Class Notes 3

AED Economics 200
Principles of Food and Resource Economics
Winter, 2003

3. Consumer Choice and Elasticity
Consumer Choice Theory - foundation of market demand
	Total utility as a function of quantity consumed Marginal utility as a function of quantity consumed Law of diminished marginal utility Assumption: Consumers seek to maximize utility with constrained budget
	OR
	They spend their scare dollars on those items that provide the highest marginal utility per dollar spent
	Consumer equilibrium MU_a / P_a = MU_b / P_b = ... = MU_n / P_n
Graphic Model of Consumer Choice
	Utility Function Indifference Curves Budget Constraints Consumer Equilibrium Price Change Substitution Effect Income Effect Income Change Engel Curve - quantity vs. income
Deriving Individual's Demand Curve Market Demand Curve Consumer Surplus Price Elasticity of Demand
	Inelastic Elastic Unitary Elasticity
Income Elasticity of Demand
	Normal Good - income elasticity is positive Inferior Good - income elasticity is negative
Price Elasticities of Demand for Selected Goods
	Good	Price Elasticity
	Farm products
	Corn Hay Cattle Hogs Eggs Vegetables	-0.77 -0.78 -0.68 -0.50 -0.23 -0.10
Food
	Beef Pork Milk Food away from home Fresh tomatoes	-0.50 -0.40 -0.31 -1.63 -4.60
Autos Beer Housing Tobacco Major League Baseball Hospital and Physicians Gasoline Short Run Long Run Electricity Short Run Long Run Airline travel Chevrolet autos		-1.35 -1.15 -1.00 -0.33 -0.23 -0.10 -0.20 -1.50 -0.13 -0.88 -2.40 -4.00
Income Elasticities of Demand for Selected Goods
	Good	Income Elasticity
	Margarine Milk Meat Restaurant Meals Electricity Clothing Autos Housing Beer Charitable Donations Major League Baseball Hospital and Physicians Private education	-0.20 0.07 0.35 1.48 0.20 2.01 3.00 1.15 0.93 0.70 1.30 0.69 2.46
Cross Price Elasticity
	Substitutes Complements
Summary: Quantity demanded of a good is a function of:
	price of the good price of complements and substitutes income population tastes and preferences (price expectations)
Price elasticity of demand
	factors affecting
	substitutes share of budget length of time to respond
	elasticity changes
	along demand curve with time
	elasticity higher for brands
Effect of price change on total revenue depends on elasticity
	Examples:
	grain price discrimination stadium ticket prices
Price elasticity of supply Price instability Price elasticity of demand: implications for price change in response to change in quantity
	Total revenue Pricing strategy of producer
Price discrimination: segmenting market, and charge different prices in different segments. Differences do not reflect cost differences.
	-reflects different demand elasticities of segments -examples
Impact of tax on goods depends on elasticities of supply and demand Markets:
	with inelastic demand - consumer pays most of tax with elastic demand - producer pays
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