Microeconomics

Session 1-2

The demand curve

Q
Q=q(P)

5000

680

The inverse demand curve

P
P=p(Q)

680

5000

SUPPLY AND DEMAND

The Demand Curve
Figure 2.2
The Demand Curve

The demand curve, labeled D,

shows how the quantity of a good
demanded by consumers
depends on its price. The
demand curve is downward
sloping; holding other things
equal, consumers will want to
purchase more of a good as its
price goes down.
The quantity demanded may also
depend on other variables, such
as income, the weather, and the
prices of other goods. For most
products, the quantity demanded
increases when income rises.
A higher income level shifts the
demand curve to the right (from D
to D).

Gold demand sluggish as price hardens

Reuters Jul 4, 2012
Gold prices in India, one of the world's leading
consumers, edged higher on Wednesday on a weak
rupee, keeping demand muted as there wasn't any
festival in the short-term to lure buyers.
"Buyers are not comfortable with the current price.
Jewellers, investors all are waiting for correction," said a
Mumbai-based dealer with a private bank dealing in
bullion.

Investors shun gold as poor monsoon spoils

rural demand
ET Bureau Jul 5, 2012
Delayed monsoon and recovering equity markets have
turned investors away from gold.
A large section of traditional gold investors has moved to
equity markets that rose by 9% in June compared to 2%
rise in gold prices.
"Weak monsoon will most likely hamper gold demand in
rural India, which usually contributes 60% to total
consumption. Also, investors are putting their money in
fixed deposits that give them more than 9% returns,"
says Prithviraj Kothari, president of Bombay Bullion
Association.

Class Participation Games 1

Show that the term demand can be used
in two different senses implying either
quantity demanded or demand curve using
some newspaper articles.

Shifts in Demand
Substitutes - Two goods for which an
increase in the price of one leads to an
increase in the quantity demanded of the
other.
Complements - Two goods for which an
increase in the price of one leads to a
decrease in the quantity demanded of the
other.

SUPPLY AND DEMAND

The Supply Curve
supply curve Relationship between the quantity of a good that
producers are willing to sell and the price of the good.
Figure 2.1
The Supply Curve

The supply curve, labeled S in

the figure, shows how the
quantity of a good offered for
sale changes as the price of the
good changes. The supply
curve is upward sloping: The
higher the price, the more firms
are able and willing to produce
and sell.
If production costs fall, firms
can produce the same quantity
at a lower price or a larger
quantity at the same price. The
supply curve then shifts to the
right (from S to S).

THE MARKET MECHANISM

Figure 2.3
Supply and Demand

The market clears at price P0

and quantity Q0.
At the higher price P1, a surplus
develops, so price falls.
At the lower price P2, there is a
shortage, so price is bid up.

CHANGES IN MARKET
EQUILIBRIUM
Figure 2.6
New Equilibrium Following
Shifts in Supply and Demand

Supply and demand curves

shift over time as market
conditions change.
In this example, rightward
shifts of the supply and
demand curves lead to a
slightly higher price and a
much larger quantity.
In general, changes in price
and quantity depend on the
amount by which each
curve shifts and the shape
of each curve.

A change in quantity
P
P=p(Q)

700

680

5000

4990

ELASTICITIES
elasticity Percentage change in one variable resulting from
a 1-percent increase in another.

Price Elasticity of Demand

price elasticity of demand Percentage change in quantity
demanded of a good resulting from a 1-percent increase in its
price.

(2.1)

ELASTICITIES
Linear Demand Curve
linear demand curve

Figure 2.11
Linear Demand Curve

The price elasticity of demand

depends not only on the slope
of the demand curve but also
on the price and quantity.
The elasticity, therefore, varies
along the curve as price and
quantity change. Slope is
constant for this linear demand
curve.
Near the top, because price is
high and quantity is small, the
elasticity is large in magnitude.
The elasticity becomes smaller
as we move down the curve.

Demand curve that is a straight line.

ELASTICITIES
Linear Demand Curve
Figure 2.12
(a) Infinitely Elastic Demand

(a) For a horizontal demand

curve, Q/P is infinite.
Because a tiny change in price
leads to an enormous change
in demand, the elasticity of
demand is infinite.

infinitely elastic demand Principle that consumers will buy as much

of a good as they can get at a single price, but for any higher price the
quantity demanded drops to zero, while for any lower price the
quantity demanded increases without limit.

ELASTICITIES
Linear Demand Curve
Figure 2.12
(b) Completely Inelastic Demand

(b) For a vertical demand curve,

Q/P is zero. Because the
quantity demanded is the same
no matter what the price, the
elasticity of demand is zero.

completely inelastic demand Principle that consumers will buy a

fixed quantity of a good regardless of its price.

A change in quantity (algebra)

Total Revenue TR(Q) = p(Q) Q

Marginal Revenue MR(Q) = TR(Q)
TR(Q) = p(Q) + p(Q) Q
= p(Q) [ 1 + p(Q) Q / p(Q)]
= p(Q) [ 1 + 1/e]
where
e = p / (p(Q) Q)

Price elasticity of demand

e = p Q(p) / Q(p)
TR(Q) = MR(Q) = p(Q) [ 1 + 1/e]
Abs(e) > 1 ; demand is elastic; TR(Q) > 0
Abs(e) < 1 ; demand is inelastic; TR(Q) < 0

ELASTICITIES
Other Demand Elasticities
income elasticity of demand Percentage change in the quantity
demanded resulting from a 1-percent increase in income.

(2.2)

cross-price elasticity of demand Percentage change in the

quantity demanded of one good resulting from a 1-percent increase in
the price of another.
(2.3)

Elasticities of Supply
price elasticity of supply Percentage change in quantity supplied
resulting from a 1-percent increase in price.

SHORT-RUN VERSUS LONG-RUN ELASTICITIES

Demand
Figure 2.13
(a) Gasoline: Short-Run and Long-Run
Demand Curves

(a) In the short run, an increase in

price has only a small effect on the
quantity of gasoline demanded.
Motorists may drive less, but they will
not change the kinds of cars they are
driving overnight.
In the longer run, however, because
they will shift to smaller and more
fuel-efficient cars, the effect of the
price increase will be larger.
Demand, therefore, is more elastic in
the long run than in the short run.

SHORT-RUN VERSUS LONG-RUN ELASTICITIES

Demand
Demand and Durability
Figure 2.13
(b) Automobiles: Short-Run and Long-Run
Demand Curves

(b) The opposite is true for

automobile demand. If price
increases, consumers initially defer
buying new cars; thus annual
quantity demanded falls sharply.
In the longer run, however, old cars
wear out and must be replaced; thus
annual quantity demanded picks up.
Demand, therefore, is less elastic in
the long run than in the short run.

SHORT-RUN VERSUS LONG-RUN ELASTICITIES

Demand
Income Elasticities

Income elasticities also differ from the short run to the

long run.
For most goods and servicesfoods, beverages, fuel,
entertainment, etc. the income elasticity of demand is
larger in the long run than in the short run.
For a durable good, the opposite is true. The short-run
income elasticity of demand will be much larger than the
long-run elasticity.

MARKET DEMAND
market demand curve Curve relating
the quantity of a good that all consumers
in a market will buy to its price.

From Individual to Market Demand

TABLE 4.2

Determining the Market Demand Curve

(1)
Price
($)

(2)
Individual A
(Units)

(3)
Individual B
(Units)

(4)
Individual C
(Units)

(5)
Market
(Units)

10

16

32

13

25

10

18

11

MARKET DEMAND
From Individual to Market Demand
Figure 4.10
Summing to Obtain a Market Demand
Curve

The market demand curve is

obtained by summing our three
consumers demand curves DA,
DB, and DC.
At each price, the quantity of
coffee demanded by the market is
the sum of the quantities
demanded by each consumer.
At a price of $4, for example, the
quantity demanded by the market
(11 units) is the sum of the
quantity demanded by A (no
units), B (4 units), and C (7 units).

CONSUMER SURPLUS
consumer surplus Difference between what a consumer is willing to
pay for a good and the amount actually paid.

Consumer Surplus and Demand

Figure 4.13
Consumer Surplus

Consumer surplus is the

total benefit from the
consumption of a product,
less the total cost of
purchasing it.
Here, the consumer surplus
associated with six concert
tickets (purchased at $14
per ticket) is given by the
yellow-shaded area.

CONSUMER SURPLUS
Consumer Surplus and Demand
Figure 14.4
Consumer Surplus Generalized

For the market as a whole, consumer

surplus is measured by the area under
the demand curve and above the line
representing the purchase price of the
good.
Here, the consumer surplus is given
by the yellow-shaded triangle and is
equal to
1/2 ($20 $14) 6500 = $19,500.

Applying Consumer Surplus

When added over many individuals, it measures the aggregate benefit that
consumers obtain from buying goods in a market.
When we combine consumer surplus with the aggregate profits that producers
obtain, we can evaluate both the costs and benefits not only of alternative
market structures, but of public policies that alter the behavior of consumers
and firms in those markets.

Consumer and Producer Surplus

Individual consumer surplus is the difference
between the maximum amount that a consumer is
willing to pay for a good and the amount that the
consumer actually pays.
 Producer surplus for a particular unit of output is
the difference between the price at which it is sold
and the marginal cost of producing it. Total
producer surplus is the sum of producer surplus
over all units sold. It equals the difference between
revenue and variable costs.