The Market Forces of Demand and Supply: The Consumer Behavior

Markets and Competition

Supply and demand are the two words that economists use most often. Supply and demand are the forces that make market economies work. Modern microeconomics is about supply, demand, and market equilibrium.

What is a Market?

A market is a group of buyers and sellers of a particular good or service.

The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.

What is a Market?
Market: A place or service that enables buyers and sellers to exchange goods and services and that exchange determines the prices of goods and services. Buyers determine demand. Sellers determine supply. Example: A. Product Markets: Market for goods and services B .Financial Market: Market for finance Money Market Stock Market Bond Market C. Factor Market : Market for resources/input Land Market Labor Market D. Foreign Exchange Market: Market for foreign exchange

What are the Types of Market?

A) Black Market: Illegal Exchange ex. Buying and selling illegal drugs and counterfeit Underground Market: unreported or unrecorded transactions or exchange of goods and services, whether legal or illegal. B) Regulated Market: Prices are fixed Unregulated Market: Prices are determined by demand and supply. C) Organized market: Ex stock Exchange Loosely organized: ex. Market for bicycles
5

Competitive Markets
A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price. Competition: Perfect and Otherwise Perfect Competition Products are the same Numerous buyers and sellers so that each has no influence over price Buyers and Sellers are price takers Monopoly One seller, and seller controls price Oligopoly Few sellers Not always aggressive competition Monopolistic Competition Many sellers Slightly differentiated products Each seller may set price for its own product

Goods Markets: Demand and Supply of Goods

Demand
Demand means the willingness and capacity to have it. Need: Necessity to have it either by option or compulsion Price is a tool by which the market coordinates individual desires. Demand for a product means the amount of a product that people are willing and capacity to purchase at each possible price during a given period of time. Price is a tool by which the market coordinates individual desires. The Quantity demand is the amount of a product that people are willing and able to purchase at one, specific price.

The Law of Demand

Law of demand there is an inverse relationship between price and quantity demanded assuming other things held constant (ceteris paribus) Quantity demanded rises as price falls, other things constant. Quantity demanded falls as prices rise, other things constant. Other things constant places a limitation on the application of the law of demand. All other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not. These factors may include changing tastes, prices of other goods, income, even the weather. Two Reasons for Law of Demand 1. Income Effect 9 2. Substitution Effect

Components of Demand: The Income Effect

Income Effect: The change in quantity demanded that occurs when the purchasing power of income is altered as a result of price changes. Ex: When the price of a commodity falls , a consumer can purchase more of a commodity with given money income( i.e his /her real income increases) A change in the real value of income:
will have a direct effect on quantity demanded if a good is normal. will have an inverse effect on quantity demanded if a good is inferior. ( Hotdogs. Bread etc.)

The income effect is consistent with the law of demand only if a good is normal.
10

Components of Demand: The Substitution Effect

Substitution Effect: When the price of a good falls, the quantity demanded of the commodity by the individual increases because the individual substitutes in consumption of commodity X for other commodities. Assuming that real income is constant:
If the relative price of a good rises, then consumers will try to substitute away from the good. Less will be purchased. If the relative price of a good falls, then consumers will try to substitute away from other goods. More will be purchased.

The substitution effect is consistent with the law of demand.

11

From a Demand Table to a Demand Curve

The demand table assumes other things remaining the same The demand curve is the graphic representation of the law of demand You plot each point in the demand table on a graph and connect the points to derive the demand curve.

A Demand Table
Price per DVDs (in dollars) Price per DVD rentals cassette demanded per week

$6.00 5.00 4.00 3.50 3.00 2.00 1.00 .50 0 E

A Demand Curve

A B C D E

$0.50 1.00 2.00 3.00 4.00

9 8 6 4 2

G C F B A Demand for DVDs

1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of DVDs demanded (per week)

12

Ex. Demand Schedule and Demand Curve for DVDs

13

Types of Demand
1. Individual Consumers Demand QdX = f(PX, I, PY, T) QdX =quantity demanded of commodity X by an individual per time period PX =price per unit of commodity X I =consumers income PY =Price of related (substitute or complementary) commodity T =tastes of the consumer
Qdxi=f(Pxi) Qdx=f(P)
14

2. Market Demand Function QDX = f(PX, N, I, PY, T) QDx=quantity demanded of commodity X Px=price per unit of commodity X N=number of consumers on the market I=consumer income PY=price of related (substitute or complementary) commodity T=consumer tastes

How to Derive Market Demand Curves

A market demand curve is the horizontal sum of all individual demand curves. This is determined by adding the individual demand curves of all the demanders. Sellers estimate total market demand for their product which becomes smooth and downward sloping curve. Limitations of Law of Demand ( market) Bandwagon Effect: People some times demand a commodity because others are purchasing it. Snob (Veblen) Effect: Opposite to bandwagon effect, People some times demand less of a commodity because others are purchasing more of it
15

From Individual Demands to a Market Demand Curve

Price per cassette (in dollars)

(1) (2) (3) Price per Alices Bruces cassette demand demand

(2) Cathys demand

(3) Market demand

$4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0

G F E D C B A
Cathy Bruce Alice Market demand

A $.0.50 B 1.00 C 1.50 D 2.00 E 2.50 F 3.00 G 3.50 H 4.00

9 8 7 6 5 4 3 2

6 5 4 3 2 1 0 0

1 1 0 0 0 0 0 0

16 14 11 9 7 5 3 2

8 10 12 14 16

Quantity of cassettes demanded per week

16

A Sample Demand Curve

Price (per unit)

PA

D 0
Quantity demanded (per unit of time)
17

QA

Demand Faced by a Firm

Depends Upon 1. Size of the market or industry demand for a commodity 2. Form in which industry is organized 3. Number of firms in the industry 4. Type of Goods Durable Goods ( TV, Car, Refrigerator) Provide a stream of services over time Demand is volatile Nondurable Goods and Services Direct demand, less volatile Producers Goods Used in the production of other goods, they are the inputs for other firms. Demand is derived from demand for final goods or services This is called as derived demand
18

Perfect Competition
Perfect Competition is a market structure characterized by: Many large firms, so large that no one firm has the ability to affect the market. These firms are price takersthey have to go along with the market price. Identical products, the products are identical, generic products. Easy entry into the industry. The demand curve is perceived by each firm to be horizontal. Ex. Same type of wheat produced in Indian by large farmers Firms demand curve is horizontal, industry Demand curve is downward sloping

19

Monopoly
Monopoly is a market structure in which there is just one firm, and entry by other firms is not possible. There are no close substitutes. The firm has the power to set the price, but still sets an optimal price to maximize profit. If the monopolist sets the price too high, revenue will decline. The firm is a price maker. The firms demand curve is the market demand curve, and it is downward sloping. Ex. Local telephone, electricity, Public transport system etc.

20

Monopolistic Competition
Monopolistic competition is a market structure in which there are many firms selling differentiated products. Monopolistic Competition is characterized by: A large number of firms Easy entry(There are few barriers to entry) Differentiated products, because each firms product is slightly different, each firm is kind of a minimonopolythe only producer of that specific product. This allows the firm to be a price maker. The firms demand curve is downward sloping and depending on the differentiation of the firms product, it may be fairly inelastic. Or flat Ex. Gaosline stations and barber shop, CDs, movies, computer games, restaurants,

21

Oligopoloy
Oligopoly is a market structure in which there are a few interdependent firms. Oligopoly is characterized by: Few firmsmore than one, but few enough so each firm alone can affect the market. Entry is more difficult, but can occur. There are often significant barriers to entry. The firms are interdependent each is affected by what others do. The demand curve is downward sloping for each firm. Ex. Homogeneous product: Cement, Steel, Chemicals, Differentiated Product: automobiles, Cigarettes, soft drinks,

22

Duopoly:
A duopoly is an oligopoly with only two Sellers of similar products. It is the simplest type of oligopoly. Price competition is severe lead to price war. Each react to the other. The duopolies may agree on a monopoly outcome.
Collusion An agreement among firms in a market about quantities to produce or prices to charge. Cartel A group of firms acting in unison The Demand Curve Slopes downward from left to right Ex. Prisoners dilemma

23

Four Basic Market Types

24

Assumption of Law of Demand: Ceterius paribus

25

Assumption of Law of Demand: Other Things Constant

Other things constant places a limitation on the application of the law of demand. All other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not. These factors may include changing tastes, prices of other goods, income, even the weather.

26

Changes in Quantity Demanded

Change in Quantity Demanded movement along the same demand curve in response to a price change.

Price (per unit)

$2

B Change in quantity demanded (a movement along the curve) A

$1

D1 0 100 200 Quantity demanded (per unit of time)

27

Change in Demand

Change in Demand - shift in entire demand curve in response to a change in a determinant of demand (a ceteris paribus variable) A shift /change in demand is the graphical representation of the effect of anything other than price on demand.

Price (per unit)

$2

Change in demand (a shift of the curve)

$1

A D0 D1

250 200 100 Quantity demanded (per unit of time)

28

Ex. Change in Demand vs. Change in the Quantity Demanded

29

Determinants and Shift Factors of Demand

Societys Income
Taxes on subsidies Taxes on subsidies to consumers to consumers

Prices of related goods

Tastes

Number of buyers

Expectations

Shift factors of demand are factors that cause shifts in the demand curve:
30

The Income
The demand for any goods and services depends upon income. The higher the income the higher the quantity demanded. A change in the real value of income will have a direct effect on quantity demanded if a good is normal. So an increase in income will increase demand for normal goods. will have an inverse effect on quantity demanded if a good is inferior. Exc. Corn, bread. So an increase in income will decrease demand for inferior goods. The income effect is consistent with the law of demand only if a good is normal.
31

Prices of Related Goods: The Substitution:

Assuming that real income is constant: If the relative price of a good rises, then consumers will try to substitute away from the good. Less will be purchased. If the relative price of a good falls, then consumers will try to substitute away from other goods. More will be purchased. The substitution effect is consistent with the law of demand. When the price of a substitute good falls, demand falls for the good whose price has not changed. Ex. BMW and Accura When the price of a complement good falls, demand rises for the good whose price has not changed. Ex. Car and Petrol
32

Tastes and Expectations and Number of buyers

a) A change in taste will change demand with no change in price.

b) If you expect your income to rise, you may consume more now. If you expect prices to fall in the future, you may put off purchases today. c) Number of Buyers: Higher the number of buyers, greater the demand for the product
33

Shift Factors of Demand: Mathematical Expression

QdX = f(PX, I, PY, T)
QdX/PX < 0 QdX/I > 0 if a good is normal QdX/I < 0 if a good is inferior QdX/PY > 0 if X and Y are substitutes QdX/PY < 0 if X and Y are complements An increase in income will increase demand for normal goods. An increase in income will decrease demand for inferior goods. When the price of a substitute good falls, demand falls for the good whose price has not changed. When the price of a complement good falls, demand rises for the good whose price has not changed.

34

Factors Affecting Demand for a commodity (Internal vs External Factors)

Product management life-cycle
Income Prices of Substitutes Prices of Complements Expectations, Changing customer Tastes and preferences Random fluctuation Seasonality Competition New customers Plans of major customers Government policies Regulatory concerns Economic conditions/cycles Environmental issues Weather conditions Global and local trends

Planned price changes Changes in the sales force Resource constraints Marketing promotion Advertising Product substitution and sales

35

Supply of Goods and Services

Supply
Goods and Services are supplied by Firms (also households) The analysis of the supply of produced goods has two parts: An analysis of the supply of the factors of production to households and firms. An analysis of why firms transform those factors of production into usable goods and services.

37

Supply of Goods and Services

Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant. Quantity supplied is the amount of a good that sellers are willing and able to sell at a given price at a point of time. Law of Supply The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises. Direct relationship between price and quantity supplied. Quantity supplied rises as price rises, other things constant. Quantity supplied falls as price falls, other things constant
38

Supply of Goods and Services

The Law of Supply The law of supply is accounted for by two factors: When prices rise, firms substitute production of one good for another. Assuming firms costs are constant, a higher price means higher profits. The Supply Curve The supply curve is the graphic representation of the law of supply. The supply curve slopes upward to the right. The slope tells us that the quantity supplied varies directly in the same direction with the price. 39

A Sample Supply Curve

The Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied.

Price (per unit)

S A

PA

QA Quantity supplied (per unit of time)

40

Ex: Supply Curve DVDs

41

From Individual Supplies to a Market Supply

The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

(1) (2) (3) (4) (5) Quantities Price Ann's Barry's Charlie's Market Supplied (per DVD) Supply Supply Supply Supply A B C D E F G H I $0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 0 1 2 3 4 5 6 7 8 0 0 1 2 3 4 5 5 5 0 0 0 0 0 0 0 2 2 0 1 3 5 7 9 11 14 15
42

From Individual Supplies to a Market Supply

$4.00 3.50
Price per DVD

Charlie

Barry

Ann

Market Supply H G F

3.00 2.50 2.00 1.50 1.00 0.50 0 A B C CA D E

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Quantity of DVDs supplied (per week)
43

Change in Quantity Supplied

A movement along a supply curve the graphic representation of the effect of a change in price on the quantity supplied. If the amount supplied is affected by anything other than a change in price, there will be a shift in supply. S
0

Price (per unit)

B A Change in quantity supplied (a movement along the curve)

$15

1,250 1,500 Quantity supplied (per unit of time)

44

Change/Shift in Supply
Shift in supply the graphic representation of the effect of a change in a factor other than price on supply.

S0 S1 Price (per unit)

$15

B Shift in Supply (a shift of the curve)

1,250 1,500 Quantity supplied (per unit of time)

45

Decrease in Supply

Increase in Supply

46

Factors that Shifts Supply Curve

Other factors besides price affect how much will be supplied:
Resource/Input Prices

Prices of Related Goods and Services

Technology And Productivity

Supply

Number Of Producers

Expectations Of Producers
47

Factors that Shifts Supply Curve

Price of Inputs (Resource Prices) When costs go up, profits go down, so that the incentive to supply also goes down. Technology Advances in technology reduce the number of inputs needed to produce a given supply of goods. Costs go down, profits go up, leading to increased supply. Expectations If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later. Numbers of Suppliers As more people decide to supply a good the market supply increases (Rightward Shift).
48

Change in Supply vs. Change in the Quantity Supplied

49

Equilibrium between Supply and Demand

Supply and Demand Together

Equilibrium is a concept in which opposing dynamic forces cancel each other out. Demand and Supply Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. Equilibrium Price The price that balances quantity supplied and quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity The quantity supplied and the quantity demanded at the equilibrium price. On a graph it is the quantity at which the supply and demand curves intersect.

Supply and Demand not Together

When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change. Excess supply a surplus, the quantity supplied is greater than quantity demanded
Prices tend to fall.

Excess demand a shortage, the quantity demanded is greater than quantity supplied
Prices tend to rise.

The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall. When quantity demanded equals quantity supplied, prices have no tendency to change.
52

The Graphical Interaction of Supply and Demand

Price (per DVD) $3.50 $2.50 $1.50

Quantity Supplied 7 5 3

Quantity Demanded 3 5 7

Surplus (+) Shortage (-) +4 0 -4

53

The Graphical Interaction of Supply and Demand

$5.00 4.00 Price per DVD 3.50 3.00 2.50 2.00 1.50 1.00 1 Excess demand E C A Excess supply

2 3 4 5 6 7 8 9 10 11 12 Quantity of DVDs supplied and demanded

54

Equilibrium (Graph)

55

Shifts in Supply and Demand

Shifts in either supply or demand change equilibrium price and quantity.

56

Increase in Demand
An increase in demand creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and quantity are reached.

Price (per DVDs)

S0 $2.50 2.25 B A Excess demand

D0 0

D1

8 9 10 Quantity of DVDs (per week)

57

The Effects of a Shift of the Demand Curve

58

Decrease in Supply
A decrease in supply creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and lower quantity are reached.

Price (per DVDs)

S1 C $2.50 2.25 B S0 Excess demand A D0 0 8 9 10 Quantity of DVDs (per week)

59

The Limitations Of Supply and Demand Analysis

Sometimes supply and demand are interconnected. Other things don't remain constant. The other-thingsconstant assumption is likely not to hold when the goods represent a large percentage of the entire economy. All actions have a multitude of ripple and possible feedback effects. The ripple effect is smaller when the goods are a small percentage of the entire economy.

60

Elasticity

61

The Concept of Elasticity

Elasticity is a measure of the degree of responsiveness of one variable to another.
The greater the elasticity, the greater the responsiveness.

Types:
Price Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand
62

1. Price Elasticity and Its sign

The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price
Percentage change in quantity demanded Percentage change in price Q2 Q1 1 % Q 2 (Q 1 + Q 2 ) = E = P2 P1 % P 1 2 (P1 + P 2 ) ED =

According to the law of demand, whenever the price rises, the quantity demanded falls. Thus the price elasticity of demand is always negative. Because it is always negative, economists usually state the value without the sign. Price elasticity of demand and supply gives the exact quantity response to a 63 change in price.

Defining elasticities
1) Demand is Inelastic if E<1 or When price elasticity is between zero and -1 we say demand is inelastic. 2) Demand is Elastic if E>1 or When price elasticity is between -1 and infinity, we say demand is elastic. 2) Unitary Elastic if E=1 or When price elasticity is -1, we say demand is unit elastic.

64

a. Price Elasticity: Calculating Elasticity at a Point

To calculate elasticity at a point determine a range around that point and calculate the arc elasticity.

$10 9 8 7 6 5 4 3 2 1

Price

C A B

8 .33 EatA = = 24 = =.66 53 2 .5 1 4 (5+3) 2

1 (28+20 ) 2

2820

EatA =
20 24 28 Quantity 40

20 24 4 .33 16 * = = =.66 54 24 24 .5
65

b. Arc Elasticity : Calculating Elasticity of Demand Between Two Points

1 Elasticity of demand (Q + Q 2 ) %Q = 2 1 E= P2 P1 between A and B: %P

Q2 Q1

$26 24
Price

B midpoint C A

1 2

(P1 + P2 )

22 20 18 16 14 0

Demand

10 14 4 (14 + 10) 12 .33 ED = = = = 1.27 26 20 6 .26 1 23 2 (26 + 20)

1 2

10 12 14 Quantity of software (in hundred thousands)

66

c. The Price Elasticity of Demand Along a Straightline Demand Curve

67

Demand Curve: Shapes and Elasticity

Perfectly Elastic Demand Curve: The demand curve is horizontal, any change in price can and will cause consumers to change their consumption. Perfectly Inelastic Demand Curve: The demand curve is vertical, the quantity demanded is totally unresponsive to the price. Changes in price have no effect on consumer demand.

68

Determinants of Price Elasticity of Demand

The degree to which the price elasticity of demand is inelastic or elastic depends on: How many substitutes there are The importance of the product in the consumers total budget The time period under consideration

Demand for a commodity will be more elastic if: It has many close substitutes It is narrowly defined More time is available to adjust to a price change

Demand for a commodity will be less elastic if: It has few substitutes It is broadly defined Less time is available to adjust to a price change
69

2. Income Elasticity of Demand

a. Point Definition
EI = Q /Q Q I = I / I I Q

Linear Function
b. Arc Definition

E I = a3

I Q

EI =

Q2 Q I2 + I1 1 I2 I1 Q2 +Q 1

Normal Goods EI>0 Inferior Goods EI<0

70

2. Income Elasticity of Demand

(i) Normal goods are those whose consumption increases with an increase in income. So Normal Goods EI>0, Normal goods are divided into luxuries and necessities. a. Luxuries are goods that have an income elasticity greater than one. Typical elasticities are 1.5 to 2.0.Their percentage increase in demand is greater than the percentage increase in income. b) Necessity has an income elasticity less than 1. Typical income elasticities are 0.4 or 0.5. The consumption of a necessity rises by a smaller proportion than the rise in income. (ii) Inferior goods are those whose consumption decreases when income increases. So Inferior Goods EI<0
71

Calculating Income Elasticity

(26 - 20) 1 26 2 (26 + 20) = = = 1 .3 20 20

Eincome
P0

P0 Shift due to 20% rise in D0 D1 income 20 26 Quantity

72

3. Cross-Price Elasticity of Demand

Cross-price elasticity of demand the percentage change in quantity demand divided by the percentage change in the price of another good.
E Cross
- Price

Percentage change in quantity demand Percentage change in priceof a related good

a. Point Definition Linear Function

E XY =

QX / QX Q X PY = PY / PY PY Q X

X Y

= a

PY Q X

b. Arc Definition Substitutes Goods EXY>0

E XY =

Q X 2 Q X 1 PY 2 + PY 1 PY 2 PY 1 Q X 2 + Q X 1

Complements Goods EXY<0

73

Calculating Cross-Price Elasticity

D1 D0 P0

Ecross

(108 - 104) (108 + 104 ) .038 = = = .12 .33 .33

1 2

P0
Shift due to 33% rise in price of pork

104 108 Quantity of Beef

74

75

The Use of Price Elasticity of Demand

Why Elasticity matters?

Elasticity, Total Revenue, Marginal Revenue and Demand

The elasticity of demand tells suppliers how their total revenue will change if their price changes. Total Revenue equals total quantity sold multiplied by price of good. TR=PQ Marginal Revenue equals the change in total revenue due to change in output MR=TR/ Q
77

Elasticity, Total Revenue, Marginal Revenue and Demand

If ED is elastic (ED > 1), a rise in price lowers total revenue. If ED is inelastic (ED < 1), a rise in price increases total revenue. Price and total revenue move in opposite directions. If ED is unit elastic (ED = 1), a rise in price leaves total revenue unchanged. Price and total revenue move in the same direction.
78

Elasticity and Total Revenue

Unit Elastic Demand: E = 1
$10 8 Price 6 4 2 0 1 A B 3 4 5 6 7 8 9 Quantity
79

TR constant
F C TRE= $4x6=$24 TRF= $6x4=$24 Gained revenue E Lost revenue

Elasticity and Total Revenue

$10 8 Price 6 4 2 A 0 1 2 3 Gained revenue

Inelastic Demand: E < 1 TR rises if price increases

TRG = $1 x 9 = $9 TRH = $2 x 8 = $16

Lost revenue H C B 4 5 6 7 8 9 Quantity

80

Elasticity and Total Revenue

Elastic Demand: E > 1 $10 8 Price 6 4 2 0 1 2 C K J TRJ = $8 x 2 = $16 TRK = $9 x 1 = $9 TR falls if price increases.

A B

Gained revenue Lost revenue 3 4 5 6 7

Quantity
81

Total Revenue Along a Demand Curve: Example

Let the demand function is Q= 600-100P So, MR= 6- Q/50

With elastic demand a rise in price lowers total revenue. With inelastic demand a rise in price increases total revenue.

82

83

With elastic demand a rise in price lowers total revenue. With inelastic demand a rise in price increases total revenue.

84

Example: Using Elasticities in Managerial Decision Making

A firm with the demand function defined below expects a 5% increase in income (M) during the coming year. If the firm cannot change its rate of production, what price should it charge?

Demand: Q = 3P + 100M
P = Current Real Price = 1,000 M = Current Income = 40

85

Solution
Elasticities
Q = Current rate of production = 1,000 P = Price = - 3(1,000/1,000) = - 3 I = Income = 100(40/1,000) = 4

Price
%Q = - 3%P + 4%I 0 = -3%P+ (4)(5) so %P = 20/3 = 6.67% P = (1 + 0.0667)(1,000) = 1,066.67
86

The Elasticity Of Supply

Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied resulting from a percentage change in price.
87

The Price Elasticity of Supply

(a) Perfectly Inelastic Supply: Elasticity Equals 0 Price Supply $5 4 1. An increase in price . . .

100

Quantity

2. . . . leaves the quantity supplied unchanged.

88

The Price Elasticity of Supply

(b) Inelastic Supply: Elasticity Is Less Than 1 Price Supply $5 4 1. A 22% increase in price . . .

100

110

Quantity

2. . . . leads to a 10% increase in quantity supplied.

89

The Price Elasticity of Supply

(c) Unit Elastic Supply: Elasticity Equals 1 Price Supply $5 4 1. A 22% increase in price . . .

(If SUPPLY is unit elastic and linear, it will begin at the origin.)

100

125

Quantity

2. . . . leads to a 22% increase in quantity supplied.

90

The Price Elasticity of Supply

(d) Elastic Supply: Elasticity Is Greater Than 1 Price Supply $5 4 1. A 22% increase in price . . .

100

200

Quantity

2. . . . leads to a 67% increase in quantity supplied.

91

The Price Elasticity of Supply

(e) Perfectly Elastic Supply: Elasticity Equals Infinity Price 1. At any price above $4, quantity supplied is infinite. $4 2. At exactly $4, producers will supply any quantity. Supply

0 3. At a price below $4, quantity supplied is zero.

Quantity

92

The Price Elasticity of Supply and Its Determinants

Ability of sellers to change the amount of the good they produce.

Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.

Time period
Supply is more elastic in the long run.

93

Computing the Price Elasticity of Supply

The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Percentage change
Price elasticity of supply = in quantity supplied Percentage change in price

94

Three Applications Of Supply, Demand, And Elasticity

Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?
95

Can Good News for Farming Be Bad News for Farmers?

Examine whether the supply or demand curve shifts. Determine the direction of the shift of the curve. Use the supply-and-demand diagram to see how the market equilibrium changes.

96

An Increase in Supply in the Market for Wheat

Price of Wheat 2. . . . leads to a large fall in price . . . $3 2 1. When demand is inelastic, an increase in supply . . . S1 S2

Demand 0 100 110 Quantity of Wheat

3. . . . and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220.

97

Compute the Price Elasticity of Demand When There Is a Change in Supply

100 110 (100 + 110) / 2 ED = 3.00 2.00 (3.00 + 2.00) / 2 = 0.095 0.24 0.4

Demand is inelastic.
98

Why Did OPEC Fail to Keep the Price of Oil High?

Supply and Demand can behave differently in the short run and the long run
In the short run, both supply and demand for oil are relatively inelastic But in the long run, both are elastic
Production outside of OPEC More conservation by consumers

99

Does Drug Interdiction Increase or Decrease Drug-Related Crime?

Drug interdiction impacts sellers rather than buyers.

Demand is unchanged. Equilibrium price rises although quantity falls.

Drug education impacts the buyers rather than sellers.

Demand is shifted. Equilibrium price and quantity are lowered.
100

Policies to Reduce the Use of Illegal Drugs Education Drug Drug Interdiction
Price of Drugs S2 S1 S1 Price of Drugs

It is amazing how useful knowledge of elasticities can be!

D1 D2

D1

But in one market the price In each case, for illegal in price is the same. The demand the change Interdiction shifts the supply, while education shifts the demand. goes up. drugs is inelastic. The changes in quantities (and TR) are And in the other it goes down. remarkable.
101

Quantity of Drugs

Quantity of Drugs

Cases: Handout
The demand for Big Macs The demand for sweet potatoes in US Income, Price and Cross elasticties in real World

102

Thank You All

103

104

105