Econ1001 day2 :Introduction to Microeconomics Day 2

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 MicroeconomicsDay 2

Professor Gordon MacAulay andDr Tran Van Hoa

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

– 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)Demandquantity(kg/month)

Supplyquantity(kg/month)

Demand Relationship

– Slopes down– Quantity is

negatively related to price

– Other things constant

y = 452.89e-0.042x

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Demand Relationship•Demand relationship

•y = -23.96ln(x) + 146.54

•Shifted demand relationship•y = -23.96ln(x) + 160

Demand Relationship Shift

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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)

Demand Relationship Shifts

– Substitute

• Provides some of the same satisfaction

•As price of the other good rises demand shifts out

• For rice maybe corn is a substitute– Complement

• Tend to be consumed together

• As price of the other good rises demand shifts in• For example, coffee and sugar

Movements Along

• Shifts of the

demand curve are different from

movements along.

• Both price

and quantity change

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Supply Relationship

•The Economists’ definition

•A supply curve is a relationship between the

price of a particular good and the quantity of the good that firms are willing to sell at that

price all other things the same (ceteris

•Supply refers to the behaviour of producers

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 = 23.023ln(x) - 105.21

Supply Relationship•Supply

is

positively related

with price

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Supply Relationship Shifts

– Technology

– The price of the inputs into production– The number of firms in the market

– Expectations of future prices

– Government taxes, subsidies and regulations

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

Shift of the Supply Relationship

•Shift to the

right or left occurs

when factors

other than price

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Movement Along•Both

prices and quantities change

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Market Equilibrium

in the market

or they may fall Why?

to change to the point where the quantity demanded equals the quantity supplied

Market Equilibrium

supplied and the

quantity demanded are equal there is a market

equilibrium In this case a price of

$220/kg

Price ($/kg)Demandquantity(kg/month)

Excess ofdemandover supply

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Supply and Demand Shift

equilibrium price moves down from $220 and 18 units to $205 and 32 units demanded

and supplied 050100150200250300350400450

Supply and Demand Shift

• Shifts in supply and demand ceteris paribus

• In reality both supply and demand shift together

Effect onequilibrium

quantity

Price Ceilings and Floors

•Price controls exist in many places

throughout the world

•Price ceilings

– Governments can stipulate a maximum price, eg US and oil in the early 1970s, rent controls,

interest rate controls

– Usually result from widespread complaints

Price Ceilings and Floors

Price Ceilings and Floors

• Price

ceiling at $150

creates a shortage, at $300 creates a surplus

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Price Ceilings and Floors•Government intervention with price

ceilings and floors creates surpluses or shortages (usually surpluses)

•Government then runs a stock holding

operation to reduce the surplus

•This is costly and inefficient

Elasticity•Elasticity defined:

– In general, elasticity is a measure of responsiveness

– Elasticity is a measure of how sensitive one economic variable is to another economic variable within an economic relationship

Price Elasticity of Demand•Price elasticity of demand

– Is the sensitivity in the quantity demanded of a good to a change in the price of the good– It refers to a particular relationship—in this

case the demand relationship

– The price elasticity of demand helps

understand how much the price of eggs will rise if the demand of eggs is reduced

Elastic RelationshipPrice

P1P2•Percent

change in quantity is grater than the percent change in price

Inelastic Relationship•Percent

change in quantity is smaller than the percent change in price

Unit Elasticity Relationship

change in quantity is equal to the percent

change in price

Perfectly Inelastic Relationship•Perfectly

inelastic if there is no response in quantity to price

P r i c e

Q u a n t i t yD e m a n d

QP 1

P 2

Perfectly Elastic Response

•Any change

in quantity has no

effect on the price, eg small country exporting

P r i c e

Q u a n t i t yD e m a n dP 1

•Price elasticity of demand changes

along a linear demand function

Price Elasticity of Demand

regardless of the units of measure

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)/2E = 2.33

The value would be 2 if we used the value of Q = 60 and P = 40

Effects of Price on Revenue

For small price falls the following expenditure changes result:ElasticMore will be spent on the commodity

UnitaryThe same amount will be spent on the commodityInelasticLess will be spent on the commodity

PerfectlyFall in the amount spent will beinelasticproportional to the fall in price

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 1 % increase in the price of eggs the

quantity demanded falls by 0.1 %

•Why?

Differences in Elasticity of Demand

Differences in Elasticity of Demand

– If temporary price, elasticity tends to be high• Eg specials and sales

– Price elasticities tend to increase as the length of run increases—it is more costly to make long run changes (habits hard to change)

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

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

Elasticity of Supply

•The price elasticity of supply measures the

percentage change in the quantity

supplied from a percentage change in the price

Elasticity and Supply Response

• Price

elasticity of supply is positive

•Inelastic < 1•Elastic >1

Inelastic Es = 0.05

More elastic Es = 0.90

Supply and Demand

Thank you