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Demand Supply and Price Theory - 2.pptx

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Demand Supply and Price Theory - 2.pptx

  1. 1. Week 2
  2. 2.   What is opportunity Cost?  Why are incentives important to policy makers?  Why isn’t trade amongst countries a game with winners and losers?  Why is productivity important?  What is the relationship between Marginal Benefit and Marginal Cost Recap
  3. 3.   Economics is a Science  Economists devise theories, collect data and analyze it  Scientific economists make positive statements The Scientific Method Identify the problem Develop a model based on simplified assumptions Collect data and test models
  4. 4.   The Circular Flow Diagram  The production possibilities frontier  Market equilibrium Three Economic Mode
  5. 5.   “A visual model of the economy that shows how money flows through markets amongst households and firms” The Circular flow diagram
  6. 6.   A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.  Example  Economy can produce 300 shirts or 100 cakes  Producing at the PPF causes the market to be “efficient”  It is easy to see trade offs and opportunity costs  Opportunity Cost = the slope of the PPF Line  Slope = Change in Y/ Change in X  300-0/100/0 = 3 Production Possibilities Frontier
  7. 7.   What happens  To the price of petrol when war breaks out in Iran  To the price of mangoes when farmers have an abundant year  To the number of tourists when the tsunami hit Sri-Lanka  All of the above show the workings of Supply and Demand  Supply and Demand are the forces that make market economies work.  They determine the following  Quantity of Goods produced  Price of which goods are sold Markets and Competition
  8. 8.   A group of buyers and sellers of a particular good or service.  Characteristics of markets  Organized markets  Less Organized markets.  A competitive market is a market which has many buyers and sellers so that each has a negligible impact on price.  For today’s class we will assume that markets are perfectly competitive.  The goods offered for sale are exactly the same so that no single buyer or seller has influence over price. What is a Market?
  9. 9.   Quantity Demanded – the amount of a good that buyers are willing and are able to pay.  Market Demand – the sum of all individual demand for a particular good or service Demand Law of Demand The claim that other things equal the quantity Demanded of a good falls when the price of The good increases.
  10. 10.  Price Quantity Demanded 0 6 50 5 100 4 150 3 200 2 250 1 300 0 Demand Shifts in the demand curve Demand curves can shift • To the RIGHT (A) • To the LEFT (B) Shifts to the right means demand has increased Shift to the left means demand has decreased
  11. 11.   Income  Prices of Related goods  Tastes  Expectations  Number of Buyers Variables that cause Demand Curves to shift
  12. 12.   Normal goods  A good for which other things equal an increase in income leads to an increase in demand  Inferior Good  A good for which other things equal an increase in income leads to a decrease in demand. Income
  13. 13.   Substitutes  Two goods for which an increase in price of one leads to an increase in demand for the price of the other  Complements  Two goods for which an increase in the price of one leads to a decrease in demand for the other. Price of Related Goods
  14. 14.   Quantity Supplied  The amount of a good that sellers are willing and able to sell. Supply Law of Supply The claim that other things equal the quantity Supplied of a good increase when the price of The good increases.
  15. 15.  Price of cone Quantity Supplied 0 0 50 0 100 1 150 2 200 3 250 4 300 5 Supply Shifts in the Supply Curve • Shifts to the right increase supply • Shifts to the left decrease supply
  16. 16.   Input Prices  Costs of inputs. If they increase production decreases, if they decrease production will increase  Technology  Machinery increases productivity  Expectation  Number of Sellers Variables that cause the supply curve to shift
  17. 17.   Equilibrium – A situation which the market price has reached the level at which quantity supplied equals the quantity demanded.  Equilibrium price – the price that balances Qd and Qs  Equilibrium quantity – the quantity that balances Pd and Ps Market Equilibrium Law of Supply and Demand The claim that the price of any good adjusts to bring the Qd and the Qs for the good into balance.
  18. 18.   Surplus – A situation where Qs is greater than Qd  Shortage – A situation where Qd is greater than Qs Surplus and Shortage No change in Supply An increase in supply Decrease in supply No change in demand P.Q No change P down Q up P up Q down Increase in Demand P up Q down P ambiguous Q up P is up Q ambiguous Decrease in demand P down Q up P down Q ambiguous P ambiguous Q down
  19. 19.   We use absolute numbers even though Qd is negatively related to its price.  |Ped|= △Q/△P = 20/10 = 2 Elasticity of Supply and Demand Price Elasticity of Demand
  20. 20.   Perfectly Inelastic Demand  Inelastic Demand  Unitary Elastic Demand  Elastic Demand  Perfectly Elastic Demand Different Types of Demand
  21. 21.   Sustainability  Nature of the Product  Proportion of Income  Definition of Market  The Possibility of new purchases  Time Horizons  Addiction  Complementary goods  Price expectations Determinants of Price Elasticity
  22. 22.   A measure of how much the quantity demanded for a good responds to a change in consumers income. Income Elasticity of Demand
  23. 23.   Negative elasticity  Ey>0 – D decreases as I increases  Zero Income Elasticity  Ey=0 – D does not change as I rises of falls  Income Inelastic Demand  0<Ey<1 – D rises at a smaller proportion than I  Unit Income Elasticity  Ey=1 – D rises exactly the same proportion as I  Income elastic demand  1<Ey<∞ - D rises at a greater proportion than income (Ey)
  24. 24.   The measure of how much the quantity demanded of one good responds to a change in the price of another good. The Cross Price Elasticity of Demand
  25. 25.   Es = △Q/Q = △Q x P △P/P △P Q Price Elasticity of Supply
  26. 26.   Time  Excess Supply or Unsold Stock  Factor Mobility  Natural Constraints  Risk Taking Determinants of Elasticity of Supply
  27. 27.