Transcript Lecture 1

Supply and Demand
Chapter 2
1
introduction
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why did the price of gasoline rise (around %16.33)
after hurricane Katrina (new orleans: August
2005)and hurricane rita (Texas: September 2005),
although price of crude oil did not change
significantly?
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By early October 2005, %30 of U.S. refining
capacity was shut down by the 2 storms.
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by how much would the price (P) have fallen if 1/2 of
the capacity came back?
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to answer such questions, we use a model of supply
and demand.
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demand
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a product’s demand curve (D) shows how much buyers
of the product want to buy (QD)at each possible price
(P), holding all other factors that affect demand
constant.
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Demand curve slopes downward to reflect the negative
relationship between (P) and (Qd)
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Factors affecting demand (population growth, tastes,
income, prices of other goods, government regulations.
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P
7.5
a. Demand
Curve:
Movement
along D
b. Shift of
Demand Curve:
other factors
P
D’
D
15
Qd
15
4
Qd
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Make sure to know the following:
1. substitutes and complements
2. inferior and Normal goods
2. Movements Along vs. Shifts of the demand curve.
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Assignment 1
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Demand functions
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it shows the amount of quantity demanded for each
possible combination (P) and other factors.
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Qd=D(P, other factors)
or:
Qxd = 5 - 2Px +4Py -0.25Pz +0.0003M
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where: Qxd quantity demand of X per unit of time,Px
is the price of X, Py is price of y, Pz is the price of z,
and M is income.
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according to this D function:
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Qxd = 5 - 2Px +4Py -0.25Pz +0.0003M
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if Py =$0.5 , Pz =$4, and M=$30,000, then:
d
Qx = 15
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demand for x becomes:
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if corn is free (Px=0), then then Qxd =15
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thats figure (a)
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- 2Px
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figure (b) shows shift in demand due to one of the
factors affecting demand (not Px)
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if Py is $0.5 then QDX = 9 while it is 11 when Py = $1.
8
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Ex. Suppose that Qxd = 5 - 2Px +4Py -0.25Pz +0.0003M
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Px = $0.5, Py=$4, and M=$30,000. At what price of
good X that demand will be 8?
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Ans.: Qxd = 15-2Px, or 15-2Px=8
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therefore Px=$3.5
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if Py is $1now, then Px=$4.5 so QDX=8.
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Assignment 2: in-text exercise 2.1
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supply
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this is the 2nd part of the market
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S curve shows how much sellers of a product want to
sell at each possible price, holding fixed all other
factors (determining S).
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P
a. Supply
Curve:
Movement
along S
P
S
Qs
b. Shift of
Supply Curve:
other factors
S
S’
Qs
11
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if P=3, then Qs=9
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if P=2, the Qs=4
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positive relationship between P and Qs
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when P is higher, producing and selling the product is
more profitable.
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Other factors: technology, input cost, price of other
outputs, taxes and subsidies
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supply functions
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Qxs = S(P, other factors),
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Qxs = 9 + 5Px - 2PF -0.2Pz - 1.25Ps
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Market Equilibrium
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after knowing D and S for a product, next step is to
determine equilibrium P and Q.
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Thats when Qs=Qd
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The market clears at Pe.
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Market prices tend to adjust so that Qs=Qd
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Equilibrium in the Market
S
3
D
9
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Excess S
S
3
Excess D
D
9
16
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ex.: Qd=15-2P and Qs=5P-6, what is the equilibrium
price?
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Qs=Qd
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P=3 and QE=9
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Assignment III: in-text exercise 2.2
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Changes in market
equilibrium
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if Pf fall from $2.5 to $2, and Pz fall from $8 to $6, the
supply curve will shift outward
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after the shift, the market is not in equilibrium (at p=$3).
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there is excess of .......... ?
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P
S
S’
3
A
B
D
9
Q
12.5
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As a result of excess S,
P falls
P
S
S’
3
A
B
D
9
Q
12.5
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P
S
S’
3
2.5
A
B
C
D
9
Q
10 12.5
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When prices change, the supply function becomes:
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QxS =5Px - 2.5, using the same D function:
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15 - 2Px = 5Px -2.5
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Px=2.5 and QxD=15- 2(2.5)=10 and QxS=5(2.5) - 2.5
=10
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SR and LR changes in market equilibrium.
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Assignment 4: Graph D vs. S changes:
Change D while S is fixed
Change S while D is fixed
Change both and show the effect of relative size of
change.
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Elasticities of D and S
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To measure responsiveness of changes in D and S.
• εxy=%∆X
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/ %∆Y
Values ε that are further than 1 means greater
responsiveness.
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Price elasticity of D
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εd = %∆Qd / %∆ P
= (∆Q/Q) / (∆P/P)
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Factors determining εd
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measuring small price changes.
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elasticity of linear d
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this is a straight line D curve, the demand function
takes the form:
Qd = A - BP ,
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Calculating elasticity:
εd = (∆Qd/∆P)(P/Q),
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(∆Qd/∆P) is the change is Qd for each $ that the P increase.
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for a linear D, this is just (-B).
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to show that, using a linear D curve, for any ∆P the
change in D is:
∆Q= -B(∆P),
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divide both sides by ∆P:
(∆Qd/∆P) = -B.
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therefore, elasticity of demand for a straight line is:
εd = -B (P/Q).
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P
ε along linear D curve
Qdx=15-2P
ε = -2(6/3)= -4
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ε = -2(3.75/7.5)= -1
3.75
ε = -2(1.75/12)= -1/4
1.5
3
7.5
12
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Q
P
ε along linear D curve
Qdx=15-2P
ε = -2(6/3)= -4
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ε = -2(3.75/7.5)= -1
3.75
ε = -2(1.75/12)= -1/4
1.5
3
7.5
12
Q
D is more elastic at higher
P than than at lower P
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dividing (∆Qd/∆P)(P/Q) by ∆Qd/∆Qd:
• εd =
1/(∆P/∆Qd) * (P/Q)
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where (∆P/∆Qd) is the slope if the linear D curve.
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Note: using our D function Qxd = 15-2Px, the slope is (1/B) or (-1/2).
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Horizontal D:
Perfectly
Elastic
S
P
Vertical D:
Perfectly
inelastic
D
S’
D
P
P’
Q
Q’
Q
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S
S’
Horizontal D:
Perfectly
Elastic
S
P
Vertical D:
Perfectly
inelastic
D
S’
D
S
P
P’
Q
Q’
Q
Slope = 0
εd = ∞
Slope = ∞
εd = 0
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S’
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Using absolute value:
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D is elastic if |εd| > 1
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D is inelastic if |εd| < 1
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elasticities of non-linear d
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the slope of the tangent line to a curve at a point is the
“slope of the curve” at that point.
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for a small P changes starting at price P, the ratio
(∆P/∆Q)=the slope of the demand curve at point A.
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P’
slope =∆P’/∆Q’
C
slope=∆P”/∆Q”
P”
B
A
P
slope=∆P/∆Q
Q’
Q”
Q
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constant elasticity D curve
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is knows as isoelastic D curve.
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is has the same elasticity at every price.
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D function takes the general form:
Qd=A(P-B), WHERE A>0, B>0.
• εd =
-B
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C-E D:
D function:
Qd=100/P
slope =∆P’/∆Q’=1
2
1
slope=∆P/∆Q=1
50
100
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total Expenditure and
elasticity of D
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elasticity of D shows how TE changes when P
increases and we move along the D curve.
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TE=PQ
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TE will increase for a small P increase when D is
inelastic and decrease when D is elastic.
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Since Total revenue (TR) always =TE, the same is true
for sellers’ revenue. (TR and εd)
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price elasticity of s
• εd =
(1/(∆P/∆Q))*(P/Q),
where (∆P/∆Q) is the slope of S curve.
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Perfectly elastic S.
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Perfectly inelastic supply.
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other elasticities
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income elasticity of demand
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cross-price elasticity of demand
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