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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 square6 Demand and Supply are the basic building blocks for economic analysis square6 A model of demand and supply describes how prices affect the behaviour of both consumers and producers square6 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. square6 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 square6 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) square6 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. square4 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 square6 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 square6 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 square6 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). square6 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 square6 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 square6 An equilibrium is a situation where none of the agents have an incentive to change anything. square6 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) square6 If q D > q S , then some consumers would like to buy more than is supplied in the market by firms square6 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.
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