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Lecture 3 dds sand elasticity

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Lecture 3 dds sand elasticity

  1. 1. 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.
  2. 2. 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.
  3. 3. 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
  4. 4. 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.
  5. 5. Shortage• When the price is below the equilibrium quantity demanded exceeds quantity supplied• Shortages put upward pressure on the price QS QD 6
  6. 6. Surplus• When the price is above the equilibrium quantity supplied is greater than the quantity demanded.• Surplus puts downward pressure on demand QD QS 7
  7. 7. 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.
  8. 8. Which market can be characterized by the following graph? P Q
  9. 9. Which market can be characterized by the following graph? P Q 10
  10. 10. Ford Motors2004 Supply CurvePrice E PE Demand Curve Quantity QE
  11. 11. Ford Motors• What happens to the equilibrium price from 2004 to 2012?
  12. 12. Ford Motors2012 D Supply Curve D’Price E PE E’ PE’ D D’ QE’ QE Quantity
  13. 13. Ford Motors• What happens to the equilibrium price from 2012 to 2013?
  14. 14. Case A: Change in SS> Change in DD S’2013 2004-2012 2012-2013 D S E’’Price PE’’ E PE E’ PE’ D D’ QE’’ QE’ QE Quantity
  15. 15. 2004 to 2012: Decrease in Demand- Equilibrium Quantity Decreased- Equilibrium Price Decreased2012 to 2013: Decrease in Supply- Equilibrium Quantity Decreased- Equilibrium Price IncreasedNet Effect- Equilibrium Quantity Decreased- Equilibrium Price Increased
  16. 16. Case B: Change in SS< Change in DD2013 S’ 2004-2012 2012-2013 D SPrice D’ PE E E’’ PE’’ E’ PE’ D D’ QE’’ QE’ QE Quantity
  17. 17. 2004 to 2012: Decrease in Demand- Equilibrium Quantity Decreased- Equilibrium Price Decreased2012 to 2013: Decrease in Supply- Equilibrium Quantity Decreased- Equilibrium Price IncreasedNet Effect- Equilibrium Quantity Decreased- Equilibrium Price Decreased
  18. 18. 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?
  19. 19. 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
  20. 20. The Effect of Demand and Supply Shifts on EquilibriumHow Shifts in Demand and Supply AffectEquilibrium Price (P) and Quantity (Q) SUPPLY CURVE SUPPLY CURVE SUPPLY CURVE UNCHANGED SHIFTS TO THE RIGHT SHIFTS TO THE LEFTDEMAND CURVE Q unchanged Q increases QUNCHANGED P unchanged P decreases PDEMAND CURVE Q increases QSHIFTS TO THE RIGHT Q P increases or P P decreasesDEMAND CURVE Q decreases Q increases or Q decreasesSHIFTS TO THE LEFT P decreases decreases P decreases or P decreases increases
  21. 21. The Effect of Demand and Supply Shifts on EquilibriumHow Shifts in Demand and Supply AffectEquilibrium Price (P) and Quantity (Q) SUPPLY CURVE SUPPLY CURVE SUPPLY CURVE UNCHANGED SHIFTS TO THE RIGHT SHIFTS TO THE LEFTDEMAND CURVE Q unchanged Q increases Q decreasesUNCHANGED P unchanged P decreases P increasesDEMAND CURVE Q increases Q increases orSHIFTS TO THE RIGHT Q increases P increases or decreases P increases decreases P increasesDEMAND CURVE Q decreases Q increases or Q decreasesSHIFTS TO THE LEFT P decreases decreases P decreases or P decreases increases
  22. 22. Equilibrium QD a bP.......... DemandFunction QS c dP..........SupplyFunction .Equilibrium : Quantity Demand = Quantity Supplied eq a c P b d eq ad bc Q b d
  23. 23. Demand and Supply a/b Supply CurvePrice E PE Demand Curve c a Quantity -c/d QE
  24. 24. Change in Equilibrium: Ford Analysis QD a bP.......... DemandFunction QS c dP..........SupplyFunction . Supply Function does not change Demand Function changes: DD shifts inside QD a bP.......... DemandFunction Q S c dP..........SupplyFunction . a a
  25. 25. Demand and Supply a/b Supply CurvePrice a’/b E PE E’ Demand Curve c a’ a Quantity -c/d QE
  26. 26. Change in Equilibrium: Ford Analysis2004 QD a bP.......... DemandFunction QS c dP..........SupplyFunction . 2012 QD a bP.......... DemandFunction Q S c dP..........SupplyFunction . a a 2004 2012 Change Quantity (ad+bc)/ (b+d) (a’d+bc)/(b+d) Decrease Price (a-c)/(b+d) (a’-c)/(b+d) Decrease
  27. 27. 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?
  28. 28. 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?
  29. 29. • 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?
  30. 30. What is elasticity?A term economists use to describeresponsiveness, or sensitivity, to a change in afactor like price/income 32
  31. 31. Measure Price ElasticityThe ratio of the percentage change in thequantity demanded of a product to apercentage change in its price 33
  32. 32. Extreme CasesPerfectly Inelastic DD CurvePrice Quantity
  33. 33. Extreme CasesPerfectly Elastic DD CurvePrice Quantity
  34. 34. CALCULATING PRICE ELASTICITY
  35. 35. Point Price ElasticityThe ratio of the percentage change in thequantity demanded of a product to apercentage change in its price 37
  36. 36. What is the Price Elasticity?Price Quantity Price Elasticity.9995 20,0021.0 20,0001.005 19,998
  37. 37. What is the Price Elasticity?Price Quantity Price Elasticity.9995 20,0021.0 20,000 -0.21.005 19,998
  38. 38. What is the Price Elasticity?Price Quantity Price Elasticity3 504 40 -61.67 (if P=3) -3.70 (if P= 4)5 3
  39. 39. Arc Elasticityin quantity demandedsum of quantities/2 divided by in price sum of prices/2 41
  40. 40. Arc Elasticity Q P(Q1 Q2 ) / 2 (P1 P2 ) / 2 42
  41. 41. Why is elasticity 4 in the previous example and not -4? Economists drop the negative sign because weknow from the law of demand that quantitydemanded and price are inversely related 43
  42. 42. Elasticity and Demand Function• Calculate the price elasticity of a demand function P a bQ
  43. 43. Elasticity and Demand Function• Calculate the price elasticity of a demand function P a bQ ( 1 / b)(a bQ) / Q
  44. 44. Elasticity and Demand Function• What can you say about the elasticity of demand along linear demand function?
  45. 45. Elasticity and Demand FunctionPrice η>|1|, Elastic Demand η=|1|, Unit Elastic Demand η< |1|, Inelastic Demand a/b Quantity
  46. 46. P Elastic Demand Ed > 1$40 A$30 B$20$10 10 20 48 30 40 Q
  47. 47. What is elastic demand?A condition in which the percentage change inquantity demanded is greater than the percentagechange in price %∆ Quantity demanded > %∆ Price 49
  48. 48. Elastic Demand ( 1 / b)( a bQ) / Q 1Thus, if Q < a/2b, it is the elastic portion of linear demand curve.
  49. 49. Elasticity and Demand FunctionPrice η>|1|, Elastic Demand η=|1|, Unit Elastic Demand η< |1|, Inelastic Demand a/2b a/b Quantity
  50. 50. 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?
  51. 51. 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
  52. 52. Elastic Demand Increase in total revenuePrice decrease 54
  53. 53. Elastic DemandIn an elastic portion of the demand curve, to increase revenue:Price must be reduced!!
  54. 54. Inelastic Demand Ed < 1$40 A$30 B$20$10 10 20 30 40 56
  55. 55. What is Inelastic demand?A condition in which the percentage change inquantity demanded is Less than the percentagechange in price %∆ Quantity demanded < %∆ Price 57
  56. 56. Elastic Demand ( 1 / b)( a bQ) / Q 1Thus, if Q > a/2b, it is the Inelastic portion of linear demand curve.
  57. 57. Elasticity and Demand FunctionPrice η>|1|, Elastic Demand η=|1|, Unit Elastic Demand η< |1|, Inelastic Demand a/2b a/b Quantity
  58. 58. 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?
  59. 59. 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
  60. 60. Inelastic Demand Decrease in total revenuePrice decrease 62
  61. 61. Inelastic DemandIn an Inelastic portion of the demand curve, to increase revenue:Price must be increased!!
  62. 62. What is a unitary elastic demand curve?The percentage change in the quantitydemanded is equal to the percentage change inprice 64
  63. 63. Unitary Elastic Demand Ed = 1$40 E$30 F$20 D$10 10 20 30 40 65
  64. 64. Unitary Elastic Demand No change in total revenuePrice decrease 66
  65. 65. $40$30$20 Perfectly Elastic Demand Ed = 8$10 10 20 30 40 67
  66. 66. 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 68
  67. 67. Perfectly Elastic Demand Infinite change in quantity demandedPrice change 69
  68. 68. What is a perfectly inelastic demand curve? A condition in which the quantity demanded does not change as the price changes 70
  69. 69. Perfectly Inelastic Demand Ed = 0$40$30$20$10 10 20 30 40 71
  70. 70. Perfectly Inelastic Demand Zero change in quantity demandedPrice change 72
  71. 71. 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) -0.01 to -0.2 Gasoline –Long Run (Canada) -0.4 to -0.8Transportation Domestic Cars (US) -0.78
  72. 72. 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
  73. 73. What Determines the Elasticity?• Time DurationGreater elasticity if demand is considered over a greater range of time period.Ability to find substitutesIf price of gas increases, in short term consumers may not be able to find alternatives. In long run its demand may decrease.
  74. 74. Elasticity in Use• How would you price First class and Economy class airline tickets?• What is one reason for this?
  75. 75. Elasticity in UseType of Ticket Price ElasticityFirst Class -0.45Regular Economy -1.3Excursion -1.83
  76. 76. 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
  77. 77. Measure Income ElasticityThe ratio of the percentage change in thequantity demanded of a product to apercentage change in Income 79
  78. 78. Income ElasticityGood ElasticityAgricultural ProductsGrain (China) -0.12 to + 0.15Potatoes (UK) -0.32Potatoes (US) +0.15Lettuce (US) +0.88Animal ProductsMeat (China) +0.1 to + 1.2Eggs (UK) -0.21AutomobilesDomestic Cars (US) +1.62
  79. 79. 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
  80. 80. 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.
  81. 81. Measure Cross Price ElasticityThe ratio of the percentage change in thequantity demanded of a product to apercentage change in Price of other good 83
  82. 82. Cross Price Elasticity• Substitutes Good : Cross Price elasticity is positive• Complimentary Good : Cross Price elasticity is negative

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