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Transcript of Lecture 2: The Basics of Supply and DemandSlide 1 Topics to Be Discussed Supply and Demand The...
Lecture 2: The Basics of Supply and Demand Slide 1
Topics to Be Discussed
Supply and Demand
The Market Mechanism
Changes in Market Equilibrium
Elasticities of Supply and Demand
Short-Run Versus Long-Run Elasticities
Lecture 2: The Basics of Supply and Demand Slide 2
Introduction
Applications of Supply and Demand AnalysisUnderstanding and predicting how world
economic conditions affect market price and production
Analyzing the impact of government price controls, minimum wages, price supports, and production incentives
Analyzing how taxes, subsidies, and import restrictions affect consumers and producers
Lecture 2: The Basics of Supply and Demand Slide 3
Supply and Demand
The Supply CurveThe supply curve shows how much of a good
producers are willing to sell at a given price, holding constant other factors that might affect quantity supplied
Lecture 2: The Basics of Supply and Demand Slide 4
Supply and Demand
The Supply CurveThis price-quantity relationship can be shown
by the equation:
)(PQQ Ss
Lecture 2: The Basics of Supply and Demand Slide 5
Horizontal axis measures quantity (Q) supplied innumber of units per time period
Vertical axis measures price (P) receivedper unit in pounds
Supply and Demand
The SupplyCurve Graphically
The SupplyCurve Graphically
Quantity
Price(£ per unit)
Lecture 2: The Basics of Supply and Demand Slide 6
Supply and Demand
S
The supply curve slopesupward demonstrating that
at higher prices firmswill increase output
The SupplyCurve Graphically
The SupplyCurve Graphically
Quantity
Price(£ per unit)
P1
Q1
P2
Q2
Lecture 2: The Basics of Supply and Demand Slide 7
Supply and Demand
Non-price Determining Variables of SupplyCosts of Production
LaborCapitalRaw Materials
Lecture 2: The Basics of Supply and Demand Slide 8
Supply and Demand
The cost of raw materials falls
At P1, produce Q2
At P2, produce Q1
Supply curve shifts right to S’
More produced at any price on S’ than on S
P S
Change in SupplyChange in Supply
Q
P1
P2
Q1Q0
S’
Q2
Lecture 2: The Basics of Supply and Demand Slide 9
Supply and Demand
The Demand CurveThe demand curve shows how much of a
good consumers are willing to buy as the price per unit changes holding non-price factors constant.
This price-quantity relationship can be shown by the equation:
(P)QQ DD
Lecture 2: The Basics of Supply and Demand Slide 10
Supply and Demand
Quantity
Horizontal axis measures quantity (Q) demanded innumber of units per time period
Vertical axis measures price (P) paidper unit in pounds
Price(£ per unit)
Lecture 2: The Basics of Supply and Demand Slide 11
Supply and Demand
D
The demand curve slopesdownward demonstrating that consumers are willing
to buy more at a lower priceas the product becomes
relatively cheaper and the consumer’s real income
increases.
Quantity
Price(£ per unit)
Lecture 2: The Basics of Supply and Demand Slide 12
Supply and Demand
Non-price Determining Variables of DemandIncome
Consumer Tastes
Price of Related GoodsSubstitutesComplements
Lecture 2: The Basics of Supply and Demand Slide 13
DP
QQ1
P2
Q0
P1
D’
Q2
Change in DemandChange in Demand
Supply and Demand
Income Increases At P1, produce Q2
At P2, produce Q1
Demand Curve shifts right
More purchased at any price on D’ than on D
Lecture 2: The Basics of Supply and Demand Slide 14
The Market Mechanism
Quantity
D
S
The curves intersect atequilibrium, or market-
clearing, price. At P0 thequantity supplied is equalto the quantity demanded
at Q0 .
P0
Q0
Price(£ per unit)
Lecture 2: The Basics of Supply and Demand Slide 15
The Market Mechanism
Characteristics of the equilibrium or market clearing price:
QD = QS
No shortage
No excess supply
No pressure on the price to change
Lecture 2: The Basics of Supply and Demand Slide 16
The Market Mechanism
Quantity
D
S
P0
Q0
If price is above equilibrium:
1) Price is above the market clearing price2) Qs > Qd
3) Price falls to the market-clearing price
P1
Surplus
Price($ per unit)
Lecture 2: The Basics of Supply and Demand Slide 17
The Market Mechanism
The market price is above equilibriumThere is excess supplyProducers lower pricesQuantity demanded increases and quantity
supplied decreasesThe market continues to adjust until the
equilibrium price is reached.
A SurplusA Surplus
Lecture 2: The Basics of Supply and Demand Slide 18
The Market Mechanism
D
S
Q1
Assume the price is P1 , then:1) Qs : Q1 > Qd : Q2 2) Excess supply is Q1:Q2.3) Producers lower price.4) Quantity supplied decreases
and quantity demanded increases.
5) Equilibrium at P2Q3
P1
Surplus
Q2 Quantity
Price($ per unit)
P2
Q3
Lecture 2: The Basics of Supply and Demand Slide 19
Changes In Market Equilibrium
Equilibrium prices are determined by the relative level of supply and demand.
Supply and demand are determined by particular values of supply and demand determining variables.
Changes in any one or combination of these variables can cause a change in the equilibrium price and/or quantity.
Lecture 2: The Basics of Supply and Demand Slide 20
S’
Q2
Raw material prices fall
S shifts to S’
Surplus @ P1 of Q1, Q2
Equilibrium @ P3, Q3
P
Q
SD
P3
Q3Q1
P1
Changes In Market Equilibrium
Lecture 2: The Basics of Supply and Demand Slide 21
D’ SD
Q3
P3
Q2
Income Increases
Demand shifts to D1
Shortage @ P1 of Q1, Q2
Equilibrium @ P3, Q3
P
QQ1
P1
Changes In Market Equilibrium
Lecture 2: The Basics of Supply and Demand Slide 22
Shifts in Supply and Demand
When supply and demand change simultaneously, the impact on the equilibrium price and quantity is determined by:
1) The relative size and direction of the change
2) The shape of the supply and demand models
Lecture 2: The Basics of Supply and Demand Slide 23
The Price of a College Education
The real price of a college education rose 68 percent from 1970 to 1995.
Supply decreased due to higher costs of equipping and maintaining modern classrooms, laboratories and libraries, and higher faculty salaries.
Demand increased due a larger percentage of a larger number of high school graduates attending college.
Lecture 2: The Basics of Supply and Demand Slide 24
Market for a College Education
Q (millions of students enrolled))
P(annual cost
in 1970dollars)
D1970
S1970
S1995
D1995
$4,248
14.9
Prices rose untila new equilibrium
was reached at $4,573and a quantity
of 12.3 million students
$2,530
8.6
Lecture 2: The Basics of Supply and Demand Slide 25
Consumption & Price of Copper 1880-1998
Lecture 2: The Basics of Supply and Demand Slide 26
The Long-Run Behaviorof Natural Resource Prices
ObservationsConsumption of copper has increased about
a hundred fold from 1880 through 1998 indicating a large increase in demand.
The real price for copper has remained relatively constant.
Lecture 2: The Basics of Supply and Demand Slide 27
S1998
D1998D1900
S1900 S1950
D1950
Long-Run Path ofPrice and Consumption
Changes In Market Equilibrium
Quantity
Price
Lecture 2: The Basics of Supply and Demand Slide 28
Elasticities of Supply and Demand
Generally, elasticity is a measure of the sensitivity of one variable to another.
It tells us the percentage change in one variable in response to a one percent change in another variable.
Lecture 2: The Basics of Supply and Demand Slide 29
Elasticities of Supply and Demand
Measures the sensitivity of quantity demanded to price changes.It measures the percentage change in the
quantity demanded for a good or service that results from a one percent change in the price.
Price Elasticity of DemandPrice Elasticity of Demand
Lecture 2: The Basics of Supply and Demand Slide 30
Elasticities of Supply and Demand
The price elasticity of demand is:
P
Q
Q
P
P/P
Q/Q EP
Price Elasticity of DemandPrice Elasticity of Demand
Lecture 2: The Basics of Supply and Demand Slide 31
Elasticities of Supply and Demand
Interpreting Price Elasticity of Demand Values
1) Because of the inverse relationship between P and Q; EP is negative.
2) If EP > 1, the percent change in quantity is greater than the percent change in
price. We say the demand is price elastic.
Lecture 2: The Basics of Supply and Demand Slide 32
Elasticities of Supply and Demand
Interpreting Price Elasticity of Demand Values
3) If EP < 1, the percent change in quantity is less than the percent change in price. We say the
demand is price inelastic.
Lecture 2: The Basics of Supply and Demand Slide 33
Elasticities of Supply and Demand
The primary determinant of price elasticity of demand is the availability of substitutes.Many substitutes demand is price elastic
Few substitutes demand is price inelastic
Price Elasticity of DemandPrice Elasticity of Demand
Lecture 2: The Basics of Supply and Demand Slide 34
Price Elasticities of Demand
Q
Price
Q = 8 - 2P
Ep = -1
Ep = 0
- EP The lower portion of a downward sloping
demand curve is less elasticthan the upper portion.
4
8
2
4
Linear Demand CurveQ = a - bPQ = 8 - 2P
Lecture 2: The Basics of Supply and Demand Slide 35
Price Elasticities of Demand
DP*
- EP
Quantity
Price Infinitely Elastic Demand
Lecture 2: The Basics of Supply and Demand Slide 36
Price Elasticities of Demand
Q*
0 EP
Quantity
PriceCompletely Inelastic Demand
Lecture 2: The Basics of Supply and Demand Slide 37
Elasticities of Supply and Demand
Income elasticity of demand measures the percentage change in quantity demanded resulting from a one percent change in income.
Other Demand ElasticitiesOther Demand Elasticities
Lecture 2: The Basics of Supply and Demand Slide 38
Elasticities of Supply and Demand
The income elasticity of demand is:
I
Q
Q
I
I/I
Q/Q EI
Other Demand ElasticitiesOther Demand Elasticities
Lecture 2: The Basics of Supply and Demand Slide 39
Elasticities of Supply and Demand
Cross elasticity of demand measures the percentage change in the quantity demanded of one good that results from a one percent change in the price of another good.
For example consider the substitute goods, butter and margarine.
Other Demand ElasticitiesOther Demand Elasticities
Lecture 2: The Basics of Supply and Demand Slide 40
Elasticities of Supply and Demand
The cross elasticity of demand is:
m
b
b
m
mm
bbPQ
P
Q
Q
P
/PP
/QQ E mb
The cross elasticity for substitutes is positive, while that for complements is negative.
Lecture 2: The Basics of Supply and Demand Slide 41
Elasticities of Supply and Demand
Price elasticity of supply measures the percentage change in quantity supplied resulting from a 1 percent change in price.
The elasticity is usually positive.
We can refer to elasticity of supply with respect to interest rates, wage rates, and the cost of raw materials.
Elasticities of SupplyElasticities of Supply
Lecture 2: The Basics of Supply and Demand Slide 42
Elasticities of Supply and Demand
1981 Supply Curve for Wheat
QS = 1,800 + 240P
1981 Demand Curve for Wheat
QD = 3,550 - 266P
The Market for WheatThe Market for Wheat
Elasticities of Supply and Demand
Equilibrium: Q S = Q D
PP 266550,3240800,1
750,1506 P
bushelP /46.3
bushels million 630,2)46.3)(240(800,1 Q
The Market for WheatThe Market for Wheat
Chapter 2: The Basics of Supply and Demand Slide 43
Elasticities of Supply and Demand
Inelastic 035.)66.2(630,2
46.3
P
Q
Q
PE DD
P
Inelastic 032.)40.2(630,2
46.3
P
Q
Q
PE SS
P
The Market for WheatThe Market for Wheat
Chapter 2: The Basics of Supply and Demand Slide 44
Lecture 2: The Basics of Supply and Demand Slide 45
Short-Run Versus Long-Run Elasticities
Price elasticity of demand varies with the amount of time consumers have to respond to a price.
DemandDemand
Lecture 2: The Basics of Supply and Demand Slide 46
Most goods and services:Short-run elasticity is less than long-run
elasticity. (e.g. gasoline, Drs.)
Other Goods (durables):Short-run elasticity is greater than long-run
elasticity (e.g. automobiles)
Short-Run Versus Long-Run Elasticities
DemandDemand
Lecture 2: The Basics of Supply and Demand Slide 47
Gasoline: Short-Run andLong-Run Demand Curves
DSR
DLR
People tend to drive smaller and more fuel efficient
cars in the long-run
Gasoline
Quantity
Price
Lecture 2: The Basics of Supply and Demand Slide 48
DSR
DLR
People may putoff immediate
consumption, buteventually older cars
must be replaced.
Automobiles
Automobiles: Short-Run andLong-Run Demand Curves
Quantity
Price
Lecture 2: The Basics of Supply and Demand Slide 49
Most goods and services:Long-run price elasticity of supply is greater
than short-run price elasticity of supply.
Other Goods (durables, recyclables):Long-run price elasticity of supply is less
than short-run price elasticity of supply
Short-Run Versus Long-Run Elasticities
SupplySupply
Lecture 2: The Basics of Supply and Demand Slide 50
SSR
Primary Copper: Short-Run and Long-Run Supply Curves
Primary Copper: Short-Run and Long-Run Supply Curves
Quantity
Price
Short-Run Versus Long-Run Elasticities
SLR
Due to limitedcapacity, firmsare limited by
output constraintsin the short-run.
In the long-run, theycan expand.
Lecture 2: The Basics of Supply and Demand Slide 51
SSR
Secondary Copper: Short-Run and Long-Run Supply Curves
Secondary Copper: Short-Run and Long-Run Supply Curves
Quantity
Price
Short-Run Versus Long-Run Elasticities
SLR
Price increasesprovide an incentive
to convert scrapcopper into new supply.
In the long-run, thisstock of scrap copper
begins to fall.
Lecture 2: The Basics of Supply and Demand Slide 52
Elasticity explains why coffee prices are very volatile.Due to the differences in supply elasticity in
the long-run and short run.
Short-Run Versus Long-Run Elasticities
Weather in Brazil andthe price of Coffee
in New York
Weather in Brazil andthe price of Coffee
in New York
Lecture 2: The Basics of Supply and Demand Slide 53
Price of Brazilian Coffee
Lecture 2: The Basics of Supply and Demand Slide 54
D
S
P0
Q0 Quantity
Price
P1
Short-Run1) Supply is completely inelastic2) Demand is relatively inelastic3) Very large change in price
A freeze or drought decreases the supply
of coffee
S’
Q1
Short-Run Versus Long-Run ElasticitiesCoffeeCoffee
Lecture 2: The Basics of Supply and Demand Slide 55
S’
D
S
P0
Q0
P2
Q2
Intermediate-Run1) Supply and demand are more elastic2) Price falls back to P2.3) Quantity falls to Q2
Short-Run Versus Long-Run Elasticities
Quantity
Price
CoffeeCoffee
Lecture 2: The Basics of Supply and Demand Slide 56
D
SP0
Q0
Long-Run1) Supply is extremely elastic.2) Price falls back to P0.3) Quantity increase to Q0.
Short-Run Versus Long-Run ElasticitiesCoffeeCoffee
Quantity
Price
Lecture 2: The Basics of Supply and Demand Slide 57
First, we must learn how to “fit” linear demand and supply curves to market data.
Then we can determine numerically how a change in a variable will cause supply or demand to shift and thereby affect the market price and quantity.
Understanding and Predicting the Effects of Changing Market Conditions
Lecture 2: The Basics of Supply and Demand Slide 58
Available DataEquilibrium Price, P*
Equilibrium Quantity, Q*
Price elasticity of supply, ES, and demand, ED.
Understanding and Predicting the Effects of Changing Market Conditions
Lecture 2: The Basics of Supply and Demand Slide 59
Summary
Supply-demand analysis is a basic tool of microeconomics.
The market mechanism is the tendency for supply and demand to equilibrate, so that there is neither excess demand nor excess supply
Lecture 2: The Basics of Supply and Demand Slide 60
Summary
Elasticities describe the responsiveness of supply and demand to changes in price, income, and other variables.
Elasticities pertain to a time frame.
If we can estimate the supply and demand curves for a particular market, we can calculate the market clearing price.