I enjoy my dog. That means that I get more pleasure from him than he costs me, in feeding, vet bills, grooming, etc. That is a surplus. I enjoy my dog; I have a surplus from him. The pleasure I get is greater than the cost.
Consumer surplus is the difference between what things cost and the pleasure each unit gives us. The pleasure is the marginal utility from each unit. At the margin, the last unit we consume costs us just as much as the marginal utility we get. Up until that point, each unit is inframarginal , or within the margin, and the marginal utility exceeds the price or the cost. The difference between the marginal utility on each unit and the price is the surplus on that unit, consumer surplus. The sum of all the differences is represented by the triangle above the price and below the marginal utility line on the demand curve graph. This consumer surplus is the sum of the difference between the marginal utility and the price of the inframarginal units.
You can calculate the consumer surplus for each unit as the difference between the marginal utility and the price. In this example, for the first unit, the marginal utility, the pleasure you get from that first cold beer, is $15. The price is only $1.25; the consumer surplus is the difference, $13.75. The second unit, the second beer, is still really wonderful. It is worth $10 to you; at a price of $1.25, you get $8.75 in surplus. Total surplus on those two beers is the sum, (13.75+ 8.75) or $22.50. Keep going, keep consuming until the cost of the beer, 1.25, equals marginal utility. If you calculate consumer surplus on each beer up to that point you get total consumer surplus of $13.75+ 8.75+ 4.75 . . . you do the math.
Your elasticity of demand for your puppy is very low because you can’t find an equivalent to the feelings you have for your puppy. Your puppy is special to you. Your puppy is not like any other; your love for your puppy is not like the feelings you would have for any other puppy. Therefore, even if your puppy becomes more expensive, maybe she broke a leg, maybe she developed kidney troubles, maybe food became more expensive, maybe your mom doesn’t want to walk the dog anymore and you have to walk the dog by yourself, whatever, you will keep your puppy. Your demand for your puppy is inelastic, you do not respond to changes in prices because you can’t find any equivalent. If you could, perhaps if you find your feelings could be transferred to a fish, you might decide if the puppy becomes more expensive, to replace her with a beta fish.
The elasticity of demand depends on two separate factors. The first, emphasized in much economics, is “can you do without the service.” Obviously, it would be very hard to do without puppy love; and very hard to do without gasoline. The second is “can you find another way to get the service” without that particular service. For example, you may find one puppy expensive but the elasticity of demand may be high because you can replace her with a beta fish. You may need gasoline, but your elasticity of demand for Cumberland Farms gas is very high because you can go down the road to another station.
If demand is highly elastic, then a change in price will give a very large change in quantity. If demand is inelastic, then even a large change in price will give very little change in quantity.
Elasticity of demand depends on the availability of substitutes as much as it depends on the importance of the product. Dunkin Donuts is irreplaceable: where else can you get a Dunkin donut? You might think that penicillin would be inelastic. But the elasticity of demand for Merck penicillin is very high because you can get other penicillins, from other companies or generic, or you could get other antibiotics. Therefore, the elasticity of demand for Dunkin’s glazed sticks might be lower than for Merck penicillin.
Companies try to reduce the elasticity of demand for their product so they can raise prices without reducing sales. The best way to reduce the elasticity of demand for your product is to make your product distinct so that nothing can substitute for it. You try to make your penicillin special by giving it a distinct color; you make your skirts special by persuading people that they are sexy wearing them. You try to reduce alternative sources of supply by establishing copyright and trademark protection for your product so you drive out competition and consumers have to buy your product.
It would be nice if capitalists could only profit from good products. Instead, they can profit from products that are distinct and different from their competition, giving them a monopoly with a relatively low elasticity of demand. Trademark protection, brand names, advertising to make products appear to be different from the competition even if they are the same, all of these are designed to lower the elasticity of demand so they can raise prices and profits.
If you can reduce the elasticity of demand, then you can raise prices without losing sales and that allows you to transfer consumer surplus from the consumer to you, the monopolist. Capitalists can make profits by charging higher prices unless consumers stop buying. To raise profits, you need to lower the elasticity of demand; and the best way to do that is to engineer scarcity by reducing consumer access to competition.
Class 11 elasticity of demand and surplus 100409
Where we are The elasticity of demand, and consumer surplus. Friedman, Microeconomics, chapter 6.
Big ideas <ul><li>Consumer surplus is the extra pleasure you get over-and-above the price of commodities. It makes life worth living </li></ul><ul><li>The elasticity of demand reflects how much consumption falls if prices rise, or vice versa . </li></ul><ul><li>The elasticity of demand reflects both need and how easy it is to replace a product. </li></ul><ul><li>Capitalists try to turn consumer surplus into profits by raising prices without losing sales. They need to reduce demand elasticity. </li></ul>
I like dogs because they give me more pleasure than I lose by paying for them. Consumer surplus : the extra pleasure we get from consuming.
No surplus on the last, or marginal purchase. Last unit price = MU We pay just as much as our pleasure. Surplus only from inframarginal purchases, before the marginal purchase.
Buy until MU=price You get no net pleasure from the last unit because MU=price! MU diminishes. Therefore before the last, MU>price for previous (inframarginal) items. This is surplus! It is the inframarginal that makes you happy!
You get consumer surplus from every purchase before the final one Beer MU Price Consumer surplus or MU-price 1 15 1.25 13.75 2 10 1.25 8.75 3 6 1.25 4.75 4 3 1.25 1.75 5 2 1.25 .75 6 (The marginal beer) 1.25 1.25 0 7 0.5 1.25 -.75 8 .25 1.25 -1 9 0 1.25 -1.25
When I buy wine, I buy until the last glass is just worth the cost This means that until then, each gives me more pleasure than it cost. This is surplus .
Surplus falls on additional purchases Because of diminishing marginal utility – of course! (You knew that!)
How to find total surplus <ul><li>First figure out how many glasses you will buy. (Buy until MU=price, or 2 glasses.) </li></ul><ul><li>Then figure out how much surplus on each glass you buy, or MU-price. </li></ul><ul><li>On first glass, MU-price = $10-5=$5. </li></ul><ul><li>On second glass, MU-price=$5-5=0. </li></ul><ul><li>Total: $5+0=$5. </li></ul>
The Elasticity of Demand is the relative change in quantity demanded for a change in price The elasticity is the percentage change in quantity divided by the percentage change in price. This tells you how responsive demand is to price changes Some people would keep their puppies at any price That is in elastic demand!
Demand elasticity depends on two things Can you do without the service. (Could you live without puppy love?) Can you find another source if the price rises? (I need gas but I could get it from another gas station.) 10:47:43
High and low demand elasticity Inelastic demand: large change in price, small change in quantity Elastic demand: large change in quantity for a small change in price Quantity Price
“ Necessities” don’t necessarily have inelastic demand Highly elastic demand: It is easy to stop buying when prices rise. Consumers either do without or they find another way to get it. Inelastic demand : It is hard to stop buying even when prices rise. Consumers can’t do without and they can’t find another way to get it.
It is not only about whether you need the product The elasticity of demand for Dunkin Donuts may be low even though you don’t need donuts because almost no one else makes good donuts. The elasticity of demand for penicillin from Merck is high even though it may save your life because others make penicillin and there are other antibiotics
Companies want inelastic demand Then they can raise prices and increase profits without losing sales They try to make you think you need their product, and to distinguish theirs from their rivals.
Some things come in inelastic demand because they are distinct, even unique Demand elasticity for these depends on how important they are.
Two ways to reduce elasticity of demand Make people think that life without the product is not worth living. Reduce alternative sources of supply. Harass and destroy the competition.
Advertising is about persuading you that you need things 10:47:44
They would have you think that their product, and only their product, will make you sexy and happy Sometimes they have it wrong 10:47:44
Created scarcity is the key to power and profit Make your product special, unique, and you reduce the elasticity of demand, allowing you to raise prices and profit. <ul><li>Ways to create scarcity: </li></ul><ul><li>Branding: create a reputation for quality </li></ul><ul><li>Control access to technology </li></ul><ul><li>Control access to essential resources </li></ul>
Capitalism is about profit, not use value. Companies want little monopolies with low elasticity of demand They brand name, and grab resources, and technology to restrict consumer choices. Trademarks, patents, restrictive labor contracts, land-grabs. Microsoft, the RIAA, the drug companies: all do this to increase profits.
Artificial scarcity allows companies to “milk the consumer surplus” Consumer surplus makes life worth living. It is the extra value you get from consumption beyond what you pay. It is the value from your “inframarginal” purchases.
By raising prices, artificial scarcity reduces consumer surplus and makes you less happy Even, unhappy
So, down with artificial scarcity! Down with monopoly profits!
Take-away points <ul><li>Consumer surplus is the extra pleasure you get over-and-above the price of commodities. </li></ul><ul><li>The elasticity of demand tells how much you will reduce consumption if prices go up, or how much more you will buy if prices fall. </li></ul><ul><li>The elasticity of demand reflects how much you need the product, and how easy it is to find substitutes. </li></ul><ul><li>Capitalists try to turn surplus into profits by raising prices. To do this, they need to lower the elasticity of demand by reducing substitution and competition. </li></ul>