mr_103overheadspart2.ppt

8/7/2019 mr_103overheadspart2.ppt

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Part 2

Markets: Demand,Supply, and Elasticity

What determines the price of a goodor service and the quantity boughtand sold?

Demand and supply model of a

market This simple model of a marketassumes competitive conditions

Distinguish between a demand sideand a supply side of the market

Together they determine theequilibrium price and quantity


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Demand Demand is the quantity of a goodpeople will plan to purchase over a

given time and at a particular price The quantity of a good a person willplan to purchase will depend on:- Preferences (tastes)

- Price of the good- Prices of other goods- Expected future prices- Income

In the aggregate, demand will alsodepend on:- Population and demographics


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The Law of Demand

Other things remaining thesame, the higher the price of agood, the smaller is the quantitydemanded

Substitution effectthe effectof the change in relative price

Income effectthe effect of thechange in overall purchasingpower


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Demand Schedules andDemand Curves

Demand schedule Demand curve--shape What is held constant along ademand curve?Cha nges in t h e qu a ntitydema nded movements al ong the demand curve


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Changes in QuantityDemanded

P

Q

P

P

P

Q Q Q

Decrease in quantitydemanded

Increase in quantitydemanded

Change in quantity demandeda movementalong the demand curve


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Demand Curves Can be linear or non-linear

A linear demand curveP

Q

20

30P = 20 - 2/3Qor Q = 30 - 3/2P


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Changes in Demand

Shift in a demand curve is a Cha ngein Dem a nd

Change in tastes or preferences Change in the prices of other goods

- substitutes- complements Changes in expected future prices Changes in income

- normal goods- inferior goods

Changes in population/demographics


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An Increase in Demand An increase in demanda

rightward shiftP

Q

D

D


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An Increase in Demand

Price of a substitute rises Price of a complement falls Expected future price rises

Income rises (normal good) or income falls (inferior good) Preferences move toward thegood

Population increases


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A Decrease in Demand

A decrease in demandaleftward shift

P

Q

D

D


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A Decrease in Demand

Price of a substitute falls Price of a complement rises Expected future price falls

Income falls (normal good) or income rises (inferior good) Preferences move away fromthe good

Population falls.


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Supply

Supply is the quantity of a goodfirms plan to produce over agiven time and at a particular price

The firm has to have theresources and technology toproduce the good

The firm has to think it canproduce the good at a profit


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Supply The amount of any particular goodor service supplied by a firm will

depend on:- The price of the good- The prices of inputs needed toproduce the good- The available technology- Prices of other goods- Expected future prices

In the aggregate, supply will alsodepend on:- The number of firms in the market


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The Law of Supply

Other things remaining thesame, the higher the price of agood, the greater will be thequantity supplied

Higher prices mean it will beprofitable to expand production

With rising marginal costs

higher prices are required for firms to be willing to increaseproduction


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Supply Schedules andSupply Curves

Supply schedule Supply curveshape Supply curves can only bedefined for competitive

industries (where price is agiven to the firm)

What is held constant along asupply curve?Cha nges in t h e qu a ntitysupp l ied movements al ong thesupply curve


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Changes in QuantitySupplied

P

Q

P

Q Q Q

Change in quantity supplieda movement

along the supply curve

P

P

S

Increase in quantitysupplied

Decrease in quantity supplied


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Supply Curves

P

Q

S

c

P = c + d QOr Q = (-c + P) 1/d

Slope is = d


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Changes in Supply

Shift in a supply curve is aCha nge in Supp l y

Change in input prices Changes in technology Changes in expected futureprices

Changes in the number of firmsentry and exit of firms


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An Increase in Supply

An increase in supplya rightward shift inthe supply curve

S SP

Q


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An Increase in Supply Price of inputs fall

More efficient technology Expected future price fall(ie natural resource production)

Number of firms in the industrygrows


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A Decrease in Supply

P

Q

S

S

A decrease in supply is a leftwardshift in the supply curve


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A Decrease in Supply Price of inputs rise

Expected future price rise(natural resources) Loss of technologicalknowledge

Number of firms in the industryshrinks


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Market Equilibrium

Market equilibrium is where demand= supply

Equilibrium price Equilibrium quantity Price adjusts to bring about anequilibrium

If D>S price rises which reducesquantity demanded and increasesquantity supplied

If S>D price falls which increasesquantity demanded and reducesquantity supplied


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Market EquilibriumP

Q

S

D

E

P*

Q*

Surplus-price falls

Shortage-Price rises


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Market Equilibrium

Demand curve P = a bQ d Supply Curve P = c + dQ s Equilibrium Q d = Q s = Q*and P = P*

P* = a bQ* P* = c + dQ*

Two equations and twounknownscan solve


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Market Equilibrium

Demand curve P = 800 2Q d Supply Curve P = 200 + 1Q s Solve for Q* 800 2Q* = 200 + 1Q* 600 = 3Q* Q* = 200

Solve for P* P* = 800 400 P* = 400


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Equilibrium Price andQuantity Changes

A change in demand with a given supply curve

P

Q

S

D

D

E

E

Rightward shift in demand leads to a movement

along the supply curve. P and Q both rise.

P

P

Q Q


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A change in supply with a given demand curve

D

SS

E

E

P

P

P

Q Q Q

A rightward shift in supply leads to a

movement along the demand curve. P fallsand Q rises.


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A change in supply and demand

same directions

D

SS

E

P

P

Q Q

A rightward shift in both demand and supply

leads to a higher Q. P may rise, fall, or staythe same.

Q

E

D


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A change in supply and demand

opposite directions

D

S SP

Q

A rightward shift in supply and a leftward

shift in demand leads to a lower P. Q may rise,fall, or stay the same.

D

E

E

Q

P

P


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Elasticity

Elasticity is a measure of responsiveness

Many elasticities can bemeasured: price elasticity of demand, cross price elasticity of demand, income elasticity of demand, and elasticity of supply

Elasticity measures aremeasures of proportionateresponsiveness and are unit free


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Elasticity

General form:The elasticity of X with respectto Y is given by the % or proportionate change in Xdivided by the % or proportionate change in Y

EXY = % X / % Y or EXY= X/X / Y/Y or EXY= X/ Y Y/X


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Price Elasticity of Demand

Elasticity of Demand with respect tothe goods own price

EDxPx = % Q/% P or EDxPx = Q/Q / P/P or

EDxPx = Q/ P P/Q For price elasticities of demand thesign is ignored as they are allnegative

Elastic demand > 1 Inelastic demand < 1 Unit elastic demand = 1


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Inelastic and ElasticDemand

P

Q

D

Elasticity = 0

DElasticity = g

Elasticity = 1

P

QP

QD


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Price Elasticity of Demand Over an Arc

Dx

Qx(Kgs)

Px ($)

15

10

100 200

100

5

150

12.5

EDxPx= 100/150 / 5/12.5 = .66/.4 = 1.66

EDxPx= 100/5 x 12.5/150 = 20 x .083 = 1.66

If measuring price elasticityof demand over an arc usethe average P and Q


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Price Elasticity of Demand at a Point

EDxPx = Q/ P P/Q

Q/ P = inverse of the slope of the demand curve

100

50

80

20

Slope = 2Inverse of slope = 0.5Elasticity = 0.5 x 4 = 2

Q

P

D


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Price Elasticity Along a

Straight Line DemandCurve

P

Q

Slope = 2/3Inverse of slope = 1.5

EDxPx = 1

EDxPx > 1

EDxPx < 1

300150

200

100

EDxPx > 1 Elastic DemandEDxPx = 1 Unit Elastic DemandEDxPx < 1 Inelastic Demand


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Price Elasticity of

Demand and TotalRevenue

If the price elasticity of demand is >

1, then a reduction in price willincrease demand more thanproportionately and TR (P x Q) willincrease.

If the price elasticity of demand = 1,then a reduction in price willincrease demand in proportion andTR will be unchanged

If the price elasticity of demand is


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Price Elasticity of

Demand and TotalRevenue

E = 1

D

P

Q

Q

TR

E > 1

E < 1

TR falling

Max TR

TR rising


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Factors that Affect PriceElasticity of Demand

The closeness of substitutes- the more close substitutes thehigher the price elasticity of demand

The proportion of income spent onthe good- the higher the proportion of incomespent on the good the higher theprice elasticity of demand

The time elapsed- The more time elapsed the moreelastic the demand


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Cross Price Elasticity of Demand

The elasticity of the demand for good X with respect to the priceof another good Y

EDxPy= % Q X/% P Y or

EDxPy= Q X/QX / P Y/PY or EDxPy= Q X/ P Y PY/QX The sign matters, positive crossprice elasticities indicatesubstitutes, negative cross priceelasticities indicatecomplements


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Complements andSubstitutes

D

D

D

Q

P

The demand curve for good X shiftswith changes in the price of good Y

Price of a complement fallsPrice of a substitute rises

Price of a complement risesPrice of a substitute falls


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Income Elasticity of Demand

The elasticity of demand for good X

with respect to income (I)

EDxI= % Q X/% I or EDxI= Q X/QX / I/I or EDxI= Q X/ I I/QX

EDxI > 1 normal and income elastic EDxI < 1 > 0 normal and incomeinelastic

EDxI


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Elasticity of Supply

The elasticity of the supply of good

X with respect to its own price ESxPx= % Q S/% P or ESxPx= Q S/QS / P/P or ESxPx= Q S/ P P/QS

Elasticities of supply can range fromzero to infinity. Depends ontechnology, resource substitution,and time frame

All straight line supply curvesthrough the origin will haveelasticities of supply = 1


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mr_103overheadspart2.ppt

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