Price Elasticity in the Real World

Price elasticity is also concerned with the amount people will be willing to pay for a product. If somebody has a low income they may be only willing to pay less for a product than somebody with a higher income. The person with the low income could be described as having low price elasticity because they are limited in the amount of money they can spend. Alternatively the individual can be said to have high price elasticity because they can afford to spend a lot more money on a product.

An understanding of price elasticity can greatly help our understanding of how things happen in the real world. If there are many similar products available then increasing price of one brand will usually lead to a fall in demand. This is because consumers can see that they can get a similar product for a cheaper price. If the item has a unique place in the market then price elasticity can have a different effect. A good example of this is gasoline. Even when prices increase at the pump the demand will stay almost constant. This is because there are no alternatives and people feel that buying this fuel is a necessity. If a unique item isn’t a necessity then people may respond to a price increase by just not using it anymore.

The Importance of Price Elasticity

An understanding of price elasticity can be very important for anyone who intends to sell products. They will want to know what is likely to happen should they decide to increase or decrease the price for their goods. There are complex mathematical formulas that can allow good predictions of price elasticity and these can be very useful. If a manufacturer can see that by raising their prices they will earn more money it will be a good path to follow. So long as the profits from the price increase outweigh any drop in demand it will be a good move. In fact with some products a price increase can actually increase demand because it makes them appear more exclusive.

The manufacturer or seller will also want to know what will happen if they reduce their prices. If this were to lead to an increase in demand then it could be a very shrewd move. If price elasticity is high the company may be able to make a lot more money by reducing the amount they charge for their products. Alternatively if decreasing the price of products is unlikely to have much impact on demand the company will want to know this before they make such a move.

What is Consumer Equilibrium?

Before any attempt to define consumer equilibrium it is important to understand what is meant by utility. This word utility is used in economics to refer to the ability of some product or service to satisfy our desires. One of the ideas behind consumer equilibrium is that humans will buy different products and services in such a way as to maximize their total utility; in layman’s terms they will try to get the biggest bang from their money.

Unfortunately most people are restrained by their income as to how many goods and services they can buy; they can only create a certain amount of utility. In fact it isn’t only income but also other demographic variables that will determine how many products and services they can buy.

This all means that the individual will need to make choices about what products and services they buy in an attempt to get the maximum utility. The point at which a person’s income is spread in such a way that they could not possibly increase their utility is referred to as consumer equilibrium.

An Example of Consumer Equilibrium

Imagine that you had £10 and you want to buy apples and oranges. Oranges cost £1 and apples cost 50p. Now you could purchase 20 apples for your £10 but that won’t give you maximum customer utility because you also wanted oranges. The best way to find the consumer equilibrium would be to assign a utility value to an apple and orange; of course you would also need to take into account marginal utility ( http://www.econguru.com/law-of-diminishing-marginal-utility/ ) because things mean slightly less to us the more we have of them. You would find the consumer equilibrium by reaching the point where the purchase of a certain number of apples of oranges produced the highest possible utility value.

Micro Economics (10th Edition) by Roger A. Arnold – 2010

The author of this book sets out to make the material interesting and he does seem to do a good job of this – even the cover looks like a bit more interesting than your average economics tome. Arnold is not afraid to bring economics into this century and his text is peppered with plenty of modern examples. This is one of the very few microeconomics books that you would actually want to read from start to finish, and by the time you have finished you are sure to feel like you have learned something.

Microeconomics Demystified: A Self Teaching Guide by Craig Depken – 2005

This book by Craig Depken is an excellent resource for those who are new to the topic – it can also be suitable for those who are more knowledgeable.  The explanations are quite clear and a lot of the confusing terminology has been removed. This can be a great book to turn to if you are being confused by a bulkier text. Microeconomics Demystified would also be a good choice for those people who don’t want to study economics formally but just want an idea about what it is all about.

Microeconomics (7th Edition) by Patrick Pindyck and Daniel Rubinfield – 2008

This book is good as a general text for those hoping to learn more about microeconomics. It is used as a set text in many universities around the world and so is quite well respected. All the major topics are covered in depth and this is a useful book to have in your library as a source of reference. The book is nicely laid out with plenty of graphs alongside clear explanations. This book is likely to be useful to those who already know a lot about the subject as well as those who are complete novices to the subject. Microeconomics provides a good foundation for each subject from which people can explore other material.

Microeconomics: A Contemporary Introduction (8th Edition) by William A. McEachern – 2008

The nice thing about this book is that McEachern doesn’t assume that the reader already has a lot of knowledge about microeconomics. This makes the book a lot more approachable for the beginner. The author uses real life experiences to better help the reader identify and later remember the material presented – a novel approach that seems to work quite well. One problem that students can have is seeing how microeconomics fits in with their own life; this book should help them see this.

Microeconomics (3rd Edition) by David Besanko and Ronald Braeutigam – 2007

The approach used by this book is to use real life examples as a way to demonstrate microeconomic theory. This works quite well and should make the concepts a bit easier for many of us to understand.  Those who will likely get the most benefit from this text will be people who already have a bit of understanding about the subject – it is probably not the best book for the very new person to microeconomics unless used in conjunction with easier texts.

What is Economy of Scale?

The simplest way to describe economies of scale would be to say that it refers to the fact that the more of a product you produce the cheaper each unit of this product becomes. In other words, if you are to make one million units of product x it will work out cheaper per unit then it would if you were only making 100 units. Economies of scale exist because increased production means that the fixed costs of producing the product are now spread over a larger number of units. Economies of scale can be divided into two types: internal economies and external economies.

Examples of Internal Economies

• Bigger companies can take advantage of the most advanced technology because of their size. This technology would be beyond the reach of small companies because they are too expensive for small scale production. Bigger companies are producing units in numbers large enough to take advantage of this economy.
• A big company is able to buy the things they need in bulk and so save money that way.
• A big company will find it far easier to get finance on very favorable terms.
• The big company can save money by acting as their own insurer
• A larger company can produce more efficient management
• Things like advertising can work out far more cost-effective for the large company.

Examples of External Economies

• Local educational establishments may help the local population learn the skills needed to work for the company if they are a big local provider of employment. This can save the company a lot of money in needing to train staff.
• Many local companies may grow up to support the bigger company. For example if the company uses a lot of printing material then a printers might open up in the area; this will save the company from needing to look further afield for their printing needs.
• If a company is really big the government may do things like improve the transport links servicing their production facilities.

Diseconomies of Scale

As well as economies of scale there are also diseconomies when a company grows too big that it becomes ineffective.

Technical analysis, in a nutshell, is analyzing stock charts. However, this is a much denser, thicker “nut” than meets the eye. Here is a general overview of how to get started with technical analysis.

Support and Resistance: The Volatile Meeting of Supply and Demand

Is there any facet of investing where supply and demand don’t make an appearance? Not a chance. Understanding support and resistance is one of the first steps of being able to properly interpret a stock chart, which is a little different than a stock listing. Basically, support is the point where the price is “just right”, much like the porridge from the old fairy tale. Support is a good thing — this is the price where demand is steady enough to keep the price from dropping. On the other side of the coin, resistance is the level where price isn’t likely to go higher. If support is “just right”, then resistance can be thought of as “too cold” — too cold to buy, that is. These two concepts work together to help investors decide when to buy and when to sell.

Are they an exact science? Absolutely not — as price movements become more volatile, it’s difficult to actually pinpoint a precise support and resistance calculation. Approximation is the name of the game when it comes to technical analysis.

Revealing Support and Resistance for the First Time

So, how do we calculate these two important factors? We have to study the historical highs and lows on the chart and look for common peaks and dips. For measuring support, we look at the lowest point, since we’re looking for the point at which price cannot go any lower. For measuring resistance, we look at the highest point in the range, since we’re looking for the point at which the price cannot go any higher.

The goal of any gentle introduction is to slowly ease you into a concept that’s greater than the scope of one article or even a full series — technical analysis is a skill that will take time to master, but understanding support and resistance is required in order to move on to more complex topics. The best way to ease into this is to do a little paper trading, taking a few stocks and measuring the support and resistance levels using historical data of at least 3 months to ensure you’re getting the clearest picture possible. Six months may be even better for a different perspective, but a year is a little too much for the beginning investor. Go try it today!

Q – quantity of good
TU – total utility
MU – marginal utility (ΔTU)

Author: Pawel Zdziarski (faxe)