9 Demand-Introduction to Economic Aspects Demand and Elasticity In economics, demand theory refers to the theory of consumer behavior; business firms will demand labor as well, but this is in the process of production (net section in course0 Economic approach to microeconomics questions: Actors have goals, act rationally to achieve goals, and function in a particular environment. Consumers as actors: Maimize utility (well being, happiness, satisfaction). [NOTE: Scitovsky will suggest problems with this] Act rationally, which implies choices are transitive, and More is better. MORE IS BETTER UTILITY = F(CONSUMPTION) y U c b a Marginal utility, defined as du/dx In most instances (arts may be an eception), marginal utility declines diagram C
10 Given the assumptions more is better, and declining marginal utility, we can derive two interesting aspects of consumer behavior. The optimal combination of goods, and The amount purchased of a given good as its price changes, i.e., the demand curve Optimal Combination Assuming all prices are the same MU = MUy; and if prices differ MU/P = Muy/Py This equating of marginal utilities provides the General Law of Demand Simply put, the quantity demanded increases as the price falls. This is true for most goods; eceptions are snob goods and inferior goods (more on this later when we get to elasticity). Summing individual demand curves yields the market demand curve (which must be downward sloping) P D summing the curves = industry demand 1 2 D in 2 is the demand curve, assuming all else equal, which includes income, other prices, tastes and preferences ----latter will be etra important in the arts)
11 Need to distinguish between movements along the curve, and shifts in the curve. Brief comments on the model itself: granted, the world is a far more comple place: people fall in love, get angry, and do crazy things just for the hell of it but, simplicity (abstraction) has its virtues, and may often (not always) get at the essence of an issue, or at factors that might otherwise be overlooked... Shifts in Demand and Elasticity Shifts in the demand curve--again, as distinct from movements on the curve a function of:. tastes, income, fairly straight forward (almost), prices of other commodities (either substitutes or complements), and epectations
12 Elasticity Generalized definition: a reaction to a force Many elasticities in economics (output to labor, sales to advertising but major focus on: Price and Income Price Elasticity: the percentage change in quantity, given the percentage change in price. dq/q = dq/dp times P/Q dp/p that is, both the slope (dq/dp) and the position (P/Q) are relevant. And elasticity is a function of several factors: availability of substitutes (etent to which the commodity is a necessity), percentage of income spent on the commodity, time period----short vs. long run, and the more specifically the good is defined, the more the substitutes. What s the big deal??? Elasticity tells what happens to total revenue when prices change, and we define the demand curve as elastic or inelastic. That is E < - 1 and E > - 1 Note:: convention often uses just the absolute value e.g. we may say the demand is elastic, where E > 1, when we mean less than 1 [that is, -10 is less than 1, but 10 is greater than 1. Clear???]
13 Income Elasticity (quite relevant in the arts) Concept could refer to an individual or family, but in general refers to changes in income in the overall economy, associated with time, which generally means growth (but not always). Income elasticity determines the nature of the good: normal, inferior, and superior (luury). Some eamples: In the government, Education and Welfare may be thought of as normal, or even superior goods (depending to a very great etent on the nature of the government). In the private sector, we often distinguish between goods: Basic necessities food, clothing, Basic raw materials may be a problem in developing countries, and Luury goods. Where do the arts fit in???????