Transcript Lecture2x

Sotiris Georganas
City University London
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To understand the demand and supply
function
To outline the laws of demand and supply
To analyse what causes movements and
shifts
To understand the concepts of equilibrium
and comparative statics
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Understanding how markets work is a key
part of a course in economics
In particular you need to understand the key
role played by prices
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Differ in a number of important ways
1. Number of buyers and sellers
2. Level of information
▪ Knowledge about the product and different prices
3. How easy it is to set up in business
▪ Barriers to entry
▪ Can service/product be easily copied?
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One type of market structure
A market is perfectly competitive if no
participant has market power
 Market power: the power to set the price of the good
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1.
2.
3.
Key Assumptions
Numerous (many!) buyers and sellers
Perfect information
Free entry and exit
Supply by
firms
Consumer
demand
Market
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Demand: the amount of a good or service
that consumers are willing and able to
purchase at each price
Can be different from the amount purchased
Reflects the degree of value/pleasure/utility
consumers place on the good/service
Different people will value the same
good/service differently
What?
Preferences
Good’s
price
Income
Demand
Other
goods’
prices
Market demand function:
relationship between quantity demanded of a
particular product and all factors that influence
demand
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Qdx= f(Px, Py, I,....)
Quantity demanded is the ‘dependent’
(endogenous) variable
 Price, income etc are the independent variables
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Isolate the impact of price
Qdx = f(Px) ceteris paribus
 (demand depends on price, holding all else equal)
Complication – demand curves are drawn with price
(independent variable) on the vertical axis
 Why ?
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 Walras (1834 – 1910) developed the theory, with quantity
the dependent variable
 Marshall (1842 – 1924) developed graphical representation
(probably following Cournot’s work 30 years earlier), with
price as the dependent variable
 Today we use Walrasian theory, but the Marshallian
representation
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Since price is the vertical axis we use the
inverse demand for graphs
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Inverse demand : Px = g(Qdx)
 “Price as a function of quantity”
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Direct demand : Qdx = f(Px)
 Where g=f-1
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Isolate the impact of price
↑ Px ⇒ ↓ Qdx (Ceteris paribus)
↓ Px ⇒ ↑ Qdx (Ceteris paribus)
 Why?
a. Substitution effect - as price rises consumers
have an incentive to switch to cheaper
alternatives
b. Income effect - a rise in price reduces
consumers’ `real’ income so they purchase less
of a `normal’ good
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We can use this model of demand to analyse
the effect on demand of changes in price and
other variables, such as income.
We distinguish between these by use of
special terms:
– Movement along the demand curve, for
price changes
– Shift in the demand curve, for changes in
other variables
Substitutes: If price of X increases and demand
for Y goes up, X and Y are substitutes.
 Complements: If price of X increases and
demand for Y goes down, X and Y are
complements.
 Normal Goods: If increase in income leads to
increase in demand
 Inferior goods: If increase in income leads to
decrease in demand.
 Examples?
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substitutes
“inferior”
“normal”
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Supply – the amount of a good or service
producers are willing to offer for sale at each
and every price
Market supply function – relationship
between quantity supplied and all the factors
that influence that supply
Supply curve isolates the impact of price
Qsx = f(Px) ceteris paribus
Inverse supply curve: Px=g(Qsx)
 As before, g=f-1
Good’s
price
Other
goods’
prices
Technology
Supply
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simple supply functions
Qs =a+bP
more complex supply functions
Qs =a+bP+dPi –ePj
a simple demand function Qd =a-bP
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↑ Px ⇒ ↑ Qsx (ceteris paribus)
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Why?
Higher price, ceteris paribus, the more
profitable the good. Acts as an incentive
 In the short run, existing suppliers switch more
resources into producing good X
 The existing producers increase supply because it
is profitable to produce more – has to do with the
cost function.
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Demand and supply curves are:
Qd= a-bP
Qs= c+dP
(1)
(2)
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We need to solve for equilibrium price and quantity (P* , Q*)
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Set quantity demanded and supplied equal, and solve for P
.
(1)=(2)
=>
a-bP*=c+dP* => a-c= bP*+dP* => a-c= (b+d)P* =>
P*=(a-c)/(b+d)
(3)
Insert result (3) into (1) =>
Q*=a-b( (a-c)/(b+d) )
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So if, for example, a=30, b=1, c=0, d=2,we have
P*=30/3 = 10 and Q*= 30-(10)=20 units
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To understand the demand and supply
function
To outline the laws of demand and supply
To analyse what causes movements and
shifts
To understand the concepts of equilibrium
and comparative statics