Consumer Choice

and Elasticity
Full Length Text — Part: 5 Chapter: 20
Micro Only Text — Part: 3 Chapter: 7

To Accompany “Economics: Private and Public Choice 13th ed.”

James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson
Slides authored and animated by:
Joseph Connors, James Gwartney, & Charles Skipton

Copyright ©2010 Cengage Learning. All rights reserved.

Next page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Fundamentals of
Consumer Choice

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Fundamentals of Consumer Choice
• Factors affecting choice:
• Limited income necessitates choice.
• Consumers make choices purposefully.
• One good can be substituted for another.
• Consumers must make decisions without
perfect information, but knowledge and past
experience will help.
• Law of diminishing marginal utility:
As the rate of consumption increases, the
marginal utility derived from consuming
additional units of a good will decline.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Marginal Utility, Consumer
Choice, and the Demand
Curve of an Individual

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
The Demand Curve
• The height of an individual's demand curve
indicates the maximum price the consumer
would be willing to pay for that unit.
• A consumer's willingness to pay for a unit
of a good is directly related to the utility
derived from consumption of the unit.
• The law of diminishing marginal utility
implies that a consumer's marginal benefit,
and thus the height of their demand curve,
falls with the rate of consumption.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 The Demand Curve
• An individual’s demand curve,
Jones’s demand for frozen pizzas Price Jones’s demand curve
in this case, reflects the law of for frozen pizza
diminishing marginal utility. MB1
• Because marginal utility (MU) falls $3.50
with increased consumption, so does MB2
$3.00
a consumer’s maximum willingness
MB3
to pay -- marginal benefit (MB).Price = $2.50
• A consumer will purchase until MB4
$2.00
MB = Priceso. at
. . $2.50 Jones
would purchase 3 frozen pizzas and
receive a consumer surplus shown
by the shaded area (above the price d = MB
line and below the demand curve).

MB4 < MB3 < MB2 < MB1 Frozen pizzas

because 1 2 3 4 per week
MU4 < MU3 < MU2 < MU1
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Consumer Equilibrium
With Many Goods
• Each consumer will maximize his/her
satisfaction by ensuring that the last dollar
spent on each commodity yields an equal
degree of marginal utility.

MUa MUb MUn

Pa = Pb = . . . = Pn

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Price Changes and Consumer Choice
• The demand curve shows the amount of a
product consumers would be willing to buy
at different prices for a specific period.
• The law of demand states that there is an
inverse relationship between the quantity of
a product purchased and its price.
• Reasons the demand curve slopes downward:
• Substitution effect:
as a product’s price falls, the consumer will
buy more of it and less of other, now more
expensive, products.
• Income effect:
as a product’s price falls, a consumer’s real
income rises and so induces the individual
to buy more of both it and other goods.
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Time Cost and Consumer Choice
• The monetary price of a good is not always a
complete measure of its cost to the consumer.
• Consumption of most goods requires time as
well as money. Like money, time is scarce to
the consumer.
• So, a lower time cost, like a lower money
price, will make a product more attractive.
• Time costs, unlike money prices, differ
among individuals.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Questions for Thought:
1. Chuck is currently purchasing 3 pairs of jeans
and 5 t-shirts per year. The price of jeans is
$30, and t-shirts cost $10. At his current rate
of consumption, his marginal utility of jeans is
60 and his marginal utility of t-shirts is 30.
Is Chuck maximizing his utility? Would you
suggest he buy more jeans and fewer t-shirts,
or more t-shirts and fewer jeans?
2. “If the price of gasoline goes up and Fran now
buys fewer candy bars because she has to
spend more on gas, this would best be
explained by the substitution effect.”
-- Is this statement true or false?
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Market Demand Reflects
the Demand of Individual
Consumers

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Individual and Market Demand Curves
• Consider Jones’s demand for frozen pizza.At $3.50 Jones
demands 1 pizza … at $2.50 3 pizzas … and so on …
• Consider Smith’s demand for frozen pizza. At $3.50 Smith
demands 2 pizzas … at $2.50 3 pizzas … and so on …
• The market demand curve is merely the horizontal sum of the
individual demand curves (here Jones and Smith).
• The market demand curve will slope downward to the right,
just as the individual demand curves do.
Jones Smith 2-Person market
Price Price Price

$3.50 $3.50 $3.50

$2.50 $2.50 $2.50

D
d
d
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8
Weekly frozen pizza consumption
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Elasticity of Demand

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Price Elasticity of Demand
• Price elasticity reveals the responsiveness of
the amount purchased to a change in price.
% Change in
Price Elasticity quantity demanded % Q
of demand = % Change in Price = % P

(Q0Q
1) (
P0P
1)
=
(
Q0Q)2(
1 P
0P)2
1

- or put more simply -

(Q0 - Q1 ) (Q0 + Q 1)
=
( P0 - P1 ) ( P0 + P1)
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Price Elasticity Numerical Application
• Suppose Trina bakes specialty cakes. She can sell
50 specialty cakes per week at $7 a cake, or 70
specialty cakes per week at $6 a cake.
• What is the demand elasticity for Trina’s cakes?

Percent change in ( 50  70 )  20
   33 . 33 %
quantity demanded: ( 50  70 ) 2 60

Percent change ( 7  6) 1
  15 .38 %
in price: ( 7  6 ) 2 6 .5
The price elasticity % Q -33.33
= = -2.17
of demand equals: % P 15.38
- Recall -
Price Elasticity (Q0Q
1) (
P0P
1)
of demand = (
Q Q)2(PP)2
0 1 0 1
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Price Elasticity of Demand
• After calculating the price elasticity of
demand, you can determine whether it is
elastic, inelastic, or unitary elastic with the
following:
• If the absolute value of the elasticity term < 1,
then the demand is inelastic.
• If the absolute value of the elasticity term > 1,
then the demand is elastic.
• If the absolute value of the elasticity term = 1,
then the demand is unitary elastic.
• Because price elasticity of demand is always
negative, the sign on the coefficient is often
omitted in discussions of elasticity.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Elasticity of Demand
Price
• Perfectly inelastic:
Mythical An increase in price results in
demand no
curve
change in consumers
purchases.
The vertical demand curve is
Quantity/ mythical as the substitution
(a) time and
income effects prevent this
from
happening in the real world.
Price
• Relatively inelastic:
Demand for
A percent increase in price Cigarettes
results
in a smaller % reduction in
sales.
The demand for cigarettes has
been estimated to be highly Quantity/
inelastic. (b) time

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Elasticity of Demand
Price
• Unitary elasticity:
Demand curve of The percent change in quantity
unitary elasticity
demanded due to an increase
in
price is equal to the % change
Quantity/ in
(c) time price. A decreasing slope
results. Sales revenue (price
times quantity) is constant.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Elasticity of Demand
Price
• Relatively elastic:
Demand for A % increase in price leads to
Granny Smith
apples a
larger % reduction in
purchases.
When there are good
substitutes
Quantity/ for a product (as with Granny
(d) time Smith apples), the quantity
purchased will be highly
sensitive to changes in price.
Price
• Perfectly elastic: Demand for Farmer
Jones’s wheat
Consumers will buy all of
Farmer
Jones’s wheat at the market
price, but none will be sold
above Quantity/
the market price. (e) time

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Elasticity of Demand
(
Q Q)(
Q Q)
Recall - (P0

1
P)(
P
0

1
P
)
0 1 0 1

(110 - 100) (110 + 100)

Price
• With this straight-line (constant-slope) ($1 - $2) ($1 + $2)
demand curve, demand varies across
a range of prices. = ( - ) 0.14
Elasticity = (-) 0.14
• Using the equation for elasticity, the
formula shows that, when price rises
from $1 to $2 … while quantity
demanded falls from 110 to 100 …
the elasticity for that region of the
demand curve is ( - 0.14 ) – inelastic.
2
1
D
Quantity
100 110 demanded
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Elasticity of Demand
(
Q Q)(
Q Q)
Recall - (P0

1
P)(
P
0

1
P
)
0 1 0 1

(20 - 10) (20 + 10)

Price
• A price increase of the same amount, ($10 - $11) ($10 + $11)
from $10 to $11, . . leads
. to a decline = (-) 7.0
in quantity demanded from 20 to 10. 11
10 Elasticity = (-) 7. 0
• Note that this change in price was
smaller (as a %) than in the previous
slide but resulted in the same change
in quantity demanded.
• Applying the elasticity formula, the
calculated elasticity is (- 7.0) – greater
than (- 0.14) from before.
• The price-elasticity of a straight-line
demand curve increases as price rises. D
Quantity
10 20 demanded
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Determinants of
Price Elasticity of Demand
• Availability of substitutes
• When good substitutes for a product are
available, a rise in price induces many
consumers to switch to another product.
• The greater the availability of substitutes,
the more elastic demand will be.
• Share of total budget expended on product
• As the share of the total budget spent on the
product increases, demand is more elastic.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Elastic and Inelastic Demand
Price Price

$6.00 $6.00

$4.00 $4.00
D

D
25 100 90 100
(a) 1/2 lb. hamburgers per week (in thousands) (b) Cigarette packs per week (in millions)
• the from $4.00 to $6.00 . . .
As the price of 1/2 lb. hamburgers (a) rises
quantity demanded plunges from 100,000 to 25,000 per week.
• The % reduction in quantity demanded is larger than the % increase in
price, hence the demand for 1/2 lb hamburgers is relatively elastic.
quantity
• As the price of cigarettes (b) rises from $4.00 to $6.00 . . .
demanded declines from 100 million to 90 million packs per week.
• The % reduction in quantity demanded is smaller than the % increase
in price, hence the demand for cigarettes is relatively inelastic.
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Time and Demand Elasticity
• If the price of a product increases,
consumers will reduce their consumption
by a larger amount in the long run than in
the short run.
• Thus, demand for most products will be more
elastic in the long run than in the short run.
• This relationship is sometimes referred to as
the second law of demand.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Elasticity of Demand
Inelastic Approximately Unitary Elasticity
Salt - 0.1 Movies - 0.9
Matches - 0.1 Homes, owner occupied (long run) - 1.2
Toothpicks - 0.1 Shellfish (consumed at home) - 0.9
Airline travel (short run) - 0.1 Oysters (consumed at home) - 1.1
Gasoline (short run) - 0.2 Private education - 1.1
Gasoline (long run) - 0.7 Tires (short run) - 0.9
Natural gas, home (short run) - 0.1 Tires (long run) - 1.2
Natural gas, home (long run) - 0.5 Radio and television receivers - 1.2
Coffee - 0.3
Fish (cod), at home - 0.5 Elastic
Tobacco products (short run) - 0.5 Restaurant meals - 2.3
Foreign travel (long run) - 4.0
Legal services (short run) - 0.4
Airline travel (long run) - 2.4
Physician services - 0.6
Fresh green peas - 2.8
Taxi (short run) - 0.6
Automobiles (short run) - 1.2 to -1.5
Automobiles (long run) - 0.2
Chevrolet automobiles - 4.0
Fresh tomatoes - 4.6
• Can you explain why the demand for some goods
is highly inelastic while that for others is elastic.
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
How Demand Elasticity and
Price Changes Affect Total
Expenditures (or Revenues)
on a Product

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Total Expenditures
and Demand Elasticity
Impact of higher price Impact of lower price
Elasticity on total consumer on total consumer
Price elasticity coefficient expenditures or a expenditures or a
of demand (in absolute value) firm’s total revenue firm’s total revenue

Elastic 1 to  decrease increase

Unitary Elastic 1 -- unchanged-- -- unchanged--
Inelastic 0 to 1 increase decrease

• The table above summarizes the relationship

between changes in price and total expenditures
for demand curves of varying elasticity.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Income Elasticity

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Income Elasticity
• Income elasticity indicates the responsiveness
of a product’s demand to a change in income.
% Change in
Income Elasticity quantity demanded
of demand = % Change in Income

• A normal good is a good with a positive

income elasticity of demand.
• As income expands, the demand for normal
goods will rise.
• Goods with a negative income elasticity are
called inferior goods.
• As income expands, the demand for inferior
goods will decline.
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 Income Elasticity of
Low Demand
Income Elasticity High Income Elasticity
Margarine - 0.20 Private education 2.46
Fuel 0.38 New Cars 2.45
Electricity 0.20 Recreation and amusements 1.57
Fish (haddock) 0.46 Alcohol 1.54
Food 0.51
Tobacco 0.64
Hospital care 0.69

• Why is the income elasticity of demand for some

goods greater than for others?
• What does it mean that the income elasticity of
demand for margarine is negative? Can you think
of any other goods which you would expect to
have
a negative income elasticity of demand
coefficient? Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Price Elasticity of Supply

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Price Elasticity of Supply
• The price elasticity of supply is the percent
change in quantity supplied divided by the
percent change of the price causing the
supply response.
• analogous to the price elasticity of demand
• If the % change in quantity is small
relative to the % change in price, supply
is inelastic.
• If the % change in quantity is large
relative to the % change in price, supply
is elastic.
• However, price elasticity of supply is
positive because the quantity producers are
willing to supply is directly related to price.
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Questions for Thought:
1. (a) Studies indicate that the demand for Florida
oranges, Bayer aspirin, watermelons, and
airfares
(b) Why to Europe
is the demandare
forelastic. Why? and
salt, matches,
gasoline (short-run) inelastic?
2. Are the following statements true or false?
Explain your answers.
(a) A 10% reduction in price that leads to a 15%
increase in amount purchased indicates a
price elasticity of more than 1.
(b) A 10% reduction in price that leads to a 2%
increase in total expenditures indicates a
price elasticity of more than 1.

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
Questions for Thought:
3. Suppose Bobby, the owner-manager of Bobby’s
Red Hot BBQ restaurant, projects the following
demand for his baby-back rib platter:
Price Quantity purchased
----------------------------------------------
$9 110 per night
$11 100 per night
$13 80 per night
(a) Calculate the price elasticity of demand
between $9 and $11. Was demand in this
price range elastic, inelastic, or unitary?
(b) Calculate the price elasticity between $11
and $13. Is it elastic, inelastic, or unitary?
Copyright ©2010 Cengage Learning. All rights reserved.
Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.
 End
Chapter 20

Copyright ©2010 Cengage Learning. All rights reserved.

Jump to first page May not be scanned, copied or duplicated, or posted to a
publicly accessible web site, in whole or in part.