2 chem3401 supply & demand (1)

8/12/2019 2 CHEM3401 Supply & Demand (1)

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CHEM3401 ECONOMICS

Supply, Demand

and ElasticityCopyright 2009 Pearson Education, Inc.

Publishing as Prentice Hall.

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Overview

Market Demand

Market Supply

Market Equilibrium

Short-run Analysis, Long-run Analysis

Supply, Demand, and Price

Chapter Three Copyright 2009 Pearson Education,Inc. Publishing as Prentice Hall.

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Learning Objectives

Define supply, demand, and equilibrium price

Identify non-price determinants of supply and demand

Distinguish between short-run rationing function andlong-run guiding function of price

Illustrate how supply and demand can be used toimprove management decisions

Use supply and demand diagrams to determine price inthe short and long run

Copyright 2009 Pearson Education,Inc. Publishing as Prentice Hall.

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Market Demand

Demand for a good or service is defined

as quantities that people are ready

(willing and able) to buy at various prices

within some given time period.

Other factors besides price are held constant(ceteris paribus).


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Market Demand

Non-price Determinants of Demand

Tastes and preferences

Income

Prices of related products

Future expectations

Number of buyersCopyright 2009 Pearson Education,

Inc. Publishing as Prentice Hall.5


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Market Demand

Market demandis the sum of all the individual demands


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Demand Schedule: Table showing quantities of a good aconsumer is willing and able to buy at alternative prices in a given

time period, ceteris paribus.Example: demand for pizza


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Market Demand

The inverse

relationship

between price

and the quantitydemanded of a

good or service is

called the Law ofDemand


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Market Demand

What does the demand curve above tells us about the relationship

between price and quantity demanded?

What is the direction of the slope of the demand curve? Why?

Law of Demand:The quantity of a good demanded in a given time

period increases as its price falls, ceteris paribus.

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Market Demand

The demand schedule and curve remain unchanged only so long asthe underlying determinants of demand remain constant.

Shifts in Demand: A change in any of the determinants ofdemand (except price) will cause demand curve to shift.

Changes in demand: shifts of the demand curve due tochanges in other determinants, and not prices

E.g. Does an increase in income cause the demand

curve to shift inward or outward? Show this graphically.9


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Market Demand

Movements Along a Demand Curve: Movements alonga demand curve are a response to price changes for that good.

Change in Quantity Demanded

Such movements assume that the other determinants ofdemand are unchanged.

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Market Demand

Questions

What would happen to the market demand for steak as a result of

each of the following?

1. An increase in the averageincome of consumer.

2. An increase in the size of thepopulation.

3. Increased advertisingfor lamb and pork.

4. An increase in theprice of lamb.

5. A decrease in thepriceofpork.

6. An increase in theprice of steak11


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Market Supply

The supplyof a good or service is defined as quantities that

people are ready (willing and able)to sell at various prices

within some given time periodOther factors besides price held constant


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Market Supply

Non-price Determinants of Supply

Costs and technology

Prices of other goods or services offered by the seller

Taste of producers

Expectations

Number of sellers

Weather conditions

Taxes and subsidies


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Changes in price result in changes in the quantitysupplied

movementalongthe supply curve

Changes in non-price determinants result inchanges in supply

a shiftin the supply curve


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Market Supply


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Market Equilibrium

Equilibrium price: the price that equates the

quantity demanded with the quantity supplied

Equilibrium quantity: the amount that people are

willing to buy and sellers are willing to offer at the

equilibrium price level


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Market Equilibrium

Shortage (Excess Demand): A market situation in which the quantitydemanded exceeds the quantity supplied.

Shortage occurs at a price below the equilibrium level

Surplus (Excess Supply): A market situation in which the quantitysupplied exceeds the quantity demanded.

Surplus occurs at a price above the equilibrium level

Begin analysis by assumingthat the market is in equilibrium


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Market Equilibrium

Assume all factors

except the price of

pizza are constant

Buyers demand

and sellers supply

are represented by

lines shown


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Market Equilibrium

Assume that a new studyshows pizza to be the most

nutritious of all fast foods

Consumers increase theirdemand for pizza as a result


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Market Equilibrium

The shift in demand results in

a new equilibrium price (P2)

And a new equilibrium

quantity (q2)


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Market Equilibrium

Comparing the new

equilibrium point with the

original one, we see that

both equilibrium price andquantity have increased


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Short-Run

The short runis the period of time in which:

Sellers already in the market respond to a change in

equilibrium price by adjusting variable inputs

Buyers already in the market respond to changes inequilibrium price by adjusting the quantity demanded

for the good or service


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Long-Run

The long runis the period of time in which:

New sellers may enter a market

Existing sellers may exit from a market

Existing sellers may adjust fixed factors of production

Buyers may react to a change in equilibrium price by

changing their tastes and preferences


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Long Run

Long run changes show the allocating function of price

Theallocating function of price is the movement of

resources into or out of markets in response to a changein the equilibrium price


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Supply, Demand, and Price:

The Managerial Challenge

In the extreme case, the forces of supply and demand arethe sole determinants of the market price, not any singlefirm

This type of market is perfect competition

In many cases, individual firms can exert market powerover price because of their:

Dominant size

Ability to differentiate their product through advertising, brandname, features, or services


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Consumer Surplus

The value the consumer derives above the price he is willing to

pay when a good is purchased.


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Producer Surplus

The value the producer derives above the price he is willing to sell

his good when a transaction takes place.


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Total Surplus


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Facilitator: Oswald [email protected]

Introduction to Elasticity

El ti it Th R i f


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Elasticity: The Responsiveness of

Demand and Supply

Definition of Elasticity

A measure of how much one economic variable

responds to changes in another economic variable

Binchangepercent

AinchangepercentElasticityoftCoefficien

h i l i i f d d i


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The Price Elasticity of Demand and its

Measurement

Price Elasticity of Demand

o Percentage change in quantity demanded caused by

a 1 percent change in price (Interpretation)

Measuring the Price Elasticity of Demand


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Price%

Quantity%

E

p


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Price Elasticity of Demand:

The percentage change in quantity demanded

caused by a 1 percent change in price


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Arc elasticity: elasticity which is measured over adiscrete interval of a curve

Ep= coefficient of arc price elasticity

Q1= original quantity demandedQ2= new quantity demanded

P1= original price

P2= new price


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2/)(2/)( 21

12

21

12

PP

PP

QQ

QQEp


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Point Elasticity: elasticity measured at a given

point of a demand (or a supply) curve


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1

1

P

PdQx

dP Q=


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1

1

Q

P

P

Q

p


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The point elasticity of a linear demand

function can be expressed as:

Th P i El i i f D d


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The Price Elasticity of Demand

and Its Measurement

Elastic Demand and Inelastic Demand

Elastic demando Percentage change in quantity demanded greaterthan the percentage change in

priceo Price elasticity is greaterthan 1 in absolute value.Ed > 1

Inelastic demando Percentage change in quantity demanded lessthan percentage change in price

o

Price elasticity is lessthan 1 in absolute value.Ed < 1

Unit-elastic demando Percentage change in quantity demanded equal topercentage change in price.

Ed = 1

Th P i El ti it f D d


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and its Measurement

An Example of Computing Price Elasticities

Elastic and InelasticDemand Curves

*

*

M th d f C l l ti P i El ti it


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Methods of Calculating Price Elasticity

of Demand

1. Simple Method:

Basic percentage calculation

2. Mid-Point Method:

Modified percentage approach

using the data mid-points

3. Point Method :

Calculus

Elasticity at a specific point

Three Methods

Th P i El ti it f D d d


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The Price Elasticity of Demand and

its Measurement

CALCULATING PERCENTAGE CHANGES

priceinchange%

demandedquantityinchange%demandofelasticityprice

100%xpriceinchange

priceinchange%1P

100%x-

1

12

P

PP

100%xdemandedquantityinchange

demandedquantityinchange%1Q

100%x-

1

12

Q

QQ

Th P i El ti it f D d


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and its Measurement

The Midpoint Formula

Price elasticity of demand =

Point Elasticity Formula



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Calculating the Price Elastici ty of Demand for

Electri ci ty Using the Midpoint Formula

YEAR

PRICE

(PER kWh)

QUANTITY

(PER kWh)

2010 $3.00 3.0

2011 $3.60 2.8

The price elasticity of demand is_________

*

*


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Measurement

Dont Confuse Inelastic withPerfectly

Inelastic

Determinants the Price Elasticity of


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Determinants the Price Elasticity of

Demand

Key Determinantsof Price Elasticity ofDemand:

Availability of close substitutes

Passage of time

Necessities versus luxuries

Definition of the market

Share of good in the consumers budget

Durability of product

Th R l ti hi B t P i


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The relationship between price and revenue depends

on elasticity

Why? By itself, a price fall will reduce receipts

BUT because the demand curve is downward sloping,

the drop in price will also increase quantity demanded

Q: Which effect will be stronger?

Chapter Four Copyright 2009 Pearson Education,Inc. Publishing as Prentice Hall. 47

The Relationship Between Price

Elasticity and Total Revenue


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Summary: Elasticity of Demand and Total Revenue

Elasticity

CoefficientElasticity When Price Increases Total Revenue

ED >1

Somewhat Elastic.

% Qd > % P

Quantity changing a lot

so you could lose lots of

money.

Decreases

ED= 1 Unitary Elasticity.Quantity/price changing

same %No change

ED


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Cross-Price Elasticity

1. Recall again the demand function

2. Cross-Price Formula:Ea,b= %Qda/ %Pb

3. Interpretation of valuesa. If Ea,b> 0 => Substitutes;Why?

b. If Ea,b < 0 => Complements;Why?

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*

Two products are

considered goodsubstitutes or

complements when

the coefficient is

larger than 0.5 (in

ab. Value)

i l i i f d


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Empirical Elasticities: Examples

Coffee: short run -0.2, long run -0.33

Meals at restaurants: -2.27

Beer: -0.84, wine: -0.55cigarettes: short run -0.4, long run -0.6

Wine imports: -0.15

Crude oil: -0.06

White pan bread:-0.69, premium white pan bread1.01

Chapter Four Copyright 2009 Pearson Education,Inc. Publishing as Prentice Hall. 53


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Extensions, Problem & Discussion

1. Relevance to Business

a. Can a firm raise price and revenue fall?

b. Does elasticity matter when setting price?

c. Does income elasticity make a difference?

2. Sample Problems

a. Tropical Vibes Restaurant

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its Measurement

Point Elasticity Formula


Some demand curves have constant elasticity

such a curve has a nonlinear equation:

Q = aP-b

where b is the elasticity coefficient

e.g.Qd1= 2.5P1-1.3 Inc0.3P20.4P3-0.1


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Price Discrimination, E asticity &


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Price Discrimination, E asticity &Revenue

1. What is price discrimination? Why discriminate?

2. Types of price discrimination

3. Under what conditions is price discrimination possible?a. Elasticity differences

b. Market separation

4. Effect of price discrimination on revenue

5. Price discrimination, consumer & producer surplus

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Price Discrimination


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Segmenting the market into separate classifications or regions

Assuming that each class of consumers have different demand, afirm can charge different prices in each market segment Enables firm to achieve higher revenue from given unit of sales

Some consumers are willing to pay more than the market price fora good which leads to a consumer surplus.

Firm eats into consumer surplus by charging higher prices

E.g. charging higher prices for business travel than to tourists.

Examples of Price Discrimination


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Examples of Price Discrimination

Senior citizen, youth, and student discounts

Airlines charge less for flyers willing to fly off peak, i.e.

early morning and late night.

MatineesTheaters charge less for earlier shows.

Evening meals in restaurants often cost more than thesame meal at lunch



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To Price-discriminate:

Firm must identify consumer groups/classes with different downward-slopingdemand curves and therefore different elasticities of demand

Business travellers may be less sensitive to air fare levels than tourists

Charge customers with more inelastic demands higher price

Charge customers with more elastic demands lower price.

Firm must be able to prevent consumers of one class from reselling its product tothe consumers of another class; no intermarket redistribution of the product isallowed

e.g. dental treatment; barber

Firm must have some market power

Buyers can be separated at reasonable cost

2 chem3401 supply & demand (1)

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