chapter 3 17

18 Indifference Curves: An Example (pp ) Market Basket A B D E G H Units of Food Units of Clothing Chapter 3 18

19 Indifference Curves: An Example (pp ) Graph the points with one good on the x- axis and one good on the y-axis Plotting the points, we can make some immediate observations about preferences The more, the better Chapter 3 19

20 Indifference Curves: An Example (pp ) Clothing B H E The consumer prefers A to all combinations in the yellow box, while all those in the pink box are preferred to A. 30 A G D Food Chapter 3 20

21 Indifference Curves: An Example (pp ) Points such as B & D have more of one good but less of another compared to A Need more information about consumer ranking Consumer may decide they are indifferent between B, A and D We can then connect those points with an indifference curve Chapter 3 21

22 Indifference Curves: An Example (pp ) Clothing 50 B H 40 E A 30 Indifferent between points B, A, & D E is preferred to any points on the indifference curve U 1 Points on U 1 are preferred to H & G 20 G D U 1 10 Food Chapter 3 22

23 Indifference Curves (pp ) Any market basket lying northeast of an indifference curve is preferred to any market basket that lies on the indifference curve Points on the curve are preferred to points southwest of the curve Chapter 3 23

24 Indifference Curves (pp ) Indifference curves slope downward to the right If they sloped upward, they would violate the assumption that more is preferred to less Some points that had more of both goods would be indifferent to a basket with less of both goods Chapter 3 24

25 Indifference Curves (pp ) To describe preferences for all combinations of goods/services, we have a set of indifference curves an indifference map Each indifference curve in the map shows the market baskets among which the person is indifferent Chapter 3 25

26 Indifference Map (pp ) Clothing D B A Market basket A is preferred to B. Market basket B is preferred to D. U 3 U 2 U 1 Food Chapter 3 26

27 Indifference Maps (pp ) Indifference maps give more information about shapes of indifference curves Indifference curves cannot cross Violates assumption that more is better Why? What if we assume they can cross? Chapter 3 27

28 Indifference Maps (pp ) Clothing U 2 U 1 B is preferred to D A is indifferent to B & D B must be indifferent to D but that can t be if B is preferred to D. A contradiction A B D U 1 U 2 Food Chapter 3 28

29 Indifference Curves (pp ) The shapes of indifference curves describe how a consumer is willing to substitute one good for another A to B, give up 6 clothing to get 1 food D to E, give up 2 clothing to get 1 food The more clothing and less food a person has, the more clothing they will give up to get more food Chapter 3 29

30 Indifference Curves (pp ) Clothing 16 A B 1-4 D 1-2 E G Observation: The amount of clothing given up for 1 unit of food decreases from 6 to 1 Food Chapter 3 30

31 Indifference Curves (pp ) We measure how a person trades one good for another using the marginal rate of substitution (MRS) It quantifies the amount of one good a consumer will give up to obtain more of another good, or the individual terms of trade It is measured by the slope of the indifference curve Chapter 3 31

Econ 303. Weeks 3-4 Consumer Theory

Econ 303. Weeks 3-4 Consumer Theory Econ 303 Weeks 3-4 Consumer Theory CHAPTER 3 OUTLINE 3.1 Consumer Preferences 3.2 Budget Constraints 3.3 Consumer Choice 3.4 Revealed Preference 3.5 Marginal Utility and Consumer Choice Consumer Behavior