Economics 101: Principles of Economics

1. Queries?

2. Don’t forget to answer the “Links & Smiles” questions in PS #1

3. Read chapters 7 & 19 of Fair Play (electronic reserve)

Determinants of Demand• What causes the demand curve to shift?

– Incomes• Normal good

• Inferior good Examples?

– Tastes

– Prices of Substitutes and Complements

– Expectations

– Population

• Shift in Demand vs. Change in quantity demanded– The effect of Traffic Schools on D for speeding

– Movement along the D-curve for speeding ?

– Shift of the D curve?

Supply Curve• Law of Supply• Other factor influence S and they are assumed constant along this S - curve• Market vs. Firm supply• Supply is not greater at a higher price, rather quantity supplied is greater. “Supply” typically refers to the entire curve. • Same distinction as D-curve: movement along S-curve vs. shift of S-curve

S

$150

$130

300,000 600,000

Price of VCRs

Quantity of VCRs

Determinants of Supply• What causes the supply curve

to shift?

– Technology– Factor prices & productivity – Profitability of Alternate products

– # suppliers

– Expectations

– Weather, Govt, Goals

• Right or Left?

– Higher wages?

– Lower interest rates?– Higher price of electricity?

– Bad weather?

– More market entrants?

S

Price

Quantity

S

S

Determinants of Demand: revisited

• Right or Left?

– Price of complement falls?

– Price of substitute falls?

– Income rises?

– Population grows?

– Price increase expected?

– Tastes shift away from the good?

D

Price

Quantity

D

D

Equilibrium Price & Quantity(graphically)

• Equilibrium price is the price at which quantity demanded = quantity supplied

• Intersection of the S and D curves

• If not there, market tends to move toward equilibrium

– at $125 = Excess Demand– at $155 = Excess Supply

• Describe the process of moving toward the equilibrium!

• NB: we have a “moving target”,

i.e., the equilibrium itself can be moving if forces are causing the S & D-curves to shift

S

$155

$125

200 600

Price of VCRs

$140

475

D

Quantity of VCRs

E*

Equilibrium Price & Quantity(algebraically)

• Find the equilibrium Price and Quantity for a market whose supply curve is P = 2+3Qs and demand curve is P = 10 - Qd.

• Analytical steps(1) Characterize the market (g/s, decision-makers, & mkt structure)

(2) Identify goals and constraints

(3) Find the equilibrium (which method will you use)

(4) What happens when things change

Comparative Statics Market Adjustments to Changes in Demand and Supply

Shock P* Q*

Increase in Demand (“leads to”) higher higher

Increase in Supply lower higher

Decrease in Demand lower lower

Decrease in Supply higher lower

Examples:

• Why do baby-sitters get paid more these days?

• Denied Boarding Compensation

• For all these transitions to equilibrium to happen, prices must be free to adjust. Sometimes they aren’t: Price ceilings and price floors.

Elasticity• We assume all D-curves have a downward-slope, but how

steep one is depends on the commodity.

• A reduction in the Pmilk may lead to a small increase in purchases, but a in Pairline may lead to a big increase in purchases.

• Price Elasticity of Demand = X,Px = % QdX / % PX

– Just how sensitive is qty demanded to a change in price? = (Q/Q)/(P/P) = (Q/P)*(P/Q) = (1/slope)*(P/Q)

• If < -1 we say D for that good is elastic> -1 D is inelastic = -1 D is unit-elastic

Elasticity• Find the elasticity of a D-curve: Q = a - bP.

• Properties of Price Elasticity of Demand when D-curve is linear

– it is different at every point along the D-curveapproaching - at vertical intercept, 0 at

horizontal intercept

– it is never positive (always negative, except one point)

– it is inversely related to the slope of the linear D-curve

• Two polar cases

– slope of D-curve is much easier to calculate, so why bother with elasticity at all?