04. Economics (II)

8/13/2019 04. Economics (II)

1/72

CHAPTER 5

DEMAND

5.1. DEMAND AND THE LAW OF DEMAND

Demandis a schedule which summarizes the willingness of buyers topurchase a given product during a specific time period at each of the variousprices at which it might be sold. Demand does not reflect what buyers wantor need, but only what they are willing and able to pay for.

5.1.1. Expressing Demand

Information concerning the demand can be expressed in threedifferent, but dependent, ways: demand tables (schedules, demand cur!es,and"or demand functions.

(1 Demand schedulesuppose data are shown in tables(#ab.5.1. $sa tabular statement of a buyer%s plans or intentions, with respect to thepurchase of a product demand for construction surface, for instance, is

represented in table 5.1. It is !ery important to obser!e, the &uantitydemanded at each price le!el must relate to some specific time period (anhour, a day, a wee', a month, a year, etc..

8/13/2019 04. Economics (II)

2/72

Economics

Tab.5.!. An "ndividual #uyer$s %emand for Construction &urface'hypothetical data(

)rice of the construction surface(monetary unit"s&uare metre

*uantity demanded(s&uare metre"year

+

- 1

1

/-0

(+ Demand curve is the line showing the relationship between priceper unit and the ma)imum *uantity buyers would be willing to buy. Ineconomics texts, demand cur!e could be usually a straight line which isassumed to ha!e a negative slope (ig.5.1.

2ther things being e&ual, as price falls the corresponding *uantitydemanded rises and conversely as price increases the corresponding*uantity demanded falls. 3enerally, if the price of a good rises, then othergoods might loo' a little more attracti!e, and buyers would demand less ofthis good. 4ut that assume that consumersincomes, tastes etc. stay

constant. If they change, then we would ha!e an entirely new demand cur!e.#his is the law of demand.

8/13/2019 04. Economics (II)

3/72

8/13/2019 04. Economics (II)

4/72

Economics

#he effects of changes in price of the &uantities demanded aredifferent. 9uppose that price starts out at ), with associated &uantitydemanded of *(ig.5.1:

7 if price risesfrom )to )+, &uantity demanded will fall from *to *+8 athigher prices, a lower &uantity will be demanded8

7 if price fallsfrom )to ), &uantity demanded will rise from *to *8 at

lower prices, &uantity demanded will be higher.

5.1.6.Market Demand Curve

4ecause consumers are willing to buy different amounts at differentprices, market demand curve is found by ta'ing the hori-ontal summationof all the individual demand curves for a good. #his way, the demand cur!eD shows how much of the good * buyers will purchase in the mar'et at eachpossible price ) (ig.5.+.

E)emple

9uppose that there were ust two consumers in the mar'et for thegood 3: consumer $ and consumer 4. #heir indi!idual demand cur!es will bedifferent, according to their different preferences for the good 3. igure 5.6represents the two indi!idual demand cur!es along with the mar'et demandcur!e for good 3, obtained by a horizontal summation of the two indi!idualcur!es.

8/13/2019 04. Economics (II)

5/72

%emand 0

+ig.5.. /ar,et %emand Curve '%( as the &um of the "ndividual %emandCurves '%!0%0...0%n(

8/13/2019 04. Economics (II)

6/72

- Economics

+ig.5.1. /ar,et %emand Curve 'An E)emple(

8/13/2019 04. Economics (II)

7/72

%emand /

#he mar'et demand cur!e for good 3 is found by summing togetherthe *uantities that both consumers demand at each price . or exemple, at aprice of one monetary unit, consumer $ demands two units, while consumer4 demands ust one unit, and the mar'et demand will be:

+ units ; 1 unit < 6 units of good 3.

5.2. CHANGES IN DEMAND

5.2.1. Shifts in Demand

Demand on the mar'et does not alway stay the same. )rices changeand, conse&uently, &uantities demanded change.

$ change in demand refers to a shift in the entire demand curveeither (ig.5..:

7 outward, to the right (an increase in demand, or7 inward, to the left (a decrease in demand.

8/13/2019 04. Economics (II)

8/72

5 Economics

+ig.5.2. A Change in 3ne or /ore of the %eterminants of %emand

#he demand cur!e will shift:

7 outward, if the mar'et demand increases from, say, the originalcur!e Dto cur!e D1, so that &uantity demanded at the price le!el ) will begreater (*+8

4 inward,if mar'et demand decreases from, say, the original cur!e Dto cur!e D1, so that the &uantity demanded at the price le!el ) is now less(*+.

5.2.2. Demand Shifters

In the simple demand model we are discused up to now, =other thingsbeing e&ual= (or ceteris paribus assumption ignores exogenous !ariables

(things that happen outside the model. 4ut there are some commonexemples of exogenous, real>world causes of shifts in demand.

$n increase or decrease in the demand for a specific product can becaused by some nonprice determinants (demand shifters: changes inconsumer tastes, number of buyers, changes in money income, price ofrelated goods, and consumer expectations.

8/13/2019 04. Economics (II)

9/72

%emand 51

(1 $ change in the number of buyers in a mar'et, in terms of theincreasing or decreasing of consumers will constitute an increase ordecrease of their demand.

(+A change in consumer tastes, prompted by ad!ertising, fashion ortechnological changes can increase or decrease the demand for this product.

(6 Consumer e)pectations about different aspects of the future, such

as changes in the product le!el, can determine a shift in demand in terms ofits increase or decrease.

( The change in income has an impact more complex upon thedemand. It depends on the type of the specific product: normal inferior orlu)ury goods.

! "ormal goods are those for which demand varies directlywith the money income: a rise in income cause an increase indemand and, alternati!ely, a fall in income cause an decline indemand. ?ost products are commodities, normal goods and theirdemand cur!es slope downward from left to right (negati!ely.

! #nferior goods are those for which demand variesinversely with a change in money income: a rise in income causea decline in demand and a fall in income cause an increase indemand.

! $uxury goods do not obey the law of demand. #heirdemand cur!es go an un>typical way: *uantity demanded ishigher at high prices than at low prices . amous brands of someproduct (fashion brands, for instance are desirable especiallybecause they are expensi!e8 their main destination is to expressthe owner%s weath, but they aren%t much use for anything else. Ifthey were cheap, they wouldn%t ser!e this purpose, and the&uantity demanded of them would be less.

(5 The price of related goods has, once again, a complex impact on thedemand for a specific product depending on the type of relationship. @edistinguish here three types of relationship between two different goods:substitute goods, complementary 'associated( goods and independentgoods.

! %u&stitutes are two or more products for which the price

of one good and the demand for the other are directly related.A Complements (associatedare two or more products forwhich the price of one good and the demand for the other areinverselyrelated.

A #ndependents are two or more products for which achange in the price of one would ha!e little or no impactupon thedemand of the other.

8/13/2019 04. Economics (II)

10/72

5+ Economics

5.. DEMAND ELASTICIT!

5..1. E"asti#it$ %f Demand

#he most basic thing about elasticitiesis that they are measures of howsensiti!e, how responsi!e, one !ariable is to change in another !ariable. #he

specific measure of sensiti!ity we choose is the ratio of percentage change,for exemple, the percentage change in the dependent !ariable per unitpercentage change in the independent !ariable.

or any relationship between a dependent !ariable and one or moreindependent !ariables, an elasticity can be calculated between thedependent !ariable and each of the independent !ariable.

3enerally, elasticity is a measure of the percentage change in onevariable 'say ( compared to the percentage change in another 'say 6(7

Y

XExy

=%

%

$ccording to the laws of algebra, elasticity is:

7positiveif the slope of the function it describes is a positi!e one87 negative if the slope of the function it describes is a negati!e one.In our case, a demand cur!e, for which &uantity demanded changes in

the opposite direction from a change in price (as price rises, &uantitydemanded falls and !ice !ersa, except luxury goods, has a negativeelasticity. $lthough elasticity usually is mathematically negati!e, economistsgenerally show it as positi!e.

$s we already saw, demand changes o!er time as response to changesin prices and income. #he point is how much could be these changes8

#here are two main factors which determine changes in demand: thelevel of price in the mar,etand consumers$income.

7 'rice elasticity of demand describes the relationship betweenchanges in price 'P( and changes in *uantity demanded (*D, whether&uantity demanded changes more or less rapidly than does price. )riceelasticity of demand shows:

A how *uantity demanded reacts to changes in price8A what happens to total revenue, the total sum of money spent

in the mar'et on the good in &uestion, when price changesand the demand cur!e does not shift.

8/13/2019 04. Economics (II)

11/72

%emand 56

7 #ncome elasticity of demand measures the response of the*uantity demanded of a good when consumers$income change .

5.6.+. Meas&rin' (ri#e E"asti#it$ %f Demand

)rice elasticity of demand is measured as the percentage change in&uantity demanded di!ided by the percentage change in price:

priceinchangepercentage

demandedquantityinchangepercentage=

DE , or

priceoriginal

priceinchange:

demandedquantityoriginal

demandedquantityinchange=

DE

#he &uantity demanded leads us to a specific le!el of the totalrevenue (spending the total sum spent on the good in the mar,et for a

specific price.

Total revenue = Price Quantity demanded

2n the mar'et, can be identified three generic situations (ig.5.6:elastic demand, inelastic demand, and unit elastic demand.

(1 Demand is elastic if a gi!en percentage change in price isaccompanied by a relati!ely larger percentage change in the &uantitydemanded.

)rice and total re!enue change in oppositedirection:

A when price rises, total re!enue falls8A when price falls, total re!enue rises.

% QD> % P, soEp > 1,

where:

8/13/2019 04. Economics (II)

12/72

5 Economics

% QD is the percentage change in the quantity demanded;

% Pis the percentage change in the level of price;

Epis the price elasticity of demand.

8/13/2019 04. Economics (II)

13/72

%emand 55

+ig.5.5. Price Elasticity of %emand

8/13/2019 04. Economics (II)

14/72

5 Economics

E)emple

B ) < (1 > - " - < +5B

B *D< (1 > " < 0B

Cp < B *D " B ) < 0B " +5B < 2)*+

(+ Demand is inelastic if a gi!en percentage change in price isaccompanied by a relati!ely smaller percentage change in the &uantitydemanded.

)rice and total re!enue change in the same direction. @hen:

A price rises, total re!enue rises8A price falls, total re!enue falls, too.

% QD< % P, soEp < 1,

where:



Cpis the price elasticity of demand.

E)emple

B ) < (1 > - " - < +5B

B *D< (1 > / " / < 11BCp < B *D " B ) < 11B " +5B < ,)--

(6 Demand has a unit elasticity if a gi!en percentage change inprice is accompanied by a e&ually percentage change in the &uantitydemanded.

8/13/2019 04. Economics (II)

15/72

%emand 50

% QD= % P, soEp = 1,

where:



Ep is the price elasticity of demand.

E)emple

B ) < (1 > - " - < +5B

B *D< (1 > - " - < +5B

Cp < B *D " B ) < +5B " +5B < 1),,

#hese different cases of the price elasticity of demand array betweentwo extreme situations (ig.5.: perfectly elastic demand and perfectlyinelastic demand.

(1 Demand is erfe#t"$ e"asti#when there is a small price reductionwhich would cause buyers to increase their purchases from -ero to all theycould obtain8 a perfectly elastic demand cur!e is a line parallel to thehori-ontal a)is.

8/13/2019 04. Economics (II)

16/72

5- Economics

+ig.5.9. Perfectly Elastic '%!( and "nelastic '%( %emand

(+ Demand isperfectly inelastic when a change in price results in no

change whatever in the *uantity demanded8 a perfectly inelastic demandcur!e is a line parallel to the !ertical axis (D+.

$ particular case of the demand elasticity concerne the relationshipbetween the product demand and resource demand. 3enerally, the elasticityof demand for any resource will depend upon the elasticity of demand forthe product which it helps produce. The greater the elasticity of productdemand the greater the elasticity of resources demand.

#he explanation consists in the deri!ed nature of resources demand. $small rise in the price of a product with great elasticity of demand will gi!erise to a sharp drop in output and, therefore, a relati!ely large decline in theamounts of the !arious resources demanded. #his correctly implies that thedemand for the resource is elastic.

5.6.6. Determinants %f (ri#e E"asti#it$ %f Demand

#here are se!eral factors which can affect the direction and themagnitude of consumers%adustments to price changes, depending on theirsensibility. #he main of these factors are: importance of the good in theconsumer%s budget, substituibility of the product, type of goods, and theadustment time a!ailable.

8/13/2019 04. Economics (II)

17/72

%emand 5/

(1 #mportance of the good in the consumer)s &udget. 2therthings being e&ual,the larger a good portion in one$s budget the greatertend to be the elasticity of demand for this product.

onsumers are not !ery concerned about prices of goods upon whichthey spend a small percent of their income. #heir demand for them tends tobe inelastic. 4ut price changes of goods that they spend a large percent oftheir budget on ha!e much more significant impacts8 demand for such goods

tends to be more elastic.(+ %u&stitui&ility of the productmeans thedegree to which a good

could be replaced in consumption by another good . #he larger the number ofsubstitute products a!ailable, the greater the elasticity of demand.

(6 Type of goods* necessities or luxuries. #he demand for goodsthat consumers consider to be necessities is li'ely to be more inelastic!ersus the demand for luxuries and frills, which tends to be elastic.

( +d,ustment time. Demand changes pertain to a time frame,therefore, for most goods it is important to distinguish between short:runand long:run elasticities.

Demand tends to be more elastic the longer the time a!ailable to adustto changes in the price le!el. #he explanation of this phenomenon consist in

the fact that many consumers, e!en organizations, are creatures of habits.@hen the price of a product rises, it is necessary a specific time period tosee' out and experiment with other products to !erify if they are acceptable.

5..-. Cr%ss E"asti#it$ %f Demand

If price elasticity of demand expresses the effect of a change in aproduct%s price upon the &uantity of that product, another !irtual influence

ha!e to be measured: the price of a different product.

Cross elasticity of demand shows how sensitive consumerpurchases of one product 'say/( are to change in the price of some otherproduct 'say;(.#he formula for the coefficient of cross elasticity of demandis similar to simple price elasticity ,except that we are relating thepercentage change in the consumption of E to a percentage change in theprice of F:

8/13/2019 04. Economics (II)

18/72

Economics

Nofpriceinchangepercentage

Mofdemandedquantityinchangepercentage=

MNE

ross elasticity concept allow us to more deeply understand substituteand complementary goods. If cross elasticity of demand is:

7positive &uantity demanded of good ? !aries directly with a changein the price of good G, then ? and G are substitutegoods (for instance:coffee and tea8

7 negative &uantity demanded of good ? !aries indirectly with achange in the price of good G, then ? and G are complementary goods thatmeans they =go together= in consumption (for exemple: gaz and cars.

5..5. In#%me E"asti#it$ %f Demand

)rice is not the only factor which influences the &uantity demanded.#here are many other economic influence and a !ery important one isconsumers%income. #he core logic of elasticity also apply in this particularcase.

#ncome elasticity of demand measures the sensibility of *uantitydemanded of a good in response to changes in the incomes of consumerswho buy it.

I

QE DI

=%

%

or normal goods, income elasticity of demand is positive: &uantitydemanded rises or falls as income does.

#here are two generic situation: income elasticity above1, and incomeelasticity below1.

(1 'ositive income elasticity- Income elasticity is above1 whenthepercentage change in *uantity demanded e)ceeds the percentage change inincome. #hat means &uantity demanded rises or falls faster than incomedoes.

% QD > % I,

8/13/2019 04. Economics (II)

19/72

%emand 1

where:

% QD is the percentage change in quantity demanded.

% Iis the percentage change in income.

onsumers will spend a larger fraction of their incomes on the good astheir incomes rise, and a smaller fraction of their incomes on it when theirincomes fall. or most goods the income elasticity coefficient will be positi!e,but it still !aries greatly among products.

(+ "egative income elasticity- Income elasticity of demand is below1 when the percentage change in *uantity demanded is less than it is forincome.

% QD< % I,

where:

% QD is the percentage change in quantity demanded.

% Iis the percentage change in income.

#hat means consumers will spend a smaller fraction of their incomes onthe good as their incomes rise, and a larger fraction of their incomes on itwhen their incomes fall.

5.. NECESSITIES AND L/0/IESNOMAL AND INFEIO GOODS

Depending on their income elasticity of demand, goods are classified inlu)uriesand necessities.

8/13/2019 04. Economics (II)

20/72

+ Economics

. $uxuriesare those goods with income elasticity of demand above !.

. "ecessitiesare and those with income elasticity of demand below!.

@hen income falls, consumers cut bac' more on goods they can dowithout. on!ersely, when income rises, they feel they can better affordthese luxuries, for which income elasticity of demand, then, exceeds 1.

$nother classification of goods regards their income elasticity ofdemand. #hey are normal 'superior(and inferior goods.

. "ormal (superior goods are those for which the income elasticityof demand is positive.#hat is, as consumer income increases or falls, the&uantity demanded of normal goods rises and falls with income. ?ost goodsare normal goods.

$ll inferior goods are necessities, but normal good are necessities onlyif they are not luxuries (ig.5.0.

+ig.5.

8/13/2019 04. Economics (II)

21/72

%emand 6

7 when their incomes fall, consumers can adust by substituting theother way8 they buy more of the inferior good, substituting it for the moreexpensi!e normal good8

7 when their incomes increase, consumers are more easily able to buythe preffered, but more expensi!e substitute, close substitutes for them.

#he practical significance of income elasticity coefficients is that they

help uspredictwhich industries are li'ely to expand in the future and whichto decline. 2ther things being e&ual:

7 a high positive income elasticity implies that industry will share morethan proportionately in the o!erall income growth of the economy8

7 a small positive or, worse yet, a negati!e coefficient implies adeclining industry.

3E! CONCE(TS

%emand

%emand schedule 'table(%emand curve%emand function 'e*uation(?uantity demanded/ar,et demand curve>aw of demandElasticityElasticity of demandPrice elasticity of demandTotal revenue 'spending("nelastic demandElastic demand@nit elastic demandPerfectly elastic demandPerfectly inelastic demand

Elasticity of product demand Elasticity

of resource demand %eterminants ofdemandChange in demand&hift in demand%emand shiftersCross elasticity of demand&ubstitute goodsComplementary goods"ncome elasticity of demandPositive income elasticity;egative income elasticity;ecessities>u)uriy goods;ormal 'superior( goods"nferior goods

8/13/2019 04. Economics (II)

22/72

CHAPTER 9

S/((L!

*.1. S/((L! AND LAW OF S/((L!

%upply is a schedule which summari-es the willingness of firm assellers to produce a given product during a specific time period at each ofthe various price at which it might be sold.

.1.1. E4ressin' S&"$

Hust as with demand, the information concerning supply can beexpressed in three different, but related ways: supply schedules (tables,supply cur!es, and"or supply functions.

(1 $ supply schedules suppose data are shown in tables.

$s a tabular statement of a producer%s plans or intentions with respectto the production of a specific good, supply for construction surface, forinstance, is represented in table .1. It is !ery important to obser!e, the&uantity supplied at each price le!el must relate to some specific time period(an hour, a day, a wee', a month, a year etc..

8/13/2019 04. Economics (II)

23/72

&upply 5

Tab.9.!. An "ndividual Producer$s 3ffer for Construction &urface'hypothetical data(

)rice of the construction surface(monetary unit"s&uare metre

*uantity supplied(s&uare metre"year

+-

1

0-/

1.

(+ $ supply curve showsthe ma)imum *uantity sellers would bewilling to offer at each possible price and at any given level of othervariables that might affect supply. In economics texts supply cur!e usuallycould be a straight line which is assumed to be positi!ely sloped (ig..1.

2ther things being e&ual:

7 as price increases, the corresponding &uantity supplied rises8

7 as price falls, the corresponding &uantity supplied falls.

It is the law of supply. It states the producers are stimulated ordissapointed according to the mo!ement of price: an increase or a decrease.

7 $ higher pricewould encourage sellers to offer more, partly becauseit would help co!er the costs of expansion. If any of the !ariables that affectproduction costs change, then the whole supply cur!e would shift.

7 $ lower pricewould discourage sellers to continue offering on themar'et and, conse&uently, it is most li'ely, they will restrain their productioncapacities.

#he supply cur!e in a graph usually slopes upward from left to right'positively( reflecting the law of supply.

8/13/2019 04. Economics (II)

24/72

Economics

+ig.9.!. An "ndividual Producer$s &upply Curve

(6 $ supply function is a mathematical relationship between priceand *uantity supplied. In the graph (ig..1 we obser!e as price increasesby + monetary units, &uantity supplied rises by 1 units (&uadrat metres inour case. #his suggest a supply function.

.1.+. The &antit$ S&"ied

Quantity supplied is the amount of a good that will be produced forthe mar,et at a given price. #he graph from figure .1. shows different priceand &uantity supplied combinations:

7 at mar'et price )( m.u., &uantity supplied will be *(- s&uaremetres8

7 at mar'et price )+(1 m.u., &uantity supplied will be *+(1. s.m.87 at mar'et price )(+m.u., &uantity supplied will be *( s.m..

#he effects of changes in price on the &uantity supplied are different.9uppose that price starts out at ), with associated &uantity demanded of *(ig..1:

8/13/2019 04. Economics (II)

25/72

&upply 0

7 if price rises from )to )+, &uantity supplied will rise from *to *+8 athigher prices, &uantity supplied will be higher8

7 if prices falls from )to ), &uantity supplied will fall from *1to *+8 atlower prices, a lower &uantity will be supplied.

.1.6. Mar6et S&"$ C&r7e

4ecause producers are willing and able to offer different amounts atdifferent price le!els for a specific good, market supplycurve is the cumulati!e indi!idual supplies for that good. It is found byta'ing the hori-ontal summation of all the individual supply curves for agood. #his way, the supply cur!e 9 shows how much of the good *producers will offer in the mar'et at each possible price ) (ig..+.

E)emple

9uppose that there were ust two suppliers in the mar'et for the good 3:supplier $ and supplier 4. #heir indi!idual supply cur!es will be different,according to their different productions for the good 3. igure .+ represents

the two indi!idual supply cur!es along with the mar'et supply cur!e forgood 3, obtained by a horizontal summation of the two indi!idual cur!es.#he mar'et supply cur!e for good 3 is found by summing together the

*uantities that both producers offer at each price. or exemple, at a price ofone monetary unit, supplier $ offers two units, while supplier 4 offers ustone unit, and the mar'et supply will be +;1

8/13/2019 04. Economics (II)

26/72

- Economics

+ig.9.. /ar,et &upply Curve '&( as a &um of "ndividual &upply Curves'&! 0 & 0......0&n(

8/13/2019 04. Economics (II)

27/72

&upply /

*.2. CHANGES IN S/((L!

*.2.1. Shifts in S&"$

9upply on the mar'et does not always stay the same. )rices changeand, conse&uently, &uantities supplied change.

$ change in supply refers to a shift in the entire supply cur!e thatmo!es either (ig..6:

7 outward, to the right (an increase in supply87 inward, to the left (a decrease in supply.

8/13/2019 04. Economics (II)

28/72

0 Economics

+ig.9.1. A Change in 3ne or /ore of the %eterminants of &upply

#he supply cur!e will shift:

7 outward if mar'et supply increases from, say, the original position 9to cur!e 91, so that &uantity supplied at the price le!el ) will be greater (*18

4 inward if mar'et supply decreses from the original position 9 tocur!e 9+, so that &uantity supplied at the price le!el ) will be now less (*+.

*.2.2. S&"$ Shifters

8/13/2019 04. Economics (II)

29/72

8/13/2019 04. Economics (II)

30/72

0+ Economics

'rice elasticity of supply describes the relationship betweenchanges in price 'P( and changes in *uantity supplied '? s(7 whether &uantitysupplied changes more or less rapidly than does price.

)rice elasticity of supply is measured as the percentage change in&uantity supplied di!ided by the percentage change in price. @hencalculated, price elasticity of supply should be positi!e. #herefore, whenmar'et price changes, total re!enue will change in the same direction asprice:

7increases in price lead to increases in total re!enue87decreases in price lead to decreses in total re!enue.

P

QE S

S

=%

%

9upply elasticity is calculated in the same fashion as demand elasticity.In the mar'et, can be identified three generic situations (ig..: elasticsupply, inelastic supply, and unit elastic supply.

8/13/2019 04. Economics (II)

31/72

&upply 06

+ig.9.2. Price Elasticity of &upply

8/13/2019 04. Economics (II)

32/72

0 Economics

(1 %upply is elastic if a gi!en percentage change in price isaccompanied by a relati!ely larger percentage change in the &uantitysupplied. )rice and supply change in the same direction:

7 when price rises, supply rises87 when price falls, supply falls, too.

% Qs> % P, soEs> 1,

where:

% Qsis thepercentage change in the quantity supplied;

% Pis thepercentage change in the level of price.

Esis the price elasticity of supply.

E)emple:

B ) < (1 > - " - < +5B

B *s< (1 > " < 0B

Cp < B *s " B ) < 0B " +5B < 2)*+

(+ %upply is inelastic if a gi!en percentage change in price isaccompanied by a relati!ely smaller percentage change in the &uantity

supplied.

% Qs< % P, soEp< 1,

where:

8/13/2019 04. Economics (II)

33/72

&upply 05



Csis the price elasticity of supply.

E)emple:

B ) < (1 > - " - < +5B

B *s< (1 > / " / < 11B

Cp < B *s " B ) < 11B " +5B < ,)--

(6 %upply has a unit elasticity if a gi!en percentage change inprice is accompanied by a e*ually percentage change in the &uantitysupplied.

% Qs= % P, soEp= 1,

where:



Csis the price elasticity of supply.

E)emple:

B ) < (1 > - " - < +5B

B *s< (1 > - " - < +5B

Cp< B *s " B ) < +5B " +5B < 1),,

8/13/2019 04. Economics (II)

34/72

0 Economics

*..2. Ima#t %f Time

Clasticity of supply depends partly on the time a!ailable for firms toadust to mar'et price changes. #he amount of time which a producer has torespond to a gi!en change in product price is the main determinant of theelasticity of supply.

3enerally spea'ing, a greater output response is expected the longerthe amount of time a producer has to adust to a gi!en price change. #his isbecause a producer%s response to an increase in the price of product Edepends upon its ability to shift resources (factor of production from theproduction of other goods to the production of E. #his resources shiftingta'es time.

@e distinguishes between immediate mar'et period, short>run, andlong> run (ig..5.

(1 In the immediate market period, there is insufficient time tochange output, so supply will be perfectly inelastic.

(+ In the short/run firms are restricted by plant capacity, factory,supplies etc., but output can be altered by changing the intensity of its use,so supply will be more elastic.

(6 In the long/run all necessary adustments, including changes inplant capacity, can be made and supply become still more elastic.

*... (erfe#t"$ Ine"asti# S&"$

'erfectly inelastic supplyoccur when supply cur!e is graphed as avertical line. In this situation, supply cannot change at all no matter howhigh or low prices go.

@hen supply is perfectly inelastic, shifts in demand change only priceand total re!enue, since &uantity supplied cannot change.

8/13/2019 04. Economics (II)

35/72

&upply 00

+ig.9.5. Time and Elasticity of &upply

8/13/2019 04. Economics (II)

36/72

8/13/2019 04. Economics (II)

37/72

CHAPTER imited income 'budget(

Cardinal utility

3rdinal utility

/arginal utility

Total utility>aw of diminishing marginal utility

/a)imi-ing total utility 'consumer e*uilibrium(

/arginal utility per monetary unit spent

/arginal rate of substitution

&ubstitution effect of a price change

"ncome effect of a price change

Real purchasing power

Consumer surplus

#udget line 'constraint(

"ndifference curve

"ndifference map

@tility ma)imi-ation

8/13/2019 04. Economics (II)

60/72

CHAPTER F

MA3ET E/ILI9I/M

$ marketisa mechanism which brings together buyers and sellers ofparticular goods and services and operates in order to allocate resources.

?ar'ets exists in a wide and complex !ariety of forms:resources mar'et8 labor mar'et8 capital mar'et8 monetary mar'et.Cach of them has its own subdi!isions.

Megardless the specific type, any mar'et has three crucial elements:

7 &uyers L those who are see'ing to ac&uire the good or ser!ice,forming the demand8

7 sellersL those who are offering the good or ser!ice, forming thesupply87pricesL established so that to satisfy both groups simultaneously.

Cconomic acti!ities that determine society%s allocation of its resourcesdepend upon supply and demand. #hese are the forces that dri!e mar'etsand are the fundamental aspects of microeconomics. In this context, thefirms decide what to produce, how to produce it, and how much to consume.

+.1. DEFINING MA3ET E/ILI9I/M

#he pre!ious two chapters ha!e examined the demand decisions of

buyers and the supply decisions of sellers, separately. owe!er, in themar'et for a particular good E, the decisions of buyers interactsimultaneously with the decisions of sellers.

#he mar'et mechanism is the tendency for supply and demand toe&uilibrate, so that there is neither excess demand nor excess supply. @hen

8/13/2019 04. Economics (II)

61/72

/ar,et E*uilibrium 16

the demand for good E e&uals the supply of good E, the mar'et for good E issaid to be in equili&rium (market clearing.

9upply>demand analysis is one of the basic tools of microeconomics. Incompetiti!e mar'ets, supply and demand cur!es tell us how much will beproduced by firms and how much will be demanded by consumers as afunction of price.

If we could estimate, at least approximati!ely, the supply and demandcur!es for a particular mar'et, we could calculate the mar'et>clearing priceby e&uating supply and demand. $lso, if we 'now how supply and demanddepend on other economic !ariable, such as income or the prices of othergoods, we could calculate how the mar'et>clearing price and &uantity willchange as these other !ariables change. #his is a means of explaining orpredicting mar'et beha!ior.

#he intersection of demand cur!e (D and the supply cur!e (9, point Con the graph (ig.-.1, expresses e*uilibrium between mar'et supply andmar'et demand.

+ig.F.!. /ar,et E*uilibrium

8/13/2019 04. Economics (II)

62/72

8/13/2019 04. Economics (II)

63/72


(+ #he graphical approach to e&uilibrium analysis is illustrated infigure -.+ which combines the demand and supply cur!es into a singlegraph. #he e&uilibrium price and &uantity are determined by the intersectionof the two cur!es.

+ig.F.. /ar,et E*uilibrium for =ood

#he e&uilibrium &uantity is - units for good E, and the e&uilibriumprice is monetary units per unit of good E.

+.2. MA3ET DISE/ILI9I/MAND ESTOING MA3ET E/ILI9I/M

Market disequili&rium (departure from equili&rium occurs whenthe price prevailing in the mar,et is in another point as PE. #hat means,&uantity demanded and &uantity supplied are not the same either.

8/13/2019 04. Economics (II)

64/72

1 Economics

+ig.F.1. /ar,et %ise*uilibriums

#here are two main situations : surplus 'e)cess supply(and shortage'e)cess demand(.

8/13/2019 04. Economics (II)

65/72


+ig.F.2. /ar,et %ise*uilibriums

8/13/2019 04. Economics (II)

66/72

1- Economics

(1 %urplus (excess supply or shortfall in demand which wouldexists at abo!e>e&uilibrium prices, push price downand thereby increasesthe &uantity demanded and reduces the &uantity supplied until e&uilibriumis achie!ed. #his happens because the surplus of good E would promptcompeting sellers to bid down the price to incourage buyers to ta'e thissurplus off their hands.

In figure -.a, at price le!el )?, &uantity demanded is only *+, much less

than *1. $s a result, firms will ha!e to cut bac' their production and reduceprice to sell the surplus.4y the law of demand, the &uantity demanded (* D, will rise as price

falls. 4y the law of supply, the &uantity supplied (*9 will fall as price falls.#his will continue until &uantity supplied (*9 and &uantity demand (*D bothare e&ual (at &uantity *C. #his will be at the e&uilibrium point C, where priceis )C.

(+ %hortage (excess demand or shortfall in supply ,which wouldexists at below>e&uilibrium prices, drives price up, and in doing so, increasesthe &uantity supplied and reduces the &uantity demanded until e&uilibriumis achie!ed. #his happens because many potential consumers, in order toensure that they will not ha!e to do without, will express a willingness to paya price in excess.

In figure -.b, at price le!el )H, &uantity demanded is *6, which is much

more than *. #his situation will encourage firms to increase price andincrease production.

4y the law of demand, the &uantity demanded (* D will fall as pricerises. 4y the law of supply, the &uantity supplied (*9 will rise as price rises.

#his will continue until &uantity supplied (*9 and &uantity demanded (*Dboth are e&ual (at &uantity *C. #his will be at the e&uilibrium point C, whereprice is )C.

+.. SHIFTS IN DEMAND AND S/((L!

+..1. Shifts in Demand

$ shift in demand usually leads to a change in the *uantitydemanded. It designates the mo!ement from one point to another point(from one price>&uantity combination to another on a fixed demand cur!e.

#he only time it won%t is if the supply cur!e happens to shift at thesame time so that, by coincidence, the same price or the same &uantitydemanded"supplied exists at the new e&uilibrium. If only the supply cur!eshifts, then a change in e&uilibrium &uantity demanded also will occur, buton the same demand cur!e as before.

8/13/2019 04. Economics (II)

67/72

/ar,et E*uilibrium 1/

@e ha!e to a!oid the !irtual confusion of a =shift in demand= with a=change in the &uantity demanded=:

7 a shift in demandmeans that the mar'et demand cur!e actually hasmo!ed to a new position8

7 a change in the *uantity demanded means that there is a newe&uilibrium, but not necessarily a new demand cur!e. $ change in &uantity

demanded can occur on the same demand cur!e when only the supply cur!eshifts.

+..2. Shifts in S&"$

$ shift in supplyusually leads to a change in e&uilibrium price, ande&uilibrium &uantity supplied.

#he only time it won%t is if the demand cur!e happens to shift at thesame time in such a way that, by coincidence, the same price or the same&uantity demanded"supplied exists at the new e&uilibrium. If only thedemand cur!e shifts, then a change in &uantity supplied will occur, but onthe same supply cur!e as before.

@e ha!e to a!oid the !irtual confusion of a =shift in supply= with a=change in &uantity supplied=:

7 a shift in supplymeans that the mar'et supply cur!e has actuallymo!ed to a new position:

7 a change in *uantity suppliedmeans that there is a new e&uilibriumbut not necessarily a new supply cur!e. $ change in &uantity supplied canoccur on the same supply cur!e by mo!ing from one point to another if it isthe demand cur!e that shifts.

+... Demand ShiftsB&antit$ S&"ied

9hifts in demand along the same supply cur!e lead to new e&uilibriumpositions, with both price and &uantity demanded and supplied different

from the original e&uilibrium C, where price is ) and &uantitydemanded"supplied is *(ig.-.5a.#here are two possible movesfor the demand cur!e: outward shift and

inward shift.

(1 2utward shift in demand (from D to D1 in the graph. In thissituation, e&uilibrium mo!es along the supply cur!e (9 from C to ?. )ricewill be higher ()1 and &uantity demanded"supplied will be higher (* 1.

8/13/2019 04. Economics (II)

68/72

8/13/2019 04. Economics (II)

69/72


+ig.F.5. &hifts in demand and supply

8/13/2019 04. Economics (II)

70/72

11+ Economics

+..-. S&"$ ShiftsB&antit$ Demanded

%hifts in supplyalong the same supply cur!e lead to new e&uilibriumpositions, with both price and &uantity demanded and supplied differentfrom the original e&uilibrium C, where price is )and &uantity demanded"supplied is *(ig.-.5b.

#here are two possible movesfor the supply cur!e: outward shift and

inward shift.

(1 2utward shift in supply (from 9 to 91 in the graph. In thissituation, e&uilibrium mo!es along the demand cur!e (D from C to ?. )ricewill be lower ()1, and &uantity demanded"supplied will be higher (* 1.

(+ #nward shift in supply (from 9 to 9+ in the graph. In thissituation, e&uilibrium mo!es along the demand cur!e (D from C to G. )ricewill be higher ()+, and &uantity demanded"supplied will be lower (*+.

It is important to understand that, in both cases, since the demandcur!e remains the same, mar'et demand has no changed. 2nly the &uatitydemanded changes. ?ar'et e&uilibrium has changed, but along the samedemand cur!e.

In brief:

7 an increase in supply has a price:decreasing and a *uantity:increasing effectB

4 a decrease in supply has a price:increasing and a *uantity:decreasing effect.

#here is an inverse relationship between a change in supply and theresulting change in e&uilibrium price, but the relationship between a changein supply and the resulting change in e&uilibrium &uantity is direct.

+.-. COM(LE0 CASES INCHANGING DEMAND AND S/((L!

?ore complex cases arise if in the mar'et mo!es in!ol!e changes in

both supply and demand. #here are two possible cases: supply and demandchange in opposite directions8 supply and demand change in the samedirection.

(1 %upply and demand change in opposite direction.urther, wecan find here other two situations: when supply increases and demanddecreases8 when supply decreases and demand increases.

8/13/2019 04. Economics (II)

71/72

8/13/2019 04. Economics (II)

72/72

11 Economics

$nother special case in the analysis of demand and supply modelconcerns the government price controlsfor any gi!en goods or ser!ices.?ar'ets are rarely free of go!ernment inter!ention. 4esides imposing taxesand granting subsidies, go!ernments often regulate mar'ets in a !ariety ofways. #his is a!ailable e!en for competiti!e mar'ets.

#heprice ceilingmeansthe government mandate that the price canbe no higher than a ma)imum allowable level. #he &uantitati!e impact ofeffecti!e price ceilings is an e)cess demandcaused by an increase in the&uantity demanded (consumers will demand more at this low price and adecrease in the &uantity supplied (producers, particularly those with highercosts, will produce less. In this situation, the economic analisys has toestimate how largethat excess demand might ha!e been.

0E1 C2"CE'T%

/ar,et

/ar,et e*uilibrium

E*uilibrium analysis

E*uilibrium price

E*uilibrium *uantity

/ar,et dise*uilibrium

&urplus 'e)cess supply(

&hortage 'e)cess demand(

&hift in demand

&hift in supply

=overnment price control

Price ceiling

04. Economics (II)

Documents

Transcript of 04. Economics (II)