Short-Run Versus Long-Run

Elasticity (pp. 38 - 46)

 Price elasticity varies with the amount of

time consumers have to respond to a
price
 Short-run demand and supply curves
often look very different from their long-
run counterparts

©2005 Pearson Education, Inc. Chapter 3 1

 Short-Run vs. Long-Run
Elasticity – An Application (pp. 45 - 6)

 Why are coffee prices very volatile?

Most of the world’s coffee is produced in
Brazil
Many changing weather conditions affect the
crop of coffee, thereby affecting price
Price following bad weather conditions is
usually short-lived
In long run, prices come back to original
levels, all else equal

©2005 Pearson Education, Inc. Chapter 3 2

 Price of Brazilian Coffee (pp. 45 - 6)

©2005 Pearson Education, Inc. Chapter 3 3

 Short-Run vs. Long-Run
Elasticity – An Application (pp. 45 - 6)

 Demand and supply are more elastic in

the long run
 In the short run, supply is completely
inelastic
Weather may destroy part of the fixed supply,
decreasing supply
 Demand is relatively inelastic as well
 Price increases significantly

©2005 Pearson Education, Inc. Chapter 3 4

 An Application - Coffee (pp. 45 - 6)
S’ S
Price
A freeze or drought
decreases the supply
of coffee

Price increases
P1 significantly due to
inelastic supply and
demand

P0

Q1 Q0 Quantity
©2005 Pearson Education, Inc. Chapter 3 5
 An Application - Coffee (pp. 45 - 6)
S’ S Intermediate-Run
Price
1) Supply and demand are
more elastic
2) Price falls back to P2.

P2

P0

Q2 Q0 Quantity
©2005 Pearson Education, Inc. Chapter 3 6
 An Application - Coffee (pp. 45 - 6)
Price
Long-Run
1) Supply is extremely elastic
2) Price falls back to P0.
3) Quantity back to Q0.

P0 S

Q0 Quantity
©2005 Pearson Education, Inc. Chapter 3 7
 Chapter 3

Consumer Behavior
 Introduction (pp. 64 - 5)

 How are consumer preferences used to

determine demand?
It is very likely that your consumption pattern is
different from any of your friends with more or less
same income.
 How do consumers allocate income to
the purchase of different goods?
Do you spend your income only on phone bills?

©2005 Pearson Education, Inc. Chapter 3 9

 Introduction (pp. 64 - 5)

 How do consumers with limited income

decide what to buy?
Do you think a family with no babies spend their
income for baby’s items?
 How can cost of living indexes measure
the well-being of consumers?

©2005 Pearson Education, Inc. Chapter 3 10

 Consumer Behavior (pp. 64 - 5)

 The theory of consumer behavior can be

used to help answer these and many
more questions
 Theory of consumer behavior
The explanation of how consumers allocate
income to the purchase of different goods
and services, or theories behinds consumer
demand curves, QD=QD(P, …)

©2005 Pearson Education, Inc. Chapter 3 11

 Consumer Behavior (pp. 64 - 5)

 Example: Consumption patterns of

Japanese Households (See the figures
on my handouts. The figures are taken
from Kakei Chosa (Family Income and
Expenditure Survey, Ministry of Internal
Affairs and Communications))
http://www.stat.go.jp/english/data/kakei/index.htm

©2005 Pearson Education, Inc. Chapter 3 12

 Consumer Behavior (pp. 64 - 5)

 There are three steps involved in the

study of consumer behavior
1. Consumer Preferences
 To describe how and why people prefer
one good to another (You have
preferences)
2. Budget Constraints
 People have limited incomes (Opportunities
are limited)

©2005 Pearson Education, Inc. Chapter 3 13

 Consumer Behavior (pp. 64 - 5)

3. Given preferences and limited incomes,

what amount and type of goods will be
purchased?
 What combination of goods will consumers
buy to maximize their satisfaction? (Make a
rational or optimal choice)

©2005 Pearson Education, Inc. Chapter 3 14

 Consumer Preferences (pp. 65 - 79)
 How might a consumer compare different
groups of items available for purchase?
 A market basket is a collection of one or
more commodities
 Individuals can choose between market
baskets containing different goods

©2005 Pearson Education, Inc. Chapter 3 15

 Consumer Preferences – Basic
Assumptions (pp. 65 - 79)
1. Preferences are complete
 Consumers can rank market baskets
2. Preferences are transitive
 If they prefer A to B, and B to C, they must
prefer A to C
3. Consumers always prefer more of any
good to less
 The more, the better

©2005 Pearson Education, Inc. Chapter 3 16

 Consumer Preferences (pp. 65 - 79)

 Consumer preferences can be

represented graphically using
indifference curves (for the case of 2
goods)
 Indifference curves represent all
combinations of market baskets that the
person is indifferent to
A person will be equally satisfied with either
choice

©2005 Pearson Education, Inc. Chapter 3 17

 Indifference Curves:
An Example (pp. 65 - 79)
Market Basket Units of Food Units of Clothing

A 20 30

B 10 50

D 40 20

E 30 40

G 10 20

H 10 40

©2005 Pearson Education, Inc. Chapter 3 18

 Indifference Curves:
An Example (pp. 65 - 79)

 Graph the points with one good on the x-

axis and one good on the y-axis
 Plotting the points, we can make some
immediate observations about
preferences
The more, the better

©2005 Pearson Education, Inc. Chapter 3 19

 Indifference Curves:
An Example (pp. 65 - 79)

The consumer prefers

Clothing 50 B A to all combinations
in the yellow box, while
40 all those in the pink
H E box are preferred to A.

30 A

20 D
G
10

Food
10 20 30 40
©2005 Pearson Education, Inc. Chapter 3 20
 Indifference Curves:
An Example (pp. 65 - 79)
 Points such as B & D have more of one
good but less of another compared to A
Need more information about consumer
ranking
 Consumer may decide they are
indifferent between B, A and D
We can then connect those points with an
indifference curve

©2005 Pearson Education, Inc. Chapter 3 21

 Indifference Curves:
An Example (pp. 65 - 79) •Indifferent
between points B,
A, & D
•E is preferred to
50 B
Clothing any points on the
H indifference curve
40 E U1
•Points on U1 are
A preferred to H & G
30

D
20
G U1
10

Food
10 20 30 40
©2005 Pearson Education, Inc. Chapter 3 22
 Indifference Curves (pp. 65 - 79)

 Any market basket lying northeast of an

indifference curve is preferred to any
market basket that lies on the
indifference curve
 Points on the curve are preferred to
points southwest of the curve

©2005 Pearson Education, Inc. Chapter 3 23

 Indifference Curves (pp. 65 - 79)

 Indifference curves slope downward to

the right
If they sloped upward, they would violate the
assumption that more is preferred to less
 Some points that had more of both goods would
be indifferent to a basket with less of both goods

©2005 Pearson Education, Inc. Chapter 3 24

 Indifference Curves (pp. 65 - 79)

 To describe preferences for all

combinations of goods/services, we have
a set of indifference curves – an
indifference map
Each indifference curve in the map shows
the market baskets among which the person
is indifferent

©2005 Pearson Education, Inc. Chapter 3 25

 Indifference Map (pp. 65 - 79)

Clothing
Market basket A
is preferred to B.
Market basket B is
D preferred to D.
B A
U3

U2

U1

Food

©2005 Pearson Education, Inc. Chapter 3 26

 Indifference Maps (pp. 65 - 79)

 Indifference maps give more information

about shapes of indifference curves
Indifference curves cannot cross
 Violates assumption that more is better
Why? What if we assume they can cross?

©2005 Pearson Education, Inc. Chapter 3 27

 Indifference Maps (pp. 65 - 79)
•B is preferred to D
U1
U2 •A is indifferent to B & D
Clothing
•B must be indifferent to
D but that can’t be if B is
preferred to D. A
contradiction
A

B
U2
D
U1
Food

©2005 Pearson Education, Inc. Chapter 3 28

 Indifference Curves (pp. 65 - 79)

 The shapes of indifference curves

describe how a consumer is willing to
substitute one good for another
A to B, give up 6 clothing to get 1 food
D to E, give up 2 clothing to get 1 food
 The more clothing and less food a person
has, the more clothing they will give up to
get more food

©2005 Pearson Education, Inc. Chapter 3 29

 Indifference Curves (pp. 65 - 79)
A
Clothing 16
14 Observation: The amount
-6 of clothing given up for
12 1 unit of food decreases
from 6 to 1
10 B
1
8 -4
D
6 1
-2 E
4 G
1 -1
1
2
Food
1 2 3 4 5
©2005 Pearson Education, Inc. Chapter 3 30
 Indifference Curves (pp. 65 - 79)

 We measure how a person trades one

good for another using the marginal rate
of substitution (MRS)
It quantifies the amount of one good a
consumer will give up to obtain more of
another good, or the individual terms of trade
It is measured by the slope of the
indifference curve

©2005 Pearson Education, Inc. Chapter 3 31