Supply, Demand, and the Price System

Quick Review – the following information should be in your notes already.

Elasticity – a measure of responsiveness to price.

Elastic demand – consumers are very sensitive to price changes.

Inelastic Demand – consumers show a relatively small response to price changes.

Unit elastic – consumers show a proportional response to price changes.

Determinants of demand elasticity.Urgent?Amount of income requiredAre there substitutes?

Determinant of Supply Elasticity

How fast can suppliers respond?

Supply ShiftersCost of inputsTaxes and SubsidiesProductivityTechnologyNumber of Suppliers

Government Regulations

Expectations

Change / Shift in Supply

P

Q

S1S2

Change in quantity supplied

P1

P2

Q1 Q2

S

Change In Demand

P

Q

D1 D2

Demand ShiftersConsumer TastesConsumer IncomeConsumer ExpectationsNumber of ConsumersExpectationsSubstitutes / Complements

Change in Quantity Demanded

P1

P2

D

Q2 Q1

Equilibrium Price

Market Clearing Price

Supply is equal to demand

Surplus

S

D

P1

QsQd

ShortageS

D

P

Qs Qd

Two Types of Price Controls

Price Ceilings

Price Floors

Price ceilings and price floors distort market outcomes.

Price ceiling – rent control

If a price ceiling is lower than the natural market clearing price, a shortage occurs.

ShortageS

D

P $1200

Qs Qd

1000 2000

If a price floor is higher than the market clearing price, a surplus will occur.

Surplus of Labor

S

D

P $10.00

QsQd

Price Supports