Appendix B. Making Smart Choices

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Sydney Kelly
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1 Appendix B Making Smart Choices

2 Making Smart Choices The Law of Demand

3 LEARNING OBJECTIVES B.1 Describe what determines your willingness to pay for a product/service B.2 Choice depends on marginal benefit, not total benefit B.3 The relationship between price and quantity demanded B.4 Demand vs Quantity Demanded B.5 Elasticity of demand

4 PUT YOUR MONEY WHERE YOUR MOUTH IS WEIGHING BENEFITS, COSTS, AND SUBSTITUTES Your willingness to buy a product/service depends on your ability to pay, comparative benefits and costs and the availability of substitutes.

5 WEIGHING BENEFITS, COSTS, & SUBSTITUTES Preferences your wants and their intensities Demand consumers willingness and ability to pay for particular product/service what you are willing to pay or give up depends on the cost availability of substitutes

6 LIVING ON THE EDGE SMART CHOICES ARE MARGINAL CHOICES Key 2 for smart choices states, Count only additional benefits and additional costs. Additional benefit means marginal benefit not total benefit and marginal benefit changes with circumstances.

7 SMART CHOICES ARE MARGINAL CHOICES Marginal benefit additional benefit from a choice changes with circumstances Marginal benefit explains diamond/water paradox willingness to pay depends on marginal benefit, not total benefit water is abundant, marginal benefit is low diamonds are scarce, marginal benefit is high

8 WHEN THE PRICE ISN T RIGHT THE LAW OF DEMAND If the price of a product/service rises, the quantity demanded decreases. Consumers economize on products/services that become more expensive by switching to substitutes.

9 LAW OF DEMAND Quantity Demanded amount you actually plan to buy at a given price Fig. B.1 Your Demand for ipod Nano Price (willing to pay) Quantity Demanded $ 75 2 $ $ 225 0

10 Market demand sum of demands of all individuals willing and able to buy a particular product/service Law of demand if the price of a product/service rises, quantity demanded decreases

11 Fig. B.2 Market Demand for Water Price Quantity Demanded $ $ $ $ $

12 MOVING THE MARGINS WHAT CAN CHANGE DEMAND? Quantity demanded is changed only by a change in price. Demand is changed by all other influences on consumer choice.

13 continued WHAT CAN CHANGE DEMAND? Demand is a catch-all term summarizing all possible influences on consumers willingness and ability to pay for a particular product/service increase in demand increase in consumers willingness and ability to pay decrease in demand decrease in consumers willingness and ability to pay

14 Demand changes with changes in preferences prices of related goods income expected future price number of consumers

15 Demand increases with: increase in preferences rise in price of a substitute fall in price of a complement increase in income for normal goods decrease in income for inferior goods rise in expected future prices increase in number of consumers

16 JUST HOW BADLY DO YOU WANT IT? PRICE ELASTICITY OF DEMAND & TOTAL REVENUE Elasticity measures how responsive quantity demanded is to a change in price, and determines business pricing strategies to earn maximum total revenue.

17 continued PRICE ELASTICITY OF DEMAND & TOTAL REVENUE Elasticity (or price elasticity of demand) measures how much quantity demanded responds to a change in price Price elasticity of demand = % change in quantity demanded % change in price

18 continued Inelastic demand small response in quantity demanded when price rises example demand for insulin by a diabetic elasticity > 1 low willingness to shop elsewhere Elastic demand large response in quantity demanded when price rises example demand for yellow tennis balls elasticity < 1 high willingness to shop elsewhere

19 continued Price elasticity of demand influenced by substitutes more substitutes, more elastic demand time to adjust longer time, more elastic demand proportion of income spent greater proportion income spent, more elastic demand

20 Total revenue = price per unit (P) multiplied by quantity sold (Q) When Demand Elastic (>1) % change Q > % change P price cuts increase total revenue When Demand Inelastic (<1) % change Q < % change P price rises increase total revenue

2011 Pearson Education. Elasticities of Demand and Supply: Today add elasticity and slope, cross elasticities

2011 Pearson Education. Elasticities of Demand and Supply: Today add elasticity and slope, cross elasticities 2011 Pearson Education Elasticities of Demand and Supply: Today add elasticity and slope, cross elasticities What Determines Elasticity? Influences on the price elasticity of demand fall into two categories: