Supply & Demand cont.

How do supply and demand work together?

PRICING….

…is determined by the pressure that is created between suppliers and consumers.

…where they interact determines the price of a good or service.

…consumers want to purchase high quality g/s @ lowest possible price

…suppliers want to sell g/s @ highest possible price

Equilibrium

The point where consumers will buy the amount suppliers will produce at the same price is called….(the point where they intersect) - labeled e1

EQUILIBRIUM

Important information..

– indicates the market clearing price.– indicated the market clearing quantity exchanged

– will remain the same as long as the determinants of supply and demand remain constant

– If either the supply or demand curve change, so will the equilibrium price

When not in equilibrium:When not in equilibrium:

SURPLUS

Price is higher than equilibrium price

SURPLUS

Price is higher than equilibrium price

SHORTAGE

Price is lower than equilibrium price

SHORTAGE

Price is lower than equilibrium price

SURPLUSSURPLUS

Quantity supplied is higher than the quantity demanded

Quantity supplied is higher than the quantity demanded

SHORTAGESHORTAGE

Quantity demanded is greater than quantity supplied

Quantity demanded is greater than quantity supplied

When would equilibrium change?

When there is a shift in supply or demand

Steps to predict how shifts change equilibrium…

1. Determine whether event will cause change in supply or change in demand (usually not both)

2. Does it shift right or left? Increase or decrease in supply or demand for product?

Demand Shifts

Supply shift

What happens when e1 moves to e2?What happens when e1 moves to e2?

The price changes, but how does quantity demanded change?

If the quantity demanded changes, how does the price change?

The price changes, but how does quantity demanded change?

If the quantity demanded changes, how does the price change?

Price Elasticity…..Price Elasticity…..

A measure of responsiveness to price changes

Measures how much quantity demanded changes based on a change in price

A measure of responsiveness to price changes

Measures how much quantity demanded changes based on a change in price

Price elasticity of demandPrice elasticity of demand

Elastic - change in price=large change in

quantity demanded

Inelastic -change price=very small change

in quantity demanded

Elastic - change in price=large change in

quantity demanded

Inelastic -change price=very small change

in quantity demanded

Calculating ElasticityCalculating Elasticity

E=(New quantity demanded-Old quantity demanded)/Old quantity demanded (New price - Old price)/Old price

E=(New quantity demanded-Old quantity demanded)/Old quantity demanded (New price - Old price)/Old price

Example:Old price = $4.00 Old quantity demanded = 8New price = $6.00 New quantity demanded = 6

E = (6 - 8)/8 E= -2/8 E= -.25 E= -.5 E= .5(6 - 4)/4 2/4 .5 (cancel neg. by multiplying by -1)

What does the calculation mean?What does the calculation mean?

E = <1

inelastic

E = <1

inelastic

E = >1

elastic

E = >1

elastic

E = 1

unit elastic

What does all of this mean? What does the elasticity really mean to us?

How volatile is the change in demand when price moves?

Ex 1. A hotdog vendor increases the price of hotdogs a

small amount, and sales decrease a large amount.

What type of elasticity?

Ex 2.A gas station owner increased their price by a large amount, yet consumers still purchased the same amount of gas.

What type of elasticity?

Being Perfect means…Being Perfect means…

Unique good that are completely unaffected by price changes

Unique good that are completely unaffected by price changes

Goods very sensitive to price

TOTAL REVENUETOTAL REVENUE

TR = PRICE x QUANTITY cost of good = $5, sells 15 units TR = $5 x 15 or TR = $75

A measure of how much a company earns from the sale of its goods and services

Price change vs. Total Revenue

Price change vs. Total Revenue

PRICE Qty. SOLD TR

$10 25 $250

$20 20 $400

$30 15 $450

$40 10 $400

$50 5 $250

What do you notice? Does higher price mean more TR?

Does more items sold mean higher TR?

ELASTICITY & TOTAL REVENUE

ELASTICITY & TOTAL REVENUE

The affect of elasticity and TR:

Inelastic (<1) : -increasing the price will not have a large effect on the quantity demanded of the g/s. -If the price increases, total revenue will also increase

*goods for which demand is inelastic experience total revenue increase when prices rise

Elastic (>1) : -increasing the price WILL have an effect on the quantity demanded for the g/s-increasing the price will cause total revenue to decrease

Unit elasticity (=1) : - price increases, quantity demanded increases same amount.-total revenue remains the same

Question:

Prescription drugs represents which type of elasticity/total revenue relationship?

Answer:Inelastic

Why-viewed as necessity

G/S viewed as not necessity - elastic

How can equilibrium be out of consumer/suppliers

control?

If the equilibrium price is considered to high to efficiently allocate g/s in a socially or politically desirable way…the government may decide to hold prices up/down at a certain level.

Price Flooring

Prevent prices from falling too low

A minimum price set by gov’t

Price usually above equilibrium price

Price is higher than demnd, yet quantity supplied is higher…creating “surplus”

Price Ceiling

The maximum price a supplier can charge

Lower price; not enough quantity supplied

Becomes permanent “shortage”

Gov’t controlled Gov’t doesn’t want prices to

go too high

What was created because of this??