Topic1 Feb2023

MFIN 827
Quantitative Methods and Economics
PART I: UNDERSTANDING MARKETS
TOPIC 1: Demand, Supply and Markets
Ricard Gil
ricard.gil@queensu.ca
Example 1: UEFA Euro 2020
“Agua, no Coca-Cola...” 
Coca-Cola value dropped by 4,000 million USD.
2
Example 2: Dijon Mustard
Question:
What should we expect
from this crisis?
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Benchmark: Perf. Comp. Market
• Main characteristics:
– 1. Many small firms
– 2. Homogeneous products
– 3. Free entry and exit
• Important note: (from 1. and 2.)

– Market price unaffected by actions of single firm
– Firms are price-takers
Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION

Benchmark: Perf. Comp. Market
Food Market, Streets of Hong Kong

Roadmap
• Demand:
– Individual demand and market demand
– Slides vs shifts
– Demand function and inverse demand function
• Supply:
– Producer supply and market supply
– Slides vs shifts
– Supply function and inverse supply function
• Market Mechanism:
– Equilibrium analysis
– Going back to examples 1 and 2

Demand

A Demand Curve…
Price
Tells us:
1. What quantity
consumers are willing
to buy at price p0
2. What price consumers
p0
Demand are willing to pay for
q0th unit
q0 Quantity

Consumer’s Demand Curve
P
WTP for $
First pint 10.00
$10
Second pint 6.50
$8 Third pint 3.50
Fourth pint 2.30
$6
Fifth pint 1.50
$4
As the price goes
$2 down, the quantity
demanded goes up
0 1 2 3 4 5 Q
Question: If you could get pints of Häagen-Dazs Ice Cream for
$7, how many would you buy? What if the price were $3?

From Consumer to Market Demand
Pint’s Your Classmates’ All Others’ Total Market demand
Price/unit Demand Demand Demand Demand
tells you the total
$10.00 1 100 1200 1301
number of units
$6.50 2 200 1300 1502
consumers will
$3.50 3 300 1400 1703
purchase at any
$2.30 4 400 1500 1904
given price
P ($) Your Demand Classmates’ Demand Others’ Demand Total Demand

10
6.5
3.5
2.3
0 1 2 3 4 5 100 300 500 700 900 1100 1300 1500 1700 1900 2100 Q

Slides vs Shifts
P
When you change the

price of the product you
P0 “slide” up or down its
demand curve
P1
D
Q0 Q1 Q

Slides vs Shifts (2)
Question: What was the impact of entry of Uber and
Lyft on demand for taxi-type transportation in NY?
P
When you change things
other than the price of
the product you shift its
demand curve
P0 Here: At any given

D0 price, consumers are
D1 demanding a smaller
quantity
Q1 Q0 Q
Question: What other examples and instances can you
come up with that would imply a demand curve shift?
P
P0
D0
D1
Q1 Q0 Q
Demand Shifters
• Income (M)
– Normal goods: demand increases with income
– Inferior goods: demand decreases with income
• Prices of Related Goods (Py)

– Substitutes: Goods for which an increase (decrease) in the
price of one good leads to an increase (decrease) in the
demand for the other
– Complements: Goods for which an increase (decrease) in
the price of one good leads to a decrease (increase) in the
demand for the other

Demand Shifters (2)
• Advertising and Consumer Tastes (A)

• Population
• Consumer expectations
• Other factors
– Anything affecting consumers’ ability/willingness to pay
• The price of the good is NOT a demand shifter

On a related note: Own Price (Po)
– Ordinary goods: demand decreases with price
– “Giffen” goods: demand increases with price

Example 3: Water
• A seafood restaurant charges $12/bottle for mineral

water
• On the other hand, peanuts and other amuse-bouches
are free
• Question: Why do you think that is?

The Demand Function
• Question: If demand is Qdx = 36 - 4Px, what is the

inverse demand?
• General Case:
– Linear demand function: Qdx = ax - bxPx
– Describes quantity demanded as funct. of:
• Price of that good
• Demand shifters, via ax = f(Py, M, A, etc.)
– Inverse demand funct.: Px = (ax/bx) – (1/bx)Qdx

Qdx = 36 - 4Px
Px = 9 – 0.25Qdx

Qdx = 36 - 4Px
Qdx /4= 36/4 - 4Px/4
Qdx /4= 9 - Px
Px = 9 - Qdx /4
Px = 9 – 0.25Qdx

Price Elasticity of Demand
P P P P
$5 $5 $5 $5
$4 $4 $4 $4
$3 $3 $3 $3
$2 $2 $2 $2
$1 $1 $1 $1
0 1 2 3 4 5 Q 0 1 2 3 4 5 Q 0 1 2 3 4 5 Q 0 1 2 3 4 5 Q
Inelastic Perfectly Elastic Perfectly

Demand Inelastic Dem. Demand Elastic Dem.
Demand fairly Demand Demand fairly Demand
insensitive to completely sensitive to infinitely
price insensitive to price sensitive to
price price

Elasticity of Demand (2)
• Definition: % change in the quantity demanded of a
good following a 1% increase in the price of that good:
%ΔQ ∆Q P
EQ,P
%ΔP ∆P Q
• Key Characteristics:
– It is negative: a price increase leads to a decrease in demand
– If >1 in magnitude: demand is elastic
– If <1 in magnitude: demand is inelastic

Elasticity (EQ,P) changes across the

demand curve
Price Absolute
% %∆ $7 Elasticity is
EQ,P = = larger than
% %∆
∆ $6 1.
= ∗
∆
$5
P is high and Q is low, EQ,P tends to $4 Absolute

be elastic Elasticity is
$3
• A price cut associated with gains smaller than
in TR 1.
$2
P is low and Q is high, EQ,P tends to
be inelastic $1
• A price increase => gain in TR
0
0 2 4 6 8 10 12
Quantity
22
• EQ,P is always a negative number

– Price elasticity is a “pure number”, it does not have units (not %, not $)
– Common convention (used in Mankiw) is to drop the negative symbol
• If EQ,P is between 0 and -1, then it is inelastic
• If EQ,P is between -1 and - , then it is elastic
• Price changes recommendations:
– Inelastic => raise P to raise TR;
– elastic => drop P to raise TR
For example if EQ,P = -3.50, then a price increase of 1% will yield a 3.50 %
decrease in demand; a manager should drop its price to increase its revenue
(remember revenue is not profit)
23
Numerical Illustration
Suppose the firm's demand curve is Q = 30 – P
1. Plot the curve

2. Consider a price cut from P1 = $25/unit to P2 = $24/unit.
→ What happens to the ﬁrm's sales revenue (TR)?
→ Is elas city more or less than -1?
3. Next, consider a price cut from P3 = $3/unit to P4 =
$2/unit.
→ What happens to the firm's sales revenue (TR)?
→ Is elas city more or less than -1?
24
Plotting a curve from the equation Q = 30 - P:
• Pick a few numbers for P, plug in the equation to
calculate Q
• If the equation is linear, only two points are needed
P
30
P ($ per unit) Q (units per period)
slope = -1
0 30
5 25
10 20
30 0
30 Q
25
Let's consider the specific price points mentioned above:
• P1 = 25, P2 = 24, P3 = 3, and P4 = 2
• Substitute each P into equation Q = 30 - P to
determine each Q
• Calculate total revenue(TR) at each price
P Q TR = P*Q EQ,P
REMINDER!
25 5 125 -5
24 6 144 -4
EQ,P
3 27 81 -0.11
2 28 56 -0.07
26
Example of Elasticity Using the Basic Formula
Milk marketing boards have driven up the price of industrial milk in Canada to a
level about 20 percent above the estimated competitive price. (Source: "Milking
Canada" National Post, December 7, 2006.)
The price elasticity of demand for milk in Canada has been estimated at -0.63.
Suppose marketing boards were eliminated:

1. Calculate the resulting % change in quantity demanded.
2. Would revenues of milk sellers increase or decrease?
%
Remember: EQ,P
%
%
Therefore: -0.63 => % change in Q = …
.
27
Other Price Elasticity Formulas
There are three ways to calculate price elasticity of demand:
1. When you have information on percentage changes:

%
– Use the Basic Price Elasticity Formula [EQ,P %
]
2. When you have two data points (for price & quantity):
∆
– Use the Arc Elasticity Formula [EQ,P ∆ ]
3. When you have an estimate of demand function

∆
– Use the Point Elasticity Formula [EQ,P ∆
]
28
Arc Elasticity Calculation
Arc Elasticity is simply plugging two
points into the expanded and simplified
Basic Price Elasticity Formula:
∆ The magnitude of the calculated ηP,Q is
EQ,P = ∗ different when P1 and Q1 are used
∆ versus when P2 and Q2: -2.71 or -2.25
For example: Ambiguity is resolved by using the
average of (P1 and P2) for “P” and the
P1 = $38, Q1 = 14 units, and average of (Q1 and Q2) for “Q”:
P2 = $36, Q2 = 16 units. • 2/-2*(37/15) = -2.47
"Arc" elasticity is sometimes referred to

Here, Q = Q2 - Q1 = 16 – 14 = + 2, and as "mid-point" elasticity
P = P2 - P1 = 36 – 38 = - 2. Note: arc elasticity calculation is

meaningful only if both data points are
Question: Which P and which Q should on the same demand curve; i.e. ceteris
be used? paribus applies
29
Point Elasticity Calculation
Sometimes the demand equation is available (marketing research or regression analysis)
The general form is: Q = a – b P where “a” is the intercept and “-b” is the slope
• “-b” represents Q/P … we can substitute it into the Basic Price Elasticity Formula
• it says that for every $1 change in price, the quantity demanded drops by “b” units
• For example, Q = 60 – 2 P says that a $1 change in price leads to a 2 unit change in
quantity sold.
Since : EQ,P =
∆
∆
∗ , where ∆∆  -b  -2.
Therefore: EQ,P = -b .
• The coefficient “b” is always negative, hence the price elasticity is a negative number.
• Now you can calculate η at any point on the demand curve by using any set of “P”
and “Q” yielded by the equation.
30
Point Price Elasticity – Example
If the demand equation is Q = 60 – 2 P, and you currently charge $23

per unit, should you raise or lower price to increase revenues?
• Calculate number of units being produced, Q = 60- 2*23 = 14

• Point elasticity formula is, EQ,P = -2*(P/Q)
• Substitute P = 23 and Q = 14 into EQ,P = -2*(P/Q)=-2*(23/14)
• Result is EQ,P = -3.29, the demand for product is elastic
• If price drops by 1%, quantity demanded increases by 3.29 %
• Drop P to gain revenue
31
Determinants of Price Elasticity
Why is the demand for some products elastic, and the demand for other
products inelastic?
• If close substitutes are available, price elasticity is higher.
• High switching cost => inelasticity
• If the share of consumer budget spent on the product is high, price
elasticity is higher.
• If consumes have sufficient time to adjust their consumption habits,
price elasticity is higher. (short-term vs. long-term)
How would you assess the elasticity of:

– Beer/Budweiser
– Gasoline/Exxon
– Mortgages
32
Questions for Discussion
1. The price elasticity of demand for cigarettes has been

estimated at – 0.4. If a pack costs $8 and the government
wants to reduce smoking by 20 percent, by how much
should it increase the price?
2. Will the price increase have greater effect one year from
now or five years from now? Explain.
3. Economic studies have shown that teenagers have a

higher price elasticity of demand for cigarettes than
adults. Why might this be so?
33
Different Shapes of Demand Curves
• Some firms can only sell at the prevailing market price; their D curve is
horizontal or perfectly elastic.
• Demand curve for some products is (close to) vertical, i.e. the buyer “must
have the good (almost) at any price.” Such type of Demand curve is perfectly
inelastic; Q=0, hence EQ,P = 0.
• Recall: elasticity of a linear downward-sloping D curve varies from point to

point; Q/P is constant; thus the value of EQ,P changes as P and Q change.
• If objective is to increase sales revenue:

– when  EQ,P  >1 (demand is elastic), price should be cut
– when  EQ,P  <1 (demand is inelastic), price should be raised
34
Income Elasticity of Demand
Concept of Elasticity goes beyond price. It can also be calculated against
different variables. Most common are own price, price of other goods,
income, advertising
The formulas are the same:
EI
Different values of ηI imply good classification:

• "normal" goods if EI > 0 (as Income ↑  QD ↑)
• "inferior" goods if EI < 0 (as Income ↑  QD ↓)
• "luxury" goods, EI > 1 (QD ↑ faster than income)
What business would benefit from a recession?
35
Cross-Price Elasticity
Definition: EX = % change in quantity demanded of good A
divided by % change in price of good B.
%
EX =
%
• Answers the question how closely two products compete

– If EX > 0 the goods are substitutes; if price of Hondas goes up, Kia
sells more.
– The closer EX is to 1, the closer the competition/substitution.
– If EX < 0 the goods are complements, the price of B goes up and
the demand for A goes down (gasoline and Hummers).
• Antitrust (competition) authorities use EX to define

markets.
36
Supply

A Supply Curve…
P
Tells us:
1. What quantity
producers are willing
p0 to sell at price p0
2. What price producers
must receive to
supply the q0th unit
q0 Q

Producer’s Supply Curve
P Price Necessary to $
Produce
$25 First hundred bottles 6.00

Second hundred bottles 8.50
$20 Third hundred bottles 11.50
Fourth hundred bottles 15.00
$15
Fifth hundred bottles 23.00
$10
As the price goes
$5 up, the quantity
supplied goes up
0 1 2 3 4 5 Q
Question: You are Jane Mavety (Owner, Blue Mountain). How

many hundreds of bottles would you produce if pinot noir sold
for $12? What if the price were $25?
From Prod. Supply To Market Supply
$ SM
The market supply curve
is the horizontal sum of
producers’ supply curves
P3
P2
P1
2 4 5 6 7 8 10 15 21 Q

Slides vs Shifts
P
When you change the

price of the product you
P1 “slide” up or down its
supply curve
P0
Q0 Q1 Q

Question: What will likely be the impact of higher
gasoline prices on the supply of airline seats?
P
When you change things
S1 S0 other than the price of
the product you shift its
supply curve
P0 Here: At any given

price, sellers are
producing a smaller
quantity
Q1 Q0 Q
Supply Shifters
• Input price (W)
• Technological change (T)
• Government regulations (G)
• Number of firms (N)
• Substitutes in production (Pr)
• Taxes (see discussion later)
• The price of the good is NOT a supply shifter

The Supply Function
• Linear Supply function: Qsx = αx + βxPx

• Describes how much of the good will be produced as
a function of:
– The price of that good
– The supply shifters, through αx :
αx = f(W, Pr, etc.)
• Inverse supply function:

Px = - (αx /βx) + (1/βx) Qsx

Qsx = 10 + 2Px

Qsx = 10 + 2Px
Qsx /2= 10/2 + 2Px/2
Qsx /2= 5 + Px
Px = - 5+ Qsx /2
Px = - 5+ 0.5Qsx

Market Mechanism

Market Equilibrium
The market equilibrium

Price is at the intersection of
supply and demand
S
The equilibrium
P0 price is such that
supply = demand
Q0 Quantity

Market Mechanism
If price is above the equilibrium, then

Price “natural” tendency for price to fall
S
Surplus
P1
P0
Q0 Quantity

Market Mechanism (2)
If price is below the equilibrium, then

Price “natural” tendency for price to rise
P0
P2
D
Shortage
Q0 Quantity

Market Mechanism (3)
Very simply:
• If there is a surplus, the market price will naturally

adjust downward until the equilibrium is reached
• If there is a shortage, the market price will adjust

upward until the equilibrium is reached
 If you let the market “do its job”, you always end up
at (Q0, P0)

Question: What factors affect the
market equilibrium?

Shift in Demand: Impact on Equil.
P
S Here:
1) Demand shifts in
2) At P0 there is now
P0 excess supply
P1 3) Price and quantity
D0 fall until new equil.
D1 (Q1, P1) is reached
Q1 Q0 Q

Example 1 Redux: UEFA Euro 2020
Agua, no
Agua
Coca
Coca-Cola...
...
Coca-Cola value dropped by 4,000 million USD.
What happened here?

54
Example 1: UEFA Euro 2020
• Question: How did CR7 manage to drop Coca-Cola’s market

value by 4bn?
Shift in Supply: Impact on Equil.
S1 S0 Here:
1) Supply shifts in
2) At P0 there is now
P1
excess demand
P0
3) Price and quantity
D rise until new equil.
(Q1, P1) is reached
Q1 Q0 Q

Example 2: Dijon Mustard
Question:
What should we expect
from this crisis?

Shifts in Supply and Demand
P
D1 D0 S1 S0
When supply and
demand shift in, Q ↓
P0 and P ↕. Here P ↓
P1
Q1 Q0 Q

Determining the Equilibrium
• In equilibrium the quantity demanded must equal the

quantity supplied
• The equilibrium price must therefore be such that:

Qdx(Px) = Qsx(Px)
• The equilibrium quantity is simply:

Qdx(Px), or equivalently Qsx(Px)

Example 4: This Little Piggy Went to Market…
• The supply and demand functions for processed meat

in Canada in the early 1990s were estimated to be:
Qs = 88 +40P
Qd = 286 – 20P
(Price is in $ per kg, and quantity is in million kg of meat per year)
• Question: What are the equilibrium price and

quantity?

Qs = 88 +40P
Qd = 286 – 20P

Qs = 88 +40P
Qd = 286 – 20P
Qs = Qd
88 +40P = 286 – 20P
40P+20P=286-88
60P = 198
P=198/60=3.3
Qs = 88 +40(3.3) = 88 + 132 = 220

Qd = 286 – 20(3.3) = 286 -66= 220

Let’s Go to the Movies!
• MPAA data on tickets sold, total box office and average
ticket price
Year Tickets Sold Total Box Office Average
Ticket Price
1995 1221689691 5314350848 4.35
1996 1310014086 5790263038 4.42
1997 1385218935 6358155799 4.59
1998 1443828069 6771554637 4.69
1999 1444683117 7338991529 5.08
2000 1397459792 7532309928 5.39
2001 1476214253 8355374308 5.66
2002 1575738917 9155044904 5.81
2003 1524299882 9191530167 6.03
2004 1495647988 9287975958 6.21
2005 1372980280 8800805718 6.41
2006 1398738283 9161738221 6.55
2007 1420036680 9769854914 6.88
2008 1358041408 9750739371 7.18
2009 1418567388 10639257284 7.5
2010 1328549023 10482254025 7.89
2011 1282891719 10173333767 7.93
2012 1381281024 10994999886 7.96
2013 1339172000 10887471336 8.13
2014 1257400618 10272966196 8.17
2015 1323262157 11155102984 8.43
2016 1301642760 11259213129 8.65
2017 1225525527 10992966773 8.97
2018 1312869715 11960245597 9.11
2019 1247341996 11363285585 9.11

The Motion Picture Industry 1995-2019
Tickets Sold vs. Box Office Revenues in
NA Movie Market
Average Ticket Price
1800000000 14000000000 10.00
1600000000 12000000000 9.00
1400000000
10000000000
1200000000 8.00
1000000000 8000000000
800000000 6000000000
7.00
600000000 6.00
4000000000
400000000
200000000 2000000000 5.00
0 0
4.00
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
3.00
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
Tickets Sold Total Box Office
Price vs Admission Ticket Sales

10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
1100000000 1200000000 1300000000 1400000000 1500000000 1600000000
64
The Motion Picture Industry 1995-2019
Price vs Admission Ticket Sales
10.00
9.00
8.00
7.00
6.00
Average Ticket Price
5.00
10.00
4.00 9.00
3.00 8.00
1100000000 1200000000 1300000000 1400000000 1500000000 1600000000
7.00
6.00
Price vs Admission Ticket Sales 5.00
10.00 4.00
3.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
1100000000 1200000000 1300000000 1400000000 1500000000 1600000000
65
Can we learn anything about elasticities?
Tickets Sold vs. Box Office Revenues in

NA Movie Market Average Ticket Price
1800000000 14000000000 10.00
1600000000
1400000000
12000000000 9.00
10000000000
1200000000 8.00
1000000000 8000000000
800000000 6000000000
7.00
600000000
4000000000 6.00
400000000
200000000 2000000000 5.00
0 0
4.00
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
3.00
Tickets Sold Total Box Office
66
Topic 1 Wrap-Up: Key Points
1. Demand curve tells us:
– What quantity consumers are willing to buy at a given price
– What price consumers are willing to pay for an additional
unit of the product
2. Supply curve tells us:
– What quantity producers are willing to sell at a given price
– What price producers must receive to supply an additional
unit of the product
3. Slides vs shifts:
– When you change the price of the product you “slide” up or
down its demand or supply curve
– When you change things other than the price of the
product you shift its demand or supply curve

Topic 1 Wrap-Up: Key Points (2)
4. Market mechanism:
– Tendency for price to move to the market clearing level
5. Market clearing price:

– Can be obtained by setting Qs = Qd
6. ANY economic variable that affects supply or demand

will have an impact on the market price and quantity.
These effects are explained and predicted using
supply-demand analysis
– “One more wafer-thin mint” example?

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MFIN 827

Quantitative Methods and Economics

PART I: UNDERSTANDING MARKETS

TOPIC 1: Demand, Supply and Markets

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 3

• Important note: (from 1. and 2.)

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Food Market, Streets of Hong Kong

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Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 6

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P ($) Your Demand Classmates’ Demand Others’ Demand Total Demand

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When you change the

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION

P0 Here: At any given

• Prices of Related Goods (Py)

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• Advertising and Consumer Tastes (A)

• The price of the good is NOT a demand shifter

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 15

• A seafood restaurant charges $12/bottle for mineral

• Question: Why do you think that is?

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 16

• Question: If demand is Qdx = 36 - 4Px, what is the

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 17

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Qdx /4= 36/4 - 4Px/4

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Inelastic Perfectly Elastic Perfectly

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Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 21

Elasticity (EQ,P) changes across the

P is high and Q is low, EQ,P tends to $4 Absolute

• EQ,P is always a negative number

Suppose the firm's demand curve is Q = 30 – P

1. Plot the curve

Suppose marketing boards were eliminated:

1. When you have information on percentage changes:

– Use the Arc Elasticity Formula [EQ,P ∆ ]

3. When you have an estimate of demand function

"Arc" elasticity is sometimes referred to

P = P2 - P1 = 36 – 38 = - 2. Note: arc elasticity calculation is

Sometimes the demand equation is available (marketing research or regression analysis)

If the demand equation is Q = 60 – 2 P, and you currently charge $23

• Calculate number of units being produced, Q = 60- 2*23 = 14

How would you assess the elasticity of:

1. The price elasticity of demand for cigarettes has been

3. Economic studies have shown that teenagers have a

• Recall: elasticity of a linear downward-sloping D curve varies from point to

• If objective is to increase sales revenue:

The formulas are the same:

Different values of ηI imply good classification:

What business would benefit from a recession?

• Answers the question how closely two products compete

• Antitrust (competition) authorities use EX to define

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 37

Ricard Gil - DO NOT SHARE OR DISTRIBUTE WITHOUT PERMISSION 38

$25 First hundred bottles 6.00

Question: You are Jane Mavety (Owner, Blue Mountain). How

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