Organization and Market

Economics
Session 1-3
Introduction to Market
 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 quantity demanded
may also depend on other
variables, such as
income, the weather, and
the prices of other goods.
A higher income level
shifts the demand curve
to the right (from D to D’).
 IEA sees surge in oil demand from India,
emerging nations
PTI May 12, 2016

As dollar values are Y

falling, oil prices are Price
falling in India.
Before oil
Surge in oil demand in demand
India and other emerging Surge
nations will lead to
reduction in global oil
surplus in the first half of After oil
2016, the International demand
Energy Agency (IEA) said Surge X
Before Oil After Oil
today. Surge Surge Oil Demand
 Monsoon to wash away diesel demand surge
Reuters Jun 16, 2016
The monsoon is expected to Shift In Demand Curve
dump above-average rainfall
Price
on the South Asian nation
after two years of drought,
cutting its use of diesel for
Failed
irrigation pumps and
monsoon
generators over the third
quarter and potentially
rejuvenating exports of the oil
product.

Good
Monsoon

Demand For Diesel

 Relationship Between Consumption
Goods
When Price of X Increases,

Quantity Demanded Quantity Demanded

of Y Decreases of Y Increases

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

More under cross price elasticity

 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.
 Mini Case: North Korean
Currency Reform 2009
• Kim Jong-il increased everybody’s salary
a hundredfold along with keeping
the same prices.

• North Korea is a non-market

economy country with the Govt. being the
producer.
• What will happen to consumption?
What Babur knew but Kim Jong-
il did not

• Babur was born in Central Asia. He

came to India in 1526 AD.
• His commanders wanted to go back to
Central Asia with all the gold acquired
from India.
• Babur understood the issue of
inflation.
 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.
 CHANGES IN MARKET
EQUILIBRIUM
Figure 2.6
New Equilibrium Following Price
Shifts in Supply and Demand
S1
Supply and demand curves
shift over time as market
conditions change.
In this example, rightward
shifts of the supply and S2
demand curves lead to a
slightly lower price and a
much larger quantity.
In general, changes in price P1
and quantity depend on the
amount by which each P2
curve shifts and the shape
of each curve. D2

D1

Q1 Q2 Quantity
 CHANGES IN MARKET EQUILIBRIUM

Demand Supply Quantity Price

Increases Increases Increases Ambiguous

Decreases Decreases Decreases Ambiguous

Increases Decreases Ambiguous Increases

Decreases Increases Ambiguous Decreases

 A change in demand for a
change in price
P
P=p(Q)

700

680

Q
4990
5000
Price Elasticity of Demand: Definition

Percentage change in
quantity demanded of a
good resulting from a 1-
percent increase in its
price.
 Elasticity for 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.
Slope is constant for
this linear demand
curve. But the
elasticity, therefore,
varies along the curve
as price and quantity
change..
 Infinitely Elastic Demand
Linear Demand Curve

For a horizontal demand

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

Goods that are perfectly

substitutable have very
highly elastic demand.
 Completely Inelastic Demand
Linear Demand Curve

For a vertical demand

curve, ΔQ/ΔP is zero.
Because the quantity
demanded is the same
no matter what the
price, the elasticity of
demand is zero.

Commodities that has

no substitute will be
completely inelastic.
 Price Elasticity of Demand

Elastic Inelastic

Tomato Hyundai Car Car Salt

-∞ -4.6 -4.3 -1.3 E = -1 -0.1 0

Infinitely Unitary Completely
Elastic Elastic Inelastic
 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
 Other Demand Elasticities

● income elasticity of demand Percentage change in

the quantity demanded resulting from a 1-percent
increase in income.

● 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.
Capital Punishment and Murder
No Capital Punishment

Capital Punishment

For each inmate put to death, the studies

say, 3 to 18 murders are prevented.
Policy Perspective: Fat Tax
• Context: Obesity Epidemic
• What is Fat tax?
• And, when will it work?
– A 20% Sugar Tax would reduce sugar
consumption by 16%, fat by 12% and salt by 10%
and calorie intake by 19%.
• Can fat tax be the government policy?
– Denmark is the first country to introduce fat
tax.
– Kerala has imposed fat tax in 2016 budget.
 SHORT-RUN VERSUS LONG-RUN : CONSUMPTION GOODS

(a) In the short run, an GASOLINE

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,

because they will shift to
smaller and more fuel-
efficient cars, the effect of
the price increase will be
larger.
 SHORT-RUN VERSUS LONG-RUN: DURABLE GOODS

(b) The opposite is true for

automobile demand. If
AUTOMOBILES
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.
 Income Elasticities:
SHORT-RUN VERSUS LONG-RUN

Income elasticities also differ from the short run to the

long run.

For most goods and services—foods, 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
From Individual to Market Demand

Market Demand
Curve relating the
quantity of a good
that all consumers
in a market will buy
to its price.
 CONSUMER SURPLUS and DEMAND

● consumer surplus Difference between what a consumer is willing to

pay for a good and the amount actually paid.

Consumer surplus is the total

benefit from the consumption
of a product, less the total
cost of purchasing it.

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.
 Consumer and Producer Surplus

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.
 Homework 2 (Page 86, exercise 5)
• Much of the demand for U.S. agricultural output has come
from other countries. In 1998, the total demand for wheat
was Q = 3244 – 283P. Of this, total domestic demand was
QD = 1700 – 107P, and domestic supply was QS = 1944
+ 207P. Suppose the export demand for wheat falls by 40
percent.
a) U.S. farmers are concerned about this drop in export
demand. What happens to the free-market price of wheat
in the United States? Do the farmers have much reason
to worry?
b) Now suppose the U.S. government wants to buy enough
wheat to raise the price to $3.50 per bushel. With the drop
in export demand, how much wheat would the
government have to buy? How much would this cost the
government?