Ch2-slides - Chapter Two Demand and Supply Analysis Chapter...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Chapter Two Demand and Supply Analysis Chapter Two Chapter Two Overview 1. Motivation The price of Corn in U.S. 1. Motivation The price of Corn in U.S. 2. Competitive Markets Defined 2. Competitive Markets Defined 3. The Market Demand Curve 3. The Market Demand Curve 4. The Market Supply Curve 4. The Market Supply Curve 5. Equilibrium 5. Equilibrium 6. Characterizing Demand and Supply Elasticity 6. Characterizing Demand and Supply Elasticity 7. Back of the Envelope Techniques 7. Back of the Envelope Techniques Chapter Two The Price of Corn in US, 1990-2006 Motivations Example: 1995 U.S. Corn Market Historical price: Historical price: $2.00 per bushel $2.00 per bushel Prices rose to $2.70 per bushel Long term contracts based on this price Prices rise to $5.00 per bushel Litigation to annul contracts Why? Why? Weather Weather Asian economic boom Asian economic boom Chapter Two Motivations Example: 1995 U.S. Corn Market Historical price: Historical price: $2.00 per bushel $2.00 per bushel Prices return to $2.00 per bushel Why? Why? Increased acreage Increased acreage Asian economic cool-down Asian economic cool-down Chapter Two Competitive Markets Defined: Competitive Markets are those with sellers and buyers that are small and numerous enough that they take the market price as given when they decide how much to buy and sell. Chapter Two The Market Demand Function Defined: The Market Demand Function tells us how the quantity of a good demanded by the sum of all consumers in the market depends on various factors. Q d = Q( p, p0 , I ,...) Chapter Two Demand Curves Defined: The Demand Curve plots the aggregate quantity of a good that consumers are willing to buy at different prices, holding constant other demand drivers such as prices of other goods, consumer income, quality. Chapter Two The Demand for Cars Chapter Two The Demand for Cars We always graph P on vertical axis and Q on horizontal axis, but we write demand as Q as a function of P... If P is written as function of Q, it is called the inverse demand. Markets defined by commodity, geography, time. Markets defined by commodity, geography, time. Chapter Two The Law of Demand Defined: The Law of Demand states that the quantity of a good demanded decreases when the price of this good increases. The Demand Curve shifts when factors other than own price change such as: The Demand Curve shifts when factors other than own price change such as: If the change increases the willingness of consumers to acquire the good, the demand curve shifts right If the change decreases the willingness of consumers to acquire the good, the demand curve shifts left Chapter Two Demand Curve Rule Defined: A move along the demand curve for a good can only be triggered by a change in the price of that good. Any change in another factor that affects the consumers' willingness to pay for the good results in a shift in the demand curve for the good. Chapter Two Market Supply vs. Demand Tells us how the quantity of a good supplied by the sum of all producers in the market depends on various factors Plots the aggregate quantity of a good that will be offered for sale at different prices. Chapter Two Supply Curve for Wheat Q s = 0.15 + P Chapter Two The Law of Supply Defined: The Law of Supply states that the quantity of a good offered increases when the price of this good increases. The Supply Curve shifts when factors other than own price change such as: The Supply Curve shifts when factors other than own price change such as: If the change increases the willingness of producers to offer the good at the same price, the supply curve shifts right If the change decreases the willingness of producers to offer the good at the same price, the supply curve shifts left Chapter Two Supply Curve Rule Defined: A move along the supply curve for a good can only be triggered by a change in the price of that good. Any change in another factor that affects the producers' willingness to offer for the good results in a shift in the supply curve for the good. Chapter Two Example: Canadian Wheat Supply Curve Rule Example QS = p + .05r QS = p + .05r QS = quantity of wheat (billions of bushels) QS = quantity of wheat (billions of bushels) p = price of wheat (dollars per bushel) p = price of wheat (dollars per bushel) rr = average rainfall in western Canada, = average rainfall in western Canada, May August (inches per month) May August (inches per month) Chapter Two Example: Canadian Wheat Supply Curve Rule Example a. Quantity of wheat supplied at price of $2 and a. Quantity of wheat supplied at price of $2 and rainfall of 33inches per month = 2.15 rainfall of inches per month = 2.15 b. Supply curve when rainfall is 33inches per month: b. Supply curve when rainfall is inches per month: QS = pp+ 0.15 QS = + 0.15 c. Law of supply holds c. Law of supply holds d. As rainfall increases, supply curve shifts right d. As rainfall increases, supply curve shifts right (e.g., rr= 44=> Q = pp+ 0.2) (e.g., = => Q = + 0.2) Chapter Two Example: Canadian Wheat Chapter Two Example: Canadian Wheat .15 Chapter Two Market Equilibrium Defined: A Market Equilibrium is a price such that, at this price, the quantities demanded and supplied are the same. Demand and supply curves intersect at equilibrium Demand and supply curves intersect at equilibrium S up ply d man De Chapter Two Market Equilibrium for Cranberries Qd = 500 4p QS = -100 + 2p p = price of cranberries (dollars per barrel) Q = demand or supply in millions of barrels per year The equilibrium price of cranberries is calculated by equating demand to supply: Qd = QS ... or... Qd = QS ... or... 500 4p = -100 + 2p ...solving 500 4p = -100 + 2p ...solving p* = $100 p* = $100 Plug equilibrium price into either demand or supply to get equilibrium quantity: Chapter Two Market Equilibrium for Cranberries Q* = 100 Chapter Two Excess Supply Defined: If sellers cannot sell as much as they would like at the current price, there is Excess Supply. If there is no excess supply or excess demand, there is no pressure for prices to change and thus there is equilibrium. When a change in an exogenous variable causes the demand curve or the supply curve to shift, the equilibrium shifts as well. Chapter Two Excess Supply Chapter Two Shift in Demand An increase in disposable income Demand curve shifts rightward Increase in equilibrium price and quantity Shift in Supply An increase in wage rate Supply curve shifts leftward Equilibrium price increases and quantity decreases Shift in Both Supply and Demand Example: The price of Corn in US Price Elasticity Defined: The Price Elasticity of Demand is the percentage change in quantity demanded brought about by a one-percent change in the price of the good. Q,P= (Q/Q) = (Q/p)(p/Q) Q,P= (Q/Q) = (Q/p)(p/Q) (p/p) (p/p) Q ,P = dQ P dP Q Chapter Two Price Elasticity Slope is the ratio of absolute changes in quantity Slope is the ratio of absolute changes in quantity and price. (= dQ/dP). and price. (= dQ/dP). Elasticity is the ratio of relative (or percentage) Elasticity is the ratio of relative (or percentage) changes in quantity and price. changes in quantity and price. Chapter Two Grocery Products Elasticity Chapter Two Price Elasticity When a one percent change in price leads to a greater than one-percent change in quantity demanded, the demand curve is elastic. (Q,P < -1) When a one-percent change in price leads to a less than one-percent change in quantity demanded, the demand curve is inelastic. (0 > Q,P > -1) When a one-percent change in price leads to an exactly one-percent change in quantity demanded, the demand curve is unit elastic. (Q,P = -1) Chapter Two Elasticity Linear Demand Curve Qd = a bp Where: a and b are positive constants p is price b is the slope a/b is the choke price Elasticity is: Chapter Two Elasticity Linear Demand Curve P Q,P = - Elastic region a/b a/2b Q,P = -1 Inelastic region Q,P = 0 0 a/2 Chapter Two a Q Constant Elasticity Demand Curve Q = aP - b Q,P dQ P - b -1 1 P b +1 = -b = = -abP dP Q a The price elasticity remains constant on the demand curve. Chapter Two Constant Elasticity vs. Linear Demand Curve Price P 0 Q Observed price and quantity Constant elasticity demand curve Linear demand curve Quantity Chapter Two Price Elasticity and Cars Berry, Levinsohn and Pakes, "Automobile Price in Market Equilibrium," Econometrica 63 (July 1995), 841-890 Chapter Two Other Elasticities Income Elasticity of Demand: percentage change in demand caused by one percent change in income. Q,I = dQ I dI Q Cross-price Elasticity of Demand: percentage change in demand caused by one percentage change in the price of another dQi Pj good. = Qi , Pj dPj Qi Substitutes: Q ,P > 0 i j Complements: Q ,P < 0 i j Price Elasticity of Supply: percentage change in supply caused by one percentage change in price. Chapter Two Price Elasticity and Cars Berry, Levinsohn and Pakes, "Automobile Price in Market Equilibrium," Econometrica 63 (July 1995), 841-890 Chapter Two Durable Goods Defined: The Durable Good is a good that provides valuable services over a long time (usually many years). Demand for non-durables is less elastic in the short run when consumers can only partially adapt their behavior. Demand for durables is more elastic in the short run because consumers can delay purchase. Chapter Two Durable Goods Chapter Two Elasticities & the Cola Wars Source: Gasmi, Laffont and Vuong, "Econometric Analysis of Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Chapter Two Estimating Demand & Supply Chapter Two Estimating Demand & Supply Chapter Two Estimating Demand & Supply Chapter Two Estimating Demand & Supply From Past Shifts Chapter Two Identifying Demand By a Shift in Supply Chapter Two Identifying Demand By a Shift in Supply This technique only works if one or the other of the curves This technique only works if one or the other of the curves stays constant. Identifying demand when both curves shift stays constant. Identifying demand when both curves shift Chapter Two Understanding California Energy Crisis Structure of the Electric Power Industry in California Understanding California Energy Crisis Whole sale price was deregulated in 1997, But the retail price remained low due to heavy regulation ...
View Full Document

This note was uploaded on 07/17/2008 for the course ECON 501.02 taught by Professor Yang during the Winter '08 term at Ohio State.

Ask a homework question - tutors are online