Transcript DEMAND_AND_SUPPLY

DEMAND AND SUPPLY
Elasticity of Demand and Supply
THE PRICE CHANGE
 substitution
effect when the price of a
good rises I naturally
tend to substitute other
similar goods for it:
 ↑Px ↓RI↓Qx
income effect – when
a price goes up, I have
in effect less income, so
I will naturally reduce
my consumption.
 ↑ Px ↑relative price of
commodity X↓Qx and
↑D for another
commodity

THE CHANGE IN NOMINAL INCOME AND DEMAND
The respond of consumers to the change in income will
differ according to the type of commodity:
 neccessary commodity – less sensitive to the
change in income
 luxury commodity – strongly sensitive to the income
change
 inferior commodity – demand for this type of
commodity tends to decrease with an increase in
income
THE EFFECT OF PRICE CHANGE OF OTHER
COMMODITIES ON DEMAND
• indifferent commodities – as long as the change in price
of one commodity doesn´t have any impact on demand
for another commodity,
• substitutes – commodities that can be mutually
exchangable in consumption increase in price of one
commodity will cause increase in demand for another
commodity
• complements – commodities that are complementary in
consumption.
PRICE ELASTICITY OF DEMAND
 concept that measures how much the quantity demanded of a
good changes when the price changes
 Measurement of Elasticity:
- The coefficient of demand elasticity between two different points
on a demand curve is:
% increase in Q
ED 
% decrease in P
ED  
Q 2  Q1 P 2  P1
:
Q1  Q 2 P1  P 2
2
2
- Note that P and Q move in opposite directions because of the law
of downward-sloping demand.
PRICE ELASTICITY – THREE CATEGORIES
price elastic demand – when a 1% rise in price calls for more than
1% decline in quantity demanded
2.
unit-elastic demand – when a 1% rise in price results in an exactly
compensating decline in quantity demanded
3.
price inelastic demand – when a 1% rise in price evokes less than
1% fall in quantity demanded
Two limiting cases of elasticity:
a) infinite elasticity – D curve is horizontal (∞ elasticity) there is sold
any amount of that commodity for the same price
b) perfect inelasticity – D curve is vertical (0 elasticity) quantity
demanded is constant, doesn’t change with the price change.
1.
Factors affecting price elasticity of demand:
1) Character of needs, that the commodity aims to satisfy
2) The ratio of expenditure for that commodity to the whole
consumer budget
3) Existence and attainability of substitutes
4) Elasticity is changing over time – the longer time period, the
higher the elasticity.
Other Demand Elasticities
1.
INCOME ELASTICITY of demand = measures the
percentage response in demand for every 1% increase in
income
2.
CROSS ELASTICITY of demand = measures the
percentage increase or decrease in the demand for a good
in response to changes in the prices of other goods –
according to the cross elasticity coefficient we can
recognize, if the commodities are substitutes or
complements.
ELASTICITY AND REVENUE
The three cases of elasticity correspond to three
different relationships between total revenue and
price changes
 if a price decrease leads to a decrease in total
revenue, this is a case of inelastic demand,
 if a price decrease leads to an increase in total
revenue, this is the case of elastic demand,
 if a price decrease leads to no change in total
revenue, this is the borderline case of unit-elastic
demand
PRICE ELASTICITY OF SUPPLY

measures the percentage change in quantity supplied in
response to a 1 percent change in the good’s price
The numerical coefficient of supply elasticity:
Es 
% increase in Q
% increase in P
Q 2  Q1 P 2  P1
Es 
:
Q1  Q 2 P1  P 2
2
2
Three important cases of supply elasticity:
 perfectly inelastic supply – the vertical supply curve (Es= 0), the
amount supplied is perfectly fixed,
 perfectly elastic supply – the horizontal supply curve (Es= ∞),
produced amount is independent on price,
 unitary elasticity of supply – straight line going through the origin
(Es= 1).
Factors determining supply elasticity:
1) the time period – a given change in price tends to have greater
effects on amount supplied in a long run,
2) possibility and costs of storage,
3) character of technology and production process.
Market Equilibrium
 MARKET DEMAND
- horizontal sum of all
individual demand by
different prices
 MARKET SUPPLY
- the sum of quantity
supplied, which are all
producers willing to
supply by different
prices (graphically
horizontal sum of
individual supply)
THE COBWEB THEOREM

•
whether the economy will wind inwards or outwards
depends primarily on elasticity of demand and supply 
converging cobweb – winds inward, when elasticity of
demand is higher than those of supply ED>Es,
•
diverging cobweb - diverges outward, ED < Es, in this
case isn’t possible to rely on market mechanism,
•
persistent oscillations – oscillates endlessly around
equilibrium ED = Es.
Converging Cobweb
P
S
P1
P2
P0
D1
E0
D0
Q0
QD2
QS1
QD1
Q
Government intervention in markets
The government sometimes legislates maximum or minimum
prices:
a) price ceiling – economic effects of a maximum price (can’t be set
higher) is a gap between demand and supply (deficiency of
supply),
b) price floor – minimum price (minimum wage rate - induces
unemployment).
Price Ceiling vs. Price Floor
P
D
SURPLUS
S
P*
SHORTAGE
Q*
Q
TASKS:
1. Calculate the coefficient of demand elasticity, as long as you know, that the price has
increased from 56,- units to 92,- units, which led to decrease in quantity demanded
from original 1400 to 1100 pieces.
2. The merchant has reduced the price of his good by 15 %. What for reaction as for
quantity of good sold and for his revenue can be expected if ED = - 1,2.
3. The merchant sells 50 pieces/per day for price 670,-. Since he has bought new goods,
he needs to vacate his warehouse. Therefore, he must increase sale to 75
pieces/per day. How high price he have to set in order to achieve his aim, if the ED
= - 0,8. How will differ his daily revenue?
4. Explain mistakes in thinking:
a) It is always advantageous for merchant to sell for highest possible price.
b) Reduction of price represents for merchant always decline in his total revenue.
5. What for change in the market induces the increase in equilibrium price from original
200,- to 250,-, if ED = - 1,2 a ES = 0,9 and original equilibrium quantity of good was
1 000?
6. Demand side pressure has induced an increase in price of a good from 260,- by 30
units. What for reaction from sellers can be expected, as long as the original
quantity produced was 640 pieces and ES = 1,1. Will the total revenue change?