1.
2.
3.
4.
5.
6.
Motivation
Competitive Markets Defined
The Market Demand Curve
The Market Supply Curve
Equilibrium
Characterizing Demand and Supply:
Elasticity
7. Back of the Envelope Techniques
Chapter 2: Demand and Supply Analysis
2
tells us how the quantity of a good
demanded by the sum of all consumers in
the market depends on various factors.
are those with sellers and buyers that are small
and numerous enough that they take the market
price as given when they decide how much to
buy and sell.
Qd = (Q,p,po, I,…)
Plots the aggregate quantity of a good that
consumers are willing to buy at different
prices, holding constant other demand drivers
such as prices of other goods, consumer
income, quality.
Qd= Q(p)
3
4
The Demand for New Automobiles in The United States
The Demand for New Cars in
Price (thousands of dollars)
Price (thousands of £)
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53
Demand curve for cars
0
5.3
0
Quantity (millions of
automobiles per year)
5
5.3
Quantity (millions of
cans per year)
6
1
Note:
We always graph P on vertical axis and Q on horizontal
axis, but we write demand as Q as a function of P… If P is
written as function of Q, it is called the inverse demand.
states that the quantity of a good demanded
decreases when the price of this good increases.
Normal Form: Qd= 100-2P
Inverse form: P = 50 - Qd/2
•
¾
Empirical regularity
The demand curve: shifts when factors other
than own price change…
Markets defined by commodity, geography, time.
•If the change increases the willingness of consumers
to acquire the good, the demand curve shifts right
•If the change decreases the willingness of consumers
to acquire the good, the demand curve shifts left
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8
tells us how the quantity of a good supplied by
the sum of all producers in the market depends
on various factors
Qs= Q(p,po, W, …)
A move along the demand curve for a good can only be
triggered by a change in the price of that good. Any
change in another factor that affects the consumers’
willingness to pay for the good results in a shift in the
demand curve for the good.
Plots the aggregate quantity of a good that will
be offered for sale at different prices.
Qs= Q(P)
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10
Definition: The Law of Supply states that the quantity of a
good offered increases when the price of this good increases.
A move along the supply curve for a good can only be
triggered by a change in the price of that good. Any
change in another factor that affects the producers’
willingness to offer for the good results in a shift in the
supply curve for the good.
¾ Empirical regularity
The supply curve shifts when factors other than own price
change…
•If the change increases the willingness of
producers to offer the good at the same price,
the supply curve shifts right
•If the change decreases the willingness of
producers to offer the good at the same price,
the supply curve shifts left
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12
2
Price (£)
QS
= p + .05r
QS = quantity of beer (millions of pints)
p = price of beer (pounds per pint)
r = football matches on TV...
0
Quantity,
million pints
13
Price (£)
14
Price (£)
r=0
r=0
r=3
Supply with
0 matches
Supply with
no matches
Supply with matches
0
0 .15
Quantity,
Billion bushels
Quantity,
Million pints
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16
Qd = 500 – 4p
QS = -100 + 2p
Definition: A market equilibrium is a price such
that, at this price, the quantities demanded and
supplied are the same.
p = price of pint
Q = demand or supply in millions of
pints per year
(Demand and supply curves intersect at equilibrium)
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18
3
a. The equilibrium price of pints is calculated by
equating demand to supply:
Example: The Market For Beer
Price
Qd = QS … or…
500 – 4p = -100 + 2p
…solving,
Market Supply: P = 50 + QS/2
p* = £100
P*=100
b. plug equilibrium price into either demand or supply
to get equilibrium quantity:
Quantity
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20
Example: The Market For Beer
Example: The Market For Beer
Price
125
Price
125
Market Supply: P = 50 + QS/2
Market Supply: P = 50 + QS/2
•
P*=100
P*=100
Market Demand: P = 125 - Qd/4
Market Demand: P = 125 - Qd/4
Q* = 100
Quantity
Quantity
21
Definition: If sellers cannot sell as much as they would like
at the current price, there is excess supply.
22
Definition: If sellers cannot sell as much as they would like
at the current price, there is excess supply.
Example: Excess Supply in the Market for Beer
Example: Excess Supply in the Market for Beer
Price
125
Price
125
Market Supply
P*=100
Market Supply: P = 50 + QS/2
P*=100
Market Demand
Market Demand: P = 125 - Qd/4
Quantity
Qd Q*
23
QS
Quantity
24
4
Definition: If sellers cannot sell as much as they would like
at the current price, there is excess supply.
•If there is no excess supply or excess demand, there is
no pressure for prices to change and we are in
equilibrium.
Example: Excess Supply in the Market for
Cranberries
Price
125
•
Excess Supply
•
•When a change in an exogenous variable causes the
demand curve or the supply curve to shift, the
equilibrium shifts as well.
Market Supply: P = 50 + QS/2
P*=100
Market Demand: P = 125 - Qd/4
Qd Q*
QS
Quantity
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26
Elasticity is not slope
•Slope is the ratio of absolute changes in
quantity and price. (= ∆Q/∆P).
Definition: The own price elasticity of demand is
the percentage change in quantity demanded brought
about by a one-percent change in the price of the good.
• Elasticity is the ratio of relative (or
percentage) changes in quantity and price.
εQ,P= (∆Q/Q) = (∆Q/∆p)(p/Q)
(∆p/p)
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28
•When a one percent change in price leads to a
greater than one-percent change in quantity
demanded, the demand curve is elastic. (εQ,P < -1)
•When a one-percent change in price leads to a less
than one-percent change in quantity demanded, the
demand curve is inelastic. (0 > εQ,P > -1)
Qd = a – bp
a,b are positive constants
p is price
•When a one-percent change in price leads to an
exactly one-percent change in quantity demanded,
the demand curve is unit elastic. (εQ,P = -1)
•-b is the slope
•a/b is the choke price
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30
5
Example: Elasticity with a Linear Demand Curve
P
•the elasticity is
εQ,P = (∆Q/∆p)(p/Q) …definition…
= -b[p/(a-bp)]
so…elasticity falls from 0 to -∞ along the linear demand
curve, but slope is constant.
•if Qd = 400 – 10p, and p = 30,
εQ,P = (-10)(30)/(100) = -3 "elastic"
Q
0
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32
Example: Elasticity with a Linear Demand Curve
Example: Elasticity with a Linear Demand Curve
P
P
a/b
Elastic region
? region
a/2b
•
? region
Inelastic region
a
0
Q
0
a/2
a
Q
33
Example: Elasticity with a Linear Demand Curve
Example: Constant Elasticity Demand Curve
P
a/b
Qd = Apε
εQ,P = -∞
ε = elasticity of demand and is
negative
p = price
A = constant
? region
a/2b
•ε
Q,P
= -1
•Elasticity is constant, but the slope of demand falls
from 0 to -∞.
? region
Example: If demand can be expressed as QP = 100, what is
the price elasticity of demand?
εQ,P = 0
0
34
a/2
a
Q
35
36
6
Example: A Constant Elasticity
versus a Linear Demand Curve
Example: A Constant Elasticity
versus a Linear Demand Curve
Price
Price
Constant elasticity demand curve
Linear demand curve
0
0
Quantity
Quantity
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38
•Elasticity varies with (among other factors):
Example: A Constant Elasticity
versus a Linear Demand Curve
-factors affecting substitutability (such as level
of aggregation, product differentiation or
switching costs)
Price
• Observed price and quantity
P
Constant elasticity demand curve
Linear demand curve
0
Q
Quantity
39
Definition: A durable good is a good that provides
valuable services over a long time (usually many
years).
40
Example: Demand for
Commercial Aircraft
Price (£/airplane)
Demand for non-durables less elastic in the short run
when consumers can only partially adapt their
behavior. Demand for durables more elastic in the
short run because consumers can delay purchase.
Quantity (aircraft/yr)
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7
Example: Demand for
Commercial Aircraft
-Other Elasticities -- Elasticity of "X" with respect to "Y":
(∆X/∆Y)(Y/X)
Price ($/airplane)
•Price elasticity of supply (∆QS/∆p)(p/QS)
…measures curvature of supply curve
Long run demand curve for commercial airplanes
•Income elasticity of demand (∆Qd/∆I)(I/Qd) …measures
degree of shift of demand curve as income changes…
Short run demand curve for commercial
airplanes
•Cross price elasticity of demand
(∆Qd/∆Po)(Po/Qd)…measures degree of shift of demand
curve…
Quantity (aircraft/yr)
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44
Example:
Suppose demand is linear: Qd = a-bp
Hence, elasticity is εQ,P = -bp/Q
1. Estimating Demand and Supply from Own Price
Elasticities and Equilibrium Price and Quantity
-Choose a general shape for functions
-Estimate parameters of demand and supply using
elasticity and equilibrium information
If we have data on ε, Q and P, we can calculate b
from elasticity equation and then calculate a by
substituting into demand.
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46
but… ε= -bp/Q Ù b = -εQ/p
b = -(-.55(70/.7)) = 55
a = Qd + bp = 108.5
•If…Qd = a – bP
Per capita consumption 70pints/person
Price £.70/pint.
εQ,P = -.55
=> Qd = 108.5 – 55p
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48
8
•If…Qd = Apε
Example: Beer in the U.K
Price
εQ,P = -.55
A = Qp-ε = 70(.7).55 = 57.53
=> Qd = 57.53P-.55
0
Quantity
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50
Example: Beer in the UK
Example: Beer in the UK
Price
Price
•
.7
Constant elasticity demand curve
Constant elasticity demand curve
Linear demand curve
0
Observed price and quantity
Linear demand curve
0
Quantity
70
Quantity
51
2. Estimating Demand and Supply from
Information on Past Shifts
52
-Suppose, then, that the supply curve shifts
back. Both the old equilibrium point (p1,Q1)
and the new equilibrium point (p2,Q2) lie on the
same (linear) demand curve. Therefore, if QD
= a-bp,
- A shift in the supply curve reveals the slope of
the demand curve while a shift in the demand
curve reveals the slope of the supply curve.
b = ∆Q/∆p = (Q2 – Q1)/(p2 – p1)
a = Q1 + bp1
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9
Example: Identifying demand by a shift in supply.
-We can “identify” the slope of supply by a shift
in demand
Price
-We can "identify" the slope of demand by a
shift in supply, similarly.
Supply
Market Demand
0
Quantity
55
Example: Identifying demand by a shift in supply.
56
Example: Identifying demand by a shift in supply.
Price
Price
New Supply
New Supply
Old Supply
Old Supply
•
P2
P1
•
Market Demand
0
Market Demand
0
Quantity
Q2 Q1
Quantity
57
-This technique only works if one or the other of the
curves stays constant.
58
-This technique only works if one or the other of the
curves stays constant.
Price
Price
New Supply
Supply
Old Supply
Demand
Old Demand
New Demand
0
0
Quantity
Example: Identifying demand when both curves shift
Quantity
Example: Identifying demand when both curves shift
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60
10
-This technique only works if one or the other of the
curves stays constant.
Price
1. First example of a simple microeconomic
model of supply and demand (two equations and an
equilibrium condition)
New Supply
•
•
P2
P1
Old Supply
2. Elasticity as a way of characterizing demand and
supply
3. Elasticity changes as market definition
changes (commodity, geography, time)
Old Demand
New Demand
0
Q2 = Q1
Quantity
Example: Identifying demand when both curves shift
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4. Elasticity a very general concept
5. Back of the envelope calculations:
•Estimating demand and supply from own price
elasticity and equilibrium price and quantity
•Estimating demand and supply from information on
past shifts, assuming that only a single curve shifts
at a time.
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