The Supply and Demand Model (continued

)
Lecture 3 Part 1

Demand Curve
Demand curve is the relationship between two economic variables
» Price of a given good » Quantity of this good consumers are willing to buy at that price in a particular time period » Ceteris paribus

Demand Curve
640 560 Price 480 400 320 240 0 10 20 Quantity Demanded
Fig 3.1

30

40

Shifts in Demand
Demand curve shows the relationship between Price and Quantity Demanded, keeping other things fixed

Graphically this corresponds to movement along the demand curve: change in price and quantity demanded What happens when some those other things change? Shift of the Demand Curve: increase or decrease in demand
Fig 3.2

Factors Which Shift Demand
Consumers’ preferences Consumers’ information Consumers’ incomes
» Normal goods » Inferior goods

Consumers’ expectations Number of consumers in the market Prices of closely related goods
» Substitutes » Complements

3 .Change in Demand & Change in the Quantity Demanded Decrease in the Quantity Demanded P Increase in Demand B A C D1 Decrease in Demand D0 D2 Q Increase in the Quantity Demanded Fig 3.

Supply Curve Supply curve is the relationship between two economic variables » Price of a given good » Quantity of this good firms are willing to sell at that price in a particular time period » Ceteris paribus .

Supply Curve 640 560 Price 480 400 320 240 0 10 20 30 40 Quantity Supplied Fig 3.4 .

Shifts in Supply Supply curve shows the relationship between Price and Quantity Supplied.2 . keeping other things fixed Graphically this corresponds to movement along the supply curve: change in price and quantity supplied What happens when some those other things change? Shift of the Supply Curve: increase or decrease in supply Fig 3.

Factors Which Shift Supply Technology Price of input goods Government taxes. subsidies and regulations Number of firms in the market Expectations of future price .

Change in Supply & Change in the Quantity Supplied Decrease in the Quantity Supplied Decrease in Supply P S1 E D F S2 S0 Increase in Supply Q Increase in the Quantity Supplied Fig 3.6 .

Equilibrium Price & Quantity 640 560 Equilibrium price ($400) Surplus S Price 480 400 320 D 240 0 10 20 30 40 Equilibrium Quantity Shortage quantity (18000) Fig 3.7 .

8 .Increase in Demand P S P1 P0 DNew DOld Q0 Q1 Q Pe↑ & Qe↑ Fig 3.

9 .Decrease in Supply P SNew P1 P0 D Q1 Q0 Q SOld Pe↑ & Qe↓ Fig 3.

4 .Effects of Shifts in Demand & Supply Effect on Pe ↑ ↓ ↓ ↑ Effect on Qe ↑ ↓ ↑ ↓ Shift Demand ↑ Demand ↓ Supply ↑ Supply ↓ Table 3.

Interference with Market Prices Price controls Price ceilings » Rent control » Making things worse Price floors » Agricultural price stabilisation schemes » Minimum wages .

Price Ceilings P S Pe Pmax Shortage QS QD D Q Fig 3.10 .

Price Floors P Pmin Pe Surplus S QD QS D Q Fig 3.11 .

Interference with Market Prices Price floor on dry milk in US » US Department of Agriculture used to keep price of dry milk above market clearing prices » It guarantees to buy any quantity of milk at that price » Support for dairy farmers .

Interference with Market Prices At some point in 2002 they were stuck with the surplus of 1.000 square feet of warehouse space is committed to storing dry milk in a Kansas City. underground warehouse (Associated Press) . Mo.3 billion gallons – 16 month of national consumption Over 100.

and the powder keeps coming.is sold for use in animal feed. Powder that is getting old -. Some of the powder is donated to domestic programs and overseas. 2002): The Agriculture Department is trying to get rid of the powder.Interference with Market Prices Philip Brasher / AP Farm Writer (June 30. . about 386 million pounds has been purchased since October.the government has been storing some of this milk for up to three years -. Storage costs are approaching $20 million a year.

L – numbers of workers LS D L Fig 3.11 .Price Floors: Minimum Wage W Unemployment S Wmin We LD W – wage.

Interference with Market Prices Price controls result in waste of resources » Over-production and storage costs in the dry milk example » Unemployment in the minimum wage example .

Elasticity and Its Importance Lecture 3 Part 2 .

Elasticity A quantitative measure of how sensitive one economic variable is to another economic variable .

.. 30 20 10 Quantity demanded is very sensitive to the price Highly elastic demand … lowers quantity demanded by 20% 10 20 30 40 50 60 70 0 Quantity Demanded .. Price of Coffee A 10% price increase ..Comparing Different Price Elasticities of Demand .

30 20 10 Quantity demanded is not very sensitive to the price Demand curve with low price elasticity … lowers the quantity demanded by 5% 10 20 30 40 50 60 70 0 Quantity Demanded ...… Comparing Different Price Elasticities of Demand Price of Coffee A 10% price increase .

. Price of Coffee Small price rise 30 20 10 Snew Sold More elastic demand Supply declines by 20 thousand kg per day 10 20 30 40 50 60 70 0 Quantity Demanded ..Importance of Price Elasticity of Demand .

… Importance of Price Elasticity of Demand Price of Coffee Large price rise 30 20 10 Snew Sold Less elastic demand Supply declines by 20 thousand kg per day 10 20 30 40 50 60 70 0 Quantity Demanded .

Price Elasticity of Demand The percentage change in the quantity demanded of a good divided by the percentage change in the price of that good ed = ed = percentage change in quantity demanded percentage change in the price Δ Qd Qd ΔP P = ΔQd / Qd ΔP / P = P Δ Qd Qd Δ P .

1 .Terminology for Elasticity Term Perfectly inelastic Inelastic Unit elastic Elastic Perfectly elastic A is relatively elastic compared with B Value of ed 0 Less than 1 1 Greater than 1 Infinity A has a higher elasticity than B Table 4.

change in quantity ed = average of old & new quantity ÷ change in price average of old & new price .The Midpoint Formula Problem with ordinary formula: Which price and quantity should we use? Solution: Use average values for both.

Special Cases P Di Perfectly Inelastic Demand De Perfectly Elastic Demand Q Fig 4.4 .

Elasticity and Revenue Price ($) 0 1 2 3 4 5 6 7 8 9 10 Q 20 18 16 14 12 10 8 6 4 2 0 R=P*Q Elasticity 0 18 32 42 48 50 48 42 32 18 0 P Revenue: Ed < 1 Ed > 1 Table 3.3 .

5a .Elasticity & a Straight Line Demand Curve 12 11 10 9 8 7 6 5 4 3 2 1 0 0 2 ed > 1 ed = 1 ed < 1 Price (P) 4 6 8 10 12 14 16 18 20 22 Quantity Demanded (Q) Fig 4.

5b If ed > 1 then Revenue↓ as P↑ If ed < 1 then Revenue↑ as P↑ .Revenue & a Straight Line Demand Curve 60 50 Revenue (P x Q) 40 30 20 10 0 0 2 4 6 8 10 12 14 16 18 20 22 Quantity Demanded (Q) Fig 4.

2 .Revenue and the Price Elasticity of Demand Effect of a Price ↑ Revenue ↑ Revenue ↔ Revenue ↓ Effect of a Price ↓ Revenue ↓ Revenue ↔ Revenue ↑ ed <1 1 >1 Terminology Inelastic Unit elastic Elastic Table 4.

Revenue & a Price↑ for Coffee .6a .. Price of Coffee Net revenue effect: $144 million ↓ $2 price increase 30 20 10 Elastic Demand Revenue rises by $96 million 10 20 30 40 50 60 Revenue falls by $240 million 70 0 Quantity Demanded Fig 4..

6b .… Revenue & a Price↑ for Coffee Price of Coffee Net revenue effect: $54 million ↑ $2 price increase 30 20 10 Inelastic Demand Revenue rises by $114 million 10 20 30 40 50 60 Revenue falls by $60 million 70 0 Quantity Demanded Fig 4.

5 2.1 0.2 1.9 1.2 0.Estimated Price Elasticities of Demand Type of good or service Eggs Petrol Shoes Foreign travel Alcoholic beverages Jewellery Price elasticity 0.6 .

Factors Affecting Price Elasticity of Demand Degree of substitutability » More substitutes – higher elasticity Big-ticket versus little-ticket items » More expensive goods – higher incentives to look for substitutes Temporary versus permanent price changes » Temporary price decrease – people will want to buy now at a lower price – higher elasticity .

Factors Affecting Price Elasticity of Demand Long-run versus short-run elasticity » Long-run – all adjustments are made » Substitution takes time Example: Demand for petrol » Inelastic in the short run. elastic in the long run .

Elasticities Related to Shifts in Demand Income elasticity of demand: The percentage change in the quantity demanded of one good divided by the percentage change in income Cross-price elasticity of demand: The percentage change in the quantity demanded of one good divided by the percentage change in the price of another good .

2 .4 1.Estimated Income Elasticities of Demand Type of good or service Food Beer Wine Cars Income elasticity 0.0 1.3 0.

. P P1 P0 A Large ↑ in Q Q0 Q1 Q Quantity supplied is very sensitive to the price B Shigh el .Comparing Different Price Elasticities of Supply ..

7b .… Comparing Different Price Elasticities of Supply P P1 P0 A Quantity supplied is not very sensitive to price Slow el C Small ↑ in Q Q0 Q2 Q Fig 4.

8a ..Importance of Price Elasticities of Supply .. P Small reduction in price Shigh el P0 P1 Dold Dnew Q0 Q Fig 4.

… Importance of Price Elasticities of Supply Large change in price P Slow el P0 P2 Dnew Q0 Q Fig 4.8b Dold .

Price Elasticity of Supply The percentage change in the quantity supplied of a good divided by the percentage change in the price of that good es = es = percentage change in quantity supplied percentage change in the price Δ Qs Qs ΔP P = Δ Q s / Qs ΔP / P = P Δ Qs Qs Δ P .

Special Cases P Si Perfectly Inelastic Supply Se Perfectly Elastic Supply Q Fig 4.9 .

Applications of Elasticity First Time Home Buyer Grant (again) » Between 14 October 2008 and 30 June 2009 first time home buyers got a subsidy of up to $14.000 » Willingness to pay goes up (for example $400.000 after the grant) .000 before grant – $414.

inelastic supply of housing » One could even argue that perfectly inelastic supply curve would be a good approximation » Who benefits from the grant? .Applications of Elasticity First Time Home Buyer Grant » Demand increases (shifts up and to the right) » Shortage of land .

9 .Applications of Elasticity P S P1 D1 P0 D0 Q Fig 4.

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