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### Lecture#2(2)

1. 1. Lecture #2: Supply and Demand Browning and Zupan Chapter 2 ECON306 Alexander Schibuola
2. 2. OUTLINE: SUPPLY AND DEMAND <ul><li>DEMAND </li></ul><ul><li>SUPPLY </li></ul><ul><li>EQUILIBRIUM </li></ul><ul><li>CHANGES IN SUPPLY AND DEMAND </li></ul><ul><li>PRICE CONTROLS </li></ul><ul><li>ELASTICITIES </li></ul>
3. 3. 1. DEMAND: The Demand Curve <ul><li>The Demand Curve </li></ul><ul><ul><li>Is a schedule showing the quantity demanded (Q d ) for a good, Q, for different prices (P) </li></ul></ul><ul><ul><li>-It shows the present price and present quantity demanded (as opposed to future price and future quantity demanded) </li></ul></ul><ul><ul><li>-Keep in mind in reality all we see is one price and one quantity over a given time, the other values we don’t see are hypothetical </li></ul></ul><ul><li>Law of Demand </li></ul><ul><ul><li>The lower the price of a good the larger the quantity demanded. </li></ul></ul><ul><ul><li>Corollary: The higher the price, the smaller the quantity demanded </li></ul></ul><ul><li>Demand vs. Quantity Demanded </li></ul><ul><ul><li>-“Demand” depicts the Q d for different P </li></ul></ul><ul><ul><li>-“Quantity demanded” depicts how much Q d for one particular P </li></ul></ul><ul><li>Shifts in Demand </li></ul><ul><ul><li>A demand curve shift (change in demand) shows that Q d changes for all P </li></ul></ul>
4. 4. 1. DEMAND: The Demand Curve <ul><li>Left-side: Demand schedule; </li></ul><ul><li>P = price </li></ul><ul><li>Q d = quantity demanded </li></ul><ul><li>Right-side: Demand curve </li></ul>D P Q d 7 0 6 0 5 100 4 200 3 300 2 400 1 500 7 6 5 1 2 3 4 100 200 300 400 600 500 700 0 1. Demand curve is a schedule of prices and quantities 2. Law of Demand—at lower P, Q d is greater 100 200 0 300 100 200 0 400 300 100 200 0 500 400 300 100 200 0 600 500 400 300 100 200 0 700 600 500 400 300 100 200 0 Underlying algebra: D: P = 6 – (1/100)*Q d , or Q d = 600 –100P P Q
5. 5. 1. DEMAND: The Demand Curve <ul><li>Left-side: Demand schedule; </li></ul><ul><li>P = price </li></ul><ul><li>Q d = quantity demanded </li></ul><ul><li>Right-side: Demand curve </li></ul>D P Q d 7 0 6 0 5 100 4 200 3 300 2 400 1 500 7 6 5 1 2 3 4 100 200 300 400 600 500 700 0 D’ (Q d )’ 100 200 300 400 500 600 700 3. Change in quantity demanded when we move along a given demand curve 4. Shift in demand = change in demand There’s been a change in Q d for all prices Underlying algebra: D: P = 6 – (1/100)*Q d , or Q d = 600 –100P D’: P= 8 – (1/100)*Q d , or Q d = 800 – 100P P Q
6. 6. 1. DEMAND: The Demand Curve <ul><li>When drawing a given demand curve we assume the following factors are constant (a.k.a. ceteris paribus): </li></ul><ul><ul><li>Income </li></ul></ul><ul><ul><li>Prices of related goods </li></ul></ul><ul><ul><li>Tastes and preferences </li></ul></ul><ul><ul><li>The number of buyers </li></ul></ul><ul><ul><li>Expected future price </li></ul></ul><ul><li>If one of these factors changes, the entire demand curve shifts… </li></ul>
7. 7. 1. DEMAND: The Demand Curve <ul><li>Why changes in demand (i.e., demand curve shifts)? </li></ul><ul><li>Changes in income </li></ul><ul><ul><li>An increase in income will cause demand to increase (shifts right) if the good is a normal good </li></ul></ul><ul><ul><li>What is a normal good ? It’s a good for which consumption increases when income rises </li></ul></ul><ul><ul><li>An increase in income will cause demand to decrease (shifts left) if the good is an inferior good </li></ul></ul><ul><ul><li>What is an inferior good ? It’s a good for which consumption decreases when income rises </li></ul></ul>
8. 8. 1. DEMAND: The Demand Curve <ul><li>Why changes in demand (i.e., demand curve shifts)? </li></ul><ul><li>2. Changes in the prices of related goods </li></ul><ul><ul><li>An increase in the price of a complement will cause demand to decrease (shifts left) </li></ul></ul><ul><ul><li>What are complements ? Goods that tend to be consumed together, so consumption of tends to rise or fall together </li></ul></ul><ul><ul><li>An increase the price of a substitute will cause demand to increase (shifts right) </li></ul></ul><ul><ul><li>What is a substitutes ? Two goods that can replace one another in consumption </li></ul></ul>
9. 9. 1. DEMAND: The Demand Curve <ul><li>Why changes in demand (i.e., demand curve shifts)? </li></ul><ul><li>3. Changes in the tastes and preferences </li></ul><ul><ul><li>Tastes and preferences are the feelings of consumers about the desirability of different goods </li></ul></ul><ul><ul><li>If preferences for a good increase demand will increase (shifts right) </li></ul></ul>
10. 10. 1. DEMAND: The Demand Curve <ul><li>Why changes in demand (i.e., demand curve shifts)? </li></ul><ul><li>4. Changes in the number of buyers </li></ul><ul><ul><li>If more people try to buy a good, they bid up prices </li></ul></ul><ul><ul><li>If the number of buyers increases demand increases (shifts right) </li></ul></ul>
11. 11. 1. DEMAND: The Demand Curve <ul><li>Why changes in demand (i.e., demand curve shifts)? </li></ul><ul><li>5. Changes in expected future price </li></ul><ul><ul><li>If the expected future price of a good rises today, buyers would want to buy more today when it’s relatively cheaper </li></ul></ul><ul><ul><li>If the expected future price increases demand increases (shifts right) </li></ul></ul><ul><ul><li>in the present </li></ul></ul>
12. 12. 1. DEMAND: The Demand Curve <ul><li>Other notes… </li></ul><ul><li>The demand curve is downward sloping for two possible reasons: </li></ul><ul><li>(1) A given individual buys more as a good’s price falls </li></ul><ul><li>(2) The number of people who buy a good rises as price falls </li></ul><ul><li>Two aspects are not necessarily mutually exclusive on a given demand curve </li></ul><ul><li>Willingness-to-pay (WTP)—the value, one attaches to a good (independent of its price) </li></ul><ul><li>Demand curve shows the maximum value attached to the q th good </li></ul><ul><li>a.k.a. (Buyer’s) reservation price —the highest price one is willing-to-pay </li></ul><ul><li>The difference between an individual’s reservation price and the market price (the price actually paid) is that consumer’s surplus </li></ul>
13. 13. 1. DEMAND: The Demand Curve <ul><li>Other notes… </li></ul><ul><li>Suppose we’re talking about the demand for 8 apartments, one buyer per good </li></ul><ul><li>Person 1—R 1 =\$1000 </li></ul><ul><li>Person 2—R 2 = \$900 </li></ul><ul><li>Person 3—R 3 = \$800 </li></ul><ul><li>… </li></ul><ul><li>Person 8—R 8 = \$300 </li></ul><ul><li>Person 9—R 9 = \$200 </li></ul><ul><li>Person 10—R 10 =\$100 </li></ul>CS i = R i – P* 1000-300=700 900-300 = 600 800-300 = 500 … 300-300 = 0 200-300 =-100 100-300 =-200 D S Q P P* Scale of P-axis in hundreds, e.g., 5 = \$500 700 600 500 400 Graphically: The total consumer surplus is measured by the area underneath the demand curve and between the market price, P* 300 200 100 CS tot = 700 + 600 + … + 100 + 0 = \$2800 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
14. 14. 1. DEMAND: The Demand Curve <ul><li>Other notes… </li></ul><ul><li>Why account for consumer surplus? </li></ul><ul><li>Most of the goods you will ever purchase come at a considerable bargain… </li></ul><ul><li>Person 3 with R = \$800 gets an apartment she values at \$800 for only \$300 </li></ul><ul><li>Person 10 (with R = \$100) opts not to rent the apartment because his wealth decreases by \$200 (= 100 – 300) </li></ul><ul><li>The opportunity cost is too high. P10 prefers to not live there and to spend his \$300 elsewhere…if the price falls to \$100 he will reconsider </li></ul><ul><li>We’ll return to this concept of consumer surplus in another lecture… </li></ul>
15. 15. 2. SUPPLY: The Supply Curve <ul><li>The Supply Curve </li></ul><ul><ul><li>Is a schedule showing the quantity supplied (Q s ) for a good, Q for different prices (P) </li></ul></ul><ul><ul><li>-It shows the present price and present quantity supplied (as opposed to future price and future quantity supplied) </li></ul></ul><ul><ul><li>-Keep in mind in reality all we see is one price and one quantity over a given time, the other values we don’t see are hypothetical </li></ul></ul><ul><li>Law of Supply </li></ul><ul><ul><li>The higher the price of a good the larger the quantity supplied </li></ul></ul><ul><ul><li>Corollary: The lower the price, the smaller the quantity supplied </li></ul></ul><ul><li>Supply vs. Quantity Supplied </li></ul><ul><ul><li>“ Supply” depicts the Q s for different P </li></ul></ul><ul><ul><li>“ Quantity supplied” depicts how much Q s for one particular P </li></ul></ul><ul><li>Shifts in Supply </li></ul><ul><ul><li>A supply curve shift (change in supply) shows that Q s changes for all P </li></ul></ul>
16. 16. 1. SUPPLY: The Supply Curve <ul><li>Left-side: Supply schedule; </li></ul><ul><li>P = price </li></ul><ul><li>Q s = quantity supplied </li></ul><ul><li>Right-side: Supply curve </li></ul>S P Q s 6 600 5 500 4 400 3 300 2 200 1 100 7 6 5 1 2 3 4 100 200 300 400 600 500 700 0 1. Supply curve is a schedule of prices and quantities 2. Law of Supply—at higher P, Q s is greater Underlying algebra: S: P = 0 + (1/100)*Q s , or Q s = 0 + 100P P Q
17. 17. 2. SUPPLY: The Supply Curve <ul><li>Left-side: Supply schedule; </li></ul><ul><li>P = price </li></ul><ul><li>Q s = quantity supplied </li></ul><ul><li>Right-side: Supply curve </li></ul>S P Q s 6 600 5 500 4 400 3 300 2 200 1 100 7 6 5 1 2 3 4 100 200 300 400 600 500 700 0 S’ (Q s )’ 800 700 600 500 400 300 3. Change in quantity supplied when we move along a given supply curve 4. Shift in supply = change in supply There’s been a change in Q s for all prices Underlying algebra: S: P = 0 + (1/100)*Q s , or Q s = 0 + 100P S’: P= -1+(1/100)*Q s , or Q s = -100 + 100P P Q
18. 18. 2. SUPPLY: The Supply Curve <ul><li>When drawing a given supply curve we assume the following factors are constant (a.k.a. ceteris paribus): </li></ul><ul><ul><li>Prices of inputs </li></ul></ul><ul><ul><li>State of technological knowledge </li></ul></ul><ul><ul><li>Price of alternative outputs </li></ul></ul><ul><ul><li>Number of sellers </li></ul></ul><ul><ul><li>Expected future price </li></ul></ul><ul><li>If one of these factors changes the entire supply curve shifts. </li></ul>
19. 19. 2. SUPPLY: The Supply Curve <ul><li>Why changes in supply (i.e., supply curve shifts)? </li></ul><ul><li>1. Changes in the prices of inputs </li></ul><ul><ul><li>To produce an output (i.e., to produce a certain “quantity supplied”, producers use inputs: </li></ul></ul><ul><ul><li>Inputs are labor (L) and capital (K) </li></ul></ul><ul><ul><li>When producers combine these inputs (L and K) we get outputs, if the price of the inputs decreases (making it cheaper to employ more inputs, supply increases </li></ul></ul>
20. 20. 2. SUPPLY: The Supply Curve <ul><li>Why changes in supply (i.e., supply curve shifts)? </li></ul><ul><li>2. Changes in the state of technological knowledge </li></ul><ul><ul><li>An improvement in the state of technological knowledge increases supply (supply curve shifts right), it makes production cheaper </li></ul></ul>
21. 21. 2. SUPPLY: The Supply Curve <ul><li>Why changes in supply (i.e., supply curve shifts)? </li></ul><ul><li>3. Changes in the price of alternative outputs </li></ul><ul><ul><li>If producers can produce an alternative to Q, let’s call it R, and the price of R falls relative to the price of Q, producers will increase the supply of Q. </li></ul></ul><ul><ul><li>Why? Because it’s Q’s price is now relatively higher, making it relatively more profitable to produce </li></ul></ul>
22. 22. 2. SUPPLY: The Supply Curve <ul><li>Why changes in supply (i.e., supply curve shifts)? </li></ul><ul><li>4. Changes in the number of sellers </li></ul><ul><ul><li>If more sellers (or producers or firms, etc.) enter a market, they must outbid each other by lowering prices to sell the greater supply </li></ul></ul><ul><ul><li>As a result an increase in the number of sellers leads the supply to increase (shifts right) </li></ul></ul>
23. 23. 2. SUPPLY: The Supply Curve <ul><li>Why changes in supply (i.e., supply curve shifts)? </li></ul><ul><li>5. Changes in the expected future price </li></ul><ul><ul><li>If the expected future price of a good falls, suppliers will want to sell more today when it’s present price is relatively higher </li></ul></ul><ul><ul><li>As a result an increase the supply to increase (shifts right) </li></ul></ul>
24. 24. 2. SUPPLY: The Supply Curve <ul><li>Other notes… </li></ul><ul><li>The supply curve is upward sloping for two possible reasons: </li></ul><ul><li>(1) A given individual sells more as a good’s price rises </li></ul><ul><li>(2) The number of people who sell a good rises as price rises </li></ul><ul><li>These two aspects are not necessarily mutually exclusive </li></ul><ul><li>Willingness-to-sell (WTS)—the value, one attaches to a good (independent of its price) </li></ul><ul><li>Supply curve shows the minimum values sellers attach to the q th good </li></ul><ul><li>a.k.a. (Seller’s) reservation price —the lowest price one is willing-to-sell </li></ul><ul><li>The difference between a the market price and the seller’s reservation price is the producer’s surplus </li></ul>
25. 25. 2. SUPPLY: The Supply Curve <ul><li>Other notes… </li></ul><ul><li>Suppose we’re talking about the supply of apartments, one seller per good </li></ul><ul><li>Person 1—R 1 = \$100 </li></ul><ul><li>Person 2—R 2 = \$200 </li></ul><ul><li>Person 3—R 3 = \$300 </li></ul><ul><li>… </li></ul><ul><li>Person 8—R 8 = \$800 </li></ul><ul><li>Person 9—R 9 = \$900 </li></ul><ul><li>Person 10—R 10 =\$1000 </li></ul>P* – R i = PS i 800-100 = 700 800-200 = 600 800-300 = 500 … 800-800 = 0 800-900 = -100 800-1000 = -200 D S Q P P* Scale of P-axis in hundreds, e.g., 5 = \$500 Graphically: The total producer surplus is measured by the area underneath the market price, P* and between the supply curve PS tot = 700 + 600 + … + 100 + 0 = \$2800 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 700 600 500 400 300 200 100
26. 26. 2. SUPPLY: The Supply Curve <ul><li>Other notes… </li></ul><ul><li>Why account for producer surplus? </li></ul><ul><li>Most of the goods you will ever sell are a bargain to part with… </li></ul><ul><li>Person 1 with R = \$100 gives up an apartment he values at \$100 for \$800 </li></ul><ul><li>Person 9 (with R = \$900) opts not to rent out the apartment because her wealth decreases by \$100 (= 800 – 900) </li></ul><ul><li>The opportunity cost is too high, you’d only rent it out for a minimum additional \$800 </li></ul><ul><li>We’ll return to this concept of producer surplus in another lecture… </li></ul>
27. 27. 2. SUPPLY: The Supply Curve <ul><li>Other notes… </li></ul><ul><li>Demand-side: Buyers, Consumers, Demanders </li></ul><ul><li>Supply-side: Sellers, Producers (or firms), Suppliers </li></ul><ul><li>Terms buyers and sellers somewhat misleading… </li></ul><ul><li>In an exchange there is neither really a buyer or seller per se, only traders… </li></ul><ul><li>Do you buy coffee from Starbucks with your money? OR </li></ul><ul><li>Does you Starbucks buy money from you with their coffee? </li></ul><ul><li>From another angle: </li></ul><ul><li>Does Starbucks sell coffee for your money? OR </li></ul><ul><li>Do you sell your money for coffee? </li></ul>
28. 28. 2. SUMMARY I <ul><li>Demand increases (shifts right) if… </li></ul><ul><ul><li>Income increases and the good demanded is a normal good </li></ul></ul><ul><ul><li>Income decreases and the good demanded is an inferior good </li></ul></ul><ul><ul><li>The price of a complement decreases </li></ul></ul><ul><ul><li>The price of a substitute increases </li></ul></ul><ul><ul><li>Tastes and preferences for the good increases </li></ul></ul><ul><ul><li>The number of buyers increases </li></ul></ul><ul><ul><li>The expected future price of the good increases </li></ul></ul><ul><li>Supply increases (shifts right) if… </li></ul><ul><ul><li>The price of inputs decreases </li></ul></ul><ul><ul><li>The state of technological knowledge improves </li></ul></ul><ul><ul><li>The price of alternative outputs decreases </li></ul></ul><ul><ul><li>The number of sellers increases </li></ul></ul><ul><ul><li>The expected future price decreases </li></ul></ul>
29. 29. 2. SUMMARY II <ul><li>Demand decreases (shifts left) if… </li></ul><ul><ul><li>Income decreases and the good demanded is a normal good </li></ul></ul><ul><ul><li>Income increases and the good demanded is an inferior good </li></ul></ul><ul><ul><li>The price of a complement increases </li></ul></ul><ul><ul><li>The price of a substitute decreases </li></ul></ul><ul><ul><li>Tastes and preferences for the good decreases </li></ul></ul><ul><ul><li>The number of buyers decreases </li></ul></ul><ul><ul><li>The expected future price of the good decreases </li></ul></ul><ul><li>Supply decreases (shifts left) if… </li></ul><ul><ul><li>The price of inputs increases </li></ul></ul><ul><ul><li>The state of technological knowledge regresses </li></ul></ul><ul><ul><li>The price of alternative outputs increases </li></ul></ul><ul><ul><li>The number of sellers decreases </li></ul></ul><ul><ul><li>The expected future price increases </li></ul></ul>
30. 30. 3. Equilibrium <ul><li>Equilibrium, (Q*, P*) </li></ul><ul><ul><li>Quantity Supplied = Quantity Demanded </li></ul></ul><ul><ul><ul><li>No one wants to make any more trades </li></ul></ul></ul><ul><ul><ul><li>Exists at the price, P* that equates the quantity supplied with quantity demanded ceteris paribus </li></ul></ul></ul><ul><li>Disequilibrium </li></ul><ul><ul><li>Q s ≠ Q d (P ≠ P*) </li></ul></ul><ul><ul><li>Shortages: </li></ul></ul><ul><ul><li>(Q d > Q s because P < P*) </li></ul></ul><ul><ul><li>Surpluses: </li></ul></ul><ul><ul><li>(Q s > Q d because P > P*) </li></ul></ul>D S Q P P* Q* 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
31. 31. 3. Equilibrium: Disequilibrium <ul><ul><li>Shortages (Q s < Q d because P < P*) </li></ul></ul><ul><ul><li>At P = \$3: </li></ul></ul><ul><ul><li>Consumers want to buy 6000g (Q d = 6000) </li></ul></ul><ul><ul><li>Producers want to sell 2000g (Q s = 2000) </li></ul></ul>D S Q P P Q s Q d XD Figure: Market for gasoline Q in thousands, i.e., 2 = 2000 gallons P is price per gallon P = \$3/gallon Buyers want more than sellers are willing to supply at P = 3 Their inventories are depleted faster than they can be replaced Sellers start to raise prices: Q d decreases and Q s increases Process continues until Q d = Q s Shortage exists if there is an excess demand (XD) for goods P* 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
32. 32. 3. Equilibrium: Disequilibrium <ul><ul><li>Surpluses (Q s > Q d because P > P*) </li></ul></ul><ul><ul><li>At P = \$7: </li></ul></ul><ul><ul><li>Consumers want to buy 2000g (Q d = 2000) </li></ul></ul><ul><ul><li>Producers want to sell 6000g (Q s = 6000) </li></ul></ul>D S Q P P Q d Q s XS Figure: Market for gasoline Q in thousands, i.e., 2 = 2000 gallons P is price per gallon P = \$3/gallon Buyers want less than sellers are willing to supply at P = 7 Their inventories accumulate more than they can be sold Sellers start to decrease prices: Q s decreases and Q d increases Process continues until Q d = Q s Surplus exists if there is an excess supply (XS) of goods P* 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
33. 33. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>Suppose there is an unexpected increase in demand… </li></ul><ul><li>Buyers want more across all prices </li></ul><ul><li>Initial equilibrium (P 1 , Q 1 ) </li></ul><ul><li>Temporary disequilibrium </li></ul><ul><ul><li>Q d > Q s  shortage (XD) </li></ul></ul><ul><ul><li>Sellers raise price </li></ul></ul><ul><ul><li>Higher price leads Q s to increase </li></ul></ul><ul><ul><li>Higher price leads Q d to decrease </li></ul></ul><ul><ul><li>Continues until: </li></ul></ul><ul><li>New equilibrium (P 2 , Q 2 ) </li></ul>D S Q P P 1 Q 1 D’ a b c Q d Q 2 P 2 Q s 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
34. 34. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>Suppose there is an unexpected decrease in demand… </li></ul><ul><li>Buyers want less across all prices </li></ul><ul><li>Initial equilibrium (P 1 , Q 1 ) </li></ul><ul><li>Temporary disequilibrium </li></ul><ul><ul><li>Q d < Q s  surplus (XS) </li></ul></ul><ul><ul><li>Sellers decrease price </li></ul></ul><ul><ul><li>Lower price leads Q s to decrease </li></ul></ul><ul><ul><li>Lower price leads Q d to increase </li></ul></ul><ul><ul><li>Continues until: </li></ul></ul><ul><li>New equilibrium (P 2 , Q 2 ) </li></ul>D S Q P P 1 Q 1 D’ a b c Q d Q 2 P 2 Q s 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
35. 35. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>Suppose there is an unexpected increase in supply… </li></ul><ul><li>Sellers want to sell more across all prices </li></ul><ul><li>Initial equilibrium (P 1 , Q 1 ) </li></ul><ul><li>Temporary disequilibrium </li></ul><ul><ul><li>Q s > Q d  surplus (XS) </li></ul></ul><ul><ul><li>Sellers decrease price </li></ul></ul><ul><ul><li>Lower price leads Q s to decrease </li></ul></ul><ul><ul><li>Lower price leads Q d to increase </li></ul></ul><ul><ul><li>Continues until: </li></ul></ul><ul><li>New equilibrium (P 2 , Q 2 ) </li></ul>D S Q P P 1 Q d a b c Q s Q 2 P 2 S’ Q 1 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
36. 36. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>Suppose there is an unexpected decrease in supply… </li></ul><ul><li>Sellers want to sell less across all prices </li></ul><ul><li>Initial equilibrium (P 1 , Q 1 ) </li></ul><ul><li>Temporary disequilibrium </li></ul><ul><ul><li>Q s < Q d  shortage (XD) </li></ul></ul><ul><ul><li>Sellers increase price </li></ul></ul><ul><ul><li>Higher price leads Q s to increase </li></ul></ul><ul><ul><li>Higher price leads Q d to decrease </li></ul></ul><ul><ul><li>Continues until: </li></ul></ul><ul><li>New equilibrium (P 2 , Q 2 ) </li></ul>D S Q P P 1 Q d a b c Q s Q 2 P 2 S’ Q 1 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
37. 37. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>In practice we will generally take the short-route: </li></ul><ul><li>Suppose (again) that there’s a decrease in supply… </li></ul><ul><li>Initial equilibrium (P 1 , Q 1 ) </li></ul><ul><li>New equilibrium (P 2 , Q 2 ) </li></ul>D S Q P P 1 Q 1 a b Q 2 P 2 S’ Rather than go through the dynamic transition from one equilibrium to another we just jump from one equilibrium to another HOW THIS GRAPH IS READ: A decrease in supply (shifts left) leads to a decrease in the quantity demanded . Equilibrium price (P*) increases and equilibrium quantity (Q*) decreases. 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
38. 38. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>In reality all we observe are P and Q </li></ul><ul><li>Suppose we look at monthly gasoline prices and quantity </li></ul><ul><li>Point 0—Initial equilibrium (P 0 , Q 0 ) </li></ul>D S Q P P 0 Q 0 0 d c b a Suppose next month, we observe that: a: P a > P 0 and Q a > Q 0 b: P b < P 0 and Q b > Q 0 c: P c < P 0 and Q c < Q 0 d: P d > P 0 and Q d < Q 0 We can infer whether supply or demand changes dominated the market over time A: Demand Increase A: Supply Increase A: Supply Decrease A: Demand Decrease e 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
39. 39. 4. CHANGES IN SUPPLY AND DEMAND <ul><li>No shortages of economic illiteracy… </li></ul><ul><li>You will frequently read/hear something like this in the news: </li></ul><ul><li>“ Increased demand is causing shortages in the market for X” </li></ul><ul><li>Generally incorrect…true only if price does not increase </li></ul><ul><li>An increased demand does not produce shortages but a higher price…if price does not increase then a prolonged shortage is possible </li></ul><ul><li>But why would prices not increase? </li></ul>
40. 40. 5. PRICE CONTOLS <ul><li>Frequently politicians attack “price-gouging” and want to impose price controls to benefit an interest group </li></ul><ul><li>E.g., New York mayoral candidate who complained that, “The Rent is too Damn High!” </li></ul><ul><li>Price ceiling —a legislated maximum price for a good </li></ul><ul><li>(Some times known as a rent control) </li></ul><ul><li>Price floor —a legislated minimum price for a good </li></ul><ul><li>These are instances in which there are good intentions but bad outcomes… (unintended consequences) </li></ul>
41. 41. 5. PRICE CONTOLS <ul><li>Can the law be effectively enforced? </li></ul><ul><li>If NO: </li></ul><ul><li>-Furnish the apartment and charge for using furniture </li></ul><ul><li>-Make tenant responsible for maintenance cost </li></ul><ul><li>-Charge a non-refundable deposit </li></ul><ul><li>-Accept bribes (monetary or non-monetary) </li></ul><ul><li>-Engage in discrimination </li></ul><ul><li>P* and Q* still prevail albeit in a less transparent manner </li></ul>D S Q P P c Q* XD New York apartment market Q in millions P in hundreds per month P c = price ceiling P* Q c 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
42. 42. 5. PRICE CONTOLS <ul><li>Can the law be effectively enforced? </li></ul><ul><li>If YES: </li></ul><ul><li>Q* will fall to Q c </li></ul><ul><li>Produces a shortage, at P c 6 million apartments are demanded, but only 2 million are made available </li></ul><ul><li>2 million people will get an apartment, the other 4 million will not get an apartment in NYC </li></ul><ul><li>Rather than produce apartments for housing—space will be used for offices or stores instead </li></ul>D S Q P P c Q* XD New York apartment market Q in millions P in hundreds per month P c = price ceiling P* Q c 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
43. 43. 5. PRICE CONTOLS <ul><li>Who is harmed? </li></ul><ul><li>Obviously landlords are worse-off—they started to rent expecting P* but end up with P c </li></ul><ul><li>Less obvious: </li></ul><ul><li>Shortages </li></ul><ul><li>Quality degradation </li></ul><ul><li>Enforcement costs </li></ul><ul><li>Misallocated resources </li></ul>D S Q P P c Q* XD New York apartment market: Q in millions P in hundreds per month P c = price ceiling P* Q c Who benefits? -Landlords not in NYC -People who do manage to find a rent-controlled apartment 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
44. 44. 5. PRICE CONTOLS <ul><li>Surplus  </li></ul><ul><li>Q s > Q d </li></ul> Shortage Q d > Q s
45. 45. 6. ELASTICITIES <ul><li>Qualitative answers not enough; need something more quantitative… </li></ul><ul><li>Elasticity—measures how responsive Q d (or Q s ) is to a change in a determinant (e.g., price, income, etc.) </li></ul><ul><li>Definition and Calculation </li></ul><ul><ul><li>Price elasticity of demand </li></ul></ul><ul><ul><li>Income elasticity of demand </li></ul></ul><ul><ul><li>Cross-price elasticity </li></ul></ul><ul><ul><li>Price elasticity of supply </li></ul></ul><ul><li>Application and Interpretation </li></ul>
46. 46. 6. ELASTICITIES: (1) Definition and Calculation: (A) Price Elasticity of Demand <ul><li>Price Elasticity of Demand —measures how responsive the quantity demanded of a good is to a change in its price </li></ul><ul><li>Formally it measures the percentage change in quantity demanded relative to the percentage change in price </li></ul>
47. 47. 6. ELASTICITIES: (1) Definition and Calculation: (A) Price Elasticity of Demand <ul><li>Calculation of Point Elasticity Formula : For small changes in Q d and P </li></ul><ul><li>Step 1: Find percentage change in Q d </li></ul><ul><li>[(Q d1 – Q d0 )/Q d0 ]*100 = (% change in Q) </li></ul><ul><li>Step 2: Find percentage change in P </li></ul><ul><li>[(P 1 – P 0 )/P 0 ]*100 = (% change in P) </li></ul><ul><li>Step 3: Divide percentage change in Q d by percentage change in P </li></ul><ul><li>(% change in Q d )/(% change in P) = η </li></ul><ul><li>Here’s the formula in the most reduced form: </li></ul><ul><li>η = ( Δ Q d / Δ P)*(P 0 /Q d0 ), </li></ul><ul><li>Where Δ (delta) indicates “change in,” e.g., Δ Q d = Q d1 – Q d0 </li></ul>
48. 48. 6. ELASTICITIES: (1) Definition and Calculation: (A) Price Elasticity of Demand <ul><li>Calculation of Arc Elasticity Formula : For large changes in Q d and P </li></ul><ul><li>Step 1: Find averaged percentage change in Q d </li></ul><ul><li>{(Q d1 – Q d0 )/[0.5*(Q d1 + Q d0 ]}*100 = (% change in Q) </li></ul><ul><li>Step 2: Find averaged percentage change in P </li></ul><ul><li> {(P 1 – P 0 )/[0.5*(P 1 + P 0 ]}*100 = (% change in P) </li></ul><ul><li>Step 3: Divide averaged % change in Q by averaged % change in P </li></ul><ul><li>(% change in Q d )/(% change in P) = η ( η is eta) </li></ul><ul><li>Here’s the formula in the most reduced form: </li></ul><ul><li>η = {(Q d1 – Q d0 )/[0.5*(Q d1 + Q d0 ]} / {(P 1 – P 0 )/[0.5*(P 1 + P 0 ]} </li></ul><ul><li>Where Δ (delta) indicates “change in,” e.g., Δ Q d = Q d1 – Q d0 </li></ul>
49. 49. 6. ELASTICITIES: (1) Definition and Calculation: (A) Price Elasticity of Demand <ul><li>When you estimate the price elasticity of demand you have three qualitative results: </li></ul><ul><li>NOTE: When calculating the price elasticity of demand, η will be negative (because of the First Law of Demand). In context, we generally speak of elasticity as a positive number so we analyze the absolute value of n, | η |: </li></ul><ul><li>(a) If | η | > 1  demand is elastic </li></ul><ul><li>(b) If | η | = 1  demand is unit elastic </li></ul><ul><li>(c) If | η | < 1  demand is inelastic </li></ul><ul><li>We’ll return to the interpretation of η </li></ul>
50. 50. 6. ELASTICITIES: (1) Definition and Calculation: (A) Price Elasticity of Demand <ul><li>Other notes on Price Elasticity of Demand: </li></ul><ul><li>It varies between goods, and this depends on: </li></ul><ul><li>The number of substitutes and/or the degree to which substitutes are close </li></ul><ul><li>The time period over which demand is analyzed </li></ul><ul><li>In particular demand will be more elastic, if: </li></ul><ul><li>(1) There are many substitutes and/or close substitutes </li></ul><ul><li>(2) The time period analyzed is of longer duration </li></ul>
51. 51. 6. ELASTICITIES: (1) Definition and Calculation: (B) Income Elasticity of Demand <ul><li>Income Elasticity of Demand —measures how responsive the quantity demanded of a good is to a change in income </li></ul><ul><li>Formally it measures the percentage change in quantity demanded relative to the percentage change in income </li></ul>
52. 52. 6. ELASTICITIES: (1) Definition and Calculation: (B) Income Elasticity of Demand <ul><li>Calculation of Income Elasticity Formula : For changes in Q d and I </li></ul><ul><li>Step 1: Find percentage change in Q d </li></ul><ul><li>[(Q d1 – Q d0 )/Q d0 ]*100 = (% change in Q) </li></ul><ul><li>Step 2: Find percentage change in income, I </li></ul><ul><li>[(I 1 – I 0 )/I 0 ]*100 = (% change in I) </li></ul><ul><li>Step 3: Divide percentage change in Q by percentage change in I </li></ul><ul><li>(% change in Q d )/(% change in I) = Φ , ( Φ is phi) </li></ul><ul><li>Here’s the formula in the most reduced form: </li></ul><ul><li> Φ = ( Δ Q d / Δ I)*(I 0 /Q d0 ), </li></ul><ul><li>Where Δ (delta) indicates “change in,” e.g., Δ Q d = Q d1 – Q d0 </li></ul>
53. 53. 6. ELASTICITIES: (1) Definition and Calculation: (B) Income Elasticity of Demand <ul><li>When you estimate the income elasticity of demand you have two qualitative results: </li></ul><ul><li>(a) If Φ ≥ 0  it’s a normal good </li></ul><ul><li>(b) If Φ < 0  it’s an inferior good </li></ul><ul><li>We’ll return to the interpretation of Φ </li></ul>
54. 54. 6. ELASTICITIES: (1) Definition and Calculation: (C) Cross-Price Elasticity of Demand <ul><li>Cross-Price Elasticity of Demand —measures how responsive the quantity demanded of a good is to a change in the price of a related good </li></ul><ul><li>Formally it is measures the percentage change in quantity demanded relative to a percentage change in the price of a related good </li></ul>
55. 55. 6. ELASTICITIES: (1) Definition and Calculation: (C) Cross-Price Elasticity of Demand <ul><li>Calculation of Cross-Price Elasticity Formula : For changes in Q d and P R </li></ul><ul><li>Step 1: Find percentage change in Q d </li></ul><ul><li>[(Q d1 – Q d0 )/Q d0 ]*100 = (% change in Q) </li></ul><ul><li>Step 2: Find percentage change in the price of the related good, P R </li></ul><ul><li>[(P R1 – P R0 )/P R0 ]*100 = (% change in P R ) </li></ul><ul><li>Step 3: Divide percentage change in Q by percentage change in P R </li></ul><ul><li>(% change in Q d )/(% change in P R ) = Χ ( Χ is chi) </li></ul><ul><li>Here’s the formula in the most reduced form: </li></ul><ul><li> Χ = ( Δ Q d / Δ P R )*(P R0 /Q d0 ), </li></ul><ul><li>Where Δ (delta) indicates “change in,” e.g., Δ Q d = Q d1 – Q d0 </li></ul>
56. 56. 6. ELASTICITIES: (1) Definition and Calculation: (C) Cross-Price Elasticity of Demand <ul><li>When you estimate the income elasticity of demand you have three qualitative results: </li></ul><ul><li>(a) If Χ > 0  it’s a substitute to good R </li></ul><ul><li>(b) If Χ < 0  it’s a complement to good R </li></ul><ul><li>(c) If Χ = 0  R is not a related good </li></ul><ul><li>We’ll return to this the interpretation of Χ </li></ul>
57. 57. 6. ELASTICITIES: (1) Definition and Calculation: (D) Price Elasticity of Supply <ul><li>Price Elasticity of Supply —measures how responsive the quantity supplied of a good is to a change in the good’s price </li></ul><ul><li>Formally it is measures the percentage change in quantity supplied relative to a percentage change in the price </li></ul>
58. 58. 6. ELASTICITIES: (1) Definition and Calculation: (D) Price Elasticity of Supply <ul><li>Calculation of Price Elasticity of Supply Formula : For changes in Q s and P </li></ul><ul><li>Step 1: Find percentage change in Q s </li></ul><ul><li>[(Q s1 – Q s0 )/Q s0 ]*100 = (% change in Q) </li></ul><ul><li>Step 2: Find percentage change in the price of the related good, P </li></ul><ul><li>[(P 1 – P 0 )/P 0 ]*100 = (% change in P) </li></ul><ul><li>Step 3: Divide percentage change in Q s by percentage change in P </li></ul><ul><li>(% change in Q s )/(% change in P ) = ε ( ε is epsilon) </li></ul><ul><li>Here’s the formula in the most reduced form: </li></ul><ul><li> ε = ( Δ Q s / Δ P)*(P 0 /Q s0 ), </li></ul><ul><li>Where Δ (delta) indicates “change in,” e.g., Δ Q s = Q s1 – Q s0 </li></ul>
59. 59. 6. ELASTICITIES: (1) Definition and Calculation: (D) Price Elasticity of Supply <ul><li>When you estimate the income elasticity of demand you have five qualitative results: </li></ul><ul><li>(a) If ε = ∞  supply curve is horizontal </li></ul><ul><li>(b) If ε > 1  supply is elastic </li></ul><ul><li>(c) If ε = 1  supply is unit elastic </li></ul><ul><li>(d) If ε < 1  supply is inelastic </li></ul><ul><li>(c) If ε = 0  supply curve is vertical </li></ul><ul><li>We’ll return to the interpretation of ε </li></ul>
60. 60. 6. ELASTICITIES: (2) Application & Interpretation: (A) Price Elasticity of Demand <ul><li>Calculation of Point Elasticity Formula : </li></ul><ul><li>For small changes in Q d and P </li></ul><ul><li>η = ( Δ Q d / Δ P)*(P 0 /Q d0 ), </li></ul><ul><li>= [(102 – 100)/(9.9 – 10.0)] * [10.0/100] </li></ul><ul><li>= [2/(-0.1)] * [0.1] </li></ul><ul><li>= -2.0, | η | = 2.0 > 1  demand is elastic </li></ul><ul><li>Read as: a 1 % decrease in price leads to a 2 % increase in Q d </li></ul><ul><li>or rather, +2%/-1% = -2.0 </li></ul>9.9 10.0 P t 102 100 Q dt t = 1 t = 0 Given:
61. 61. 6. ELASTICITIES: (2) Application & Interpretation: (A) Price Elasticity of Demand <ul><li>Calculation of Point Elasticity Formula : </li></ul><ul><li>For small changes in Q d and P </li></ul><ul><li>η = ( Δ Q d / Δ P)*(P 0 /Q d0 ), </li></ul><ul><li>= [(101 – 100)/(9.8 – 10.0)] * [10.0/100] </li></ul><ul><li>= [1/(-0.2)] * [0.1] </li></ul><ul><li>= -0.5, | η | = 0.5 < 1  demand is inelastic </li></ul><ul><li>Read as: a 2 % increase in price leads to a 1 % decrease in Q d </li></ul><ul><li>or rather, -1%/+2% = -0.5 </li></ul>9.8 10.0 P t 101 100 Q dt t = 1 t = 0 Given:
62. 62. 6. ELASTICITIES: (2) Application & Interpretation: (A) Price Elasticity of Demand <ul><li>Calculation of Point Elasticity Formula : </li></ul><ul><li>For small changes in Q d and P </li></ul><ul><li>η = ( Δ Q d / Δ P)*(P 0 /Q d0 ), </li></ul><ul><li>= [(99 – 100)/(10.1 – 10.0)] * [10.0/100] </li></ul><ul><li>= [-1/(0.1) * [0.1] </li></ul><ul><li>= -1.0, | η | = 1.0 = 1  demand is unit elastic </li></ul><ul><li>Read as: a 1 % increase in price leads to a 1 % decrease in Q d </li></ul><ul><li>or rather, -1%/+1% = -1.0 </li></ul>10.1 10.0 P t 99 100 Q dt t = 1 t = 0 Given:
63. 63. 6. ELASTICITIES: (2) Application & Interpretation: (B) Income Elasticity of Demand <ul><li>Calculation of Income Elasticity of Demand : </li></ul><ul><li>For small changes in Q d and I </li></ul><ul><li>Φ = ( Δ Q d / Δ I)*(I 0 /Q d0 ), </li></ul><ul><li>= [(101 – 100)/(101 – 100)] * [100.0/100] </li></ul><ul><li>= [1/(1)] * [1] </li></ul><ul><li>= 1.0, Φ = 1.0 > 0  normal good </li></ul><ul><li>Read as: a 1 % increase in income, I , leads to a 1 % increase in Q d </li></ul><ul><li>or rather, 1%/1% = 1.0 </li></ul>101.0 100.0 I t 101 100 Q dt t = 1 t = 0 Given:
64. 64. 6. ELASTICITIES: (2) Application & Interpretation: (B) Income Elasticity of Demand <ul><li>Calculation of Income Elasticity of Demand : </li></ul><ul><li>For small changes in Q d and I </li></ul><ul><li>Φ = ( Δ Q d / Δ I)*(I 0 /Q d0 ), </li></ul><ul><li>= [(99 – 100)/(101 – 100)] * [100.0/100] </li></ul><ul><li>= [-1/(1)] * (1)] </li></ul><ul><li>= -1.0, Φ = -1.0 < 0  inferior good </li></ul><ul><li>Read as: a 1 % increase in income, I , leads to a 1 % decrease in Q d </li></ul><ul><li>or rather, -1%/+1% = -1.0 </li></ul>101.0 100.0 I t 99 100 Q dt t = 1 t = 0 Given:
65. 65. 6. ELASTICITIES: (2) Application & Interpretation: (C) Cross-Price Elasticity of Demand <ul><li>Calculation of Cross-Price Elasticity of Demand : </li></ul><ul><li>For small changes in Q d and P R </li></ul><ul><li>Φ = ( Δ Q d / Δ P R )*(P R0 /Q 0 ), </li></ul><ul><li>= [(101 – 100)/(5.1 – 5.0)] * [5.0/100] </li></ul><ul><li>= [1/(0.1)] * [0.05] </li></ul><ul><li>= +0.5, Φ = 0.5 > 0  R is a substitute for Q </li></ul><ul><li>Read as: a 2 % increase in the P R , leads to a 1 % increase in Q d </li></ul><ul><li>or rather, +1%/+2% = 0.5 </li></ul>5.1 5.0 P Rt 101 100 Q dt t = 1 t = 0 Given:
66. 66. 6. ELASTICITIES: (2) Application & Interpretation: (C) Cross-Price Elasticity of Demand <ul><li>Calculation of Cross-Price Elasticity of Demand : </li></ul><ul><li>For small changes in Q d and P R </li></ul><ul><li>Φ = ( Δ Q d / Δ P R )*(P R0 /Q 0 ), </li></ul><ul><li>= [(101 – 100)/(4.9 – 5.0)] * [5.0/100] </li></ul><ul><li>= [1/(-0.1)] * [0.05] </li></ul><ul><li>= -0.5, Φ = -0.5 < 0  R is a complement to Q </li></ul><ul><li>Read as: a 2 % decrease in P R , leads to a 1 % increase in Q d </li></ul><ul><li>or rather, +0.5%/-1% = 0.5 </li></ul>4.9 5.0 P Rt 101 100 Q dt t = 1 t = 0 Given:
67. 67. 6. ELASTICITIES: (2) Application & Interpretation: (D) Price Elasticity of Supply <ul><li>Calculation of Price Elasticity of Supply : </li></ul><ul><li>For small changes in Q s and P </li></ul><ul><li>ε = ( Δ Q s / Δ P)*(P 0 /Q s0 ), </li></ul><ul><li>= [(102 – 100)/(10.1 – 10.0)] * [10.0/100] </li></ul><ul><li>= [2/(0.1)] * [0.1] </li></ul><ul><li>= 2.0, ε = 2.0 > 1.0  supply is elastic </li></ul><ul><li>Read as: a 1 % increase in the price, leads to a 2 % increase in Q s </li></ul><ul><li>or rather, 2%/1% = 2.0 </li></ul>10.1 10.0 P Rt 102 100 Q st t = 1 t = 0 Given:
68. 68. 6. ELASTICITIES: (2) Application & Interpretation: (D) Price Elasticity of Supply <ul><li>Calculation of Price Elasticity of Supply : </li></ul><ul><li>For small changes in Q s and P </li></ul><ul><li>ε = ( Δ Q s / Δ P)*(P 0 /Q s0 ), </li></ul><ul><li>= [(101 – 100)/(10.2 – 10.0)] * [10.0/100] </li></ul><ul><li>= [1/(0.2)] * [0.1] </li></ul><ul><li>= 0.5, ε = 0.5 < 1  supply is inelastic </li></ul><ul><li>Read as: a 2% increase in the price, leads to a 1 % increase in Q s </li></ul><ul><li>or rather, 1%/2% = 0.5 </li></ul>10.2 10.0 P Rt 101 100 Q st t = 1 t = 0 Given:
69. 69. 6. ELASTICITIES: (2) Application & Interpretation: (D) Price Elasticity of Supply <ul><li>Calculation of Price Elasticity of Supply : </li></ul><ul><li>For small changes in Q s and P </li></ul><ul><li>ε = ( Δ Q s / Δ P)*(P 0 /Q s0 ), </li></ul><ul><li>= [(101 – 100)/(10.1 – 10.0)] * [10.0/100] </li></ul><ul><li>= [1/(0.1)] * [0.1] </li></ul><ul><li>= 1.0, ε = 1.0 = 1  supply is unit elastic </li></ul><ul><li>Read as: a 1 % increase in the price, leads to a 1 % increase in Q s </li></ul><ul><li>or rather, 1%/1% = 1.0 </li></ul>10.1 10.0 P Rt 101 100 Q st t = 1 t = 0 Given:
70. 70. 6. ELASTICITIES: SUMMARY <ul><li>Price elasticity of demand </li></ul><ul><li>Q d increases ___% if price , P decreases by ___% </li></ul><ul><li>(B) Income elasticity of demand </li></ul><ul><li>Q d changes ___% if income , I increases by ___% </li></ul><ul><li>(C) Cross-price elasticity of demand </li></ul><ul><li>Q d changes ___% if the price of a related good , P R increases by ___% </li></ul><ul><li>(D) Price elasticity of supply </li></ul><ul><li>Q s increases ___% if price , P increase by ___% </li></ul>
71. 71. 6. ELASTICITIES: SUMMARY II <ul><li>Price elasticity of demand, η </li></ul><ul><li>Q d increases ___% if price , P decreases by ___% </li></ul><ul><li>Suppose elasticity is 1.0… </li></ul><ul><li>A 1% decrease in price leads to a 1% increase in Q d . </li></ul><ul><li>Price elasticity of demand is unit elastic (1.0 = 1). </li></ul><ul><li>Suppose elasticity is (1/4)… </li></ul><ul><li>A 1% decrease in price leads to a 0.25% increase in Q d . </li></ul><ul><li>(Or) A 4% increase in price leads to a 1% decrease in Q d . </li></ul><ul><li>Price elasticity of demand is inelastic ((1/4) < 1). </li></ul><ul><li>Suppose elasticity is (3/2)… </li></ul>
72. 72. 6. ELASTICITIES: SUMMARY II <ul><li>(B) Income elasticity of demand, Φ </li></ul><ul><li>Q d changes ___ % if income , I increases by ___% </li></ul><ul><li>Suppose elasticity is 1.0… </li></ul><ul><li>A 1% increase in income leads to a 1% increase in Q d . </li></ul><ul><li>Is the good normal or inferior? (Depends whether: Φ > 0 or Φ is < 0) </li></ul><ul><li>Suppose elasticity is (-3/4)… </li></ul><ul><li>A 1% increase in income leads to a 0.75% decrease in Q d . </li></ul><ul><li>(Or) A 4% decrease in income leads to a 3% increase in Q d . </li></ul><ul><li>Is the good normal or inferior? </li></ul>
73. 73. 6. ELASTICITIES: SUMMARY II <ul><li>(C) Cross-price elasticity of demand, Χ </li></ul><ul><li>Q d changes ___% if the price of a related good , P R increases by ___% </li></ul><ul><li>Suppose elasticity is (5/2)… </li></ul><ul><li>A 1% increase in P R leads to a 2.5% increase in Q d . </li></ul><ul><li>(Or) A 2% increase in P R leads to a 5% increase in Q d . </li></ul><ul><li>Are the goods complements or substitutes? </li></ul><ul><li>Suppose elasticity is (-1/2)… </li></ul><ul><li>A 1% increase in P R leads to a 0.5% decrease in Q d . </li></ul><ul><li>(Or) What’s another way this could be read as? </li></ul><ul><li>Are the goods complements or substitutes? </li></ul><ul><li>Suppose elasticity is 0… </li></ul><ul><li>NOTE: P R = Price of related good. </li></ul>
74. 74. 6. ELASTICITIES: SUMMARY II <ul><li>(D) Price elasticity of supply , ε </li></ul><ul><li>Q s increases ___% if price , P increase by ___% </li></ul><ul><li>Suppose elasticity is (6/3)… </li></ul><ul><li>A 1% increase in P leads to a 2% increase in Q s . </li></ul><ul><li>(Or) A 10% increase in P leads to a 20% increase in Q s . </li></ul><ul><li>Is supply elastic, inelastic, or unit elastic? </li></ul><ul><li>Suppose elasticity is (0.8)… </li></ul><ul><li>A 1% increase in P leads to a 0.8% increase in Q s . </li></ul><ul><li>(Or) What’s another way this could be read as? </li></ul><ul><li>Is supply elastic, inelastic, or unit elastic? </li></ul>