53-EC115_Lecture 2

# 53-EC115_Lecture 2 - EC115 Methods of Economic Analysis...

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EC115 Methods of Economic Analysis Lecture 2: Linear equations 2 – Economic Applications Week 3, Autumn 2008

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A Model of Demand and Supply s Demand and Supply are the basic building blocks for economic analysis s A model of demand and supply describes how prices affect the behaviour of both consumers and producers s In general, the quantity demanded of a good sold in a market depends not only on its own price but also on other factors, such as the prices of other goods and consumers’ income. s For example, if the price of the Pepsi increases while the one of the Coca-Cola remains constant, some consumers may switch and consume more Coca-Cola if they feel that the two products are close substitutes (they are very similar products).
Demand s The concept of a demand function is based on consumer theory: the lower is the price of the good, the more the consumer wants to buy it (taking as given the other factors) s Adding up all the individual demands gives us the market demand: q D = -ap + b, where p is the market price and a and b are positive parameters. S The demand curve is negatively sloped: The higher the price of the good, the lower is the quantity demanded of that good – Law of Demand s The quantity demanded (q D ) is the dependent variable, and we assume that, for each individual, the market price (p) is given so that she/he chooses how much to buy at that price.

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Demand curve q p q D = -ap + b
Supply s The concept of the supply function is based on the theory of firm: The higher is the market price of the good, the more firms will choose to supply that good s Combining all firms’ supply gives us the market supply: q S = cp + d, where c>0 and d is zero or negative (with zero price firms wish to supply nothing). s The supply curve is positively sloped: The higher is the price of the good the higher is the quantity supplied of that good – Law of Supply s Quantity supplied (q S ) is the dependent variable and price (p) is assumed to be given.

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Supply curve p q q S = cp + d
Market Equilibrium s An equilibrium is a situation where none of the agents have an incentive to change anything. s The market is in the equilibrium when the quantity that the consumers are willing to buy equals the quantity the producers are willing to supply: q D = q S (equilibrium condition) s If q D > q S , then some consumers would like to buy more than is supplied in the market by firms s If q D < q S , then some producers would like to supply more than is demanded in the market by consumers There is disequilibrium in the market.

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Example (1) Suppose the demand for books is specified as the following relationship between quantity (Q) and price (P) : q D = 40 – 2p. The supply of books is specified as another relationship: q S = 3p – 10. The equilibrium condition is: q
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## This note was uploaded on 02/08/2012 for the course ECO 51844 taught by Professor Sabet during the Spring '11 term at FIU.

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53-EC115_Lecture 2 - EC115 Methods of Economic Analysis...

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