Persantage changes in Price of good y

If a cross-price elasticity is positive (E_xy>0), two goods are substitutes.

If a cross-price elasticity is negative, (E_xy<0) two goods are complements.

If a cross-price elasticity is zero or near 0 (E_xy=0), two goods are independent.

2. Price elasticity of supply

The price elasticity of supply is defined as a numerical measure of the responsiveness of the quantity supplied of product to a change in price of product alone.

When there is a relatively inelastic supply for the good the coefficient is low; when supply is highly elastic, the coefficient is high.

Supply is normally more elastic in the long run than in the short run for produced goods. As spare capacity and more capital equipment can be utilised the supply can be increased, whereas in the short run only labor can be increased. Of course goods that have no labor component and a re not produced cannot be expanded. Such goods are said to be "fixed" in supply and do not respond to price changes. The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down.

The determinants of the price elasticity of supply are:

• the existence of the naturally occurring raw materials needed for production;

• the length of the production process;

• the production spare capacity (the more spare capacity there is in an industry the easier it should be to increase output if the price goes up);

• the time period and the factor immobility (the ease of resources to move into the industry);

• the storage capacity of the merchants (if they have more goods in stock they will be able to respond to a change in price more quickly).

3. Market adaptation to Demand and Supply changes in long-run and in short-run

Lecture 5. Consumer Behavior

1. Three parts and three assumptions of consumer behavior theory

Consumer behavior is best understood in 3 steps.

1. To examine consumer preferences (to describe how people might prefer one good to another)

2. To account the fact that consumers face budget constraints (they have limited incomes that restrict the quantities of goods they can buy)

3. To determine consumer choices (to put consumer preferences and budget constraints together).

In other words, given their preferences and limited incomes, what combinations of goods will consumer buy to maximize their satisfaction?

The theory of begins with three basic assumptions regarding people’s preferences for one market basket (just a collection of one or more commodities) versus another:

1. Preferences are complete (it means that consumer can compare and rank all market baskets, ignoring costs in this case).

2. Preferences are transitive (it means that if consumer prefer market basket A to market basket B, and prefer B to C, then the consumer also prefers A to C. This assumption ensures that the consumer preferences are rational).

3. All goods are “good” (i.e. desirable), so that leaving cost aside, consumers always more of any good to less. (It simplifies graphical analysis, despite of the fact that some goods are not desirable for consumer).

There are two approaches that may be used to explain an individual’s choice: cardinal and ordinal. A cardinal concept believes that individual preferences can be easily quantified or measured in terms of basic unit with the help of “utils”. By contrast, ordinal theory ranks market baskets in the order of most preferred to least preferred. Whereas this two approaches are different in the question of utility ranking they are compatible.