By Laura Lamb & material from McConnell, Brue, Flynn & Barbiero 1.
Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.
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Transcript of Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.
![Page 1: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/1.jpg)
Demand and Supply Chapter 6 (McConnell and Brue)
Chapter 2 (Pindyck)
Lecture 4
![Page 2: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/2.jpg)
The Supply and Demand Functions
The supply curve is the relationship between the quantity supplied and the price
Qs = Qs (P) This implies that supply is a function of price The demand curve shows how much of a
good consumers are willing to buy as the price per unit changes
Qd = Qd (P)
![Page 3: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/3.jpg)
Revisiting Substitute and Complementary goods
Goods are substitutes when an increase in the price of one leads to an increase in the quantity demanded of the other. E.g. Coke and Pepsi, Copper and Aluminium etc
Goods are complements when an increase in the price of one leads to a decrease in the qty. demanded of the other. E.g. automobiles and gas!
![Page 4: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/4.jpg)
Price Elasticity of Demand Law of Demand The responsiveness of consumers to a price
change is measured by a product’s price elasticity of demand
If consumers are very sensitive to a price change (e.g. luxury goods) then we say that consumers have an elastic demand for that particular good
Inelastic demand
![Page 5: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/5.jpg)
Price Elasticity Coefficient & Formula
εd = % ∆ in qty. dmd of X
% ∆ in price of X % change in X = change in qty dmd of X * 100 original qty. dmd of X % change in price = change in price of X *100 original price of X Get rid of *100 as they cancel out
![Page 6: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/6.jpg)
Price Elasticity Coefficient & Formula – alternate formula
εd = ∆ in Q * P
∆ in P Q Point elasticity - when you consider a
particular point on the demand curve or the supply curve.
*But what happens when you calculate εd
over a range of prices?
![Page 7: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/7.jpg)
ARC ELASTICITY- USING AVERAGES
Mid-point formula (Alternate name)εd = ∆ in qty. dmd of X ÷ ∆ in price sum of qtys/2 sum of prices/2 This formula simply averages out the two
prices and two quantities as the reference points for computing the percentages
The solution eliminates up-verses-down problem
![Page 8: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/8.jpg)
Linear Demand Curve (point Elasticity)
εd = ∆ in Q * P
∆ in P Q As we move along the demand curve, (∆Q/∆P)
may change, and the P and Q will always change along the curve.
Therefore the price elasticity of Demand must be measured at a particular point on the demand
curve and εd will generally change along the curve See Graph – 2.11 (Pindyck – pg 33)
![Page 9: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/9.jpg)
Q = a – bP general form Example : Q = 8 - 2P Here ∆Q/∆P = -2 (it is constant) for a linear
demand curve Slope = ∆ in y-axis ∆ in x-axis Hence slope = ∆P/∆Q But since for elasticity we use ∆Q/∆P hence
∆Q/∆P= 1/slope But ratio : P/Q falls along the curve,
therefore εd is falling!
![Page 10: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/10.jpg)
Price Elasticity of Demand Using percentages :
if absolute changes were used, then the choice of units would affect results (using dollars Vs pennies).
Percentages make it easier to compare consumer responsiveness across goods
Ignore minus sign of elasticity, as its always –ve for demand. Absolute values are used (Eg. -4 Vs -2: which is bigger ? )
![Page 11: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/11.jpg)
Interpreting εd
Elastic demand: when the % change in quantity demanded is greater than the % change in price.
εd > 1
Inelastic demand: when the % change in qty. demanded is less than the % change in price
εd < 1
![Page 12: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/12.jpg)
Unit Elasticity : when the % change in qty. demanded is the same as the % change in price εd = 1
Perfectly Inelastic: A price change results in NO change in the qty. demanded. It’s a horizontal line
εd = 0 Perfectly Elastic : where a small reduction in
price causes demand to change from 0 to all they can obtain
εd = infinity
![Page 13: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/13.jpg)
Special Cases
D
D
Q0 0 Q
Perfectly elastic demand Perfectly inelastic demand
![Page 14: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/14.jpg)
Income Elasticity of Demand
Demand for most goods usually rises when aggregate income rises.
The income elasticity of demand is the % change in the qty demanded Q, resulting for a 1% increase in income I
εi = ∆ in Q * i
∆ in i Q
![Page 15: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/15.jpg)
Income Elasticity Normal Goods: income elasticity is positive,
meaning that more of them are demanded as income rises. Such goods are called normal or superior goods
Inferior Goods: Negative income elasticity coefficient, implies that consumers decrease their purchases of inferior goods as income rises
![Page 16: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/16.jpg)
Cross-price Elasticity of Demand The demand for some goods is also
affected by the prices of other goods. A cross-price elasticity of demand refers to
the % change in the qty. demanded for a good that results from a 1% increase in the price of another good
εi = ∆ in Qb * Pm
∆ in Pm Qb
![Page 17: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/17.jpg)
Cross-price Elasticity Cross-price elasticity of substitutes is
Positive : a rise in price of margarine makes butter cheaper relative to margarine, leading to an increase in qty. dmd. of butter
C-P elasticity of complements is Negative: they are used together, an increase in price of one tends to push down the consumption of the other!
![Page 18: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/18.jpg)
Independent Goods A zero or near zero cross-elasticity
suggests that the two products being considered are unrelated or independent goods
Eg. Books and grapes !
![Page 19: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/19.jpg)
Supply Elasticity
εs = % ∆ in qty. supplied of X
% ∆ in price of X The price elasticity of supply is the
percentage change in the qty. supplied resulting from a 1% increase in price.
εs is usually positive because a higher price gives producers an incentive to increase output
![Page 20: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/20.jpg)
Supply Elasticity The degree of price elasticity of supply
depends on how easily producers can shift resources between alternate uses. The easier it is to shift resources towards the production of the good, the more elastic it’s supply
![Page 21: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/21.jpg)
Elasticity of Demand & Supply
Chap 2-The Basics of Demand & Supply - Pindyck
Lecture 5
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Total Revenue Elasticity of Demand is important for firms
with regards to changes in total revenue and thus profits (TR – TC)
TR is the total amount the seller receives from the sale of a product in a particular time period TR = P * Q
TOTAL REVENUE TEST
![Page 23: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/23.jpg)
TR and Price change in opposite direction when Demand is Elastic If demand is elastic, a decrease in price
will increase total revenue The decrease in revenue from decline in
price received per unit is more than compensated by the increase in additional units at lower price. GRAPH- pg 343 (Ch.18)
An increase in price causes TR to decline
![Page 24: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/24.jpg)
TR and Price change in same direction when Demand is Inelastic
If demand is inelastic, a decrease in price will reduce total revenue
The increase in sales from a price decline will not fully offset the decline in revenue per unit, and TR will decline.
GRAPH- pg 343 (Ch.18) An increase in price causes TR to increase
![Page 25: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/25.jpg)
TR stays constant with Price changes when Demand is Unit elastic
If demand is unit elastic, a decrease/increase in price leaves total revenue constant
The loss in revenue from a lower price is exactly offset by the gain in revenue from the accompanying increase in sales
GRAPH- pg 343 (Ch.18)
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Price Elasticity and the Total Revenue Curve
Figure 18.3 , pg 345 Chap 18
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Determinants of PED Substitutability – the more the substitutes
available, the more elastic the demand. The elasticity of demand depends on how narrowly the product is defined – (Reebok Vs Shoes)
Proportion of Income – the higher the price of a good relative to consumers’ incomes, the greater the PED (low priced items such as pencils Vs cars or houses)
![Page 28: Demand and Supply Chapter 6 (McConnell and Brue) Chapter 2 (Pindyck) Lecture 4.](https://reader031.fdocuments.in/reader031/viewer/2022013112/56649dab5503460f94a99ae5/html5/thumbnails/28.jpg)
Luxury Vs Necessities – luxury goods have more elastic demands compared to necessity goods (electricity vs jewellery)
Time – product demand is more elastic the longer the time period under consideration (SR demand for petrol is more inelastic than it’s LR demand)
Salt ? GO OVER “APPLICATIONS OF PRICE
ELASTICITY OF DEMAND” in chapter 18