Session 1 Slide # 8

The two reasons why demand curve is downward sloping: Example: Consider the market for apples, and assume that a consumer has a budget of $10, reserved for purchases of various kinds of fruit. In the supermarket, he/she notices that the price of apples has been reduced. The consumer responds to the price cut by buying more apples for two reasons: 1) The purchasing power of the $10 budget is now greater and he/she can buy more fruit 2) The lower relative price of apples encourages the consumer to substitute apples for other fruit

Session 1 Slides # 11 and 12

Q 1: Supply curve diagram Stepwise, each step represents an additional country entering the supply stream P
Peru 85 Chile 80 Zambia 75 Russia 65

720

540

5,400

1,050

Session 1 Slides # 11 and 12 (cont.)

Q 2: Slope of the curve Upward sloping the higher the price offered on the market, the more will be supplied In this case, as price rises, additional countries will be drawn into production

Session 1 Slides # 11 and 12 (cont.)

Q 3: Shape of the curve Stepwise, because the observations in the table are countries If the observations were individual mines, the steps would be much smaller (and the S curve would approximate a smooth line as, e.g., in Fig. 1.2, p. 13 of Course Notes) Q4: Does the S curve always slope upward? No, it may be downward-sloping; for example, when there are economies of scale (Chapter 3)

Session 1 Slide # 15

The equilibrium quantity of new housing would unambiguously (without doubt) increase because The demand curve shifted to the right AND The supply curve shifted to the right The impact on price is not clear: If the shift in D curve > shift in S curve, price If the shift in D curve < shift in S curve, price

[Illustration: Fig. 1.5, p. 17 of Course Notes]

Session 1 Slide # 23
Plotting a curve from the equation Q = 30 - P: Pick (arbitrarily) a few numbers for P, plug in the equation to calculate the Q, as in the table below (when the equation is linear, only two points are needed)
P ($ per unit) 0 5 10 30 Q (units per period) 30 25 20 0

Session 1 Slide # 23 (cont.)

Substitute P1 = 25, P2 = 24, P3 = 3, and P4 = 2 into the equation to evaluate the impact of a price cut on sales revenue (or total revenue, TR):
P 25 24 3 Q 5 6 27 TR = P.Q 125 144 81

28

56

Session 1 Slide # 23 (cont.)

Note that the marginal revenue (MR) for the price cut from $25/unit to $24/unit is positive, while the MR for the price cut from $3/unit to $2/unit is negative:
P 25 24 3 2 Q 5 6 27 28 TR = P.Q 125 144 81 56 56-81 = -25 144-125 = 19 MR = TR

Session 1 Slide # 25
Q1: What would happen to quantity demanded of milk if marketing boards were eliminated? Start with the formula P,Q = (% in Q)/((% in P) and plug in the numbers: Thus, assuming the article is correct and price drops by 20%, the price elasticity of -0.63 implies that quantity demanded increases by -0.63 x 20 = 12.6% Q 2: The total revenue of milk sellers would decrease, since demand is inelastic [Fig. 2.4, p. 37]

Session 1 Slide # 36
Q 1: Price elasticity of demand for cigarettes = -0.4; and the government wants to reduce smoking by 20%. By how much should price be increased? Recall that P,Q = (% in Q) / (% in P). From this, (% in P) = (% in Q) /P,Q Numerically: (% in P) = 20 / (-0.4) = 50% Thus, the price of a pack of cigarettes should be raised from $ 8 to $12: $8 x 1.50 = $12

Session 1 Slide # 36 (cont.)

Q 2: The price increase will have greater impact 5 years from now than 1 year from now: It takes time for existing smokers to kick the habit More potential smokers will be discouraged over longer period (Course Notes, pp. 34-35) Q 3: Teenagers have a higher price elasticity because The cost of cigarettes represents higher percentage of their disposable income (Course Notes, pp. 34-35) They may be more amenable to educational influences

Session 1 Slide # 40
Q1: Why does a flood (or a drought) around the world increase the total revenue of all farmers combined? A flood (or a drought) shifts the S curve to the left Quantity of grain sold declines Price or grain rises Demand for food in general (and for grain in particular) is inelastic (there are few substitutes). In Fig. 2.4, draw a S curve in the upper diagram intersecting the D curve in the inelastic region; a shift of the S curve to the left increases the TR in the lower diagram

Session 1 Slide # 40 (cont.)

Q2: A flood (or drought) in a single producing region reduces the revenues of farmers in that region: Quantity of grain sold by the region declines The market price of grain may increase only marginally, may remain constant, or may even decline (if there is abundant harvest in the rest of the world)

Session 1 Slide # 44
Income elasticity of demand for residential electricity use = 0.3, and disposable income increases by 10%. Holding all other things constant, the demand for electricity increases by 3%: 0.3 x 10 = 3% [Recall that I = (% in Q) / (% in I)] [Course Notes, p. 44 and p. 49]