supply demand
DESCRIPTION
A brief about Supply demand!TRANSCRIPT
Chapter 2
Supply and Demand
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Main Topics
Demand SupplyMarket equilibriumElasticities of demand and supply
2-2
Demand Curves
Product’s demand curve shows:How much buyers of the product want to buy at
each possible priceHolding fixed all other factors that affect demand
On a graph: vertical axis shows $ per unit of the good, horizontal axis shows quantity demanded per unit of time
Downward sloping (buying the product is less attractive when the price is high than when the price is low)
2-3
Determinants of Demand
Demand curve holds all factors other than the product’s price constant:Population growthConsumer tastes and incomesPrices of other products
Substitutes (An increase in the price of one product causes buyers to demand more of the other, all else equal)
Complements (An increase in the price of product causes buyers to demand less of the other, all else equal)
Government taxes or regulations
2-4
Shifts and Movements Along a Demand Curve
Change in price of the product causes a movement along the demand curveA change in the quantity demanded
Change in another factor causes the entire demand curve to shiftA change in demand
2-5
Figure 2.1: Demand Curve for U.S. Corn Market (hypothetical)
2-6
Demand Functions
Product’s demand function is a mathematical representation of its demand
Describes the amount of the product buyers demand for each possible combination of price and other factors
Can be determined by applying statistical techniques to historical data
2-7
Sample Demand Function
Demand for corn affected by: price of corn, price of potatoes, price of butter, consumer incomes
Increases in the prices of corn and butter will decrease the amount of corn buyers demand
Increases in the price of potatoes will increase the amount of corn buyers demand
MPPPQ butterpotatoescorndcorn 0003.025.0425
2-8
Supply Curves
Product’s supply curve shows:How much sellers of the product want to sell at each
possible priceHolding fixed all other factors that affect supply
On a graph: vertical axis shows $ per unit of the good, horizontal axis shows quantity supplied per unit of time
Upward sloping (selling the product is less attractive when the price is low than when the price is high)
2-9
Determinants of Supply
Supply curve holds all factors other than the product’s price constant:TechnologyPrices of inputsPrices of other possible outputsGovernment taxes or regulations
2-10
Shifts and Movements Along a Supply Curve
Change in price of the product causes a movement along the supply curveA change in the quantity supplied
Change in another factor causes the entire supply curve to shiftA change in supply
2-11
Figure 2.2: Demand Curve for U.S. Corn Market (hypothetical)
2-12
Supply Functions
Product’s supply function is a mathematical representation of its supply
Describes the amount of the product sellers supply at each possible combination of price and other factors
Can be determined by applying statistical techniques to historical data
2-13
Sample Supply Function
Supply of corn affected by: price of corn, price of diesel fuel, price of soybeans
Increases in the price of diesel fuel and soybeans will decrease the amount of corn sellers supply
Increases in the price of corn will increase the amount of corn sellers supply
soybeansfuelcornscorn PPPQ 25.1259
2-14
Market Equilibrium
Supply and demand for a product interact to determine the market equilibrium
The equilibrium price is the price at which the amounts supplied and demanded are equal
Graphically, the price at which the supply and demand curves intersect
2-15
Figure 2.3: Equilibrium in theCorn Market
2-16
Excess Supply, Excess Demand
If price is above equilibrium price:Amount supplied will be greater than amount
demanded (excess supply)Incentive for sellers to lower prices to boost sales
If price is below equilibrium price:Amount demanded will be greater than amount
supplied (excess demand)Incentive for buyers to offer higher prices
Market prices adjust so that amount supplied equals amount demanded
2-17
Changes in Market Equilibrium
Changing market conditions alter the market equilibrium
Changes in the determinants of supply (or demand) other than the product price cause the supply (or demand) curve to shift
Example: falling diesel fuel and soybean prices shift the corn supply curve out
2-18
Figure 2.5: Change in Market Equilibrium
2-19
Changes in Market Equilibrium
Four possible ways either supply or demand curve can shift:Demand can increase or decreaseSupply can increase or decrease
Effect on market equilibrium:If demand curve shifts, price and quantity change in
the same direction as the curveIf supply curve shifts, quantity changes in the same
direction as the curve but price changes in the opposite direction
2-20
Figure 2.6: Changes in Market Equilibrium
2-21
Table 2.1 Effects of Changes in Demand or Supply
Source of Change
Effect on Price
Effect on Amount Bought/Sold
Increase in Demand Rises Rises
Decrease in Demand Falls Falls
Increase in Supply Falls Rises
Decrease in Supply Rises Falls
2-22
Changes in Market Equilibrium
Sometimes supply and demand will both shift
Ultimate effect on equilibrium is combination of the separate effects of changes in demand and supply
Will be able to determine the necessary direction of price or quantity movement, but not both
2-23
Figure 2.9: Increase in Both Demand and Supply
2-24
Table 2.2 Effects of Simultaneous Changes in Demand and Supply
Source of Change
Effect on Price
Effect on Amount Bought/Sold
Demand and supply both increase
Ambiguous Rises
Demand and supply both decrease
Ambiguous Falls
Demand increases,
Supply decreases
Rises Ambiguous
Demand decreases,
Supply increases
Falls Ambiguous
2-25
Size of Changes in Market Equilibrium
What determines the size of changes in market equilibrium?Size of change in demand (or supply)
The larger the shift in demand (or supply), the larger the effect on price)
Steepness of the curve that does not shiftIf the supply curve shifts, the steeper demand
curve the more the price changes the less the amount bought and sold changes
Steepness reflects responsiveness to prices
2-26
Figure 2.11: Changes in Equilibrium for Two Extreme Demand Curves
2-27
Figure 2.13: Changes in Equilibrium for Two Extreme Supply Curves
2-28
Elasticities of Demand and Supply
A measure of the responsiveness of the amounts demanded and supplied to changes in prices
Not the same as the slope of the supply or demand curve
Slope of the curve depends on the units used to measure the quantity of the good and its price
Elasticity does not depend on units (e.g., gallons, dozens, dollars per pound)
2-29
General Elasticity Formula
Suppose that a change in X causes a change in Y.
Then the elasticity of Y with respect to X is the percentage change in Y divided by the percentage change in X:
X
YEYX in change %
in change %
2-30
Interpreting an Elasticity
SupposeThen Y increases 2% for each 1% increase
in XIf instead Y decreased 2% when X increased
by 1%, the elasticity would be negative.Note that the elasticity is unit-free; its
meaning is clear without information about the units of X or Y.
2YXE
2-31
Price Elasticity of Demand
Elasticity of demand for a product with respect to its price
Usually called “elasticity of demand”Denoted Elasticity of demand equals the percentage
change in the amount demanded divided by the percentage change in the price
dE
2-32
Price Elasticity of Demand
Formula:
Expect Ed to be negative:When P increases, amount demanded typically
decreasesWhen P decreases, amount demanded typically
increases
PP
QQE d
price %
demandedamount %
2-33
Price Elasticity of Demand
Goods tend to have more price elastic demand when:They have close substitutesBuyers of the product consider it a luxuryBuyers of the product are strapped for cash
and thus sensitive to changes in their expenditures
In general, elasticity of demand varies at different points along a demand curve
2-34
Elasticities for Linear Demand Curves
For linear demand curves re-write the price elasticity of demand formula as:
Notice that the first term is related to the slope of the demand curve
The second term is the initial price divided by the initial quantity
Q
P
P
QE d
2-35
Elasticities for Linear Demand Curves
Notice that:Slope is constant along linear demand curve
but (P/Q) varies, so elasticity varies along the demand curve
Demand is more elastic at higher prices since P is larger and Q is smaller
Demand is less elastic at lower prices since P is smaller and Q is larger
2-36
Categories of Elasticity of Demand
Condition for Ed
Elastic Ed<-1
Inelastic 0>Ed>-1
Perfectly Elastic Ed=infinity
Perfectly Inelastic Ed=0
Unit Elastic Ed=1
2-37
Figure 2.15: Elasticities Along a Linear Demand Curve
2-38
Total Expenditure and Elasticity of Demand
Total expenditure equals PQ, the product of the price and the total amount demanded
Elasticity of demand shows how total expenditure changes when price increases
TE will increase with a small increase in price when demand is inelastic and decrease when demand is elastic
TE is largest at a price for which elasticity equals -1
2-39
Figure 2.18: Price, Elasticity, and Total Expenditure
TE increases where demand is inelastic; for prices below $3.75
TE falls where demand is elastic
TE is largest where Ed = -1; when price = $3.75
2-40
Price Elasticity of Supply
Responsiveness of a product’s supply to changes in its price
Elasticity of supply equals the percentage change in the amount supplied divided by the percentage change in the price
Basic ideas are the same as for elasticity of demand
PP
QQE s
price %
suppliedamount %
2-41
Case Study: Rise in Food Prices
Recent worldwide rise in food prices a result of both demand and supply factors.
Demand Factors: Supply Factors: