lecture 3 dds sand elasticity

Demand and Supply

• Supply at any price is the amount of a quantity that a firm will put on sale.

• This is not the amount of quantity that he wishes to sell

• This is not the amount of quantity that he can sell

• At any price, the quantity demanded is independent of the amount that is available for sale.

Demand and Supply• Does the Demand of a product at a price influence

Supply (amount available in the market) ?

• Supply influenced by- Cost factors- Extraneous factors- Anticipation of future demand.

NOT Demand at a price-Because seller does not know that.

Demand and Supply

• The quantity that a firm sells at a price is not the supply of the product.

Quantity of Sales : determined by DD and SS at a price.

Supply of the product: Quantity available in the market

Market Equilibrium

• Market equilibrium is determined at the intersection of the market demand curve and the market supply curve.

• At equilibrium price there is no tendency to change the price.

Shortage

• When the price is below the equilibrium quantity demanded exceeds quantity supplied

• Shortages put upward pressure on the price

6QS QD

Surplus

• When the price is above the equilibrium quantity supplied is greater than the quantity demanded.

• Surplus puts downward pressure on demand

7QD QS

Equilibrium Price

• Only at $1 per pound would there be no tendency for price change.

• At any point in time, observed price may not be the equilibrium price.

• Market forces always push the market price towards equilibrium.

Which market can be characterized by the following graph?

P

Q

Which market can be characterized by the following graph?

10

P

Q

Ford Motors2004

Price PE

Quantity

Supply Curve

Demand Curve

E

QE

Ford Motors

• What happens to the equilibrium price from 2004 to 2012?

Ford Motors2012

Price PE

PE’

Quantity

Supply Curve

D

E

QE

D’

D

D’

E’

QE’

Ford Motors

• What happens to the equilibrium price from 2012 to 2013?

Case A: Change in SS> Change in DD 2013

Price PE’’

PE

PE’

Quantity

S

D

E

QE

D’

D

E’

QE’

S’

QE’’

2004-2012

2012-2013

E’’

2004 to 2012: Decrease in Demand

- Equilibrium Quantity Decreased- Equilibrium Price Decreased

2012 to 2013: Decrease in Supply

- Equilibrium Quantity Decreased- Equilibrium Price Increased

Net Effect

- Equilibrium Quantity Decreased- Equilibrium Price Increased

Case B: Change in SS< Change in DD 2013

Price PE

PE’’

PE’

Quantity

S

D

E

QE

D’

D

D’

E’

QE’

S’

E’’

QE’’

2004-2012

2012-2013

2004 to 2012: Decrease in Demand

- Equilibrium Quantity Decreased- Equilibrium Price Decreased

2012 to 2013: Decrease in Supply

- Equilibrium Quantity Decreased- Equilibrium Price Increased

Net Effect

- Equilibrium Quantity Decreased- Equilibrium Price Decreased

Price of Personal Computers

• From 1986- 2006, massive increase in demand for PCs

• For the same period, surge of PC producers and their production.

• Increase in supply more than the demand• What is the effect on the equilibrium price and

demand?

Personal Computers• If Change in DD < Change in SS=>

- Equilibrium Quantity Increases- Equilibrium Price Decreases

• If Change in DD > Change in SS=>

- Equilibrium Quantity Increases- Equilibrium Price Increases

The Effect of Demand and Supply Shifts on Equilibrium

How Shifts in Demand and Supply Affect Equilibrium Price (P) and Quantity (Q)

SUPPLY CURVE UNCHANGED

SUPPLY CURVESHIFTS TO THE RIGHT

SUPPLY CURVE SHIFTS TO THE LEFT

DEMAND CURVE UNCHANGED

Q unchangedP unchanged

Q increasesP decreases

Q P

DEMAND CURVESHIFTS TO THE RIGHT Q

P

Q increasesP increases ordecreases

Q P

DEMAND CURVESHIFTS TO THE LEFT

Q decreasesP decreases

Q increases or decreasesP decreases

Q decreasesP decreases orincreases

The Effect of Demand and Supply Shifts on Equilibrium

How Shifts in Demand and Supply Affect Equilibrium Price (P) and Quantity (Q)

SUPPLY CURVE UNCHANGED

SUPPLY CURVESHIFTS TO THE RIGHT

SUPPLY CURVE SHIFTS TO THE LEFT

DEMAND CURVE UNCHANGED

Q unchangedP unchanged

Q increasesP decreases

Q decreasesP increases

DEMAND CURVESHIFTS TO THE RIGHT Q increases

P increases

Q increasesP increases ordecreases

Q increases or decreases P increases

DEMAND CURVESHIFTS TO THE LEFT

Q decreasesP decreases

Q increases or decreasesP decreases

Q decreasesP decreases orincreases

Equilibrium

tionSupplyFuncdPcQ

tionDemandFuncbPaQS

D

...........

..........

Equilibrium : Quantity Demand = Quantity Supplied

db

caPeq

db

bcadQeq

Demand and Supply

Price

PE

Quantity

Supply Curve

Demand Curve

E

QE

a

a/b

-c/dc

Change in Equilibrium: Ford Analysis

tionSupplyFuncdPcQ

tionDemandFuncbPaQS

D

...........

..........

Supply Function does not changeDemand Function changes: DD shifts inside

'

...........

..........''

aa

tionSupplyFuncdPcQ

tionDemandFuncbPaQS

D

Demand and Supply

Price

PE

Quantity

Supply Curve

Demand Curve

E

QE

a

a/b

-c/dc a’

a’/b

E’

Change in Equilibrium: Ford Analysis

tionSupplyFuncdPcQ

tionDemandFuncbPaQS

D

...........

..........

2004 2012 Change

Quantity (ad+bc)/ (b+d) (a’d+bc)/(b+d) Decrease

Price (a-c)/(b+d) (a’-c)/(b+d) Decrease

'

...........

..........''

aa

tionSupplyFuncdPcQ

tionDemandFuncbPaQS

D

2004

2012

Coke Challenge

• Price of can of Coke Rs 10• What is the demand?• Your manager asks you to increase revenue• What will you do?• How will you change price?• How does increase/decrease in price influence

revenue?• What will you choose?

Salt Price

• Price of 1 kg Tata Salt Rs 10. Only Seller• What is the demand?• Your manager asks you to increase revenue• What will you do?• How will you change price?• How does increase/decrease in price influence

revenue?• What will you choose?

• For the same change in price why does Demand change differ in the two cases?

• What is the reason for difference in answer?• What determines whether price increases

/decreases revenue?

32

What is elasticity?

A term economists use to describe responsiveness, or sensitivity, to a change in a factor like price/income

33

% in Q demanded

% in priceEd =

Measure Price Elasticity

The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price

Extreme Cases

Perfectly Inelastic DD Curve

Price

Quantity

Extreme Cases

Perfectly Elastic DD Curve

Price

Quantity

CALCULATING PRICE ELASTICITY

37

% in Q demanded

% in priceEd =

Point Price Elasticity

The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price

What is the Price Elasticity?

Price Quantity Price Elasticity

.9995 20,002

1.0 20,000

1.005 19,998

What is the Price Elasticity?

Price Quantity Price Elasticity

.9995 20,002

1.0 20,000 -0.2

1.005 19,998

What is the Price Elasticity?

Price Quantity Price Elasticity

3 50

4 40 -61.67 (if P=3)-3.70 (if P= 4)

5 3

41

Arc Elasticity in quantity demanded

sum of quantities/2divided by in price

sum of prices/2

42

Arc Elasticity

2/)( 21 QQ

Q

2/)( 21 PP

P

43

Why is elasticity 4 in the previous example and not -4?

Economists drop the negative sign because we know from the law of demand that quantity demanded and price are inversely related

Elasticity and Demand Function

• Calculate the price elasticity of a demand function

bQaP

Elasticity and Demand Function

• Calculate the price elasticity of a demand function

bQaP

QbQab /))(/1(

Elasticity and Demand Function

• What can you say about the elasticity of demand along linear demand function?

Elasticity and Demand Function

Price

Quantitya/b

η< |1|, Inelastic Demand

η>|1|, Elastic Demandη=|1|, Unit Elastic Demand

48

$40

$30

$20

$10

10 20 30 40

A

B

Elastic Demand Ed > 1P

Q

49

What is elastic demand?

A condition in which the percentage change in

quantity demanded is greater than the percentage

change in price

%∆ Quantity demanded > %∆ Price

Elastic Demand

1/))(/1( QbQab

Thus, if Q < a/2b, it is the elastic portion of linear demand curve.

Elasticity and Demand Function

Price

Quantitya/b

η< |1|, Inelastic Demand

η>|1|, Elastic Demandη=|1|, Unit Elastic Demand

a/2b

Total Revenue and Elasticity

• What can you say about total revenue and the elasticity of demand?

• What happens to total revenue when you decrease price on an elastic portion of demand curve?

Total Revenue and Elasticity

• What happens to total revenue when you decrease price on an elastic portion of demand curve?

- Demand increases- Elastic portion of demand curve=> %∆ Quantity demanded > %∆ Price- %∆Revenue = %∆Q %∆P

54

Price decrease

Increase in total revenue

Elastic Demand

Elastic Demand

In an elastic portion of the demand curve, to increase revenue:

Price must be reduced!!

56

$40

$30

$20

$10

10 20 30 40

A

B

Inelastic Demand Ed < 1

57

What is Inelastic demand?

A condition in which the percentage change in

quantity demanded is Less than the percentage

change in price

%∆ Quantity demanded < %∆ Price

Elastic Demand

1/))(/1( QbQab

Thus, if Q > a/2b, it is the Inelastic portion of linear demand curve.

Elasticity and Demand Function

Price

Quantitya/b

η< |1|, Inelastic Demand

η>|1|, Elastic Demandη=|1|, Unit Elastic Demand

a/2b

Total Revenue and Elasticity

• What can you say about total revenue and the elasticity of demand?

• What happens to total revenue when you decrease price on an Inelastic portion of demand curve?

Total Revenue and Elasticity

• What happens to total revenue when you decrease price on an Inelastic portion of demand curve?

- Demand increases- Elastic portion of demand curve=> %∆ Quantity demanded < %∆ Price- %∆Revenue = %∆Q %∆P

62

Price decrease

Decrease in total revenue

Inelastic Demand

Inelastic Demand

In an Inelastic portion of the demand curve, to increase revenue:

Price must be increased!!

64

What is a unitary elastic demand curve?

The percentage change in the quantity demanded is equal to the percentage change in price

65

$40

$30

$20

$10

10 20 30 40

E

F

Unitary Elastic Demand Ed = 1

D

66

Price decrease

No change in total revenue

Unitary Elastic Demand

67

$40

$30

$20

$10

10 20 30 40

Perfectly Elastic Demand Ed =

8

68

What is a perfectly elastic demand curve?

A condition in which a small percentage change in price brings about an infinite percentage change in the quantity demanded

69

Price change

Infinite change in quantity demanded

Perfectly Elastic Demand

70

What is a perfectly inelastic demand curve?

A condition in which the quantity demanded does not change as the price changes

71

$40

$30

$20

$10

10 20 30 40

Perfectly Inelastic Demand Ed = 0

72

Price change

Zero change in quantity demanded

Perfectly Inelastic Demand

Determinants of ElasticityGood /Service ElasticityAgricultural Products Apples (US) -1.159 Potatoes (UK) -0.13 Oranges (US) -0.62 Lettuce (US) -2.58Manufactured Products Beer (US) -2.83 Wine (UK/Ireland) -1.12 Bread (UK) -0.26Energy Gasoline –Short Run (Canada) Gasoline –Long Run (Canada)

-0.01 to -0.2-0.4 to -0.8

Transportation Domestic Cars (US) -0.78

What Determines the Elasticity?

• Number of close substitutes- Greater the number of substitutes, larger

would be the elasticity- Price increase would imply substituting it with

its substitutes- Depends upon definition of the product.

Narrower the definition, more number of substitutes, greater elasticity

What Determines the Elasticity?

• Time DurationGreater elasticity if demand is considered over a

greater range of time period.Ability to find substitutes

If price of gas increases, in short term consumers may not be able to find alternatives. In long run its demand may decrease.

Elasticity in Use

• How would you price First class and Economy class airline tickets?

• What is one reason for this?

Elasticity in Use

Type of Ticket Price Elasticity

First Class -0.45

Regular Economy -1.3

Excursion -1.83

Income Elasticity

• Price is not the only factor which influences the demand of the product.

• Income also affects the quantity purchased of the product.

• Income Elasticity looks at responsiveness of demand to income

79

% in Q demanded

% in IncomeηI=

Measure Income Elasticity

The ratio of the percentage change in the quantity demanded of a product to a percentage change in Income

Income ElasticityGood Elasticity

Agricultural Products

Grain (China) -0.12 to + 0.15

Potatoes (UK)Potatoes (US)

-0.32+0.15

Lettuce (US) +0.88

Animal Products

Meat (China) +0.1 to + 1.2

Eggs (UK) -0.21

Automobiles

Domestic Cars (US) +1.62

Income Elasticity

• Normal Good : Income elasticity is positive• Inferior Good : Income elasticity is negative

• Economic Upturn: Normal goods would do better than inferior goods

• Economic Downturn : Inferior goods would loose less than normal goods

Cross Price Elasticity

• Price of the product is not the only factor which influences the demand of the product.

• Price of other goods (complimentary/ substitutes) also affects the quantity purchased of the product.

• Cross Price Elasticity looks at responsiveness of demand to price of other goods.

83

% in Q demanded of X

% in Price of Yηxy=

Measure Cross Price Elasticity

The ratio of the percentage change in the quantity demanded of a product to a percentage change in Price of other good

Cross Price Elasticity

• Substitutes Good : Cross Price elasticity is positive

• Complimentary Good : Cross Price elasticity is negative