Copy of Demand and Supply

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DEMAND



Market Demand Curve

A market demand curve isdefined as

the alternative quantities

of a good

that all consumers in aparticular market

are willing and able tobuy as price varies,

holding all other factorsconstant.

Qd

P

Demand Curve



Q f P holding cons t other factorsd ! ( tan )

Qd

P

Demand Curve

Change in Quantity Demanded(Movement Along a Demand Curve)

A movement along a demandcurve occurs when own pricechanges, holding constantother factors.

What are the other factors that we areholding constant?



The factors holding constant are:

the prices of other goods including substitutes andcomplements (PO),

aggregate consumer money income (M),

consumer population (POP), and

noneconomic factors including social, physiological,psychological, and demographic factors unique to theconsumers in the market (SPPD).

Q f P P O M P O P S P P Dd ! ( , , , )

Other Factors Affecting Demand



Change in Demand(Shift in the Position of the Demand Curve)

It is important to distinguish between:

a movement along a demand curve (change in quantitydemanded) and

a shift in the position of the demand curve (change indemand).

A movement along a demand curve occurs when own price

changes, holding constant PO, M, POP, and SPPD.

A shift in the demand curve occurs when we change one of those factors being held constant.



Shift in Demand: Population (POP)

Q d

P

With an increase in POP,the demand curve shiftsto the right.

With the demand curveshifting to the right, thequantity demandedincreases for all prices. $3

20 30Factors that leadconsumers to changedemand quantities at thesame price are referred to

as demand shifters.



Demand Shifter: Noneconomic Factor (SPPD)

Q d

P

Consider the consumptiontrend of moving away fromfoods that are perceived tobe high in fat and

cholesterol content.

This can be thought of as achange in one componentof the SPPD.

As a result of this changein the dietary habit of consumers, the demandfor red meat has shifted

to the left.

$3

20 30



Demand Shifter: Price of Other Good (PO)

How about an increase in one of the prices of other goods?

Well, it depends!

With an increase in the price of a substitute, the demand curveshifts to the right.

Qbeef

P beef As the price of muttonincreases, consumersdemand more beef eventhough the price of beef

does not change.

$3

20 30

This is because beef is nowrelatively more inexpensivecompared to mutton.



On the other hand, with an increase in the price of a

complement, the demand curve shifts to the left.

Qbutter

P butter

As the price of bread increases,

the demand for bread decreases.

Hence the demand for butter decreases even though theprice of butter stays the same.

$3

20 30

This is because butter is, ingeneral, complementary tobread.



Demand Shifter: Money Income (M)

How about an increase in income?

Again, it depends!

In most cases, an increase in income shifts the demandcurve to the right.

Q d

P This is consistent with the

idea that as income increasespeople buy more of the

products.

In this case, the good iscalled a normal good.

$3

20 30



A few commodities such as dry beans and potato

are called inferior goods.

As income increases consumers

tend to buy less of the inferior goods as they can now affordmore expensive normal goods.

That is, an increase in

income shifts the demandcurve for an inferior good tothe left.

Q d

P

$3

20 30



Slope of a Demand Curve

P

Qd

Demand Curve

sloperise

run|

( P

( Qd From the definition, theslope of a demand curve isthe change in price dividedby change in quantitydemanded:

slope of demand curve

P

Qd

!(

(< or = 0



Measuring Responsiveness

It is often of useful to have ameasure of how "responsive"demand is to some change inown price.

T hat is sponsiveQ

P d : R e !

(

(

Now the first idea that springs to mind is to use the inverse of the slope of a demand curve as a measure of responsiveness.

After all, the definition of theslope of a demand curve isthe change in price dividedby change in quantitydemanded:

slope of demand curve

P

Qd

!(

(

P

Qd

Demand Curve

( P

( Qd



The Own-PriceElasticity of Demand I I Q P d ,

The own-price elasticity of demand, , is defined as thepercent change in quantity demanded divided by thepercent change in own price.

I

A 10 percent increase in price is the same percentageincrease whether the price is measured in Americandollars or English pounds.

Thus, measuring increases in percentage terms keepsthe definition of elasticity unit-free.

I | ! !%

%

(

(

(

(

(

(

in Q

in P

Q

Q

P

P

Q

P

P

Q

d

d

d d

d

5%

10%

0.5%

1%



I | !%

%

(

(( (

in Q

in p

d % in Q associated with 1% in Pd

A convenient way to think of an own-price elasticity of demand is as the percentage change in quantity demandedcorresponding to a one percentage change in own price,holding other factors constant.

I | !30%

5%

(

(( (

in Q

in p

d 6% in Q associated with 1% in Pd



Own-Price Elastic VS. Inelastic

A 1% increase in the price of the good will causea 0.5% reduction in the demand quantity.

I = - 0.5

I ! 0 5. Good 1

I = - 1.5

I ! 15.


Good 2

Which of the two goods is more own-price elastic?

Good 2 is more own-price elastic. The absolutevalue of its own price elasticity is larger than that

pertains to good 1.




I = - 0.5

I !0

5.This good is own-price inelastic.

I = - 1.5

I ! 15.


This good is own-price elastic.

I = - 1.0

I ! 1 0.

A 1% increase in the price of the good will causea 1% reduction in the demand quantity.

The elasticity is unitary.

Own-Price Elastic VS. Inelastic



I |

(

(

Q

Q

P

P

d

d

I ! !

! e

(

(

(

(

Q

Q

P

P

Q

P

P

Q

Slope of the d e and curve

P

Q

d

d d

d

d

*

*1

0

Computing Own-Price Elasticity

1

slope

The own-price elasticity of demand can beexpressed as the product of the inverse of theslope of the demand curve and the ratio of ownprice to quantity.



Notice that the flatter the demand curve, the larger in

absolute value is (that is, the more price elastic is the

demand).

The flatter the demand curve, the smaller in absolute

value is the slope, (e.g., - 2, instead of - 4).

Hence, the flatter the demand curve, the larger in

absolute value is the inverse of the slope,

(e.g., - 0.5, instead of - 0.25).

Hence

I ! !(

(

Q

P

P

Q Slope of the demand curve

P

Q

d

d d

* *1

I

(

(

Q

P

d ,

(

(

P

Qd

,



P

Qd

P

Qd

The flatter the demand curve, the more price elasticis the demand.

flatter steeper

The flatter the demandcurve, the more roomthere is for the quantityto adjustment.

Hence, the flatter thedemand curve, the moreresponsive is the quantityto a price change.



P

Qd

P

Qd

slope = - 0 slope = - infinity

elasticity = - infinity elasticity = - 0

Perfectly Elastic Perfectly Inelastic

I ! !(

(

Q

P

P


P

Q

d

d d

* *1

The flatter the demand curve, the more price elastic is the demand.



Own price elasticity is definedfor a point on the demandcurve and, in general, theelasticity coefficient variesalong the demand curve.

I ! !(

(

Q

P

P


P

Q

d

d d

* *1

For example, consider a linear demand curve:

Q d

P

Along the curve, the slope stays the same, but P andQd change as we move along the demand curve.

Hence, the elasticity coefficient changes as we movealong the demand curve.



Evaluating Price Elasticity at a SamplePoint

Since the elasticity coefficient varies along a demand curve,It is not technically correct to say that the demand for acommodity is own-price elastic or inelastic.

That is, demand is price elastic or inelastic onlywithin some range of the data.

In making empirical computations, a common procedure isto evaluate the price elasticity of demand at the mean of the

data.

I !(

(

Q

P

P

Q

d

d

*where are the

price and quantity evaluated at

the mean of the data.

P and Qd



In-Class Exercise 1-a

Consider the f ollowing demand equation f or beef products:Q

The sample means of the variables are:

Q

beef

beef

!

! !

! ! ! !

001 05 003 001 004 001

2 3

5 4 20 250

. . . . . .

, ,

, , ,

P P P M S PPD

P

P P M S PPD

beef pork chicken

beef

pork chicken

Write down the formula for own price elasticity of demand for beef.

Compute the own price elasticity of demand for beef (evaluating atthe sample means). Is the demand own price elastic or inelastic?

Suppose the price of beef is projected to decrease by 2% nextmonth, what would be the percentage change in Qbeef (demand)?



SUPPLY



Factors Determining Supply

What are the factors determining supply quantity?

It depends on the output price (P).

It depends on the input prices (PI).

It depends on the price of alternative output (PO).

This is the opportunity costs of not producing other commodities.

It also depends on such noneconomic factors ascapacity, technology, and weather that firms face (CAP).

Q f P PI PO CAP s!

( , , , )



Supply Curve

A supply curve is the relationship between quantitysupplied for a good (Qs) and its price (P), holdingconstant other factors.

The factors which we are holdingconstant include: input prices (PI),prices of alternative outputs (PO),and noneconomic factors (CAP).

SupplyShifters

Q f P PI PO CAP s ! ( , , )



Change in Quantity Supplied(Movement Along a Supply Curve)

Qs

PSupply Curve

Q f P P I PO CAP s ! ( , , )

Notice that the supplycurve has a positiveslope.

slope of supply cur ve

! u(

(

P

Qs

0

That is, as priceincreases, the quantitysupplied moves up

along the supply curve.

P'

Qs

'

P"

Qs

"

( P

( Qs



Change in Supply(Shift in the Position of the Supply Curve)

It is important to distinguish between:

a movement along a supply curve (change in quantitysupplied) and

a shift in the position of the supply curve (change insupply).

A movement along a supply curve occurs when output

price changes, holding constant PI, PO, and CAP.

A shift in the supply curve occurs when we change one of those factors being held constant.



Shift in Supply: Input Prices (PI)

Q s

P With a decrease in inputprices, the supply curveshifts to the right.

With the supply curveshifting to the right, thequantity supplied increasesfor all levels of output price.

$3

20 30Factors that leadproducers to changesupply quantities at thesame price are referred to

as supply shifters.



Shift in Supply: Alternative OutputPrices (PO)

Q s

P With a decrease in alternativeoutput prices, the supply curve for the commodity in question shifts

to the right.

$3

20 30

For example, a decrease insorghum price means that the landand labor used in sorghumproduction will now be less

profitable than if used in wheatproduction.

Hence, a decrease in sorghumprice shifts the supply curve of

wheat to the right.



Q s

P

An improvement in

technology is defined assomething that enables firmsto produce more output withthe same quantity of inputs aspreviously.

Thus, with improvedtechnology, the supply curveshifts to the right.

$3

20 30

Shift in Supply: Technology (CAP)



( P

( Qs


! u(

(

P

Qs

0

The Own Price Elasticity of SupplyI Q ps ,

The price elasticity of supply, , is defined to be the

percent change in quantity supplied divided by the percent

change in the output price.

I Q ps ,

I Q P

s s

s

s

s

in Q

in P

Q

P

P

Q

P

Q

,

%

%| !

!

u

(

(

(

(

1

0


P

Qs

Supply Curve



I Q P

s s

s

s

s

in Q

in P

Q

P

P

Q

P

Q

,

%

%| !

!

(

(

(

(

1


A convenient way to think of a price elasticity of supply isas the percentage change in quantity suppliedcorresponding to a one percentage change in output price,holding other factors constant.



Notice that the flatter the supply curve, the larger is

(that is, the more price elastic is the supply).

The flatter the supply curve, the smaller is the slope,(e.g., 2, instead of 4).

Hence, the flatter the supply curve, the larger is the

inverse of the slope, (e.g., 0.5, instead of 0.25).

Hence

(

(

Q

P

s

,

(

(

P

Qs,

I Q P

s

s ss

Q

P

P

Q

P

Q, | !(

(

1


I Q ps ,



The flatter the supply curve, the more price elastic isthe supply.

P

Qs

P

Qs

flatter

steeper

The flatter the supplycurve, the more roomthere is for the quantityto adjustment.

Hence, the flatter the supplycurve, the more responsiveis the quantity to a pricechange.



P

Qd

P

Qd

slope = 0 slope = infinity

elasticity = infinity elasticity = 0

Perfectly Elastic Perfectly Inelastic

The flatter the supply curve, the more price elastic is the supply.

I Q P

s

s ss

Q

P

P

Q

P

Q, | !(

(

1




Own Price Elastic VS. Inelastic

A 1% increase in the output price will cause a0.5% increase in the supply quantity.

I = 0.5

I = 1.

5A 1% increase in the output price will cause a

1.5% increase in the supply quantity.

The supply is own price inelastic.

The supply is own price elastic.



EQUILIBRIUM



Price Determination

P

Qd, Qs

Supply

Demand

Now, we examine how theequilibrium price is determined.

Equilibrium implies "equal,"

"balanced," and "stable."

The concept of equilibriumprice is simply the price atwhich quantity demanded

equals quantity supplied.

Thus, the intersection point of the demand and supply curvesindicates the equilibrium price.

P*

Q*



Disequilibrium

In a perfectly competitivemarket, prices other than theequilibrium price cannot besustained.

At prices above the equilibriumprice, we have a situation calledexcess supply.

This is because the quantitythat consumers are willing tobuy is less than the quantityproducers are willing to sell.

P

Qd, Qs

Supply

Demand

P*

Q*

P'excess supply

Some or all producers willbegin to offer their products ata lower price.

The lower price discourages

some supply and encouragesadditional demand.

The process continues untilprice is driven down to P*, at

which point Qd = Qs.

Or May be we canexport the excesssupplies to a

foreign market!



Disequilibrium

On the other hand, at pricesbelow the equilibrium price, wehave a situation called excessdemand.

This is because the quantitythat consumers are willing tobuy is more than the quantityproducers are willing to sell.

P

Qd, Qs

Supply

Demand

P*

Q*

P'excess demand

In this case, consumerswill begin bidding up theprice.

The higher price discouragessome demand and encouragesadditional supply.

The process continues until

price is driven driven to P*, atwhich point Qd = Qs.

Accordingly, only the equilibriumprice can be sustained.

Or May be we cansatisfy the excessdemand through

imports from aforeign market!



In-Class Exercise 1-c (i)

Consider the f ollowing demand equation f or beef products:

Qbeef

d

beef pork chickenP P P M S PPD! 001 05 003 001 004 001. . . . . .

Consider the following supply equation for beef products:

Qbeef

s!

1231 02 008 0007 000

5002

. . . . . .P P P P CAPbeef pork beans corn

Forecasts are obtained for the demand and supply shifters:

+ 0.03 (5) + 0.01 (4) + 0.04 (20) + 0.01 (250)

- 0.08 (5) - 0.007 (3) - 0.005 (2) + 0.02 (30)

= + 3.49

= + 0.169

effect of demand shifters effect of supply shifters



In-Class Exercise 1-c (ii)

Consider the f ollowing demand equation f or beef products:

Qbeef

d

beef pork chickenP P P M S PPD! 001 05 003 001 004 001. . . . . .

Consider the following supply equation for beef products:

Qbeef

s!

1231 02 008 0007 000

5002

. . . . . .P P P P CAPbeef pork beans corn

+ 3.49

+ 0.169

The demand equation can be written as:

Qbeef

d

beef P ! 350 05. .

The supply equation can bewritten as:

Qbeef

s! 140 02. . P beef

What wouldhappen to thedemand

equation if there is anincrease inconsumer income?



In-Class Exercise 1-c (iii)

The demand equation is:

Qbeef d

beef P ! 350 05. .

The supply equation is:

Qbeef s ! 140 02. . P beef

P

Qd, Qs

Supply

Demand

P*

Q*

Graphically solve for the equilibrium price and quantity.

Algebraically solve for the equilibrium price and quantity.



Work Space for In-Class Exercise 1-c (i)

The demand equation is:Qbeef

d

beef P ! 350 05. .

The supply equation is:Qbeef

s! 140 02. . P beef

The equilibrium condition is:

Q Qbeef beef d s!

3.50 - 0.5 Pbeef = 1.40 + 0.2 Pbeef

Pbeef = 3

Qdbeef = 3.5 - 0.5 (3) = 2

Qs

beef = 1.4 + 0.2 (3) = 2



Work Space for In-Class Exercise 1-c (ii)


d

beef P ! 350 05. .


Qbeef

s!

140 02. .

P beef

If Pbeef = 0, then Qdbeef = 3.5

If Qdbeef = 0, then Pbeef = 7

(P,Q) = (0, 3.5)

(P,Q) = (7, 0)

If Pbeef = 0, then Qsbeef = 1.4

If Qsbeef = 0, then Pbeef = -7

(P,Q) = (0, 1.4)

(P,Q) = (-7, 0)



Work Space for In-Class Exercise 1-c(iii)


d

beef P ! 350 05. .


Qbeef

s!

140 02. .

P beef

(P,Q) = (0, 3.5)

(P,Q) = (7, 0)

(P,Q) = (0, 1.4)

(P,Q) = (-7, 0)

P

Q

7

-7

1.4 3.5



END OF

LECTURE

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