bachelor microeconomics (seminars) petr wawrosz. the demand side of the market the demand curve:...

Bachelor microeconomics(seminars)

Petr Wawrosz

The demand side of the Market

• The demand curve: Relationship between price (independent variable, vertical axis) an quantity of the goods - how much ale subject willing to buy (dependent variable, horizontal axis)

• Quantity demanded: the amount of a good that a consumer is willing and able tu purchase at a given price.

The Law of Demand

• Holding everything else constant, - when price of a product falls, the quantity demanded of the product increases- when the price of a product rise, the quantity demanded of the product will decrease

Substitution and Income Effects

• Substitution effect: the change of the price of one good makes the good more or less expensive relative to other goods.

• Income effects: the the change of the price of the good change consumers‘ purchasing power (he/she is able to buy more or les units of the goods its price is changing).

• Purchasing power is the amount of goods that can be purchased with a unit of currency.

Ceteris Paribus Condition

• = holding everything else constant• Only thing that changes is price!• The change of the price = movement along

demand curve.

Other factors affecting demand

• Income• Prices of other goods• Taste• Population and

demographics• Expected future prices• ….• If these factors changes

the demand curve shifts to the left or to the right!

The Supply Side of the Market

• Supply curve: Relationship between price (independent variable, vertical axis) an quantity of the goods - how much ale firm willing to sell (dependent variable, horizontal axis).

• Quantity supplied: The amount of a good that a firm is willing and able to supply at given price.

The Law of Supply

• Holding everything else constant, - when price of a product falls, the quantity supplied of the product decreases- when the price of a product rise, the quantity supplied of the product will increase

Opportunity costs Effect and Production Effect

• Opportunity cost effect: the growth of the price of the good) increases the firms‘ opportunity cost (what it loses if it does not produce this good).

• Production effects: the growth of the price means higher revenue of the firm that is able to use (employee) more factors of production. The more factor of production is use the higher amount of the good it is possible to produce.

Ceteris Paribus Condition

• = holding everything else constant• Only thing that changes is price!• The change of the price = movement along

supply curve

Other factors affecting supply• Prices of inputs• Prices of substitutes in

production• Technological change• Number of firms in the

market• Expected future prices• The state of nature• ….• If these factors changes the

supply curve shifts to the left or to the right!

Market equilibrium

• A situation which quantity demanded equals quantity supplied.

• Equilibrium price = price for that quantity demanded equals quantity supplied

• Competitive market equilibrium: a market equilibrium with many buyers and sellers.

Surplus and shortage on the market

• Surplus = a situation in which the quantity supplied is greater than the quantity demanded.

• Shortage = a situation in which the quantity supplied is lower than the quantity demanded.

•

Shortage on the market

• The price is the regulator!• A shortage forces the price up! Some consumers

value the good more highly than the current price. • The growth of the price

→producer are willing produce more goods (higher price covers the costs of additional goods)→ some consumers decide not to buy the good per higher price (price is higher than the consumer‘s marginal utility).

Surplus on the market

• The price is the regulator!• A surplus forces the price down! Some consumers

value the good less highly than the current price. • The fall of the price

→producer are willing produce less goods (higher price does not cover the costs of producing some units of the good)→ some consumers decide to buy the good per lower price (price is lower or same as the consumer‘s marginal utility).

Why do shortage and surplus occur?

• Shifts of demand and supply• Price control

Shifts of demand and supply • A shift of demand or a shift of

supply (usually) changes the equilibrium price.

• Very often it is costly to change the price very often.

• Factors:- kind of good- how long the surplus or the shortage will take- costs connecting with change of price („menu costs)

• If original equilibrium price differs from new one, the shortage or surplus happen.

Price control

• Government regulation of price.

• Two forms: 1. price ceilings. 2. price floor.

• Price ceilings: sets a maximum legal price for goods

• Price floors: sets a minimum legal price.

The effects of price control

• Price ceilings:- shortage- lower quality of the goods- black market

• Price floor:- surplus- inefficient allocation of the resources - growth of government expenditures

Price elasticity

• Price elasticity = how the change of price affects quantity demanded (price elasticity of demand) or quantity supplied (price elasticity of supply).

• Small change of price can have small or huge effects of quantity demanded or quantity supplied.

• Huge change of price can have small or huge effects of quantity demanded or quantity supplied.

Consumer surplus • An economic measure of

consumer satisfaction, which is calculated by analyzing the difference between what consumers are willing to pay for a good or service relative to its market price. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price.

Producer surplus • An economic measure of the

difference between the amount that a producer of a good receives and the minimum amount that he or she would be willing to accept for the good. The difference, or surplus amount, is the benefit that the producer receives for selling the good in the market.

Market equilibrium and consumer and producer surplus

• If market price equals equilibrium price than the consumer surplus and producer surplus are maximized.

Price elasticity equation • Equation:

Price elasticity of demand or supply:(e)= percentage change in quantity demanded or quantity supplied------------------------------------------------------------------------percentage change in price

• Mathematically: • Percentage change in quantity demanded

= )/(1/2 * (+ ))• Percentage change in price

= )/(1/2 * (+ ))

• e = )/(1/2 * (+ ))/ ()/(1/2 * (+ ))) ==ΔQ´/(+ ) * ΔP/(+ )

• Usually it is used absolute value in the case of quantity.

Inelastic and elastic demand or supply

e = ∞ Perfectly elastic demand/supply Quantity demanded changes by an infinitely large percentage

e > 1 Elastic demand/supply Percentage change in quantity demanded is higher then percentage change in price

e = 1 Unit elastic demand/supply Percentage change in quantity demanded equals percentage change in price

e < 1 Inelastic demand/supply Percentage change in quantity demanded is lower then percentage change in price

e = 0 Perfectly inelastic demand/supply Quantity demanded becomes constant regardless of price.

Price elasticity od demand

• How the change of price affects quantity demanded.

Straight-line demand curve and elasticity

• If the demand curve is straight-line then valid:- for upper half of curve e > 1- in the half of the curve e = 1- for down half of curve e < 1

Price elasticity od demand and total revenue (TR)

Gorwth of price Fall of price

e > 1 TR decreases TR increases

e =1 TR becomes identical TR becomes identical

e < 1 TR increases TR decreases

Price elasticity od demand and total revenue (TR)

Factors influencing the elasticity od demand

• Availability of close substitutes• Luxuries versus necessities• Share of a good in Consumer‘s budget• Definition of the market• Passage of time

Price elasticity of supply

• How the change of price affects quantity supplied.

Factors influencing the elasticity of supply

• Costs and restrictions of entry to and exit from the market (including using technology)

• Possibility to create storage• Definition of the market• Passage of time

Income elasticity of demand• Income elasticity = how the change of price affects quantity demanded• Income elasticity of demand or supply:

(e)= percentage change in quantity demanded or quantity supplied------------------------------------------------------------------------percentage change in price

• Mathematically: • Percentage change in quantity demanded

= )/(1/2 * (+ ))• Percentage change in income

= )/(1/2 * (+ ))

• e = )/(1/2 * (+ ))/ ()/(1/2 * (+ ))) ==ΔQ´/(+ ) * ΔI/(+ )

Necessities and luxuries

e > 1 Percentage change in quantity demanded is higher then percentage change in income

Luxories

e = 1 Percentage change in quantity demanded equals percentage change in income

Goods with unit income elasticity

e < 1 a e > 0 Percentage change in quantity demanded is lower then percentage change in income

Necessities

e < 1 Growht of income means decrease of quantity demanded; fall of income means increase of quantity demanded

Inferioor goods

Engel‘s curve

• The relationship among Income (Y, usually vertical axis) and quantity demanded (Q‘, usually horizontal axis)

Engel‘s curve for inferior goods

Cross-price elasticity of demand

• Cross-price elasticity of demand (CPED) = Percentage change in quantity demanded of one good/percentage change in price of another good

Value of CPED Relationship between good

Positive Substitutes

Negative Complements

Zero Unrelated