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Economists’ definition The relationship between the price of a particular good and the quantity of the good consumers are willing to buy at the price during a specific time period all other things equal (ie, ceteris paribus) Depends on many things but all the others are held constant
Introduction to Microeconomics Day Professor Gordon MacAulay and Dr Tran Van Hoa T h e U n iv e r s ity o f S y d n e y Supply and Demand Model • Overview – Define a demand curve – Movements along and of the curve – Define and supply curve – Movements along and of the curve – Supply and demand combined – Price floors and ceilings Supply Demand Model • Supply and demand first described by Alfred Marshall in 1890 • Model – Demand – Supply – Market equilibrium Demand • Economists’ definition – The relationship between the price of a particular good and the quantity of the good consumers are willing to buy at the price during a specific time period all other things equal (ie, ceteris paribus) – Depends on many things but all the others are held constant Demand and Supply Price ($/kg) 100 140 180 220 260 300 340 380 420 Demand Supply quantity quantity (kg/month) (kg/month) 36 28 22 14 18 18 14 22 10 26 30 32 34 • Demand – Rice in a town stall – Farmers supply to the stall – Equilibrium Demand Relationship Demand Price ($/ kg) – Slopes down – Quantity is negatively related to price – Other things constant Demand Rela onship 450 400 350 300 250 200 150 100 50 y = 452.89e-0.042x 10 15 20 25 30 35 40 Quan ty demanded (kg/ month) Demand Relationship • • • • Demand relationship y = -23.96ln(x) + 146.54 Shifted demand relationship y = -23.96ln(x) + 160 Demand Relationship Shift Demand Rela onship Shi 450 400 Price ($/ kg) 350 300 250 200 150 100 50 0 10 20 30 40 50 60 Quan ty demanded (kg/ month) Demand Relationship Shift • Many factors shift demand out or in – Consumers’ preferences – Consumers’ information – Consumers’ incomes – The number of consumers – Consumers’ expectations of future prices – Price of closely related goods Demand Relationship Shifts • Income changes – As income rises demand shifts out • A normal good (eg cars, TVs, etc) – As income rises demand shifts in • An inferior good (maybe rice, potatoes, etc) 10 Perfectly Elastic Response • Any change in quantity has no effect on the price, eg small country exporting P ric e D em and P1 Q u a n tity 37 Price Elasticity of Demand • Price elasticity of demand changes along a linear demand function Price Ed = -∞ Ed< -1 Elastic Mid point Ed= -1 Unitary elasticity Ed> -1 Inelastic Ed = Quantity 38 Elasticity • Elasticity measure is not the same as a slope • Elasticity is a unitless number and works regardless of the units of measure • The formula is Ed = %change in Q / %change in p ∆Qd ∆P ∆Qd / Qd Ed = ÷ = Qd P ∆P / P Note the sign is negative or omitted 39 Arc Elasticity • Calculating with a midpoint formula – Measuring a change in P or Q is easy – The level of P or Q is taken as the mid point E=(60–48)/((60+48)/2) ÷ ($40-$44)/($40+ $44)/2 E = 2.33 The value would be if we used the value of Q = 60 and P = 40 40 Effects of Price on Revenue Elasticity Expenditure changes For small price falls the following expenditure changes result: Elastic More will be spent on the commodity Unitary The same amount will be spent on the commodity Inelastic Less will be spent on the commodity Perfectly inelastic Fall in the amount spent will be proportional to the fall in price 41 Elasticity & Revenue • Revenue – Maximum and mid point of a linear demand relationship – Revenue is P*Q Differences in Elasticity of Demand • Different goods have different price elasticities of demand – Jewelry about -2.6 – Eggs -0.1 Petrol -0.2 • A % increase in the price of eggs the quantity demanded falls by 0.1 % • Why? 43 Differences in Elasticity of Demand • Degree of substitution – Price elasticity will be high if it is easy to find substitutes – Necessities cannot be easily substituted, eg food – Luxuries are usually easily substituted, eg jewelry • Share of income – The bigger the good is in terms of income the more sensitive and the higher the elasticity 44 Differences in Elasticity of Demand • Temporary versus permanent price changes – If temporary price, elasticity tends to be high • Eg specials and sales • Long run versus short run – Price elasticities tend to increase as the length of run increases—it is more costly to make long run changes (habits hard to change) 45 Income Elasticity of Demand • The income elasticity of demand is the percentage change in quantity demand at any given price as a result of a change in income 46 Cross-price Elasticities • The cross-price elasticity is the percentage change in the quantity demanded as a result of a change in a related price – Eg beef consumption related to pork price • Normal and inferior goods – A normal good has a positive income elasticity – An inferior good has a negative income elasticity 47 Elasticity of Supply • The price elasticity of supply measures the percentage change in the quantity supplied from a percentage change in the price ∆Qs ∆P ∆Qs / Qs Es = ÷ = Qs P ∆P / P 48 Elasticity and Supply Response • • Note constant elasticity functions Supply Rela onship and Elas city 500 Inelastic Es = 0.05 400 Price ($/ kg) Price elasticity of supply is positive • Inelastic < • Elastic >1 300 200 More elastic Es = 0.90 100 0 10 20 30 40 50 60 Quan ty demanded (kg/ month) 49 Supply and Demand 50 Thank you 51 [...]... ($/kg) quantity supplied and the quantity 100 140 demanded are 180 equal there is a 22 0 26 0 market 300 340 equilibrium In 380 420 this case a price of $22 0/kg Demand Supply Excess of quantity quantity demand (kg/month) (kg/month) over supply 36 28 22 18 14 10 6 4 2 2 8 14 18 22 26 30 32 34 34 20 8 0 -8 -16 -24 -28 - 32 21 Market Equilibrium • Equilibrium – When there is a surplus of supply over demand... price rises – Any price below $22 0 has an excess of demand (price rises) – Any price above $22 0 has an excess of supply (price falls) 22 Market Equilibrium Demand and Supply Equilibrium 450 400 350 Price ($/ kg) • Marshallian cross • The model can be applied to many markets and goods and services 300 25 0 20 0 150 100 50 0 0 5 10 15 20 25 30 35 40 Quan ty demanded (kg/ month) 23 Supply and Demand Shift Shi... Equilibrium 450 400 350 Price ($/ kg) • The equilibrium price moves down from $22 0 and 18 units to $20 5 and 32 units demanded and supplied 300 25 0 20 0 150 100 50 0 0 10 20 30 40 50 60 Quan ty demanded (kg/ month) 24 Supply and Demand Shift • Shifts in supply and demand ceteris paribus • In reality both supply and demand shift together Change Increase in demand Decrease in demand Increase in supply Decrease... change 450 400 350 300 25 0 20 0 150 100 50 0 0 5 10 15 20 25 30 35 40 Quan ty demanded (kg/ month) 19 Market Equilibrium • No single person or firm determines the price in the market • As buyers and sellers interact prices may rise or they may fall Why? • To have an equilibrium prices need to be free to change to the point where the quantity demanded equals the quantity supplied 20 Market Equilibrium... reduced 32 Elastic Relationship • Percent change in quantity is grater than the percent change in price Price P1 Demand P2 Q1 Q2 Quantity 33 Inelastic Relationship • Percent change in quantity is smaller than the percent change in price P ric e P1 P2 P3 Q 1 Q 2 Q 3 Q u a n tity 34 Unit Elasticity Relationship • Percent change in quantity is equal to the percent change in price P ric e P1 P2 P3 Q 1 Q 2 Q... increase profit so shift to the right 16 Movements Along and Shifts • As in demand shifts of the function are movements in or out • Movements along are when prices and quantities change together 17 Shift of the Supply Relationship Supply Rela onship Shi 450 400 350 Price ($/ kg) • Shift to the right or left occurs when factors other than price change 300 25 0 20 0 150 100 50 0 0 10 20 30 40 50 60 Quan ty... substitute – Complement • Tend to be consumed together • As price of the other good rises demand shifts in • For example, coffee and sugar 11 Movements Along Demand Rela onship Price ($/ kg) • Shifts of the demand curve are different from movements along • Both price and quantity change 450 400 350 300 25 0 20 0 150 100 50 0 0 5 10 15 20 25 30 35 40 Quan ty demanded (kg/ month) 12 Supply Relationship • The... 450 400 350 300 25 0 20 0 150 100 50 0 0 5 10 15 20 25 30 35 40 Quan ty demanded (kg/ month) 15 Supply Relationship Shifts • A number of factors cause a shift of the supply relationship – Technology – The price of the inputs into production – The number of firms in the market – Expectations of future prices – Government taxes, subsidies and regulations • Tax increases costs so shifts to the left • Subsidies... shortages or surpluses – Black markets may develop – Reductions in quality of goods 27 Price Ceilings and Floors Price Ceiling 450 Demand 400 350 Price ($/ kg) • Price ceiling at $150 creates a shortage, at $300 creates a surplus Surplus 300 25 0 20 0 150 Shortage 100 Supply 50 0 0 5 10 15 20 25 30 35 40 Quan ty demanded (kg/ month) 28 Price Ceilings and Floors • Government intervention with price ceilings and... quantity of the good that firms are willing to sell at that price all other things the same (ceteris paribus) • Supply refers to the behaviour of producers 13 Supply Relationship • The law of supply: – The higher the price the higher the quantity supplied and the lower the price the smaller the quantity supplied • Supply relationship • y = 23 . 023 ln(x) - 105 .21 14 Supply Relationship Supply Rela onship ... 100 140 180 22 0 26 0 300 340 380 420 Demand Supply quantity quantity (kg/month) (kg/month) 36 28 22 14 18 18 14 22 10 26 30 32 34 • Demand – Rice in a town stall – Farmers supply to the stall... a 22 0 26 0 market 300 340 equilibrium In 380 420 this case a price of $22 0/kg Demand Supply Excess of quantity quantity demand (kg/month) (kg/month) over supply 36 28 22 18 14 10 2 14 18 22 26 ... equilibrium price moves down from $22 0 and 18 units to $20 5 and 32 units demanded and supplied 300 25 0 20 0 150 100 50 0 10 20 30 40 50 60 Quan ty demanded (kg/ month) 24 Supply and Demand Shift • Shifts