Download - Lecture 3 dds sand elasticity
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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.
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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.
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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
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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.
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Shortage
• When the price is below the equilibrium quantity demanded exceeds quantity supplied
• Shortages put upward pressure on the price
6QS QD
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Surplus
• When the price is above the equilibrium quantity supplied is greater than the quantity demanded.
• Surplus puts downward pressure on demand
7QD QS
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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.
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Which market can be characterized by the following graph?
P
Q
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Which market can be characterized by the following graph?
10
P
Q
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Ford Motors2004
Price PE
Quantity
Supply Curve
Demand Curve
E
QE
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Ford Motors
• What happens to the equilibrium price from 2004 to 2012?
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Ford Motors2012
Price PE
PE’
Quantity
Supply Curve
D
E
QE
D’
D
D’
E’
QE’
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Ford Motors
• What happens to the equilibrium price from 2012 to 2013?
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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’’
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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
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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
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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
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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?
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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
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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
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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
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Equilibrium
tionSupplyFuncdPcQ
tionDemandFuncbPaQS
D
...........
..........
Equilibrium : Quantity Demand = Quantity Supplied
db
caPeq
db
bcadQeq
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Demand and Supply
Price
PE
Quantity
Supply Curve
Demand Curve
E
QE
a
a/b
-c/dc
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Change in Equilibrium: Ford Analysis
tionSupplyFuncdPcQ
tionDemandFuncbPaQS
D
...........
..........
Supply Function does not changeDemand Function changes: DD shifts inside
'
...........
..........''
aa
tionSupplyFuncdPcQ
tionDemandFuncbPaQS
D
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Demand and Supply
Price
PE
Quantity
Supply Curve
Demand Curve
E
QE
a
a/b
-c/dc a’
a’/b
E’
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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
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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?
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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?
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• 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?
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What is elasticity?
A term economists use to describe responsiveness, or sensitivity, to a change in a factor like price/income
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% 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
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Extreme Cases
Perfectly Inelastic DD Curve
Price
Quantity
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Extreme Cases
Perfectly Elastic DD Curve
Price
Quantity
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CALCULATING PRICE ELASTICITY
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% 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
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What is the Price Elasticity?
Price Quantity Price Elasticity
.9995 20,002
1.0 20,000
1.005 19,998
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What is the Price Elasticity?
Price Quantity Price Elasticity
.9995 20,002
1.0 20,000 -0.2
1.005 19,998
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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
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Arc Elasticity in quantity demanded
sum of quantities/2divided by in price
sum of prices/2
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Arc Elasticity
2/)( 21 QQ
Q
2/)( 21 PP
P
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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
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Elasticity and Demand Function
• Calculate the price elasticity of a demand function
bQaP
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Elasticity and Demand Function
• Calculate the price elasticity of a demand function
bQaP
QbQab /))(/1(
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Elasticity and Demand Function
• What can you say about the elasticity of demand along linear demand function?
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Elasticity and Demand Function
Price
Quantitya/b
η< |1|, Inelastic Demand
η>|1|, Elastic Demandη=|1|, Unit Elastic Demand
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$40
$30
$20
$10
10 20 30 40
A
B
Elastic Demand Ed > 1P
Q
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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
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Elastic Demand
1/))(/1( QbQab
Thus, if Q < a/2b, it is the elastic portion of linear demand curve.
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Elasticity and Demand Function
Price
Quantitya/b
η< |1|, Inelastic Demand
η>|1|, Elastic Demandη=|1|, Unit Elastic Demand
a/2b
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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?
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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
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Price decrease
Increase in total revenue
Elastic Demand
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Elastic Demand
In an elastic portion of the demand curve, to increase revenue:
Price must be reduced!!
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$40
$30
$20
$10
10 20 30 40
A
B
Inelastic Demand Ed < 1
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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
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Elastic Demand
1/))(/1( QbQab
Thus, if Q > a/2b, it is the Inelastic portion of linear demand curve.
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Elasticity and Demand Function
Price
Quantitya/b
η< |1|, Inelastic Demand
η>|1|, Elastic Demandη=|1|, Unit Elastic Demand
a/2b
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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?
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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
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Price decrease
Decrease in total revenue
Inelastic Demand
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Inelastic Demand
In an Inelastic portion of the demand curve, to increase revenue:
Price must be increased!!
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What is a unitary elastic demand curve?
The percentage change in the quantity demanded is equal to the percentage change in price
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$40
$30
$20
$10
10 20 30 40
E
F
Unitary Elastic Demand Ed = 1
D
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Price decrease
No change in total revenue
Unitary Elastic Demand
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$40
$30
$20
$10
10 20 30 40
Perfectly Elastic Demand Ed =
8
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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
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Price change
Infinite change in quantity demanded
Perfectly Elastic Demand
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What is a perfectly inelastic demand curve?
A condition in which the quantity demanded does not change as the price changes
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$40
$30
$20
$10
10 20 30 40
Perfectly Inelastic Demand Ed = 0
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Price change
Zero change in quantity demanded
Perfectly Inelastic Demand
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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
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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
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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.
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Elasticity in Use
• How would you price First class and Economy class airline tickets?
• What is one reason for this?
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Elasticity in Use
Type of Ticket Price Elasticity
First Class -0.45
Regular Economy -1.3
Excursion -1.83
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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
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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
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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
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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
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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.
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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
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Cross Price Elasticity
• Substitutes Good : Cross Price elasticity is positive
• Complimentary Good : Cross Price elasticity is negative