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# Lecture 3 - DemandModel Mercedes Mercedes Miranda BE530 1...

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Mercedes Miranda BE530 1 Applying the Supply and  Demand Model

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2 1. How shapes of demand and supply matter? The shapes of the demand and supply curves determine by how much a shock affects the equilibrium price and quantity. Example A supply shock has different effects depending on the shape of the demand curve
BE530 3 Fig. 1 How the Effect of a Supply Shock Depends on the Shape of the  Demand Curve D 1 S 1 S 2 3.55 3.30 3.675 3.30 176 215 220 0 176 220 0 D 2 S 1 S 2 Q, Million kg of lamb per year p , \$ per kg p , \$ per kg (a) (b) e 2 e 1 e 2 e 1 This shift of the supply curve causes a movement along the demand curve… and a reduction in quantity. An increase in the price of an input causes the supply of lamb to shift to the left But equilibrium quantity does not change since consumption is not sensitive to price Q, Million kg of lamb per year

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4 Fig. 1.1 How the Effect of a Supply Shock Depends on the Shape of  the Demand Curve (cont’d.) 3.30 220 Q, Million kg of lamb per year p , \$ per kg 205 176 0 (c) e 1 e 2 D 3 S 1 S 2 When demand is very sensitive to price… a shift in the supply curve
5 2. Sensitivity of quantity demanded to price Elasticity – the percentage change in a variable in response to a given percentage change in another variable. Price elasticity of demand ( ε ) – the percentage change in the quantity demanded in response to a given percentage change in the price.

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6 A C T I V E  L E A R N I N G   A C T I V E  L E A R N I N G   1 1       Calculate an elasticity Calculate an elasticity Use the following information to calculate the price elasticity of demand for hotel rooms:
7 A C T I V E  L E A R N I N G   A C T I V E  L E A R N I N G   1 1         Answers Answers Use midpoint method to calculate 50% 25% = 2.0

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8 Sensitivity of quantity demanded to price Formally, where indicates change. Example If a 1% increase in price results in a 3% decrease in quantity demanded, the elasticity of demand is ε = -3%/1% = -3. Q p p Q p p Q Q p Q = = = % % ε
9 Sensitivity of quantity demanded to price Along linear demand curve with a function of: Where -b is the slope or the elasticity of demand is bp a Q - = p Q b = - (3.3) Q p b Q p p Q - = = ε

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10 A C T I V E  L E A R N I N G   A C T I V E  L E A R N I N G   2 2       Calculate an elasticity Calculate an elasticity The estimated linear demand function for lamb is: Q = 286 -20 p where Q is the quantity of lamb demanded in million kg per year and p is the price of Lamb in \$ per year.
11 A C T I V E  L E A R N I N G   A C T I V E  L E A R N I N G   2   2   Answers Answers

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