Transcript Chapter 02 PowerPoint Presentation

Chapter 2
Supply and Demand
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Main Topics
Demand
Supply
Market equilibrium
Elasticities 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 price
Holding 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 growth
Consumer tastes and incomes
Prices 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 curve
A change in the quantity demanded
Change in another factor causes the
entire demand curve to shift
A 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
d
Qcorn
 5  2Pcorn  4Ppotatoes  0.25Pbutter  0.0003M
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
2-8
Supply Curves
Product’s supply curve shows:
How much sellers of the product want to sell at each
possible price
Holding 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:
Technology
Prices of inputs
Prices of other possible outputs
Government taxes or regulations
2-10
Shifts and Movements Along a
Supply Curve
Change in price of the product causes a
movement along the supply curve
A change in the quantity supplied
Change in another factor causes the
entire supply curve to shift
A 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
s
Qcorn
 9  5Pcorn  2Pfuel 1.25Psoybeans
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
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 the
Corn 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 decrease
Supply can increase or decrease
 Effect on market equilibrium:
If demand curve shifts, price and quantity change in
the same direction as the curve
If 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 shift
If 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:
E
Y
X
% change in Y

% change in X
2-30
Interpreting an Elasticity
Suppose E XY  2
Then Y increases 2% for each 1% increase
in X
If 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.
2-31
Price Elasticity of Demand
Elasticity of demand for a product with
respect to its price
Usually called “elasticity of demand”
d
Denoted E
Elasticity of demand equals the percentage
change in the amount demanded divided by
the percentage change in the price
2-32
Price Elasticity of Demand
Formula:
% amount demanded Q Q 
d
E 

P P 
% price
Expect Ed to be negative:
When P increases, amount demanded typically
decreases
When P decreases, amount demanded typically
increases
2-33
Price Elasticity of Demand
Goods tend to have more price elastic
demand when:
They have close substitutes
Buyers of the product consider it a luxury
Buyers 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:
 Q  P 
E 
 
 P  Q 
d
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
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 P*Q, 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
% amount supplied Q Q 
E 

P P 
% price
s
2-41