Download - Chapter 2 Demand and Supply Updated - Weebly · 2019. 8. 6. · quantity demand ! Demand v. quantity demanded: ! Quantity demanded refers to the relationship that is determined by

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CIA4U Ms. Schirk

CHAPTER 2: DEMAND AND SUPPLY

¡  A market can be: §  A physical place where goods are bought and sold §  A collective reference to all the buyers and sellers

of a particular good and service §  The demand that exists for a particular good or

service §  The process by which a buyer and seller arrive at a

mutually acceptable price and quantity ¡  Market and economy are NOT synonymous

2.3 THE MARKET

¡  Demand: quantity of a good or service that buyers will purchase at various prices during a given period of time §  Must have the desire and ability to purchase (so

demand only exists for those good that you both want and are able to afford)

¡  Law of demand: the quantity demand varies inversely with price, as long as other things do not change

¡  Ceteris paribus: meaning “other things remaining the same”

2.1 DEMAND

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¡  Why is the law of demand true? §  Substitution effect: as the price of a particular good

rises, we tend to substitute similar goods for it §  E.g. buying no-name cola instead of Coca-Cola

when the price of the brand name rises, or buying the brand name instead of no-name when the price of Coca-Cola falls

§  Income effect: consumer income is fixed, so a rise in price limits the quantity they can purchase while a fall in price increases it §  Real income: income measured in terms of the

amount of goods or services that it can buy

2.1 DEMAND

¡  Why is the law of demand true? (continued) §  Law of diminishing marginal utility: as a person

increases consumption of a product (while keeping consumption of other products constant) there is a decline in the marginal utility (increased usefulness or satisfaction) that person receives from consuming each additional unit of that product §  E.g. a buffet

2.1 DEMAND

¡  Demand schedule: a numerical tabulation (usually a table) of the relationship between price and quantity demand

¡  Demand v. quantity demanded: §  Quantity demanded refers to the relationship that is

determined by price and is represented by a movement along the curve

§  Demand is affected by many other things, called demand determinants, and is represented by a shift of the curve

2.1 DEMAND

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2.1 DEMAND

If the price of t-shirts were… The consumer would buy in a given time period

(quantity demanded)…

$20 4 t-shirts

$24 3 t-shirts

$28 2 t-shirts

$32 1 t-shirt

$36 0 t-shirts

¡  Individual Demand:

¡  Demand curve: curved or straight line that graphically depicts the relationship between price and quantity demanded §  Downward sloping because of the inverse

relationship between the two variable §  X-axis is always quantity demanded §  Y-axis is always price

2.1 DEMAND

P

P

QD

QD

¡  Demand curve:

2.1 DEMAND

Pric

e

Quantity

D

P$

Q 0

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¡  Demand curve:

2.1 DEMAND

¡  Market demand schedule: considers the sum total of all the consumer demands for a product

2.1 DEMAND

Price of t-shirt

Buyer 1

Buyer 2

Buyer 3

Buyer 4

Total quantity demanded

$20 4 3 5 4 16 $24 3 2 4 3 12 $28 2 1 3 2 8 $32 1 0 2 1 4 $36 0 0 0 0 0

¡  Market demand:

2.1 DEMAND

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¡  Supply: the quantities that sellers will offer for sale at various prices during a given period of time §  Suppliers react to prices opposite of consumers:

when prices rise, they want to supply more (while consumers want to purchase less) because they are driven by profit

¡  Law of supply: the quantity supplied will increase if price increases and fall if prices falls, as long as other things do not change

2.2 SUPPLY

¡  Supply schedule: a table showing the quantity of products supplied at various prices (though not actually sold)

2.2 SUPPLY

If the price of t-shirts were…

The seller would like to sell in a given time period (quantity supplied)…

$20 0 t-shirts

$24 4 t-shirts

$28 8 t-shirts

$32 12 t-shirt

$36 16 t-shirts

¡  Supply v. quantity supplied: §  A change in the price level cannot change the

supply; it does, however, lead to a change in the quantity that a producer is willing and able to make available (hence a change in quantity supplied)

§  Quantity supplied refers to one relationship that is determined by price

§  Supply refers to the whole series of price and quantity relationships which are affected by supply determinants

2.1 SUPPLY

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¡  Supply curve: curved or straight line that graphically depicts the relationship between price and quantity supplied §  Upward sloping because of the direct relationship

between the two variables §  X-axis is always quantity supplied §  Y-axis is always price

2.2 SUPPLY

¡  Supply curve:

2.2 INDIVIDUAL SUPPLY

Pric

e

Quantity

S

P$

Q 0

¡  Market supply schedule: considers the sum total of all the consumer demands for a product §  Market supply curve is upward sloping because as

price increases, current producers will produce more AND new firms will enter the market

2.2 SUPPLY

Price of t-shirt

Buyer 1 Buyer 2 Buyer 3 Buyer 4 Total quantity supplied

$20 0 0 0 0 0 $24 1 0 2 1 4 $28 2 1 3 2 8 $32 3 2 4 3 12 $36 4 3 5 4 16

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¡  Market supply:

2.2 SUPPLY

2.4 MARKET EQUILIBRIUM

Price of t-shirt

Market Demand

Market Supply

Shortage/Surplus

$20 16 0 -16

$24 12 4 -8

$28 8 8 0

$32 4 12 +8

$36 0 16 +16

¡  Equilibrium price: price at which no shortage or surplus occurs §  No tendency for it change (i.e., it is stable) §  The only acceptable compromise for sellers who

wan the highest price and consumers who want the lowest price

§  Price above equilibrium: surplus of goods §  Price below equilibrium: shortage of goods


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¡  Why is the equilibrium price stable? §  When a product is in surplus:

§  There is excess supply §  Price is pushed down

§  When a product is in shortage: §  There is excess demand §  Price is pushed up



¡  Changes in demand: § are shown by shifts in the demand curve § are caused by changes in demand determinants § Occur when the ceterius paribus assumption is not

maintained

2.5 CHANGE IN DEMAND

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0 1 3 5 7 9 11 13

Quantity Demanded (millions of kg per year)

Market Demand Curve for Strawberries

Market Demand Schedule for Strawberries

Quantity Demanded (millions of kg)

Price ($ per kg)

2.50

2.00

1.50

5

7 9 11

7 9

9 11 13

Pric

e ($

per

kg)

0.50

1.00

1.50

2.00

2.50

D0 D1 D2

(D2) (D0) (D1)

¡  Demand determinants include the following factors: § The number of buyers: an increase causes a

rightward demand shift (direct relationship) § Consumer incomes § For normal products, an increase causes a

rightward demand shift (direct relationship) § For inferior products, an increase causes a

leftward demand shift (inverse relationship)


¡ Demand determinants (continued): § Prices of related products § For substitute (or competitive) products, a rise in

the other product’s price causes a rightward demand shift.

§ For complementary products (which must be used together), a rise in the other product’s price causes a leftward demand shift.

§ Consumer preferences § Consumer expectations


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§ Change in equilibrium: § A rightward demand shift pushes up both

equilibrium price and quantity. § A leftward demand shift pushes down both

equilibrium price and quantity.



0 1 3 5 7 9 11 13

Quantity (millions of kg per year)

Market Demand and Supply Curves for Strawberries

Pric

e ($

per

kg)

1.00

1.50

2.00

2.50

3.00 S

D0

15

a

3.00

2.50

2.00

1.50

1.00

Market Demand and Supply Schedules for Strawberries

Price Quantities

(D0) (D1) (S) ($ per kg.) (millions of kg)

D1

b

shortage 5

7

9

11

13

9

11

13

15

17

13

11

9

7

5 17

§ Changes in supply: § are shown by shifts in the supply curve § are caused by changes in supply determinants § Also affect the ceterius paribus assumption

2.6 CHANGE IN SUPPLY

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Market Supply Schedule for Strawberries

Quantity Supplied (millions of kg)

Price ($ per kg)

2.50

2.00

1.50

11

7 9 11

13 15

3 5 9

S0 S1 S2

Market Supply Curve for Strawberries

0 1 3 5 7 9 11 13

Quantity Demanded (millions of kg per year)

Pric

e ($

per

kg)

0.50

1.00

1.50

2.00

2.50

15

(S2) (S0) (S1)

§ Supply determinants include the following factors: § Number of producers (an increase causes a

rightward supply shift) § Resource prices (an increase causes a leftward

supply shift) § State of technology (an improvement causes a

rightward supply shift) § Prices of related products (an increase causes a

leftward supply shift)


§ Supply determinants (continued): § producer expectations (an expectation of lower

prices in the future causes an immediate rightward supply shift)

§ changes in nature (an improvement causes a rightward shift for some products)


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§ Change in equilibrium: § A rightward supply shift pushes equilibrium price

down and equilibrium quantity up. § A leftward supply shift pushes equilibrium price up

and equilibrium quantity down.



0 1 3 5 7 9 11 13

Quantity (millions of kg per year)

Market Demand and Supply Curves for Strawberries

Pric

e ($

per

kg)

1.00

1.50

2.00

2.50

3.00 S0

D0

15

3.00 2.50 2.00 1.50 1.00

Market Demand and Supply Schedules for Strawberries

Price Quantities

($ per kg) (millions of kg)

5

7

9

11

13

13

11

9

7

5

17

15

13

11

9 17

S1

a

b

(D0) (S0) (S1)

Surplus

§ Price elasticity of demand: § the responsiveness of a product’s quantity

demanded to a change in its price § Elastic demand: demand for which a percentage

change in a product’s price causes a larger percentage change in quantity demanded

§ Inelastic demand: demand for which a percentage change in a product’s price causes a smaller percentage change in quantity demanded

2.7 ELASTICITY OF DEMAND

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¡ Price elasticity of demand (continued): § How to measure basic increases/decreases in demand or

price: § During winter, an ice cream vendor raises her price from

$2.00 to $2.40 § % change = P2 – P1 / P1 §  = [($2.40 - $2.00)/$2.00] x 100% §  = 0.20 x 100% §  = 20% (therefore 20% increase)

§ Demand drops from 1000 to 500 cones § % change = D2 – D1 / D1 §  = [(500 - 1000)/1000] x 100% §  = -0.50 x 100% §  = -50% (therefore 50% decrease)

§ The percentage decline in demand is greater than the percentage increase in price, so demand is elastic



¡ Price elasticity of demand (continued): § How to measure basic increases/decreases in demand

or price: § During the summer, an ice cream vendor raises her

price from $2.00 to $2.40 § % change = 20% (therefore 20% increase)

§ Demand decreases from 2000 to 1800 cones § % change = D2 – D1 / D1

§  = [1800 - 2000)/2000] x 100% §  = -0.10 x 100% §  = -10% (therefore 10% decrease)

§ The percentage decline in demand is less than the percentage increase in price, so demand is inelastic


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¡ Price elasticity of demand (continued): § Perfectly elastic demand: demand for which a

product’s price remains the constant regardless of quantity demanded § E.g. A soybean farmer is a price-taker, as he has

no influence over the market price of soybeans § Perfectly inelastic demand: demand for which a

product’s quantity demanded remains the constant regardless of price § E.g. Insulin is essential for a diabetic, who will be

willing to pay any price for it



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§ Effect on total revenue: § Total revenue: total income earned from a product § TR = P x Qd

§ If a supplier raises his prices, that higher price itself raises the supplier’s revenue, BUT the decrease in demand has the opposite effect § Price elasticity of demand determines which of

these has the bigger effect on total revenue: increase in price or decrease in quantity demanded


§ Effect on total revenue (continued): § Elastic demand: § Price increase of a certain percentage causes an

even bigger percentage decrease in Qdà TR is reduced

§ Price decrease of a certain percentage causes an even bigger percentage increase in Qd à TR is reduced

§ Inverse relationship between P and TR


§ Effect on total revenue (continued): § Elastic demand (continued): §  Blockbuster Videos


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§ Effect on total revenue (continued): § Inelastic demand: § Increase in price levels leads to a smaller

percentage decrease in Qdà TR increases § Decrease in price levels leads to a smaller

percentage increase in Qdà TR decreases § Direct relationship between P and TR


§ Effect on total revenue (continued): § Inelastic demand: § Amusement park rides:


§ Effect on total revenue (continued): § Unit elastic demand: § Demand for which a percentage change in price

causes an equal change in quantity demanded


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§ Factors affecting price elasticity of demand: § Portion of consumer incomes: if the price

represents a hefty portion of consumer incomes, they will be more responsive to price changes

§ Access to substitutes: if there are many close substitutes, consumers will be more responsive to changes

§ Necessities v. luxuries: necessities have inelastic demand while luxuries (which are expendable) tend to have elastic demand

§ Time: demand tends to become elastic over time



Coefficient of demand elasticity

% change in quantity demanded

% change in price =

ed Δ Qd ÷ Avg Q Δ P ÷ Avg P

=

Effect of the change

Cause of the change

Note: Use averages

§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 1st: Calculate % change in price: § % change = P2 – P1 / Paverage

§  = $0.54 - $0.50 / [(0.54 + 0.50)/2] §  = $0.04 / $0.52 §  = 0.0769 à 7.69%


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§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 2nd: Calculate % change in quantity demanded: § % change = Qd2 – Qd1 / Qd average

§  = 9.5m – 10m / [(9.5m + 10m)/2] §  = -0.5m / 9.75 §  = 0.05128 à 5.13%


§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 3rd: Use % changes in P and Qd to find coefficient: § ed = Δ Qd / Δ Pd

§  = 5.13% / 7.69% §  = 0.667 or 0.67


Note: It is no longer a concern whether Qd is negative since we are interested in the amount of change, not the direction.

§ E.g. A gas station sells 10 million litres of gasoline a month at a price of $0.50 per litre. If the owners raise their price to $0.54 per litre, the quantity demanded falls to 9.5 million litres. Determine the coefficient of demand elasticity. § 4th: Use coefficient to make a conclusion. § Less than one: inelastic coefficient § Greater than one: elastic coefficient


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§ Price elasticity of supply: § the responsiveness of a product’s quantity supplied

to a change in price § Elastic supply: supply for which a percentage

change in a product’s price cause a larger percentage change in quantity (suppliers are responsive to change)

§ Inelastic supply: supply for which the percentage change in a product’s price causes a smaller percentage change in quantity supplied (suppliers are not as responsive to change)

2.8 ELASTICITY OF SUPPLY

§ Factors that affect the price elasticity of supply: § Short run: the production period during which none

of the resources required to make a product can be varied § Supply is said to be perfectly inelastic (supply for

which a product’s quantity supplied remains constant regardless of price)

§ E.g. Price of strawberries rises in response to sudden increase in demand for strawberries in April, but farmers cannot increase production


§ Factors that affect the price elasticity of supply: § Intermediate run: production period during which at

least one of the resources required to make a product cannot be varied § E.g. Price of strawberries rises in response to

increase in demand for strawberries in a particular growing season; farmers can add more labour, but they cannot bring more land into production


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§ Factors that affect the price elasticity of supply: § Long run: the production period during which all

resources required to make a product can be varied, and businesses can enter or leave the industry

§ Constant-cost industry: an industry that is not a major user of any single resource

§ Perfectly elastic supply: supply for which a product’s price remains constant

§ Increasing-cost industry: an industry that is a major user of at least one resource


§ Calculating the price elasticity of supply § Similar to calculating the price elasticity of demand


Coefficient of demand elasticity

% change in quantity supplied

% change in price =

es Δ Qs / average Qs Δ P / average P

=

Effect of the change

Cause of the change

Note: Use averages

§ E.g. When the price of tomatoes rises from $2 to $3 a kg, the quantity supplied by farmers increases from 100,000 to 200,000 kg. § es = Δ Qs / average Qs

§  = (200,000 – 100,000) / [(200,000 + 100,000)/2] §  = 100,000 / 150,000 $1 / $2.50 = 0.667


Δ P / average P

($3 - $2) / [($3 + $2) / 2

0.4 = 1.67