Sept. T
ues., 6 Markets cont
1. Summary of market and nonmarket goods (from last week):
Rival
Excludable
Private goods
yes
yes
Natural monopoly goods
no
yes
Common property (open access)
yes
no
no
no
Public goods
2. Markets - Supply and demand; equilibrium.
Markets determine:
Price at which a product (a good, service, financial asset, factor of production,
commodity, etc) is sold;
Amount (quantity) produced
Quantity produced depends on cost - opportunity cost of alternative use of factors
of production
Supply & Demand - not amounts or quantities, but relationships between prices and
quantities.
Law of Demand: Price and quantity demanded (Qd) are inversely (or negatively) related
- as price rises, quantity demanded falls.
Demand doesn't mean "I want," or "I would like." It means I want the good, have the
income to pay for it, and would buy it at a specific price..
Law of Supply: Price and quantity supplied (Qs) are directly (or positively) related - as
price rises, quantity supplied rises.
Equilibrium: where quantity demanded = quantity supplied; equilibrium price (Pe) and
quantity (Qe).
If price is below equilibrium, Qd > Qs, shortage in the market; price will rise
towards equilibrium.
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If price is above equilibrium, Qd < Qs, surplus in the market, and price will fall
towards equilibrium.
Supply and demand curves depict demand and supply schedules.
3. What determines demand, and changes in demand? Not price
Incomes (+),
Size of market (+)
Price of related goods (substitutes (+), complements (-))
Expected future prices (+)
Preferences & tastes (+)
4. What determines Supply, and changes in supply? Not price
Price of resources used in production (-)
Number of suppliers in the market (+)
Technology (how factors of production are used) (+)
Demand curves reflect marginal valuation of the good or service - willingness to pay,
based on marginal benefit of the good to the demander.
Supply curves reflect marginal cost of production of the good or service - marginal
valuation of resources (factors of production) in alternative uses.
5. Shift in supply and/or demand and effect on equilibrium; cases
Change in market:
Effect on market (Qe and Pe)
1. Increase in demand
Increase in Qe and Pe
2. Decrease in demand
Decrease in Qe and Pe
3. Increase in supply
Increase in Qe, decrease in Pe
4. Decrease in supply
Decrease in Qe, increase in Pe
5. Increase in demand,
decrease in supply
Increase in Pe, Qe indeterminate
6. Increase in demand,
increase in supply
Increase Qe, in Pe indeterminate
7. Decrease in demand,
Decrease in Pe, Qe indeterminate
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increase in supply
8. Decrease in demand,
decrease in supply.
Decrease in Qe, Pe indeterminate
6. What happens when the price of a good changes?
E
lasticity - Responsiveness of quantity to change in price.
a. Price elasticity of demand - % change in Qd / % change in P
Calculation of price elasticity of demand:
Use arc elasticity formula: e = (Q2 - Q1)/(Q1 + Q2)/2
(P1 - P2)/(P1 + P2)/2
: e can be >1 (elastic; relatively responsive),
=1 (unitary elastic)
< 1, (inelastic, relatively unresponsive)
Elasticity - Illustration:
Suppose P1 = 25
Q1 = 100
P2 = 30
Q2 = 90
e = (90-100)/((190)/2)
(30-25)/((55)/2)
e = (10)/(95)
= .1053 = .579
(5)/(27.5)
.1818
The elasticity coefficient is less than 1, so demand is relatively inelastic
- quantity demanded falls by a relatively small amount with respect to change in price
- total revenue (total expenditure) rises (and falls) with price
Explanation:
e,
The coefficient of elasticity,
is equal to .579. A coefficient of less than one
indicates that demand is inelastic, or relatively unresponsive to a change in price. The law
of demand tells us that price and quantity are inversely related, so the coefficient will
always be a negative number. To simplify things, economists have adopted the
convention of dropping the negative sign (since it's understood) and simply report the
absolute value of the coefficient.
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** When demand is inelastic, price and total expenditure (= price x quantity) change in
the same direction: when price rises (as in the example) total expenditure rises as well.
** When demand is elastic (when the coefficient is greater than one) the reverse is true total expenditure falls when price rises, and rises when it falls.
How do you interpret the coefficient (in this case, .579)? It tells us the percent change in
quantity demand when price changes by 1%. The coefficient of .579 means that, in this
range of the demand curve, an increase in price of 1% will result in a fall in quantity
demanded of .579% (slightly over 1/2 of 1 percent).
When demand is elastic, price increase leads to decrease in total revenue.
When demand is inelastic, price increase leads to increase in total revenue.
Price elasticity of supply= % change in Qs / % change in P - important factor in
development of alternative fuels and substitutes for scarce resources.
Factors that determine elasticity - availability of substitutes
- proportion of income spent on the good
- passage of time
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