Managerial Economics

Managerial Economics

Movement ALONG the supply curve vs SHIFTS in the supply curve

• A movement along the supply curve is caused by a change in PRICE of the good or service. • A shift in the supply curve is caused by a change in any non-price determinant of supply. The curve can shift to the right or left.

P move ment inS t heS supply S curve 2

0

1

Extension Contraction

O

fig

Q

Sh if ts in th e s upply curve P S S 2

Decrease

O

0

S1

Increase

fig

Q

Market Equilibrium

Market adjustment • Characteristics of the equilibrium –

QD = QS

–

No shortage No excess supply No pressure on the price to change

– –

Equilibrium price and output: The Market Demand and Supply of Potatoes

Equilibrium Price ($ per unit)

S The curves intersect at equilibrium, or marketclearing, price. At P0 the quantity supplied is equal to the quantity demanded at Q0 .

P0

D Q0

Quantity

Surplus Price ($ per unit)

S Surplus

P1

Assume the price is P1 , then: 1) Qs : Q1 > Qd : Q2 2) Excess supply is Q1:Q2. 3) Producers lower price. 4) Quantity supplied decreases and quantity demanded increases.

D Q1

Q2

Quantity

Shortage Price ($ per unit)

SAssume the price is P1 , then:

1) Qd : Q2 > Qs : Q1 2) Shortage is Q1:Q2. 3) Producers raise price. 4) Quantity supplied increases and quantity demanded decreases.

P2 Shortage

Q1

D Q2

Quantity

Algebra of supply and demand • Demand: QD = a – bP • Supply: QS = c + dP • Equilibrium:

QD = QS

Solve for P*:

P* = (a-c)/(b+d)

Questions •

Giv en dem and & supp ly e quat ion s, de term ine equ ilibrium pric e & quant ity. 2. Dem and: p=100 - 2q Sup pl y: p= 20 + 3q 3. Dem and: Q=7 0-4P Su pply : Q = -20+2 P 4. Dem and: Q=1 10-10P S upply: Q = -10 0+20 P

Elasticity of Supply & Demand

Elasticity • Elasticity refers to degree of responsiveness of quantity demanded/supplied to change in any of its determinants.

Elasticity DEMAND  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

SUPPLY  Price Elasticity of Supply

Elasticity of Demand • Price elasticity of demand measures the sensitivity of quantity demanded to price changes.

Value of Elasticity Coefficient • Price Elasticity should be compared in terms of absolute values. • Negative sign of the demand elasticity is ignored • However in certain cases where elasticity coefficient is given, make it a point to prefix “-” sign to its coefficient.

COEFFICIENT OF ELASTICITY: • elast ic (Ed > 1) :the percentage change in quantity demanded is greater than that in price • inelasti c (Ed < 1), the percentage change in quantity demanded is smaller than that in price • unit e last ic (or unitary elastic) (Ed = 1), the percentage change in quantity demanded is equal to that in price

COEFFICIENT OF ELASTICITY: • pe rfectly elastic (Ed = ∞), any change in the price, no matter how small, there will be huge change in quantity demanded • pe rfectly inelastic (Ed = 0), changes in the price do not affect the quantity demanded for the good

Price elasticity of demand • Price elasticity of demand will be more on a flatter curve than on a steeper curve.

Elasticity of Demand-Proportionate Method • The price elasticity of demand is:

EP = (%∆Q)/(%∆P ) ∆Q/Q P ∆Q EP = =∆P/P Q ∆P

Calculate Price elasticity of demand 1. If price o f a c ommodit y is Rs .1 2, the n the pe rs on bu ys 20 units o f it. W hen price f alls to Rs. 10 p er un it, dem an d increases to 24 units. 2. If price o f a c ommodit y is Rs .2 , then the pe rs on bu ys 1 unit of it. When price fal ls t o Re .1 p er u nit, dem an d increases to 4 units.

Factors influencing Price elasticity of demand • • • • • • •

Availability of substitute goods Nature of commodity Short and long run elasticity of demand Share in total expenditure Uses of the commodity Possibility of postponing consumption Habit of the consumer

Income elasticity of demand • Income elasticity of demand measures the percentage change in quantity demanded resulting from percentage change in income, other factors remaining constant.

Income elasticity of demand • The income elasticity of demand is:

∆Q/Q I ∆Q EI = = ∆I/I Q ∆I

Calculate Income elasticity • If inco me of a co nsu me r is R s. 200 0, th en the perso n b uys 20 u nits o f it . W hen inco me rise s to R s. 4000 , dema nd in cre ase s to 40 u nits. • If inco me of a co nsu me r is R s. 100 0, th en the perso n b uys 20 u nits o f it . W hen inco me rise s to R s. 2000 , dema nd decr ease s to 10 unit s. • If inco me of a co nsu me r is R s. 200 0, th en the perso n b uys 20 u nits o f it . W hen inco me rise s to R s. 4000 deman d re ma ins co nst ant a t 2 0 units.

Income elasticity of demand • Positive- normal good • Negative- inferior good • Zero-necessity

Cross elasticity of demand • Cross elasticity of demand measures the percentage change in the quantity demanded of one good that results from a percentage change in the price of another good. • It can vary from minus infinity to plus infinity.

Cross elasticity of demand • The cross elasticity of demand is:

∆ Qx/Qx Py ∆ Qx EQxPy = = ∆ Py/Py Qy ∆ Px

Calculate cross elasticity If price o f com modity Y is Rs .2, the n t he pe rs on buys 1 unit of X . When price of Y falls t o Re. 1 pe r un it, d em and of go od X inc re as es to 4 u ni ts. If price o f com modity Y is Rs .10, th en the pe rs on buys 5 units of X. W hen pric e of Y falls t o Rs.5 per unit, dem and of good X decreases t o 2 units.

Cross elasticity of demand • Positive-Substitute goods • Negative- Complementary goods • Zero- Unrelated goods

Price elasticity of supply • Price elasticity of supply measures the percentage change in quantity supplied resulting from a percentage change in price. • The elasticity is positive because price and quantity supplied are directly related.

Price elasticity of supply • elast ic (Ed > 1) :the percentage change in quantity supplied is greater than that in price • inelasti c (Ed < 1), the percentage change in quantity supplied is smaller than that in price • unit e last ic (or unitary elastic) (Ed = 1), the percentage change in quantity supplied is equal to that in price

Price elasticity of supply • pe rfectly elastic (Ed = ∞), any change in the price, no matter how small, there will be huge change in quantity supplied • pe rfectly inelastic (Ed = 0), changes in the price do not affect the quantity supplied for the good

Applications of Demand & Supply

Applications of Demand & Supply • Exceptions to Law of Demand • Comparative Statics • Demand Forecasting

Exceptions to Law of Demand • • • • • •

Giffen goods-special case of inferior goods Conspicuous goods Emergencies Future changes in prices Habit of the consumer Change in Fashion

Giffen goods • A Gif fen g ood is a product for which a rise in price of this product makes people buy even more of the product. • Sir Robert Giffen observed this phenomenon in 16th century in Britain in case of bread. • Giffen goods may or may not exist in the real world • All Giffen goods are inferior goods but converse is not true

Giffen goods • There are three necessary preconditions for this situation to arise: • the good in question must be an inferior good, • there must be a lack of close substitute goods, and • the good must constitute a substantial percentage of the buyer's income.