Chapter 2: The Basics of Supply and Demand

CHAPTER 2 THE BASICS OF SUPPLY AND DEMAND
1. Suppose that unusually hot weather causes the demand curve for ice cream to shift to the right. Why will the price of ice cream rise to a new market-clearing level? Assume the supply curve is fixed. The unusually hot weather will cause a rightward shift in the demand curve, creating short-run excess demand at the current price. Consumers will begin to bid against each other for the ice cream, putting upward pressure on the price. The price of ice cream will rise until the quantity demanded and the quantity supplied are equal.
Price
S

P2

P1

D1 Q1 = Q2

D2

Quantity of I ce Cream

Figure 2.1 2. Use supply and demand curves to illustrate how each of the following events would affect the price of butter and the quantity of butter bought and sold: a. An increase in the price of margarine. Most people consider butter and margarine to be substitute goods. An increase in the price of margarine will cause people to increase their consumption of butter, thereby shifting the demand curve for butter out from D1 to D2 in Figure 2.2.a. This shift in demand will cause the equilibrium price to rise from P1 to P2 and the equilibrium quantity to increase from Q1 to Q2.
Price
S

P2

P1

D1 Q1 Q2

D2

Quantity of Butter

Figure 2.2.a b. An increase in the price of milk. 5

as the price of milk increases. The supply curve for butter will shift from S1 to S2 in Figure 2. so does the quantity supplied. P2. An increase in the price of milk will increase the cost of producing butter.b. and a lower equilibrium quantity. If you are aware of this relationship.b Note: Given that butter is in fact made from the fat that is slimmed off of the milk.2. This will result in a decline in the equilibrium price from P1 to P2. A decrease in the average income level will cause the demand curve for butter to shift from D1 to D2. As the quantity supplied of milk increases. there is a larger supply of fat available to make butter. Price S c. Price S2 S1 P2 P1 D Q2 Q1 Quantity of Butter Figure 2. A decrease in average income levels. This will shift the supply of butter curve to the right and the price of butter will fall. P1 P2 D2 Q2 Q1 D1 Quantity of Butter Figure 2. What is the elasticity of demand for corn flakes? The elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in the price. The elasticity of demand for 6 .2.2. In this case. covering the higher production costs. resulting in a higher equilibrium price. See Figure 2.c 3.c. and a decline in the equilibrium quantity from Q1 to Q2. Assume that butter is a normal good. Suppose a 3 percent increase in the price of corn flakes causes a 6 percent decline in the quantity demanded.2. butter and milk are joint products.Chapter 2: The Basics of Supply and Demand Milk is the main ingredient in butter. then your answer will change. Q2.

Customers whose demands are met will attempt to purchase substitutes. However. such as televisions. The elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in price. other firms may be constrained by their production capacity in the short run. were to increase. 5. In a discussion of tuition rates. Which is a durable good? Would you expect the price elasticity of demand for paper towels to be larger in the shortrun or in the long-run? Why? What about the price elasticity of demand for televisions? Long-run and short-run elasticities differ based on how rapidly consumers respond to price changes and how many substitutes are available. demand for paper towels would be more elastic as new substitutes entered the market (such as sponges or kitchen towels). the quantity demanded of durable goods. In the long run. For example. however. but does she actually observe a demand curve? What else could be going on?) 7 . The extent of the excess demand implied by this response will depend on the relative elasticities of demand and supply. consumers might react only minimally in the short run. we expect the demand for durables to be more elastic in the long run. For instance. the long-run price elasticity of supply is larger than the short-run elasticity. the price of pork will rise. 6. As evidence she notes that while the university has doubled its tuition (in real terms) over the past 15 years. Explain why shortages of these goods will develop and what factors will determine the sizes of the shortages. Why do long-run elasticities of demand differ from short-run elasticities? Consider two goods: paper towels and televisions. (Hint: The official makes an assertion about the demand for admission. a non-durable good.Chapter 2: The Basics of Supply and Demand −6 = −2 . However. This is in the elastic region of the demand curve. Explain why. if both supply and demand are elastic. the quantity that firms are willing to supply is less than the quantity that consumers wish to purchase. the initial influence of a price increase for televisions would cause consumers to delay purchases because durable goods are built to last longer. might change dramatically in the short run following a price change. Factors such as the willingness of consumers to eat less meat and the ability of farmers to change the size of their herds and produce less determine these elasticities and influence the size of excess demand. thus increasing the demand substitutes and raising their prices. If the prices of beef and chicken are below market-clearing levels. An increase in price induces an increase in the quantity supplied by firms. Some firms in some markets may respond quickly and cheaply to price changes. What will happen to the price of pork? Explain briefly. are not for set 7. corn flakes is 4. neither the number nor quality of students applying has decreased. in the long run all firms can increase their scale of production and thus have a larger long-run price elasticity. Suppose the government regulates the prices of beef and chicken and sets them below their market-clearing levels. the shortage is larger than if both are inelastic. In contrast. The firms with shortrun capacity constraints will have a short-run supply elasticity that is less elastic. If the price of a commodity is set below its market-clearing level. a university official argues that the demand for admission is completely price inelastic. Eventually consumers must replace their televisions as they wear out or become obsolete. If the price of paper towels. for many goods. therefore.0. Rationing will result in situations of excess demand when some consumers unable to purchase the quantities desired. Would you accept this argument? Explain briefly. where +3 the elasticity of demand exceeds -1.

The price of oranges triples. b. for example.7. d. Use supply and demand curve shifts to illustrate the effect of the following events on the market for apples. The increase in the supply of apple pickers will lead to a decrease in the cost of bringing apples to market. the individual firm (a university) may determine the shape of the demand curve it faces by raising the price and observing the change in quantity sold. and the equilibrium quantity will increase. Scientists find that an apple a day does indeed keep the doctor away.7 8.) Demand could be shifting upward because the value of a college education has increased and students are willing to pay a high price for each opening. causing the equilibrium price to rise and the equilibrium quantity to fall. The university official is not observing the entire demand curve. Price D1996 S 1996 D1986 S 1986 D1976 S 1976 Quantity Figure 2. The equilibrium price of apples will rise. If demand is shifting upward. 8 . Thousands of college students abandon the academic life to become apple pickers. The lower cost of bringing apples to market results in a rightward shift of the supply curve of apples and causes the equilibrium price to fall and the equilibrium quantity to increase. resulting in a rightward shift of the demand curve. but rather only the equilibrium price and quantity over the last 15 years. Since oranges are probably a substitute for apples.Chapter 2: The Basics of Supply and Demand If demand is fixed. People will demand more apples. More market research would be required to support the conclusion that demand is completely price inelastic. as supply shifts upward. a. The supply curve for apples will shift to the left. (See Figure 2. A drought shrinks the apple crop to one-third its normal size. the demand curve for apples will shift to the right. demand could have any elasticity. The equilibrium price of apples will rise. and the equilibrium quantity will increase. Thousands of college students abandon the academic life to become apple growers. c. e. Make clear the direction of the change in both price and quantity sold.

0 cents per pound for the new equilibrium price. P ∆Q 1 2 = (−2) = − = −0. In this case. Consumers will demand a certain quantity and will pay any price for this quantity.00.2. Suppose that rather than the declining demand assumed in Example 2. To find the new equilibrium price of copper. The price of the substitute good is $2. a price control will have no effect on the quantity demanded.25. of natural gas price controls? If the demand for natural gas is perfectly inelastic. Suppose the demand for natural gas is perfectly inelastic. Suppose the demand curve for a product is given by Q=10-2P+Ps. Price elasticity of demand = Q ∆P 10 10 Cross-price elasticity of demand = Q=10- Ps ∆Q 2 = (1) = 0.7+9. What is the price elasticity of demand? What is the crossprice elasticity of demand? First you need to find the quantity demanded at the price of $1. Now what is the price elasticity of demand. 2(2)+2=8.5+16P) = -2.2.00. Q ∆Ps 8 Cross-price elasticity of demand = 10. 9 . and what is the cross-price elasticity of demand? First you need to find the quantity demanded at the price of $2. 11. (a) Suppose P=$1.Chapter 2: The Basics of Supply and Demand This would result in a rightward shift of the supply curve for apples. if any. 2(1)+2=10.00. The new supply curve is therefore Q’ = 0. then the demand curve is vertical. How will the price of copper change? If the supply curve shifts to the left by 40% then the new quantity supplied will be 60 percent of the old quantity supplied at every price.7+9. an increase in the cost of copper production causes the supply curve to shift to the left by 40 percent. Q ∆Ps 10 (b) Suppose the price of the good. Solving for price results in P=92.00.5. 9. Q ∆P 8 8 Ps ∆Q 2 = (1) = 0. Price elasticity of demand = Q=10- P ∆Q 2 4 = (−2) = − = −0. set the new supply equal to demand so that -2.6P=13. What would be the effect.6P.00.5-8P. causing the equilibrium price to fall and the equilibrium quantity to increase.7. P. increases to $2.6(-4. where P is the price of the product and Ps is the price of a substitute good.

 ∆P  20 At P = 80. quantity demanded equals 18 and 100 ED =   18  (−0. Calculate the price elasticity of supply when the price is $80. quantity demanded equals 20 and 80 ED =   (−0.1) = −0. When the price is $100.  16  10 . the quantity demanded decreases by 2.1 from the text: ∆QD Q P ∆QD ED = D = .  ∆QD  = −2 = −0.40.Chapter 2: The Basics of Supply and Demand EXERCISES 1.  ∆QS  = 2 = 0. ∆P QD ∆P P With each price increase of $20. Demand (millions) 22 20 18 16 Supply (millions) 14 16 18 20 When the Calculate the price elasticity of demand when the price is $80. b.56. Consider a competitive market for which the quantities demanded and supplied (per year) at various prices are given as follows: Price ($) 60 80 100 120 a.1) = −0. price is $100.1) = 0. ∆P QS ∆P P ES With each price increase of $20. quantity supplied equals 16 and 80 ES =   ( 0.1.  20  Similarly. quantity supplied increases by 2. The elasticity of supply is given by: ∆QS QS P ∆QS = = .5.  ∆P  20 At P = 80. at P = 100. Therefore. We know that the price elasticity of demand may be calculated using equation 2.1. Therefore.

4 on the market for wheat.) 34 28 22 16 10 4 11 . wheat demand. The U.06) = 2. (Source: http://www.283P.. QS = 1944 + (207)(3.283P) + 200 = 3444 .56.S.67 3. 1944 + 207P = 3444 . wheat demand. substitute the price into either the supply or demand equation. the equilibrium price is $100 and the equilibrium quantity is 18 million.283P. d. Suppose the government sets a price ceiling of $80.g. the new demand curve Q′ . both Brazil and Indonesia opened their wheat markets to U.577. or D Q′ = (3244 .06) = 2. how large will it be? Will there be a With a price ceiling of $80.gov/) Suppose that these new markets add 200 million bushels to U.S. 2. e.S.) 2 4 6 8 10 12 U. At the end of 1998. farmers in this case? The following equations describe the market for wheat in 1998: QS = 1944 + 207P and QD = 3244 . What will be the free market price of wheat and what quantity will be produced and sold by U. domestic supply and demand for various price levels are shown below. and. or P* = $3.283P. we may determine the new equilibrium price. quantity supplied equals 18 and 100 ES =   18  (0. Supply (million lbs.usda. Demand (million lbs. Refer to Example 2.1) = 0. consumers would like to buy 20 million. shortage. or 490P = 1500. if so. would be equal to QD + 200.577. As we see from the table. A vegetable fiber is traded in a competitive world market. c. but producers will supply only 16 million. D Equating supply and the new demand.(283)(3.Chapter 2: The Basics of Supply and Demand Similarly. Price 3 6 9 12 15 18 U.S.67 and QD = 3444 . and the world price is $9 per pound.fas. To find the equilibrium quantity. If Brazil and Indonesia add an additional 200 million bushels of wheat to U. What are the equilibrium price and quantity? The equilibrium price and quantity are found where the quantity supplied equals the quantity demanded at the same price. farmers. Unlimited quantities are available for import into the United States at this price. at P = 100.S.S.06 per bushel. This will result in a shortage of 4 million.S.

First find the slope which is increases by 3 quantity demanded falls by 6 million pounds.S. At this price. Supply is now Q = c + P. To find a. is measured in hundreds of dollars. Price. 3 To find c plug in any of the price quantity supplied points from the table: 2 2 Q = 2 = c + (3) so that c=0 and supply is Q = P. 3 3 b. In a free market. The agency also noted that the increase in Q at lower P results from more three-person families coming into the city from Long Island and demanding apartments. and all those who cannot find an apartment leave the city? To find the free market price for apartments. price and level of fiber imports? With no restrictions on trade. Q ∆P 6  3 18 P ∆Q 12  2  24 = = = 1.82. what will be the U. while the domestic demand is 22 million lbs.0. what is the price elasticity of demand? At a price of $12? Elasticity of demand at P=9 is P ∆Q 9 −18 = (−2) = = −0. Imports make up the difference and are 16 million lbs. First find the slope which is ∆Q −6 = = −2 = −b. If both the agency and the board are right about demand and supply. or P = $500. The rent control agency of New York City has found that aggregate demand is QD = 100 . What is the equation for demand? What is the equation for supply? The equation for demand is of the form Q=a-bP. You can figure this out by noticing that every time price increases by ∆P 3 2 3 quantity supplied increases by 2 million pounds. Q ∆P 8  3  24 Elasticity of supply at P=12 is d.Chapter 2: The Basics of Supply and Demand a. the domestic supply is 6 million lbs. Q ∆P 22 22 P ∆Q 12 −24 = (−2) = = −1. plug in any of the price quantity demanded points from the table: Q=34=a-2*3 so that a=40 and demand is Q=40-2P. At a price of $9. 12 .5.5P = 50 + 5P. Q ∆P 16 16 Elasticity of demand at P=12 is c. Demand is now Q=a-2P. set supply equal to demand: 100 . world price will be the price in the United States.0. The equation for supply is of the form Q=c+dP. the average monthly rental rate.5P. what is the free market price? What is the change in city population if the agency sets a maximum average monthly rental of $100. 4. You can figure this out by noticing that every time price ∆P 3 ∆Q 2 = . What is the price elasticity of supply at $9? At $12? Elasticity of supply at P=9 is P ∆Q 9  2  18 = = = 1. The city’s board of realtors acknowledges that this is a good demand estimate and has shown that supply is QS = 50 + 5P. a. Quantity is measured in tens of thousands of apartments. so that P=$9.

this would imply a loss of 600. These are the only people that were originally in the City to begin with. Rent $1.000 units would go unrented. we are told that domestic demand is Qd = 1700 . 5. 400.000 units. that since demand is only 550. and the resulting shortage is 400.000 900 800 700 600 500 400 300 200 100 20 40 60 80 100 Appartments (10.283P.000) = 100. If 50 percent of any long-run increases in apartment offerings comes from new construction. or 950.000 people. We find that at the rental rate of $500. or 200. U. the quantity supplied would then be 550.S. total demand is Q = 3244 . Substituting the equilibrium price into either the demand or supply equation to determine the equilibrium quantity: QD = 100 . In addition.000 units. a. however.000 apartments from the free market equilibrium.) At the $100 rental rate. If the rent control agency sets the rental rate at $100.000 to 550.000 units over the free market equilibrium. What happens to the free market price of wheat in the United States? Do the farmers have much reason to worry? 13 .000 units (950. a decrease of 200. (0. Therefore.000 apartments are rented. Note.000).107P. the supply of apartments would be 50 + 5(9) = 95.000’s) Excess Demand Demand Supply Figure 2.000 units would be constructed. The city population will only fall by 600. how many apartments are constructed? At a rental rate of $900.000 units.000 which is represented by the drop in the number of apartments from 750. Domestic supply is QS = 1944 + 207P. (Assuming three people per family per apartment. From Example 2. Much of the demand for U. Suppose the export demand for wheat falls by 40 percent.(5)(5) = 75 and QS = 50 + (5)(5) = 75. the demand for apartments is 950.4 b.5)(200.000 apartments with 3 people each. agricultural output has come from other countries. 750.000.S. which is an increase of 200. Suppose the agency bows to the wishes of the board and sets a rental of $900 per month on all apartments to allow landlords a “fair” rate of return.Chapter 2: The Basics of Supply and Demand since price is measured in hundreds of dollars.4.000-550.000 (QS = 50 + (5)(1) = 55). farmers are concerned about this drop in export demand.

how much wheat would the government have to buy each year? How much would this cost the government? With a price of $3. b.107P + (0.4 . Equating total supply and total demand.176P) = 2626.5a Total demand becomes QD = Qd + 0. With this drop in export demand.212. Most farmers would worry.4 . The new export demand is 0.63. At this price. P 8. Quantity demanded and supplied are QD = 2626.6P.176P. Total revenue has decreased from $6614.Chapter 2: The Basics of Supply and Demand Given total demand.5)=1882. The initial market equilibrium price is found by setting total demand equal to supply: 3244 .212.6 million to $3709. government wants to buy enough wheat each year to raise the price to $3. we may subtract and determine export demand. If you instead shifted the demand curve down to the left in a parallel fashion the effect on price and quantity will be qualitatively the same. The best way to handle the 40 percent drop in export demand is to assume that the export demand curve pivots down and to the left around the vertical intercept so that at all prices demand decreases by 40 percent. or P = $2.6P.65 million bushels.4-212.65.6)(1544 . or P = $1.6Qe=0.6P. but will differ quantitatively. and the reservation price (the maximum price that the foreign country is willing to pay) does not change.65 per bushel. Qd = 1700 107P. and domestic demand.283P.6(1544-176P)=926. the market-clearing quantity is 2280.6(3.50. Graphically. and 14 . Q = 3244 .4-105. export demand has pivoted inwards as illustrated in figure 2. Qe = 1544 . Now suppose the U.50 per bushel.77 Qe 926.5a below.3.0 million.283P = 1944 + 207P.6Qe = 1700 . 1944 + 207P = 2626. which is a significant drop from the market-clearing price of $2.S.4 1544 Figure 2. the market is not in equilibrium.

and Q* = 7. c. Solving for b. recall the formula for the price elasticity of demand D EP = P ∆Q . recall the formula for the elasticity of supply and follow the same method as above: P ∆Q Q ∆P 2 ∆Q 0. The average retail price was $2 per pack. The government must purchase this amount to support a price of $3. a. −0.5. derive the linear demand curve consistent with the smaller elasticity. as before.7 we examined the effect of a 20 percent decline in copper demand on the price of copper.4 instead of -0. and d into the above formula so that 470=c+117. using the linear supply and demand curves developed in Section 2. P* = 0. and b into the above formula so that 470=a-94*2 and a=658. To begin. Assuming.5. Q ∆P You are given information about the value of the elasticity. Let the demand curve be of the general form Q=a+bP and the supply curve be of the general form Q=c+dP. Excess supply is therefore 2668. In 1998.5 = d.8.5P.5 (the equilibrium quantity). ∆P To find the constant a.5. substitute for Q. First. where a. and Q. substitute for Q. b. In Example 2.2 million) = $2751. and the price elasticity of supply is 0. The equation for supply is therefore Q=235+117. which means that you can solve for the slope which is b in the above formula for the demand curve. P.3=786. derive linear demand and supply curves for the cigarette market.4  2  = −94 = b.4 (the long-run price elasticity). Using this information.5*2 and c=235. 15 .6.5 million metric tons per year.4 = 2 ∆Q 470 ∆P ∆Q 470  = −0.5(786. P.bP. Suppose the long-run price elasticity of copper demand were -0.5) = 2668. and will spend $3. ∆P S EP = To find the constant c.6.4. Here ED = -0. The equation for demand is therefore Q=658-94P. P. we know that for a linear demand function  P * ED = −b  . 6. Americans smoked 470 billion cigarettes.2 million bushels. we solve for a and b in the demand equation QD = a .75 (the  Q * equilibrium price). 7. that the equilibrium price and quantity are P* = 75 cents per pound and Q* = 7.Chapter 2: The Basics of Supply and Demand QS = 1944 + 207(3.5 = 470 ∆P ∆Q 470  = 0. and d are the constants that you have to find from the information given above. Statistical studies have shown that the price elasticity of demand is -0. Following the method outlined in Section 2. To find the supply curve.5  2  = 117.7 million per year.5-1882.

8)(10.4 and ED = -0.08 .0.5 − 4P ) = 8. a. example. The new demand is 20 percent below the original (using our convention that quantity demanded is reduced by 20% at every price): Q′ = (0. QD (= Q*).(0.51P SC = 7.29)(18) and 23 = a .74 and Sc = 11.2P . During the late 1990s. Example 2.3.4 = -b(18/23).0.2 cents per pound.78 and a = 32. D Equating this to supply.4 .78 + 0. With ES = 0. Saudi Arabia accounted for 3 billion barrels per year of OPEC’s production.05.(4)(0. QD = 23.10 and P* = $18.07P. Suppose that war or revolution caused Saudi Arabia to stop producing oil.75). Hence QD = 24.5 .06(18). Next solve for c and a: Sc = c + dP and QD = a . and b = 0. implying 0. 8.4 = −b   7. c. Using the data given in that Show that the short-run demand and competitive supply curves are indeed given by D = 24.672.07P. since QD = 23.5.5 + 16P.08. ES = 0. First. ES = d(P*/Q*) implies d = 0.4 = d(18/13) and -0.29P.0.5  . b. or b = 4. To find the intercept. and P in the supply equation.74 + 0. or P = 0. Using this demand curve. Similarly.4 is therefore QD = 10.51)(18). considering non-OPEC supply: Sc = Q* = 13.51.29 and b = 0.5 = a . Substituting for d.18. we substitute for b. Show that the long-run demand and competitive supply curves are indeed given by D = 32. and P (= P*) in the demand equation: 7. The linear demand equation consistent with a long-run price elasticity of -0.74 + 0.06P SC = 11. recalculate the effect of a 20 percent decline in copper demand on the price of copper.4: ES = d(P*/Q*) and ED = -b(P*/Q*).75  −0. 8. or a = 10. implying 13 = c + (0. and P = 18 in the demand equation gives 23 = a . So d = 0. ED = -b(P*/Q*) = -0.Chapter 2: The Basics of Supply and Demand 0. b.8 analyzes the world oil market. Sc.08 .06.4 − 3. c = 11. With the 20 percent decline in the demand. Substituting for b.06P. Use the model above to calculate what would happen 16 . the price of copper falls to 67. So c = 7. As above.2P = -4. so that a = 24.0.18 .4P.bP.07.

To solve this problem. We know that PO = $8 and QG = 20 trillion cubic feet (Tcf).6 to the definition of cross-price elasticity of demand given in Section 2. implying that P = $41. these curves imply a free market price of $2.00. where PO and QG are the equilibrium price cross-price elasticity. 8 1. so that: 18.51P.06P.08 in the short run.74 + 0. the crossprice-elasticity of demand for natural gas with respect to the price of oil is:  ∆QG   PO  EGO =    . or e = 3. add this lower supply of 7 bb/yr to the short-run and long-run supply equations: Sc′ = 7 + Sc = 11. For linear demand equations.78 + 0.0.   is  ∆PO  constant.Chapter 2: The Basics of Supply and Demand to the price of oil in the short run and the long run if OPEC’s production were to drop by 3 billion barrels per year.07P and S″ = 7 + Sc = 14. which analyzes the effects of price controls on natural Using the data in the example. 9. verify that if the price of oil is $8. With OPEC’s supply reduced from 10 bb/yr to 7 bb/yr.9.bPG + ePO  ∆QG  (notice that income is held constant).  20 QG = c + dPG + gPO. Refer to Example 2. we apply the analysis of Section 2. a.00 for natural gas.75PO where PG and PO are the prices of natural gas and oil. respectively.25PO Demand: Q = -5PG + 3.0. show that the following supply and demand curves did indeed describe the market in 1975: Supply: Q = 14 + 2PG + 0.75 in the long run.74 + 0.08 .29P = 32.75. For example.29P.74 + 7 + 0. because of a  ∆PO   ∆QG  small change in the price of oil. If we represent demand as: QG = a . Solving for e.  QG  * * and quantity. Similarly.5 = e   .78 + 0.18 .07P = 18. gas. if the general form of the supply equation is represented as: 17 . implying that P = $21. and 14. Also. then   = e. Substituting this into the  ∆PO   P*  * * EPO = e O*  .07P = 24.4. These are equated with short-run and long-run demand.  ∆PO   QG   ∆QG    is the change in the quantity of natural gas demanded.

these curves imply a free market price of $2. 8 0.2.  20 By substituting these values for d.25)(8) = 19. 7PG = 14. Substitute the price of oil in the supply and demand curves to verify these equations.25. there would be an excess demand of 3. If the price of oil is $8. We know that ES = 0.50) + (3.25)(8) = -5PG + (3.  20 Also. g. 2 0.00. 14 + 2PG + (0.Chapter 2: The Basics of Supply and Demand  P*  g  O*  . instead of $1.5 = b  . and Q* = 20.00. b. b. c.75)(8). and e into our linear supply and demand equations. and Supply: QS = 14 + (2)(1.5. 20 = a .50 for natural gas and a price of oil equal to $8.5b in Section 2. Suppose the regulated price of gas in 1975 had been $1.5PG. P* = 2.00 for natural gas. or a = 0.5 Tcf. ED = -0. we may solve for c and a: and 20 = c + (2)(2) + (0.1 = g  . 18 + 2PG = 60 . Solving the cross-price elasticity of supply is  QG  for g. Demand: QD = (-5)(1. With a supply of 19 Tcf and a demand of 22.00. or d = 2. then Demand: QD = -5PG + (3.(5)(2) + (3.5 Tcf. Then set the curves equal to each other and solve for the price of gas.5PG. and Supply: QS = 14 + 2PG + (0. Therefore. what would have happened to the free market price of natural gas? If the price of natural gas had not been regulated and the price of oil had increased from $8 to $16.00 per barrel.5.75)(8). which we know to be 0. so 2 −0.5) + (0. Equating supply and demand and solving for the equilibrium price.75)(16) = 60 .2 = d   . If the price of oil had increased from $8 to $16. or PG = $6. or b = -5. The price of natural gas would have tripled from $2 to $6. or g = 0.  20 The values for d and b may be found with equations 2.6. or c = 14.25)(16) = 18 + 2PG.1.75)(8) = 22.5a and 2. Suppose that the market for natural gas had not been regulated.50 per thousand cubic feet. How much excess demand would there have been? With a regulated price of $1. 18 .25)(8). or PG = $2.

35 − 10.3. To find the coefficient a. the elasticity will differ in 1997 and 1998 because price and quantity are different. Also.48 Sales of Instant Coffee (million lbs) 75 70 Retail Price of Roasted Coffee ($/lb) 4.7=-b.7*3. Using this data alone. ∆P 4.76 0. you must first estimate the slope of the demand curve: ∆Q 820 − 850 30 = =− = −85. Retail Price of Instant Coffee Year 1997 1998 ($/lb) 10. you must first estimate the slope of the demand curve: ∆Q 75 − 70 5 = =− = −38.38 Q ∆P 850 P97 + P98 ∆Q 3. The table below shows the retail price and sales for instant coffee and roasted coffee for 1997 and 1998.Chapter 2: The Basics of Supply and Demand 10.40. we can now estimate elasticity using the price and quantity data from the above table.43 Q ∆P 820 P ∆Q 3. Since the demand curve is assumed to be linear.76=1172.11 3.11 − 3.11=1172.76 Sales of Roasted Coffee (million lbs) 820 850 a. You can calculate the elasticity at both points and at the average point between the two years: P ∆Q 4. Q97 + Q98 ∆P 835 2 97 Ep = To derive the demand curve for roasted coffee.76 98 Ep = = (−85.11 = (−85.35 Given the slope.7) = −0. To find elasticity.7) = −0. Derive a linear demand curve for instant coffee.3 or a=850+85. derive a linear demand curve for roasted coffee.7P. b. note that the slope of the demand curve is -85.7) = −0. ∆P 10.3-85. Now estimate the short-run price elasticity of demand for instant coffee.5.7.13 19 . use either of the data points from the table above so that a=830+85. To find elasticity. The equation for the demand curve is therefore Q=1172. estimate the short-run price elasticity of demand for roasted coffee.35 10.48 0.935 AVE 2 Ep = = (−85.7*4.

This will cause the demand for roasted coffee to be more inelastic because at any given price there will be a higher quantity demanded for roasted versus instant coffee. we can now estimate elasticity using the price and quantity data from the above table.5) = −5.415 2 = Q +Q = (−38.5*10. though imperfect substitute for roasted coffee.Chapter 2: The Basics of Supply and Demand Given the slope. In fact.1.48 = (−38.52. Given the higher price per pound for instant coffee. the demand for roasted coffee is inelastic and the demand for instant coffee is elastic. The equation for the demand curve is therefore Q=473.76 Q ∆P 70 98 Ep = AVE Ep P97 + P98 ∆Q 10. Roasted coffee may have an inelastic demand in the short-run as many people think of coffee as a necessary good.35=473. Note also that roasted coffee is the premium good so that the demand for roasted coffee lies to the right of the demand for instant coffee. you Which coffee has the higher short-run price elasticity of demand? Why do think this is the case? Instant coffee is significantly more elastic than roasted coffee.1-38. use either of the data points from the table above so that a=75+38. 97 98 ∆P 72. and the preference for roasted over instant coffee by many consumers.5) = −5.5P. Since the demand curve is assumed to be linear.5*10.31 Q ∆P 75 P ∆Q 10.35 = (−38.5 2 To derive the demand curve for instant coffee. the elasticity will differ in 1997 and 1998 because price and quantity are different.48=473. To find the coefficient a. You can calculate the elasticity at both points and at the average point between the two years: 97 Ep = P ∆Q 10. 20 .5) = −5.5=-b.1 or a=70+38. note that the slope of the demand curve is -38. and this quantity difference will be large enough to offset the difference in the slope of the two demand curves. this will cause the demand for roasted coffee to be less elastic than the demand for instant coffee. Instant coffee on the other hand may be viewed by many people as a convenient. c.

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