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Chapter 2: Demand and Chapter 2: Demand and SupplySupply
2.12.1 Demand Demand
2.2 2.2 SupplySupply
2.32.3 Equilibrium Equilibrium
2.4 2.4 ElasticityElasticity
22
2.1 Demand & Supply in 2.1 Demand & Supply in Perfect CompetitionPerfect Competition
Assume a large number of buyers and sellers of Assume a large number of buyers and sellers of a good with full informationa good with full information
No one buyer or seller has any market power; No one buyer or seller has any market power; individuals are “price-takers”individuals are “price-takers”
A supply and demand curve exists for every A supply and demand curve exists for every goodgood in every in every locationlocation at one at one timetime
Demand and Supply are simplest in a PC Demand and Supply are simplest in a PC (perfect competition) market(perfect competition) market
33
Demand: DefinitionDemand: Definition
A A scheduleschedule showing amounts of a showing amounts of a product that consumers are willing product that consumers are willing and able to purchase at each and able to purchase at each specific price during some specified specific price during some specified time period,time period,
everything else held constanteverything else held constant (ceteris paribus)(ceteris paribus)
44
Demand: OriginsDemand: Origins Demand for a good or service Demand for a good or service
comes from two areas:comes from two areas:1) Derived Demand –desired to make 1) Derived Demand –desired to make
something elsesomething else(ie: iron is desired to make cars)(ie: iron is desired to make cars)
2) Direct Demand –desired to be 2) Direct Demand –desired to be used/consumed itselfused/consumed itself(ie: Pepsi Vanilla is desired to be (ie: Pepsi Vanilla is desired to be drank)drank)
55
The Law of DemandThe Law of Demand There is an There is an inverse relationship inverse relationship
between the quantity of anything that between the quantity of anything that people will want to purchase and the people will want to purchase and the price they must pay to obtain it:price they must pay to obtain it:
ceteris paribus (all else held equal)ceteris paribus (all else held equal)
This causes demand curves to be This causes demand curves to be downward slopingdownward sloping
When prices When prices increaseincrease, people buy , people buy lessless
When prices When prices decreasedecrease, people buy , people buy moremore
66
Price/Unit
$
Qn/yr
A B C D E
5.00 4.00 3.00 2.00 1.00
10 20 30 40 50
The Individual’s Demand Schedule
Number of Songs per Year
Pric
e of
Son
gs (
$)
1
2
3
4
5
10 20 30 40 500
A
B
C
D
E
Change in Price =Movement alongthe Demand
77
Math Note:Math Note:
We always graph P on vertical axis and Q on horizontal axis, but we write demand as Q as a function of P… If P is written as function of Q, it is called the inverse demand:Normal Form: Qd=100-2P
Inverse form: P =50 - Qd/2
Markets are defined by:1)Commodity 2)Geography3)Time.
88
Change A: Changes in Change A: Changes in Quantity DemandedQuantity Demanded
A A change in a change in a good’s pricegood’s price CausesCauses
a a change in quantity demandedchange in quantity demanded
(the same thing as a (the same thing as a movement movement alongalong the same demand curve) the same demand curve)
99
A Change in Quantity A Change in Quantity DemandedDemanded
Quantity of Songs Demanded
Pric
e of
Son
gs (
$)
1
2
3
4
5
20 30 40 50 600 8070
D1D3
Originally, song downloadscost $2
Due to a tax, song downloadsincrease to $3
1010
Change B: Shifts in Change B: Shifts in DemandDemand
AA change in change in non-price non-price determinants determinants of demand of demand
(income, tastes, etc)(income, tastes, etc)
CausesCauses
aa shift in demand*shift in demand*
*The whole demand schedule
1111
A Shift in the Demand A Shift in the Demand CurveCurve
Quantity of Songs Demanded
Pric
e of
Son
gs (
$)
1
2
3
4
5
20 30 40 50 600 8070
D1D3
Decrease in Demand
Suppose universitiesoutlaw the use of MP3 Players
D2
Increase in Demand
Suppose the federalgovernment givesevery student an ElectrohomeMP3 player
1212
Non-Price determinants of Non-Price determinants of DemandDemand
1) Income, 1) Income, wealthwealth
2) Tastes and 2) Tastes and preferencespreferences
3) The price of 3) The price of related goodsrelated goodsComplementsComplementsSubstitutesSubstitutes
4) Expectations4) ExpectationsFuture pricesFuture pricesIncomeIncomeProduct Product availabilityavailability
5) Population 5) Population (market size)(market size)
What movement would these What movement would these factors cause?factors cause?
1313
Shift vrs. MovementShift vrs. Movement
Pric
e of
Cig
aret
tes,
per
pac
k
Number of Cigarettes smoked per day
10 20
$2
$4
A tax raises the price of cigarettes, resulting in amovement along the demand curve
A policy to discouragesmoking (no smoking inpublic buildings) shiftsthe demand curve left
Pric
e of
Cig
aret
tes,
per
pac
k
Number of Cigarettes smoked per day
10 20
$2
DD’ D
1414
Normal vrs. Inferior GoodsNormal vrs. Inferior GoodsFor normal goods, Demand decreasesWith income
Pric
e of
Chi
cken
Chicken eaten in a month10 20
$2
DD’
Pric
e of
Kra
ft D
inne
r
Kraft Dinner eaten in a month
10 20
$2
D
For inferior goods, Demand increasesWhen income decrease
D’
30
1515
2.2 Supply2.2 Supply The amount supplied depends on The amount supplied depends on
PROFITSPROFITS, which depend on , which depend on COSTSCOSTS CostsCosts depend ondepend on
the kinds of inputs (factors of the kinds of inputs (factors of production) usedproduction) used
the amount of each input usedthe amount of each input usedprices of inputs usedprices of inputs usedtechnologytechnology
1616
Supply: DefinitionSupply: Definition A A scheduleschedule that shows how that shows how
much of a product a firm will much of a product a firm will supply at alternative prices for a supply at alternative prices for a given time period, ceteris paribus.given time period, ceteris paribus.
1717
The Law of SupplyThe Law of Supply• The The priceprice of a product or service and the of a product or service and the
quantity supplied quantity supplied are directly related, ceteris are directly related, ceteris paribusparibus
• This creates an upward sloping supply curveThis creates an upward sloping supply curve
• The The higherhigher the price of a good, the the price of a good, the moremore sellers sellers will make availablewill make available
• The The lowerlower the price of a good, the the price of a good, the fewerfewer sellers sellers will make availablewill make available
1818
The Individual Producer’s Supply The Individual Producer’s Supply ScheduleSchedule
Qnty of Songs Supplied Price / (thousands / Song year)
F $5 550
G 4 400
H 3 350
I 2 250
J 1 200Quantity of Songs Supplied
(thousands of constant-quality units per year)
Pric
e of
Son
g ($
)1
2
3
4
5
100 2003004005000
J
I
H
G
F
600
Change in PriceMovement alongThe Supply
1919
Change A: Change in Change A: Change in Quantity SuppliedQuantity Supplied
A change in a A change in a good’s price good’s price
CausesCauses
A A change in quantity suppliedchange in quantity supplied..
(This is also called a (This is also called a movement movement alongalong the supply curve.)the supply curve.)
2020
Change B: Shifts in SupplyChange B: Shifts in Supply
A change in A change in non-price determinants non-price determinants
of supply of supply
CausesCauses
A A shift in supplyshift in supply
2121
S1S2
a
c
A Shift in the Supply CurveA Shift in the Supply Curve
Quantity of Songs Supplied(millions of constant-quality units per year)
Pric
e of
Son
gs (
$)
1
2
3
4
5
20 40 60 80 1000 140120
When supply decreases the quantity suppliedwill be less at each price: ie: Singers form a union and successfully negotiate higher wages
b
d
S2
When supply increasesthe quantity suppliedwill be greater at each price: ie: producer finds that she can use some cheaper singers from Newfoundland
b
d
2222
1)1) Cost of inputs Cost of inputs 2)2) Technology and ProductivityTechnology and Productivity3)3) Taxes and SubsidiesTaxes and Subsidies4)4) Price Expectations Price Expectations (in the input (in the input
market)market)
5)5) Number of firms in the industryNumber of firms in the industry
Non-Price Determinants of Non-Price Determinants of SupplySupply
How will these shift How will these shift supply?supply?
2323
2.3 Market Equilibrium2.3 Market Equilibrium
In the In the MarketMarket, buyers and sellers , buyers and sellers interact, resulting in ainteract, resulting in aSingle Equilibrium ofSingle Equilibrium of
One Equilibrium PriceOne Equilibrium PriceOne Equilibrium QuantityOne Equilibrium Quantity
2424
Putting Demand and Supply Putting Demand and Supply Together: Finding Market Together: Finding Market EquilibriumEquilibrium
(1) (2) (3) (4) (5)Difference
Price per Quantity Supplied Quantity Demanded (2) - (3)Constant-Quality (Songs (Songs (Songs
Song per year) per year) per year) Condition
$5 100 million 20 million 80 million
4 80 million 40 million 40 million
3 60 million 60 million 0
2 40 million 80 million -40 million
1 20 million 100 million -80 million
Excess quantitysupplied (surplus)
Excess quantitysupplied (surplus)
Excess quantitydemanded (shortage)
Excess quantitydemanded (shortage)
2525
S
D
Market Equilibrium: Market Equilibrium: DefinitionDefinition
Quantity of Songs(millions of constant-quality units per year)
Pric
e pe
f S
ong
($)
1
2
3
4
5
20 40 60 80 1000
Excess quantity supplied at price $5
Excess quantity demanded at price $1
A B
Market clearing, orequilibrium, price
E QD= QS
The condition in a market when quantity supplied equals quantity demanded at a particular price; a point from where there tends to be no movement
2626
The Law of Supply & The Law of Supply & DemandDemand
The price of any good will adjust until The price of any good will adjust until the price is such that the quantity the price is such that the quantity demanded is equal to the quantity demanded is equal to the quantity suppliedsupplied
A high price will result in excess supply, A high price will result in excess supply, pushing price down, and a low price will pushing price down, and a low price will result in excess demand, pushing price result in excess demand, pushing price up up
the market clears resulting in a single the market clears resulting in a single market clearing or equilibrium pricemarket clearing or equilibrium price..
2727
Qd = 500 – 4p QS = -100 + 2p
p = price of cranberries (dollars per barrel) Q = demand or supply in millions of barrels per year
2828
a. The equilibrium price of cranberries is calculated by equating demand to supply:
b. plug equilibrium price into either demand or
supply to get equilibrium quantity:
100$*
42100500
21004500
p
pp
pp
QQ sd
100
)100(4500
4500
d
d
d
Q
Q
pQ
2929
Price
Quantity
Market Demand: P = 125 - Qd/4
Market Supply: P = 50 + QS/2
Q* = 100
P*=100
125
•
Example: The Market For Cranberries
50
3030
Comparative Statics: Comparative Statics: Shifts in Demand &/or SupplyShifts in Demand &/or Supply
1.) Decide whether Demand &/or Supply 1.) Decide whether Demand &/or Supply is affected.is affected.
2.) Decide in which direction the 2.) Decide in which direction the affectedaffected
Demand &/or Supply will move.Demand &/or Supply will move.
3.) Use a Demand and Supply diagram 3.) Use a Demand and Supply diagram to determine the new equilibrium.to determine the new equilibrium.
4.) Calculate the new equilibrium 4.) Calculate the new equilibrium (if possible)(if possible)
How do you analyze a change in an exogenous variable?
3131
Comparative Statics: Gas Comparative Statics: Gas PricesPrices
Summer 2009: Gas prices at Summer 2009: Gas prices at equilibrium at $1.07 per literequilibrium at $1.07 per liter
Winter arrives and certain drivers Winter arrives and certain drivers limit or end their driving for the limit or end their driving for the season (shift in demand)season (shift in demand)–The new market equilibrium is The new market equilibrium is $0.87 per liter$0.87 per liter
Cold Weather causes a decrease in Cold Weather causes a decrease in gas pricesgas prices
3232
S
D1
P1
Q1
E1
Ford Escape Market Consider the Consider the
market for Ford market for Ford Escapes.Escapes.
1.1. For each event For each event identify whether identify whether demand or demand or supply is supply is affected.affected.
2.2.Determine the Determine the direction of direction of change.change.
3.3.Draw a diagram Draw a diagram to illustrate how to illustrate how equilibrium is equilibrium is changed.changed.
3333
Steelworkers Strike Raises Steelworkers Strike Raises Steel PricesSteel Prices
D
S1
Q1
P1
E1
FordEscape Market
S2
Q2
P2
E2
3434
New Automated Machinery New Automated Machinery IntroducedIntroduced
S1
D
P1
Q1
E1
Ford Escape Market
S2
P2
Q2
E2
3535
Price of Station Wagons RisesPrice of Station Wagons Rises
S
D1
P2
Q2
E2
Ford Escape Market
D2
P1
Q1
E1
3636
D1
Stock Market Crash Lowers Stock Market Crash Lowers WealthWealth
S
P1
Q1
E1
Ford Escape Market
D2
P2
Q2
E2
3737
Simultaneous ShiftsSimultaneous Shifts
– 2 events2 events 1.1. supply supply 2.2. demand demand
only only supply supply P, P, QQ.. only only demand demand P, P, QQ..
Q Q is guaranteedis guaranteed
Example of a double shift.
3838
D1
Increased Price ExampleIncreased Price Example
S1
P1
Q1
E1
D2
S2
P2
Q2
E2
3939
D1
Decreased Price ExampleDecreased Price Example
S1
P1
Q1
E1
D2
S2
P2
Q2
E2
4040
Simultaneous ShiftsSimultaneous Shifts
Second possibility:Second possibility:– 2 events2 events
1.1. supply supply 2.2. demand demand
only only supply supply PP, , Q.Q. only only demand demand PP, , QQ
PP is guaranteedis guaranteed
Example of a double shift.
4141
Increased Quantity ExampleIncreased Quantity Example
S1
D1
P1
E1
Q1
S2
D2
P2
E2
Q2
4242
D1
Decreased Quantity Decreased Quantity ExampleExample
S1
Q1
P1
E1
D2
S2
Q2
P2
E2
4343
p = price of cranberries (dollars per barrel) Q = demand or supply in millions of barrels per year
Assume that a plague reduced cranberry supply by 100 and fear of inflection likewise reduced cranberry demand by 100 so that:
pQ
pQs
d
2100
4500
pQ
pQ
pQ
pQ
s
s
d
d
2200
1002100
4400
1004500
4444
a. The new equilibrium price of cranberries is calculated by equating demand to supply:
b. plug equilibrium price into either demand or
supply to get equilibrium quantity:
$100 *p
4p2p200400
2p 200- 4p– 400
Q Q Sd
0 Qd
4(100)-400 Qd
4p-400 Qd
4545
Price
Quantity
Old Market Demand: P = 125 - Qd/4
Old Market Supply: P = 50 + QS/2
QOLD
POLD=PNew
125
•
Example: The Market For Cranberries
50
New Market Supply: P = 100 + QS/2
New Market Demand: P = 100 - Qd/4
QNew
4646
2.4 Elasticity: Percentage 2.4 Elasticity: Percentage ChangeChange
Which is more common?Which is more common?– GDP increases by 1.4% OR GDP GDP increases by 1.4% OR GDP
increases by $2.1 Billionincreases by $2.1 Billion– Inflation is 3.2% OR “Prices have gone Inflation is 3.2% OR “Prices have gone
up between 5 cents and $350,000up between 5 cents and $350,000Percentage changes are easier to Percentage changes are easier to grasp than the amount of changegrasp than the amount of change
– Economists often use Economists often use elasticitieselasticities to to examine percentage change or examine percentage change or responsivenessresponsiveness
4747
Price Elasticity of Price Elasticity of DemandDemand
Price Elasticity of Demand (Price Elasticity of Demand (ЄЄ Q,Q,pp))
– The responsiveness of quantity The responsiveness of quantity demanded of a commodity to changes demanded of a commodity to changes in its pricein its price
– Related to the slope, but concerned Related to the slope, but concerned with percentage changeswith percentage changes
4848
One Impact of a Change in One Impact of a Change in SupplySupply
S1
Quantity (pizzas per hour)
Pri
ce (
dolla
rs p
er
pizz
a)
10.00
20.00
30.00
40.00
Da
0 255 10 15 2013
5.00
S0
Large price change and small quantity change
An increasein supplybrings ...
… and a smallincrease in quantity
… a largefall in price...
4949
Another Impact of a Another Impact of a Change in Supply…Change in Supply…
Quantity (pizzas per hour)
Pric
e (d
olla
rs p
er p
izza
)
10.00
20.00
30.00
40.00
Db
0 255 10 15 2017
S1
15.00
S0
Small price change and large quantity change
An increasein supplybrings ...
… a smallfall in price...
… and a largeincrease in quantity
5050
Solution: Price Elasticity of Solution: Price Elasticity of DemandDemand
P
Qd
%
%PQ,
Percentage change in price
Percentage change in quantity demandedЄQ,P
The ratio of the two percentages is a
number without units.
Price Elasticity of Demand
5151
Price ElasticityPrice Elasticity ExampleExample
– Price of oil increases 10%Price of oil increases 10%– Quantity demanded decreases 1%Quantity demanded decreases 1%
1.%10
%1-PQ,
When calculating the price elasticity of demand, we often ignore the minus sign for % change in Q.
5252
TYPES OF ELASTICITY -Hypothetical Demand ElasticitiesTYPES OF ELASTICITY -Hypothetical Demand Elasticities
Product % Change in price (%P)
% Change in quantity demanded (%QD)
Elasticity (%QD/%P)
Insulin
+ 10%
0%
0 Perfectly inelastic
Basic Telephone service
+ 10%
-1%
.1 Inelastic
Beef
+ 10%
-10%
1.0 Unitarily elastic
Bananas
+ 10%
-30%
3.0Elastic
5353
Price Elasticity Ranges: Price Elasticity Ranges: Extreme Price ElasticitiesExtreme Price Elasticities
Quantity Demanded per Year(millions of units)
Pric
e
0
D
8
Perfect inelasticity, zero elasticity,no matter howmuch Pricechanges,Quantitystays the same; insulin
P0
P1
Quantity Demanded per Year(millions of units)
Pri
ce
0
Perfect elasticity, infinite elasticity,the slightest increasein price will lead to zero sales.
30D
P1
P1 isthe demand curve
5454
Price Elasticity RangesPrice Elasticity RangesSummary from TableSummary from Table
1PQ, ;%% PQ
1PQ, ;%% PQ
1PQ, ;%% PQ
Unit Elastic
Inelastic Demand
Elastic Demand
5555
Elasticity of DemandElasticity of Demand Calculating elasticityCalculating elasticity
or
or
Sum of prices/2
Change in P
Sum of quantities/2
Change in QЄQ,P
Always use
the mid-point
formula
ЄQ,P
Change in
Q(Q1 Q2)/2
Change in
P(P1 P2)/2
ЄQ,P
QAvg.Q
PAvg.P
5656
Calculating the Elasticity of Calculating the Elasticity of DemandDemand
9 10 11
19.50
20.50
D
Newpoint
Quantity (pizzas/hour)
Price (dollars/pizza)
20.00
Originalpoint
Elasticity = = 4Q /Qave
P /Pave
2/10
1/20=
ΔP=1
ΔQ=2
Qave =1/2(11+9)=10
Pave =1/2(20.50+19.50)=20
5757
Elasticity of Demand (mid-point)Elasticity of Demand (mid-point)
ЄQ,P =P = $1.00
P1 + P2 ($20.50 + $19.50)
2
P =5% = $20
Q = 2
Q1 + Q2 (9 + 11)
2
Q =20% = 10
Always use the mid-point formula for calculating elasticity
20%
5%= 4= ЄQ,P =
X 100
X 100
5858
Elasticity: ExampleElasticity: Example You are the consulting economist to the You are the consulting economist to the
Guelph transportation commission, Guelph transportation commission, The current fare is $.95 The current fare is $.95 There are 17,500 riders per day There are 17,500 riders per day For each $.10 increase in the fare, rider For each $.10 increase in the fare, rider
ship decreases by 10,000 riders per day.ship decreases by 10,000 riders per day. What is the price elasticity of demand at What is the price elasticity of demand at
the current fare? the current fare? Should fares be raised or lowered?Should fares be raised or lowered? What fare will maximize revenue?...... What fare will maximize revenue?......
5959
Elasticity: ExampleElasticity: Example Should fares Should fares
be raised or be raised or lowered?lowered?
What fare What fare will will maximize maximize revenue?...... revenue?......
81.08.0
}2
)05.195.0({
1.0
}2
)500,7500,17({
000,10
,
,
,
QP
QP
QP
PP
6060
Total Revenue and Total Revenue and ElasticityElasticity
Total Revenue =
Price Per GoodX
# of Goods Sold
TR = P X Q
Total Revenue =
Price Per GoodX
# of Goods Sold
TR = P X Q
Assumption : Costs are constantAssumption : Costs are constant
6161
5555 110110
.55.55
1.101.10
3.003.00
(dol
lars
)(d
olla
rs)
Maximum total revenue
When demandis inelastic, price cut decreasestotal revenue
Unitelastic
Elasticdemand
QuantityQuantity
Inelastic demand
00
When demand is elastic, price cut increases total revenue
To
tal R
eve
nue
To
tal R
eve
nue
Pri
ceP
rice
0 550 55 110110
Ela
sti
cit
y a
nd
Tota
l Ela
sti
cit
y a
nd
Tota
l R
even
ue
Reven
ue
QuantityQuantity
.80
6262
Relationship Between PriceRelationship Between PriceElasticity of Demand and Total RevenuesElasticity of Demand and Total Revenues
InelasticInelastic ((ЄQ,P < < 1) 1) TR TR TR TR
Unit-elasticUnit-elastic ((ЄQ,P = 1) = 1) No change No change No No
change change Elastic Elastic ((ЄQ,P > 1) > 1) TR TR TR TR
Price Elasticity Effect of Price Change
of Demand on Total Revenues (TR)
Price PriceDecrease Increase
Note: It is possible to classify elasticity by Note: It is possible to classify elasticity by
observing the change in revenue from a price observing the change in revenue from a price
changechange
6363
ExerciseExercise
• 2 drivers - Tom & Jerry each drive 2 drivers - Tom & Jerry each drive to to a gas station. to to a gas station.
• Before looking at the price, each Before looking at the price, each places an order. places an order.
• Tom says, “I’d like 10 litres of gas”. Tom says, “I’d like 10 litres of gas”. • Jerry says, “I’d like $10 of gas”.Jerry says, “I’d like $10 of gas”.• What is each driver’s price What is each driver’s price
elasticity of demand?elasticity of demand?
6464
Determinants ofDeterminants ofPrice Elasticity of DemandPrice Elasticity of Demand
Existence of substitutesExistence of substitutes– Goods are more price elastic if substitutes Goods are more price elastic if substitutes
existexist
Share of budgetShare of budget– Goods are more price elastic when a Goods are more price elastic when a
consumer’s expenditure on the good is large consumer’s expenditure on the good is large (in dollar terms or relatively)(in dollar terms or relatively)
NecessityNecessity– Goods are less price elastic when seen as a Goods are less price elastic when seen as a
necessitynecessity
6565
Market and Brand Market and Brand ElasticitiesElasticities
Market and Brand Elasticities are Market and Brand Elasticities are not equalnot equal– Although a water addict is very price Although a water addict is very price
inelastic to the price of bottled water in inelastic to the price of bottled water in general, he/she would quickly switch to general, he/she would quickly switch to another brand if only 1 brand of water another brand if only 1 brand of water increased in priceincreased in price
– GENERALLY, Brand price elasticity of GENERALLY, Brand price elasticity of demand is higher than market price demand is higher than market price elasticity of demandelasticity of demand
6666
Qd = a – bp
a,b are positive constants p is price
-b is the slopea/b is the choke price (price at which nothing is sold)
6767
the elasticity is
Q,P = (Q/p)(p/Q) = -b(P/Q)
Since the slope of the graph is –b.Therefore…elasticity falls from 0 to - along the linear demand curve, but slope is constant.
if Qd = 400 – 10p, and p = 30, Q,P = (-10)(30)/(100)
Q,P = -3 "elastic"
6868
D
Quantity per Period (billions of minutes)
Pric
e pe
r M
inut
e ($
)
0
.10
.20
.30
.40
.50
.60
.70
.80
.90
1.00
1.10
1 2 3 4 5 6 7 8 9 10 11
Elastic (ЄQ,P > 1)
Inelastic (ЄQ,P < 1)
Unit-elastic (ЄQ,P = 1)
Changes in Elasticity Along a Changes in Elasticity Along a Linear DemandLinear Demand
6969
The Relationship Between Price Elasticity of The Relationship Between Price Elasticity of Demand andDemand andTotal Revenues for Cellular Phone ServiceTotal Revenues for Cellular Phone Service
$1.10$1.10 0 0
1.001.00 1 1
.90.90 2 2
.80.80 3 3
.70.70 4 4
.60.60 5 5
.50.50 6 6
.40.40 7 7
.30.30 8 8
.20.20 9 9
.10.10 1010
Quantity Total Elasticity Price Demanded Revenue ЄQ,P
21.000
6.333
3.400
2.143
1.144
1.000
.692
.467
.294
.158
Elastic
Inelastic
Unit-elastic
00
1.01.0
1.81.8
2.42.4
2.82.8
3.03.0
3.03.0
2.82.8
2.42.4
1.81.8
1.01.0
7070
Qd = Ap or ln(Qd)=ln(A)+ Ln(p)
= elasticity of demand (must be negative)p = price
A = constant
Elasticity is constant, but the slope of demand falls from 0 to -.
7171
Quantity
Price
0 Q
P • Observed price and quantity
Constant elasticity demand curve
Linear demand curve
Example: A Constant Elasticity versus a Linear Demand Curve
7272
Elasticity of SupplyElasticity of Supply
Calculating elasticityCalculating elasticity
or
or
Sum of prices/2
Change in P
Sum of quantities/2
Change in QЄQs,P
Always use
the mid-point
formula
ЄQs,P
Change in Q(Q1 Q2)/2
Change in P(P1 P2)/2
ЄQs,P
QAvg.Q
PAvg.P
7373
One example of a Change in DemandOne example of a Change in Demand
Quantity (pizzas per hour)
Pri
ce (
dolla
rs p
er p
izza
)
10.00
40.00
D0
0 255 10 15 20
Sa Large price change and small quantity change
… a largeprice rise...
20.00
D1
30.00
13
An increasein demandbrings ...
… and a smallquantity increase
7474
Another example of a Change in DemandAnother example of a Change in Demand
Quantity (pizzas per hour)
Pri
ce (
dolla
rs p
er
pizz
a)
10.00
30.00
40.00
D0
0 255 10 15 20
Sb
Small price change and large quantity change
… a smallprice rise...
20.00
D1
An increasein demandbrings ...
21.00
… and a largequantity increase
7575
Elasticity of SupplyElasticity of Supply Elasticity of supply rangesElasticity of supply ranges
(from) Perfectly Elastic Supply (from) Perfectly Elastic Supply Quantity supplied falls to 0 when Quantity supplied falls to 0 when there is any decrease in pricethere is any decrease in price
(to) Perfectly Inelastic Supply(to) Perfectly Inelastic SupplyQuantity supplied is constant no Quantity supplied is constant no matter what happens to pricematter what happens to price
7676
Supply Elasticity Supply Elasticity Ranges Ranges
Pric
e
Quantity
SElasticity of supply = 0
0
Quantity supplied is the same for any
price!
Pric
eP
rice
QuantityQuantity
SS
Elasticity of supply =
00
Suppliers will offerANY quantity at this
price
7777
Elasticity of Supply: Elasticity of Supply: Depends On:Depends On:
1. Resource substitution possibilities, -The more unique the resource, the more
inelastic the supply.
2. Time frame for the supply decision, Momentary supply Long-run supply Short-run supply
- Typically, the longer producers have to adjust to a price change, the more elastic is supply.
7878
Long-Run Elasticity of Long-Run Elasticity of DemandDemand
-For -For most goodsmost goods, elasticity of demand is , elasticity of demand is greatergreater in in the long run (curves are “flatter”)the long run (curves are “flatter”)
People are more able to adjust to changes over People are more able to adjust to changes over time (slowly switch consumption)time (slowly switch consumption)
-For -For essential durable goods essential durable goods (ie: Cars), long-run (ie: Cars), long-run demand elasticity is demand elasticity is lessless (curves are “steeper”) (curves are “steeper”)
People can change their purchases or suppliers People can change their purchases or suppliers now, but eventually they have to buy new goods now, but eventually they have to buy new goods as old ones breakas old ones break
7979
Long-Run Elasticity of Long-Run Elasticity of SupplySupply
-For -For most goodsmost goods, elasticity of supply is , elasticity of supply is greatergreater in in the long run (curves are “flatter”)the long run (curves are “flatter”)
Firms are more able to adjust to changes over Firms are more able to adjust to changes over time (slowly switch production)time (slowly switch production)
-For -For reusable goods reusable goods (ie: Aluminum), long-run (ie: Aluminum), long-run supply elasticity is supply elasticity is lessless (curves are “steeper”) (curves are “steeper”)
People resell their supplies when prices go up, but People resell their supplies when prices go up, but eventually their supplies run outeventually their supplies run out
8080
S2
Quantity Supplied per Period
Pri
ce p
er
Un
it
S1
Qe
Pe
P1
As time passes, thesupply curve rotatesto S2 and then to S3and quantity suppliedrises first to Q1 and then to Q2
Supply Elasticity and the Long Supply Elasticity and the Long RunRun
(most non-durable, (most non-durable, non-essential goods)non-essential goods)
S3
Q2Q1
8181
When is the Long Run?When is the Long Run?
The long run is how long a consumer or The long run is how long a consumer or firm takes to fully adjust to a price changefirm takes to fully adjust to a price changeTime required to change ANY variableTime required to change ANY variableie) Give up Pepsi Vanilla, Build more cost ie) Give up Pepsi Vanilla, Build more cost
efficient Pepsi factory, secure a US Pepsi efficient Pepsi factory, secure a US Pepsi Vanilla supplierVanilla supplier
The short run is anything shorter than the The short run is anything shorter than the long runlong runAt least one variable cannot be changedAt least one variable cannot be changed
8282
Cross Price Elasticity of Cross Price Elasticity of DemandDemand Demand is affected by the price of substitutes and Demand is affected by the price of substitutes and
complimentscompliments– An increase in the price of a substitute increases An increase in the price of a substitute increases
demanddemand– An increase in the price of a complement decrease An increase in the price of a complement decrease
demanddemand This effect can be measured using cross price This effect can be measured using cross price
elasticityelasticity If the cross price elasticity is zero, the good is neither If the cross price elasticity is zero, the good is neither
a complement nor a substitutea complement nor a substitute
8383
Change in Price of Y
----------------------------
(Py1 + Py2)/2
/
Cross Price Elasticity of Cross Price Elasticity of DemandDemand
Percentage change in price of Y
Percentage change in quantity demanded of X
Qi,Pj
Є
Є Qi,Pj = Change in X
---------------
(X1 + X2)/2
Substitutes – Positive Cross Price Elasticity
Compliments – Negative Cross Price Elasticity
8484
Cross Price Elasticity of Demand Cross Price Elasticity of Demand ExampleExample
““Recent cat attacks have prompted cat Recent cat attacks have prompted cat owners to buy guns for self-defense”owners to buy guns for self-defense”
Originally, 2 Econ students owned a cat. After the Originally, 2 Econ students owned a cat. After the price of guns went from $100 to $200, only 1 Econ price of guns went from $100 to $200, only 1 Econ student owned a cat.student owned a cat.
Calculate the cross-price elasticity of demandCalculate the cross-price elasticity of demand
8585
Cross-Price ElasticityCross-Price Elasticity
ЄQ,P =P = $100
P1 + P2 ($100 + $200)
2
PJ =66% = $150
Q = -1
Q1 + Q2 (2 + 1)
2
Qi =-66% = 1.5
Are cats and guns substitutes or compliments?
-66%
66%= -1= ЄQi,Pj =
X 100
X 100
8686
Income Elasticity of DemandIncome Elasticity of Demand
Income Elasticity of demand refers Income Elasticity of demand refers to a HORIZONTAL SHIFT in the to a HORIZONTAL SHIFT in the demand curve resulting from an demand curve resulting from an income changeincome change
Price elasticity of demand refers to Price elasticity of demand refers to a MOVEMENT ALONG THE a MOVEMENT ALONG THE DEMAND CURVE in response to a DEMAND CURVE in response to a price changeprice change
8787
Change in M
----------------------------
(M1 + M2)/2
/
Income Elasticity of Income Elasticity of DemandDemand
Percentage change in income
Percentage change in quantity demandedQ,I
Є
Є Q,I= Change in Q
---------------
(Q1 + Q2)/2
Normal Good – Positive Shift/Elasticity
Inferior Good – Negative Shift/Elasticity
8888
Income Elasticity of Demand ExampleIncome Elasticity of Demand Example
In New Zealand, the average family will own 4 In New Zealand, the average family will own 4 Toyotas in their lifetime.Toyotas in their lifetime.
If average Kiwi family income rose from $140K to If average Kiwi family income rose from $140K to $160K a year, the average Kiwi family would own 2 $160K a year, the average Kiwi family would own 2 Toyotas over their lifetimeToyotas over their lifetime
Calculate Income Elasticity of Demand for Toyotas Calculate Income Elasticity of Demand for Toyotas in New Zealand.in New Zealand.
Are Toyotas normal or inferior goods in New Are Toyotas normal or inferior goods in New Zealand?Zealand?
8989
Income Elasticity of DemandIncome Elasticity of Demand
ЄQ,I =I = $20K
I1 + I2 ($140K + $160K)
2
I =13.3% = $150K
Q = -2
Q1 + Q2 (4 + 2)
2
Q =-66% = 3
In New Zealand, are Toyotas normal or inferior goods?Guess which brand is the luxury car.
-66%
13.3%= -5= ЄQi,Pj =
X 100
X 100
9090
Chapter 2 Key IdeasChapter 2 Key Ideas Supply and DemandSupply and Demand
Supply and Demand MovementsSupply and Demand Movements EquilibriumEquilibrium Elasticity of DemandElasticity of Demand
Total Revenue MaximizingTotal Revenue Maximizing Elasticity of SupplyElasticity of Supply Cross Price Elasticity of DemandCross Price Elasticity of Demand Income ElasticityIncome Elasticity
