Transcript Today`s Agenda

Chapter 2
Review of S and D
• Supply Curve:
• Shows quantity supplied at each
possible price, ceteris paribus (c.p.).
– Slopes upward (positive relationship)
– Qs = Qs(P)
– Shift S Curve:
– Clarify movement along vs shift.
– C.P. factors:
– Interpret shift S curve:
Demand Curve
• Shows quantity demanded at
each possible price, ceteris
paribus (c.p.)
– Slopes downward (negative
relationship)
– Qd = Qd(P)
– Movement along versus shift.
– C.P. factors:
– Interpret shift D curve:
Market Mechanism
• Put Supply and Demand Together
• Equilibrium
– 1.
– 2.
• Describe re-equilibrating process by
changing C.P. factor:
– Increase in income causes increase in
demand (shift D rightward)
– At old P, Qd greater than Qs: so
individuals bid up price till reach new
equilibrium.
Elasticity
• Definition: %Qd in response to a
1% P
• Or: %Qd / %P
• What is %? Absolute change in
variable divided by original level of
variable.
• Ep = (Qd/Q) / (P/P)
•
= (P/Q) (Q/P)
• Remember: (Q/P) is 1/slope.
• Ep = price elasticity of demand;
usually negative.
More About Elasticities
Elastic:
Ep 1
Inelastic:
Ep 1
Unitary Elastic: Ep 1
Fact: While slope is constant along a
linear demand curve, elasticity is
not.
• Fact: At top of demand curve, when
P is high and Q is low, Ep is big
negative number so D curve is very
elastic.
• Fact: As move down D curve to
right, Ep falls (because P is  while
Q is , so P/Q is ).
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Example
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Price
60
80
100
120
Demand
22
20
18
16
Supply
14
16
18
20
• 1. What is P*, Q*?
• 2. When P=$80, what is ED?
Relative Elasticities
• Rule: the steeper the slope of
the curve, the less elastic.
• Completely horizontal demand
curve: infinitely elastic:
• So:
• Completely vertical demand
curve: completely inelastic:
• So:
Nearly Horizontal
Demand Curve
• Elasticity approaches infinity:
Recall: 1/slope = Q/P
• If nearly flat curve: small  P
causes a huge Q. This is same
as: huge  / small  , which
equals a very big number.
Income Elasticity of
Demand
• Measure responsiveness of Qd
to change in income (note this is
a ceteris paribus factor).
• EI = %in Qd resulting from a
1%  in income.
• EI = (Q/Q) / (I/I)
•
= I/Q  (Q/I).
Cross-Price Elasticity of
Demand
• Measures responsiveness in Qd of
one good to change in price of a
related good (note this is a change in
a c.p. factor).
• Cross-price elasticity of demand =
% in Qd resulting from a 1%  in
the price of a related good.
• EQ1P2 = (Q1/Q1) / (P2/P2)
•
 P2/Q1  Q1/P2.
• EQP  0: the two goods are
substitutes.
• EQP  0: the two goods are
complements.
Price Elasticity of
Supply
• Price Elasticity of Supply:
Responsiveness of Qs to P.
• ESP = %Qs / %P
• = (Qs/Qs) / (P/P)
•  P/Qs  Qs/P
• Usually positive.
Wage Elasticity of
Supply
• Measures responsiveness of Qs
to changes in the cost of labor (a
ceteris paribus factor).
• ESW = %Qs / %W
• = (Qs/Qs) / (W/W)
•  W/Qs  Qs/W.
• Usually negative.
• Remember: W   cost of
production.
Short-Run versus
Long-run Elasticities
• Focal point: how much time do
sellers and consumers have to
respond (in their Qs and Qd) to
changes in price?
• In general: LR adjustment is
more full, free adjustment so
that LR elasticity is larger; BUT
not true all the time.
• Key factors:
– Durability.
– Availability of substitutes
Government Price
Controls
• Key: If government sets P so
that there is no single P for
which Qs=Qd, then there will
be a shortage or surplus.
• Be able to show the Qs and Qd
for any price.
• Price ceiling:
• Price floor: