CDAE 254 - Class 14 Oct. 11

Last class: 4. Market demand and elasticities Class exercise

Today: 4. Market demand and elasticities Review for the midterm exam Quiz 4 (Chapter 4)

Next class:Midterm exam

Important dates:Pick up your quiz 4 anytime after 1:00pm, Oct. 12Answer key to problem set 4 will be in the website …Midterm exam: Tuesday, Oct. 16

Problem set 4

This problem set will not be collected and answer key will be posted in the website before the midterm exam.

Six problems:

4.1., 4.2., 4.4., 4.6., 4.7., and 4.8

4. Market demand and elasticity

4.1. Market demand curves

4.2. A general definition of elasticity

4.3. Price elasticity of demand

4.4. Income elasticity of demand

4.5. Cross-price elasticity of demand

4.6. Empirical studies of demand

4.7. Applications

4.4. Income elasticity of demand (1) What is income elasticity of demand?

The percentage change in the quantity

demanded of a good (Q) in response to a 1%

change in income.

Iin change Percentage

Qin change Percentage, IQe

Q

I

I

Q

II

QQ

4.4. Income elasticity of demand (2) Range of income elasticity of demand:

< 0 inferior good

< 1 inelastic

= 1 unit elastic

> 1 elastic

(3) An example:

When the average monthly income increased

from $2000 to $2200, printer demand increased

from 100 to 125. What is the income elasticity of demand for printer?

4.4. Income elasticity of demand (4) Another example:

Q = 200 + 0.005 I - 0.02 P

where Q = demand for computer

I = average income

P = average price

What is the income elasticity of demand when the average income is $30,000 and the average computer price is $1,500?

4.6. Cross-price elasticity of demand

(1) Definition: The percentage change in the quantity demanded of a good (Q) in response to a 1% change in the price of another good.

j

i, Pin change Percentage

Qin change Percentage

ji PQe

i

j

j

i

Q

P

P

Q

j

j

i

i

P

PQQ

4.6. Cross-price elasticity of demand

(2) How to calculate cross-price elasticities?

(1) When we have two observations:

e.g., the demand for pork increased from 100 to 110 when the price of beef increased from 3 to 3.6, what is the elasticity of pork demand with respect to beef price?

(2) When we have a demand function:

e.g., Qpork = 40 - 2 Ppork + 0.5 Pbeef

What is the elasticity of pork demand with respect to beef price when the pork price is 4 and beef price is 6?

Class Exercise (Tuesday, Oct. 9)

For demand function Qc = 300 – 0.3Pc – 0.1Pp + 0.05 I , where Qc is the demand for laptop computers in a market, Pc is the average price of laptop computers, Pp is the average price of printers and I is the average income. If we know the average laptop computer price is $800, the average printer price is $100 and the average income is $20,000, calculate:

(1) the income elasticity of demand for laptop computers:

(2) the own-price elasticity of demand for laptop computers:

(3) the cross-price elasticity of demand for laptop computers with respect to the average price of printers.

4.7. Empirical studies of demand

(1) Examples of estimated demand elasticities

(2) Estimation of demand functions (regression analysis)

(3) How to estimate demand elasticity from demand equation?

(4) Elasticity matrix (e.g., demand for animal

products in urban China)

Demand elasticities in urban Demand elasticities in urban China China

Marshallian price elasticity of good i with respect to good j

ExpenditureElasticities

MarginalBudget % Pork B & M Poultry Eggs Fish Milk

Pork 0.8327 39.14 -0.8503 -0.1305 0.0876 0.0844 -0.0130 -0.0227

B & M 0.8492 7.26 -0.7002 -0.6745 0.0907 0.2301 0.1736 0.0717

Poultry 1.4895 17.11 0.0549 0.0092 -1.3362 -0.5057 0.2939 -0.0068

Eggs 0.9858 14.00 0.2380 0.1281 -0.3448 -0.7766 -0.1902 0.0132

Fish 1.1909 19.99 -0.2067 0.0544 0.2337 -0.2000 -1.0253 -0.0629

Milk 1.2689 0.0250 -0.8070 0.2608 -0.0303 0.0281 -0.5703 -0.2884

Chapter 4: Review questions

(1) What is a market demand function (curve) and how to draw it from individual demand curves?

(2) How does a change in income or the price of another commodity shift a market demand curve?

(3) What is the general definition of elasticity and how to calculate it and how to interpret it?

(4) How to calculate a price elasticity from (a) two observations and (b) a demand function?

(5) What is the relation between price elasticity and total revenue and (market share)?

(6) How to calculate an income elasticity from (a) two observations and (b) a demand function?

(7) How to calculate a cross-price elasticity from (a) two observations and (b) a demand function?

(8) How to examine the relation between two commodities according to their cross price elasticities?

Midterm exam

1. What will be covered in the exam?

2. What will be the format?

3. What are the study materials and practice problems?

4. What do you need to bring to the exam?

5. Suggestions

Midterm exam

1. What will be covered in the exam?

-- Chapter 1 -- Chapter 4

-- Approximate distribution:Chapter 1 10 - 15%Chapter 2 25 - 30%Chapter 3 25 - 30% Chapter 4 30 - 35%

Midterm exam

2. What will be the format?

-- Multiple-choice questions (about 45-50 points) (e.g., interpretation of an income elasticity of 0.4) -- Problems (about 25 - 35 points) (e.g., calculate a demand elasticity)

-- Graphical analysis (about 15 - 25 points) (e.g., draw a demand curve and estimate CS)

Midterm exam

3. What are the study materials and practice problems?

Quiz 1 to Quiz 4 Class exercises

Class examples Lecture notes (class 01 -- class 14)

Problem sets Textbook (Chapter 1 to Chapter 4)

Midterm exam

4. What do you need to bring to the exam?

-- Your calculator

-- A ruler will be helpful

-- No formula sheet is needed

Midterm exam

5. Suggestions

a. Go over each quiz and make sure you understand and know how to answer every question in every quiz

b. Go over each class exercise and make sure you understand and know how to answer every question

c. Go over the lecture notes, especially for the classes you missed

d. Go over your problem sets and Chapters 1-4 of the textbook

e. Study hard and feel confident!