Subject: Price (Economic Theory) Sat Apr 12, 2008 10:29 am
On some points about 'elasticity' on the EU water thread, Pax included a youtube link where I found the below presentation. It gives a good explanation (i think anyway!) of what economists mean by elasticity by which I learned that the price of some things will never (?) affect the demand or at least affect it only slightly. So, no matter how cheap or expensive sugar is, it will always be bought in more or less the same quantities. I could be wrong about sugar but I am guessing that among 'inelastic' goods must be foods. Can ye list any? and please correct me if I'm wrong, I'm a learner here too.
Also on that below (and what I'm more interested in eventually) is the point where he puts the price up on the board - £10 and he says "that's the starting price" . How did the good get to that starting price in the first place?
On some points about 'elasticity' on the EU water thread, Pax included a youtube link where I found the below presentation. It gives a good explanation (i think anyway!) of what economists mean by elasticity by which I learned that the price of some things will never (?) affect the demand or at least affect it only slightly. So, no matter how cheap or expensive sugar is, it will always be bought in more or less the same quantities. I could be wrong about sugar but I am guessing that among 'inelastic' goods must be foods. Can ye list any? and please correct me if I'm wrong, I'm a learner here too.
I can and I will! An excellent thread, microeconomics are fascinating. They're really a look under an economy's bonnet!
Here is an example of a perfectly inelastic demand curve. No change in price will affect demand. Water is a brilliant example of a good facing a perfectly inelastic demand curve. No matter what the price, you need water to live, and your life is priceless:
This is an example of a relatively inelastic demand curve. Demand changes slightly in the face of price changes. An example might be milk. Recent price rises mean that you might miss buying a litre or two here or there:
This is an example of an elastic demand curve. All sorts of goods like tellies, computers, cars and all sorts can fall under this heading depending on your individual PED.
And this(finally) is an example of a perfectly elastic demand curve. Any change in price means that demand falls to zero. Immediately. Petrol stations operate in a market which is closest to this demand curve. Please remember that this(in the main) is a theoretical contruct by economists which exists rarely in the real world:
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Also on that below (and what I'm more interested in eventually) is the point where he puts the price up on the board - £10 and he says "that's the starting price" . How did the good get to that starting price in the first place?
If the good is being sold in the short run( ie when at least 1 of the FOP is fixed), only AVC need to be covered. If the good is being sold in the long run then all costs, not only variable, must be covered. All FOP are elastic in the long run. If AC=AR, then Normal Profit is being earned and if AR>AC then SNP occurs but that's a matter for another thread!
The availability of substitutes affects the price elasticity of demand because it gives buyers alternatives. For example, demand for grapes grown from a particular farm will be relatively elastic because of the easy availability of substitutes. Changes in the price of a particular grape variety will lead to large changes in demand, as buyers shift their demand to other varieties.
In contrast, consumers see many varieties of wine, such as Australian chardonnay, as having relatively few substitutes. Increases in the price of Australian chardonnay will lead to a relatively small decrease in demand, as many consumers view this wine as special and may be unwilling to switch to other varieties.
Brand recognition affects consumers' perceptions of the substitutability of goods and so can affect the elasticity of demand. For instance, some customers may perceive a branded good, a specific brand of soap, for example, as having many substitutes in other brands of soap. However, some brands of soap have managed to create strong brand loyalty that allows them to enjoy relatively inelastic demand.
A Product's Cost as a Percent of the Buyer's Budget
A product's cost as a percent of the buyer's budget affects the price elasticity of demand for a product because more thought is given to price when buyers are making large purchases than when they are making small purchases.
For example, the price of shoelaces may vary by as much as 80 percent and a typical buyer will not give it much thought. The price of the shoes themselves is of considerably more interest to most buyers.
Similarly, consumers will be more sensitive to price changes in goods purchased frequently, such as milk or cheese, than in goods purchased infrequently, such as gourmet mustard. Buyers, in other words, tend to be more sensitive to price changes in large-budget items because these small percentage differences translate into significant amounts of money.
The Time Horizon
The time horizon, or the amount of time over which you can analyse the effects of a price change, can also affect the price elasticity of demand. For instance, the elasticity of gasoline has been found to be much greater over the long run than over the short run.
In the short run, it may be difficult for people to find alternatives to gasoline. After all, most people own cars that run on gasoline and do not live within walking distance of their workplaces. Because it is difficult to find substitutes for products such as gasoline in the short run, such goods tend to have lower price elasticity of demand. However, in the long run, people may be able to more easily find a substitute for gasoline or purchase more fuel-efficient cars that use less gasoline.
Sometimes goods may be more elastic in the short run, however. For instance, consumers may react to a short-term sale on the price of cases of a soft drink by purchasing many cases. Consumers purchase many units because they know that in the future the price of the beverage will again increase. However, a long-term decline in the price may cause less of an effect on the quantity demanded, as consumers realise the lower price is here to stay.
Scope of Definition
The scope of definition also affects the price elasticity of demand. The scope of definition refers to the class of products considered when calculating elasticity. For instance, we can consider both the elasticity of demand for the automobile market as a whole, as well as the elasticity for a specific make or model.
Demand for cars as a whole will be relatively inelastic, as consumers need them as a form of transportation. However, demand for a specific model of car will be much more elastic as consumers can easily substitute competing models.
Generally speaking, the more broad the scope of the product, the less sensitive buyers are to changes in the price of the product. The more narrow the scope of a product, the more sensitive buyers are to changes in the price of the product. Thus, the price elasticity of firm demand is generally more elastic at any given price than the price elasticity of market demand.
If the good is being sold in the short run( ie when at least 1 of the FOP is fixed), only AVC need to be covered. If the good is being sold in the long run then all costs, not only variable, must be covered. All FOP are elastic in the long run. If AC=AR, then Normal Profit is being earned and if AR>AC then SNP occurs but that's a matter for another thread!
Hang on Ard-T.
FOP? AVC? SNP? AR=AC? PED ? I coud guess but would most likely be wrong.
Then on the elastic curve, where it shows revenue loss and gain, There must then be a price point where revenue is maximised ? Don't some manufacturers/services just add a standard margin regardless of this type of analysis ?
Nobody replied to my posts on elasticity! Am I the only one who sighs over a perfectly elastic demand curve?
The last sentence I read in my textbook read - "Thus, wine and beer may not be similar goods as such, but there may, notwithstanding this, be some competitioin between them. Economists term this relationship cross-elasticity of demand: as the price of one product rises in relation to another, so consumers switch to the lower-priced product"
Also on that below (and what I'm more interested in eventually) is the point where he puts the price up on the board - £10 and he says "that's the starting price" . How did the good get to that starting price in the first place?
If the good is being sold in the short run( ie when at least 1 of the FOP is fixed), only AVC need to be covered. If the good is being sold in the long run then all costs, not only variable, must be covered. All FOP are elastic in the long run. If AC=AR, then Normal Profit is being earned and if AR>AC then SNP occurs but that's a matter for another thread!
When someone first puts a price on something, then they are essentially guessing at what the market will actually pay. However, the minimum price they will set will be their costs plus a profit margin. What profit margin do you set, as a new business selling, say, bogwots?
If demand is elastic, then the initially guessed profit margin will have to be adjusted over time to produce the greatest amount of profit (demand x profit margin). We will try and work out (very inexactly) what price will give us the most overall profit, by creating the greatest demand. If 10 people are willing to buy, and we make a profit of €10 per sale, we'll make €100. If we drop the profit per bogwot to €5, and 1000 people are then willing to buy, we'll make €5000.
Unfortunately, we don't know in advance, and for anything other than stocks and shares, the process of actually making the sales is too cumbersome to feed back quickly or cleanly into our pricing.
If the demand is inelastic, and people simply have to have a bogwot no matter what the price, then our pricing depends on whether we have a monopoly on bogwots or not.
If we don't have a monopoly, we will set our prices so that people would rather buy our bogwots than our competitor's bogwots. Ideally, we do this by having lower costs, so that we can set the price lower than our competitors while still making a bigger profit. Alternatively, we can conspire with our competitors to form an oligopoly, or cartel, so that we don't compete on price.
If we do have a monopoly, and people have to have bogwots no matter what price they are, then the only real limit to our price is everything people can afford that still leaves them capable of paying it again next year.
In general, however, the only people who can guarantee us a monopoly on bogwots will be the government, and they will probably only allow us to charge a price that does not make them too unpopular.
If the good is being sold in the short run( ie when at least 1 of the FOP is fixed), only AVC need to be covered. If the good is being sold in the long run then all costs, not only variable, must be covered. All FOP are elastic in the long run. If AC=AR, then Normal Profit is being earned and if AR>AC then SNP occurs but that's a matter for another thread!
Hang on Ard-T.
FOP? AVC? SNP? AR=AC? PED ? I coud guess but would most likely be wrong.
Then on the elastic curve, where it shows revenue loss and gain, There must then be a price point where revenue is maximised ? Don't some manufacturers/services just add a standard margin regardless of this type of analysis ?
On some points about 'elasticity' on the EU water thread, Pax included a youtube link where I found the below presentation. It gives a good explanation (i think anyway!) of what economists mean by elasticity by which I learned that the price of some things will never (?) affect the demand or at least affect it only slightly. So, no matter how cheap or expensive sugar is, it will always be bought in more or less the same quantities. I could be wrong about sugar but I am guessing that among 'inelastic' goods must be foods. Can ye list any? and please correct me if I'm wrong, I'm a learner here too.
Also on that below (and what I'm more interested in eventually) is the point where he puts the price up on the board - £10 and he says "that's the starting price" . How did the good get to that starting price in the first place?
I'm no economist (electronics is my bag) but here's a good explanation. The 'law' of demand just says that as the price rises the quantity demanded falls, but it never says by how much. So, if a 1% increase in price leads to more than a 1% fall in quantity demanded, we say that market demand is elastic. If a 1% increase in price leads to less than a 1% fall in quantity demanded, we say that market demand is inelastic. And vice versa for law of supply.
So I don't think sugar is usually inelastic as there are alternatives available to it? If the price of sugar increases then the quantity supplied will increase further than the increase in price. So market supply of sugar is elastic. If it was less than the price increase, then it'd be inelastic.
You can use this elasticity in conjunction with supply and demand curves to find out the implications of assigning a price (or price controls of 10 pounds) or say whether more or less unemployment will result from a minimum wage level of 10 pounds etc. So you can have your labour supply and demand curves, but then put in elastic or inelastic demand curves. The drop in employment is greater with elastic than with inelastic curves. There's a similar situation with the price assigning or controls,
Last edited by Pax on Tue Apr 15, 2008 11:18 pm; edited 1 time in total
I'm no economist (electronics is my bag) but here's a good explanation. The 'law' of demand just says that the as the price rises the quantity demanded falls, but it never says by how much. So, if a 1% increase in price leads to more than a 1% fall in quantity demanded, we say that market demand is elastic. If a 1% increase in price leads to less than a 1% fall in quantity demanded, we say that market demand is inelastic. And vice versa for law of supply.
So I don't think sugar is usually inelastic as there are alternatives available to it? If the price of sugar increases then the quantity supplied will increase further than the increase in price. So market supply of sugar is elastic. If it was less than the price increase, then it'd be inelastic.
On the subject of alternatives, I posted about that above, under Factors which influence PED. Availability of substitutes is a big weight on goods' elasticity. That's why Monopolies so often face inelastic demand curves. Consumers have nowehre else to go, they have to absorb the cost.
Quote :
You can use this elasticity in conjunction with supply and demand curves to find out the implications of assigning a price (or price controls of 10 pounds) or say whether more or less unemployment will result from a minimum wage level of 10 pounds etc. So you can have your labour supply and demand curves, but then put in elastic or inelastic demand curves. The drop in employment is greater with elastic than with inelastic curves. There's a similar situation with the price assigning or controls,
That's the classical way of thinking, the best kind of thinking! Market price is arrived at via equilibrium between the supply and demand curves.
Right then Pax, how does someone whos bag is electronics, know so much about economics. That depresses me. My bag has also been electronics.. oh for ages now..but I know feck all about economics. It confuses me considerably. I think it's because I can never get a handle on the absolutes, or initial conditions or whatever.
As we're on a book club now next door and hopefully not to derail this thread just a quick aside I hope - there are some economics books for the joe bloggs in the street which are much better than others... anyone give a recommendation? I've read various things but most of my now forgotten economic knowledge was gleaned from the great populariser John Kenneth Galbraith. So he would be my recommendation if you wanted to ever get your feet wet evm. Money: Whence it Came, Where it Went and The Affluent Society (a classic apparently) Very easy to read. History of Economics too.
As we're on a book club now next door and hopefully not to derail this thread just a quick aside I hope - there are some economics books for the joe bloggs in the street which are much better than others... anyone give a recommendation? I've read various things but most of my now forgotten economic knowledge was gleaned from the great populariser John Kenneth Galbraith. So he would be my recommendation if you wanted to ever get your feet wet evm. Money: Whence it Came, Where it Went and The Affluent Society (a classic apparently) Very easy to read. History of Economics too.
Yep am also at that point of having to undergo a crash course in economics at the moment, not only re MN. Have found Tim Harford's The Undercover Economist and his columns in the FT to be a good starting point. Then on to John Kay, J Stiglitz and Hernando de Soto.
And so I come to the nemesis of my world, Cooter and Ulen's Law and Economics .
Atticus. Did you buy any of that mining company, symbol Kaz.l It was up 7% last week but had a 4% drop Monday. If you did good luck but I will give you the same advice I gave the unfortunate Saratoga when he wanted to buy Bear Sterns at 104 dollars, put in a stop loss at 14 in your case. As regards books most of these are very boring and heavy going. Galbraith narrated a great series of documentaries from the 70s called The Age of Uncertainty. Check your library for it. I have recommended this video from google before which explains what money is and how it is. It is 3.40 hours long but it is an eyeopener. When it is my turn to pick a book I think I will choose, Millionaire, It is the life story of John Law who was a wild Scot who was a financial whiz in the years about 1720. He was responsible for The Mississippi Bubble in France which happened at the same time as The South Seas Bubble in England. When the bubble burst it bankrupted France but it was great craic while it lasted with all the ladies of the court giving him The Cuir Isteach in exchange for tips. http://video.google.com/videoplay?docid=-515319560256183936
Portal 
Am I the only one who sighs over a perfectly elastic demand curve?
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