ECON 160
Week 5
February 16-18, 2010
Review
• Markets are the interaction of buyers
and sellers.
• Focus on buyers and sellers separately.
• Ceteris paribus: look at one thing at a
time; All other things held equal.
Demand for X
$Px
$ 10
$ 9
$ 8
$ 7
$ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Dx
Demand shows the amounts
purchased at alternative prices
(horizontal distances at each price)
Demand x
Dx
1 2 3 4 5 6 7 8 9 10
Qtyx /T
Supply Curve
$Price
$10
8
6
4
2
2
T
4
6
8
10
12 14
16
Qty x/
$Price
$4
3
Demand
Surplus at this $ Price
2.50
Supply
2.00
1.50
1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
$Price
$4
Demand
3
2.50
Supply
2.00
1.50
1.00
.50
.25
Shortage at this $ Price
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Market Equilibrium
$Price
4
3
2.50
2.00
Demand
Supply
Qty D = Qty S
1.50
Pe 1.00
.50
.25
100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T
Qe
$Px
$ 10
$ 9
$ 8
$ 7
Pe $ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Total Revenue = P X Q
Demand
$6x5 = $30
Supply
Dx
1 2 3 4 5 6 7 8 9 10 11 12
Qe
Qtyx /T
$Px
$ 10
$ 9
$ 8
$ 7
Pe $ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Effects of Increase in Demand on Price
and Quantity
Do
D1
Supply
Increases Price and
Quantity
Sx
D1
Do
1 2 3 4 5 6 7 8 9 10 11 12
Qe
Qtyx /T
$Px
$ 10
$ 9
$ 8
$ 7
$ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Demand Determines Price
D3
Supply: Response
D2
Demand pulls forth
output
D1
D3
Sx
D2
D1
1 2 3 4 5 6 7 8 9 10 11 12
Qtyx /T
$Px
$ 10
$ 9
$ 8
$ 7
Pe $ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Effects of an Increase in Supply on
Price and Quantity
S0
Demand
S1
Price decreases and
Quantity increases
S0
Dx
S1
1 2 3 4 5 6 7 8 9 10 11 12
Qe
Qtyx /T
Transaction Costs of Exchange
•
Information Costs
–
–
•
•
Search Costs
Quality Identification Cost
Negotiating Costs: Cost of agreeing on
what and how much will be exchanged
Transportation Costs: Cost of moving
goods between parties
12
Slope Shows Responsiveness of
Quantity to a Change in Price
B
A
Px
Px
P0
P0
P1
P1
Dx
Dx
Q0Q1
Qx/T
Q0
Q1 Qx/T
Slope of Supply
Shows responsiveness of quantity to a change
in Price
A
B
Px
Px
P1
P1
P0
P0
Q0 Q1
Qx/T
Q0
Q1
Qx/T
Elasticity: a Measure of responsiveness
of Quantity to a Change in Price
• Ed = % Δ Qd/ % Δ price
• Es = %  Qs / %  price
Measures of Elasticity
• Demand is Elastic : %Δ Qd > %Δ P;
ie |Ed| >1. A decrease in Price  an increase in
Total Revenue.
• Demand is Unitary Elastic: %ΔQd = %ΔP;
ie |Ed| = 1. A Change in price  no change in
Total Revenue.
• Demand is Inelastic: %ΔQd < %ΔP;
i.e. |Ed| < 1. An increase in Price  an increase in
Total Revenue.
Elasticity, Price Change & Total Revenue
$Px
Elastic
$Px
Inelastic
P1
P0
P0
P1
Q0
Q1
Q1 Q0
Qty/T
$Px
Increased Demand with elastic Supply
$ 10
$ 9
$ 8
Pe`$ 7
Pe $ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Dx
Sx
Sx
Dx`
Dx
1
2
3
4
5 6
Qe
7 8 9
Qe`
10 11 12
Qtyx /T
Increased Demand , Inelastic Supply
$Px
$ 10
$ 9
$ 8
Pe’$ 7
$ 6
Pe $ 5
$ 4
$ 3
$ 2
$ 1
Sx
Dx
Dx’
Sx
Dx
1 2 3 4 5 6 7 8 9 10 11 12
Qe Qe’
Qtyx /T
$Px
$ 10
$ 9
$ 8
Pe`$ 7
Pe $ 6
$ 5
$ 4
$ 3
$ 2
$ 1
Decrease in Supply, Elastic Demand
Dx
Sx’
Sx
Dx
1 2 3 4 5 6 7 8 9 10 11 12
Qe`
Qe
Qtyx /T
$Px
$ 10
$ 9
$ 8
Pe’$ 7
$ 6
Pe $ 5
$ 4
$ 3
$ 2
$ 1
Decrease in Supply, Inelastic Demand
Dx
Sx’
Sx
Dx
1 2 3 4 5 6 7 8 9 10 11 12
Qe’ Qe
Qtyx /T
Determinants of Price Elasticity of Demand
• Number & Closeness of Substitutes.
• Information about price change and
availability of substitutes.
• Percentage of Income Spent on good.
• Period of time: Second Law of Demand:
Demand is more elastic over a longer period
of time.
Other Elasticity's
A Measure of responsiveness of Quantity to a
Change in some other factor
Income Elasticity:
Measure of responsiveness of Quantity to a Change in Income
• EdI = % Δ Qd/ % Δ income
• EdI = 100 * ΔQ/Q = I * ΔQ
100 * ΔI/I
Q * ΔI
• Normal Goods: Positive
• Clothing: .95: 10% income → 9.5% 
• Stereo: 27.2: 10% income → 27.2% 
• Increase may be Quantity or Quality
• Inferior Goods: Negative
Cross Price Elasticity:
Measure of responsiveness of Quantity to a Change Price of other good
• Exy = % Δ Qx/ % Δ Py
• EdI = 100 * ΔQx/Qx = Py * ΔQx
100 * ΔPy/Py Qx * ΔPy
• Substitutes: Positive
• Complements: Negative
Uses of Cross Price Elasticity
• Magnitude of cross price elasticity reflects
closeness of substitutes or complements
• Able to identify your closest competitors
• Courts use cross-price to measure monopoly
power
Transaction Costs of Exchange
•
Information Costs
–
–
•
•
Search Costs
Quality Identification Cost
Negotiating Costs: Cost of agreeing on
what and how much will be exchanged
Transportation Costs: Cost of moving
goods between parties
27