Supply And Demand
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Supply and Demand
Supply and Demand
Demand
DEMAND ■
■
Relationship between demand and price ✜
the law of demand
✜
the income effect
✜
the substitution effect
The demand curve ✜
assumptions ✦ other ✦a
things being equal (ceteris paribus)
given time period
✜
the axes
✜
individual's and market demand curves
The demand curve: The demand for potatoes (monthly)
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
100
Price (pence per kg)
A
20
700
80
60
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
Price (pence per kg)
100
20 40
A B
80
700 500
60
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
Price (pence per kg)
100
20 40 60
A B C
80
700 500 350
C
60
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
Price (pence per kg)
100
D
80
C
60
20 40 60 80
A B C D
700 500 350 200
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) 100
Price (pence per kg)
Point Price Market demand (pence per kg) (tonnes 000s)
E
D
80
C
60
20 40 60 80 100
A B C D E
700 500 350 200 100
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
DEMAND ■
Other determinants of demand ✜
tastes
✜
number and price of substitute goods
✜
number and price of complementary goods
✜
income
✜
distribution of income
✜
expectations
DEMAND ■
Movements along and shifts in the demand curve ✜
change in price ⇒ movement along D curve
✜
change in any other determinant of demand ⇒ shift in D curve • increase in demand ⇒ rightward shift • decrease in demand ⇒ leftward shift
An increase in demand
Price
P
D0 O
Q0
Q1 Quantity
D1
DEMAND ■
Demand functions ✜
simple demand functions Qd = a – bP
✜
more complex demand functions Qd = a – bP + cY + dPs – ePc
✜
estimated demand equations
✜
problems of estimating demand equations
✜
demand functions and the demand curve
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
P
Qd (000s)
5
9
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
P
Qd (000s)
5 10
9 8
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
P
Qd (000s)
5 10 15
9 8 7
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
30
P
Qd (000s)
5 10 15 20
9 8 7 6
20
10
D 0 0
2
4
6
Q (000s)
8
10
Supply and Demand
Supply
SUPPLY ■
■
Relationship between supply and price ✜
short-run supply
✜
long-run supply
The supply curve ✜
assumptions ✦ other ✦a
things remain equal (ceteris paribus)
given time period
✜
the axes
✜
individual's and market supply curves
The supply curve: The supply of potatoes (monthly)
Market supply of potatoes (monthly) 100
Supply P
Price (pence per kg)
80
a
20 100
60
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly) 100
Supply P
Price (pence per kg)
80
a b
20 100 40 200
60
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly) 100
Supply P
Price (pence per kg)
80
a b c
c
60
20 100 40 200 60 350
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly) 100
Supply d
Price (pence per kg)
80
a b c d
c
60
P
Q
20 40 60 80
100 200 350 530
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market supply of potatoes (monthly) 100
e
Supply d
Price (pence per kg)
80
P a 20 b 40 c 60 d 80 e 100
c
60
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Q 100 200 350 530 700
SUPPLY ■
■
Relationship between supply and price ✜
short-run supply
✜
long-run supply
The supply curve ✜
assumptions ✦ other ✦a
things remain equal (ceteris paribus)
given time period
✜
the axes
✜
individual's and market supply curves
✜
why supply curves generally slope up
SUPPLY ■
Other determinants of supply ✜
costs of production
✜
profitability of alternative products (substitutes in supply)
✜
profitability of goods in joint supply
✜
nature and other random shocks
✜
aims of producers
✜
expectations of producers
SUPPLY ■
Movements along and shifts in the supply curve ✜
change in price ⇒ movement along S curve
✜
change in any other determinant of supply ⇒ shift in S curve • increase in supply ⇒ rightward shift • decrease in supply ⇒ leftward shift
SUPPLY ■
Supply functions ✜
simple supply functions Qs = a + bP
✜
more complex supply functions Qs = a + bP + cC + dPs – ePj
✜
estimated supply equations
✜
problems of estimating supply equations
Shifts in the supply curve P
S0
S1
Increase
O
Q
Shifts in the supply curve P
S2
Decrease
O
S0
S1
Increase
Q
Supply and Demand
Price and output determination
PRICE AND OUTPUT DETERMINATION ■ Equilibrium
price and output
✜ response
to shortages and surpluses ✦ shortage
(D > S)
⇒ price rises ✦ surplus
(S > D)
⇒ price falls ✜ significance
of ‘equilibrium’
Equilibrium price and output: The Market Demand and Supply of Potatoes (Monthly)
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply d
D
80
Cc
60
b
40
B
a
20
A
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply d
D
80
Cc
60
b
40
SHORTAGE
B
(300 000) a
20
A
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply D
80
SURPLUS
d
(330 000) Cc
60
b
40
B
a
20
A
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply d
D
80
60
b
40
B
a
20
A
Demand 0 0
100
200
300
Qe
400
500
Quantity (tonnes: 000s)
600
700
800
PRICE AND OUTPUT DETERMINATION ■
Effects of shifts in the demand curve ✜
movement along the supply curve and the new demand curve
Effect of a shift in the demand curve P
S
g Pe1
D1 O
Qe1
Q
Effect of a shift in the demand curve P
S
g Pe1
D1 O
Qe1
Q
Effect of a shift in the demand curve P
S
g Pe1
D2 D1 O
Qe1
Q
Effect of a shift in the demand curve P
S
i Pe2
g
h
Pe1
D2 D1 O
Qe1
Qe2
Q
PRICE AND OUTPUT DETERMINATION ■
Effects of shifts in the demand curve ✜
■
movement along the supply curve and the new demand curve
Effects of shifts in the supply curve ✜
movement along demand curve and new supply curve
Effect of a shift in the supply curve P
S1
g Pe1
D O
Qe1
Q
Effect of a shift in the supply curve P
S1
g Pe1
D O
Qe1
Q
Effect of a shift in the supply curve P
S2 S1
g Pe1
D O
Qe1
Q
Effect of a shift in the supply curve P
S2 S1 k
Pe3
j
g
Pe1
D O
Qe3
Qe1
Q
PRICE AND OUTPUT DETERMINATION ■
Effects of shifts in the demand curve ✜
■
Effects of shifts in the supply curve ✜
■
movement along the supply curve and the new demand curve
movement along demand curve and new supply curve
Identifying the position of demand and supply curves
Problems in identifying the position and shape of the demand curve: shift in supply curve P
S1
20p
O
a
1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply curve P
S2
30p
20p
O
S1
b
a
800 1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply curve P
S2
30p
20p
S1
b
a
D O
800 1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply and demand curves P
S1
20p
O
a
1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply and demand curves P
30p
20p
O
S2
S1
b
a
800 1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply and demand curves P
30p
20p
S2
S1
b
a D2 D1
O
800 1000
Q
Supply and Demand
Elasticity
ELASTICITY ■
Defining elasticity ✜
■
the responsiveness of demand and supply
Price elasticity of demand ✜
the responsiveness of demand to a change in price
Market supply and demand
Price
S1
a P1
D O
Q1 Quantity
Market supply and demand S2 S1
Price
b P2
a P1
D O
Q2
Q1 Quantity
Market supply and demand S2 S1
Price
b P2
a D'
P1
D O
Q2
Q1 Quantity
Market supply and demand S2 S1
Price
b P2
c P3
a D'
P1
D O
Q3
Q2
Q1 Quantity
ELASTICITY ■
Price elasticity of demand ✜
measurement proportionate (or %) ∆Qd / proportionate (or %) ∆P
✜
use of proportionate or percentage changes
✜
the sign (positive or negative)
✜
the value (greater or less than one)
ELASTICITY ■
■
Determinants of price elasticity of demand ✜
number and closeness of substitute goods
✜
the proportion of income spent on the good
✜
time
Price elasticity of demand and consumer expenditure (P x Q)
Total expenditure
4
3
P(£) 2
Consumers’ total expenditure = firms’ total revenue = £2 x 3m = £6m
1
D
0 0
1
2
3
4
Q (millions of units per period of time)
5
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
Elastic demand between two points Expenditure falls as price rises P(£) 5
b a
4
0
D
10
20
Q (millions of units per period of time)
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
Inelastic demand between two points Expenditure rises as price rises 8
c
P(£)
a
4
D 0
15
20
Q (millions of units per period of time)
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
✜
special cases
Totally inelastic demand (P∈ D = 0) P
D
P2
b
P1
a
O
Q1
Q
Infinitely elastic demand (P∈ D = ∞) P
a
b
Q1
Q2
P1
O
D
Q
P
20
Unit elastic demand (P∈ D = –1)
a
b
8
O
D 40
100
Q
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
✜
special cases
✜
applications to price decisions
Elastic demand between two points
Expenditure falls as price rises P(£) 5
b a
4
0
D
10
20
Q (millions of units per period of time)
Inelastic demand between two points Expenditure rises as price rises 8
c
P(£)
a
4
D 0
15
20
Q (millions of units per period of time)
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
✜
special cases
✜
applications to price decisions
✜
different elasticities along a demand curve
Different elasticities along different portions of a demand curve P
a P1
D
O
Q1
Q
Different elasticities along different portions of a demand curve P
a P1
Elastic demand
b P2
D
O
Q1
Q2
Q
Different elasticities along different portions of a demand curve P
a P1
b P2
Inelastic demand
c P3
D
O
Q1
Q2
Q3
Q
ELASTICITY ■
Measurement of elasticity: arc elasticity ✜
the formula for price elasticity of demand ∆ Q/Q ÷ ∆ P/P
✜
using the average or 'mid-point' method
10
Measuring elasticity using the arc method m
8
n
6
P (£) 4
Demand
2
0 0
10
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
7 ∆P = –2
mid Q
∆P
÷ mid P
n
6
P (£)
∆Q
∆Q = 10
Mid P 4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
mid Q 10 15
∆P
÷ mid P ÷
−2 7
n
6
P (£)
∆Q
∆Q = 10
Mid P 4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
n
6
P (£)
=
∆Q mid Q 10 15
∆P
÷ mid P ÷
−2 7
10/15 x −7/2
∆Q = 10
Mid P 4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
n
6
P (£)
∆Q = 10
Mid P
∆Q mid Q 10 15
∆P
÷ mid P ÷
−2 7
=
10/15 x −7/2
=
−70/30
4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
n
6
P (£)
∆Q = 10
Mid P
∆Q mid Q 10 15
∆P
÷ mid P ÷
−2 7
=
10/15 x −7/2
= =
−70/30 −7/3 = −2.33
4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
ELASTICITY ■
Measurement of elasticity: point elasticity ✜
the formula for price elasticity of demand dQ/dP x P/Q
✜
the elasticity of a straight-line demand ‘curve’ (constant dQ/dP)
✜
the elasticity of a curved demand curve dQ/dP is the tangent to the curve
Measuring elasticity at a point Pεd = (1 / slope) x P/Q
r P
D
0 Q
Measuring elasticity at a point 50
30
Pεd = (1 / slope) x P/Q
r
P
D
0
100
40 Q
Measuring elasticity at a point 50
Pεd = (1 / slope) x P/Q =
30
−100/50 x 30/40
r
P
D
0
100
40 Q
Measuring elasticity at a point 50
Pεd = (1 / slope) x P/Q = =
30
−100/50 x 30/40 −60/40
r
P
D
0
100
40 Q
Measuring elasticity at a point 50
30
Pεd = (1 / slope) x P/Q = = =
r
−100/50 x 30/40 −60/40 − 1.5
P
D
0
100
40 Q
ELASTICITY ■
Measurement of elasticity: point elasticity ✜
the formula for price elasticity of demand dQ/dP x P/Q
✜
the elasticity of a straight-line demand ‘curve’ (constant dQ/dP)
✜
the elasticity of a curved demand curve dQ/dP is the tangent to the curve
✜
different elasticities along a straight-line demand curve
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
m
6
P
l
4
Demand k
2
0 0
10
20
30
Q
40
50
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
(1 / slope) is constant = −50/10 = −5
m
6
P
l
4
Demand k
2
0 0
10
20
30
Q
40
50
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
(1 / slope) is constant = −50/10 = −5
m
6
But P/Q varies: at n, P/Q = 8/10
P
l
4
Demand k
2
0 0
10
20
30
Q
40
50
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
(1 / slope) is constant = −50/10 = −5
m
6
But P/Q varies: at n, P/Q = 8/10 at m, P/Q = 6/20 atl l, P/Q = 4/30
P 4
l
Demand k
2
0 0
10
20
30
Q
40
50
ELASTICITY ■
Price elasticity of supply ✜
measurement
✜
determinants
✜
applications
Supply in different time periods P
P1
a
D1 O
Q1
Q
Supply in different time periods P
P1
a
D2 D1 O
Q1
Q
Supply in different time periods P
P2
Si b
P1
a
D2 D1 O
Q1
Q
Supply in different time periods P
P2
Si
SS
b c
P3 P1
a
D2 D1 O
Q1
Q3
Q
Supply in different time periods P
P2
Si
SS
b c
P3 P4
SL d
P1
a
D2 D1 O
Q1
Q3 Q4
Q
ELASTICITY ■
■
Income elasticity of demand ✜
measurement
✜
determinants
✜
applications
Cross-price elasticity of demand ✜
measurement
✜
determinants
✜
applications
Supply and Demand
The Time Dimension
THE TIME DIMENSION ■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Response of supply to an increase in demand P
P1
a
D1 O
Q1
Q
Response of supply to an increase in demand P
P1
a
D2 D1 O
Q1
Q
Response of supply to an increase in demand P
S short-run
b P2 P1
a
D2 D1 O
Q1
Q2
Q
Response of supply to an increase in demand P
S short-run
S long-run
b P2 P3 P1
c a
D2 D1 O
Q1
Q2 Q3
Q
Response of demand to an increase in supply P
S1
a P1
O
Q1
Q
Response of demand to an increase in supply P
S1 S2 a P1
O
Q1
Q
Response of demand to an increase in supply P
S1 S2 a P1
b
P2
D short-run
O
Q1
Q2
Q
Response of demand to an increase in supply P
S1 S2 a P1 P3 P2
c b D long-run D short-run
O
Q1
Q2 Q3
Q
THE TIME DIMENSION ■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation
THE TIME DIMENSION ■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
Stabilising speculation: initial price fall P
S1
P1
a
D1
O
Q
Stabilising speculation: initial price fall P
S1
P1
P2
a
D1
b D2
O
Q
Stabilising speculation: initial price fall P
S2 S1
P1
a c
P3
P2
D1
b D2
O
D3 Q
Stabilising speculation: initial price rise P
P1
S1
a
D1 O
Q
Stabilising speculation: initial price rise P
S1
b
P2
P1
a D2 D1
O
Q
Stabilising speculation: initial price rise P
S1 S2 b
P2
c
P3 P1
a D2 D1
O
D3 Q
THE TIME DIMENSION ■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Destabilising speculation: initial price fall P
P1
S1
a
D1
O
Q
Destabilising speculation: initial price fall P
S1
a
P1 P2
b
D1 D2 O
Q
Destabilising speculation: initial price fall P
S1 S2 a
P1 P2
b
P3
c D1 D3
O
D2 Q
Destabilising speculation: initial price rise P
S1
P1
a
D1 O
Q
Destabilising speculation: initial price rise P
S1
b
P2 P1
a
D1 O
D2 Q
Destabilising speculation: initial price rise P
S2 S1
P3
c
P2
b
P1
a D3 D1
O
D2 Q
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk ✜
defining risk and uncertainty
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk ✜
defining risk and uncertainty
✜
reducing risks by holding stocks
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk ✜
defining risk and uncertainty
✜
reducing risks by holding stocks
✜
futures markets
Supply and Demand
Demand
DEMAND ■
■
Relationship between demand and price ✜
the law of demand
✜
the income effect
✜
the substitution effect
The demand curve ✜
assumptions ✦ other ✦a
things being equal (ceteris paribus)
given time period
✜
the axes
✜
individual's and market demand curves
The demand curve: The demand for potatoes (monthly)
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
100
Price (pence per kg)
A
20
700
80
60
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
Price (pence per kg)
100
20 40
A B
80
700 500
60
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
Price (pence per kg)
100
20 40 60
A B C
80
700 500 350
C
60
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) Point Price Market demand (pence per kg) (tonnes 000s)
Price (pence per kg)
100
D
80
C
60
20 40 60 80
A B C D
700 500 350 200
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market demand for potatoes (monthly) 100
Price (pence per kg)
Point Price Market demand (pence per kg) (tonnes 000s)
E
D
80
C
60
20 40 60 80 100
A B C D E
700 500 350 200 100
B
40
A
20
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
DEMAND ■
Other determinants of demand ✜
tastes
✜
number and price of substitute goods
✜
number and price of complementary goods
✜
income
✜
distribution of income
✜
expectations
DEMAND ■
Movements along and shifts in the demand curve ✜
change in price ⇒ movement along D curve
✜
change in any other determinant of demand ⇒ shift in D curve • increase in demand ⇒ rightward shift • decrease in demand ⇒ leftward shift
An increase in demand
Price
P
D0 O
Q0
Q1 Quantity
D1
DEMAND ■
Demand functions ✜
simple demand functions Qd = a – bP
✜
more complex demand functions Qd = a – bP + cY + dPs – ePc
✜
estimated demand equations
✜
problems of estimating demand equations
✜
demand functions and the demand curve
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
P
Qd (000s)
5
9
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
P
Qd (000s)
5 10
9 8
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
P
Qd (000s)
5 10 15
9 8 7
30
20
10
D 0 0
2
4
6
Q (000s)
8
10
Demand curve for equation: Qd = 10 000 – 200P 50
40
P
30
P
Qd (000s)
5 10 15 20
9 8 7 6
20
10
D 0 0
2
4
6
Q (000s)
8
10
Supply and Demand
Supply
SUPPLY ■
■
Relationship between supply and price ✜
short-run supply
✜
long-run supply
The supply curve ✜
assumptions ✦ other ✦a
things remain equal (ceteris paribus)
given time period
✜
the axes
✜
individual's and market supply curves
The supply curve: The supply of potatoes (monthly)
Market supply of potatoes (monthly) 100
Supply P
Price (pence per kg)
80
a
20 100
60
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly) 100
Supply P
Price (pence per kg)
80
a b
20 100 40 200
60
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly) 100
Supply P
Price (pence per kg)
80
a b c
c
60
20 100 40 200 60 350
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly) 100
Supply d
Price (pence per kg)
80
a b c d
c
60
P
Q
20 40 60 80
100 200 350 530
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market supply of potatoes (monthly) 100
e
Supply d
Price (pence per kg)
80
P a 20 b 40 c 60 d 80 e 100
c
60
b
40
a
20
0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Q 100 200 350 530 700
SUPPLY ■
■
Relationship between supply and price ✜
short-run supply
✜
long-run supply
The supply curve ✜
assumptions ✦ other ✦a
things remain equal (ceteris paribus)
given time period
✜
the axes
✜
individual's and market supply curves
✜
why supply curves generally slope up
SUPPLY ■
Other determinants of supply ✜
costs of production
✜
profitability of alternative products (substitutes in supply)
✜
profitability of goods in joint supply
✜
nature and other random shocks
✜
aims of producers
✜
expectations of producers
SUPPLY ■
Movements along and shifts in the supply curve ✜
change in price ⇒ movement along S curve
✜
change in any other determinant of supply ⇒ shift in S curve • increase in supply ⇒ rightward shift • decrease in supply ⇒ leftward shift
SUPPLY ■
Supply functions ✜
simple supply functions Qs = a + bP
✜
more complex supply functions Qs = a + bP + cC + dPs – ePj
✜
estimated supply equations
✜
problems of estimating supply equations
Shifts in the supply curve P
S0
S1
Increase
O
Q
Shifts in the supply curve P
S2
Decrease
O
S0
S1
Increase
Q
Supply and Demand
Price and output determination
PRICE AND OUTPUT DETERMINATION ■ Equilibrium
price and output
✜ response
to shortages and surpluses ✦ shortage
(D > S)
⇒ price rises ✦ surplus
(S > D)
⇒ price falls ✜ significance
of ‘equilibrium’
Equilibrium price and output: The Market Demand and Supply of Potatoes (Monthly)
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply d
D
80
Cc
60
b
40
B
a
20
A
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply d
D
80
Cc
60
b
40
SHORTAGE
B
(300 000) a
20
A
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply D
80
SURPLUS
d
(330 000) Cc
60
b
40
B
a
20
A
Demand 0 0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium (potatoes: monthly)
E
100
e
Price (pence per kg)
Supply d
D
80
60
b
40
B
a
20
A
Demand 0 0
100
200
300
Qe
400
500
Quantity (tonnes: 000s)
600
700
800
PRICE AND OUTPUT DETERMINATION ■
Effects of shifts in the demand curve ✜
movement along the supply curve and the new demand curve
Effect of a shift in the demand curve P
S
g Pe1
D1 O
Qe1
Q
Effect of a shift in the demand curve P
S
g Pe1
D1 O
Qe1
Q
Effect of a shift in the demand curve P
S
g Pe1
D2 D1 O
Qe1
Q
Effect of a shift in the demand curve P
S
i Pe2
g
h
Pe1
D2 D1 O
Qe1
Qe2
Q
PRICE AND OUTPUT DETERMINATION ■
Effects of shifts in the demand curve ✜
■
movement along the supply curve and the new demand curve
Effects of shifts in the supply curve ✜
movement along demand curve and new supply curve
Effect of a shift in the supply curve P
S1
g Pe1
D O
Qe1
Q
Effect of a shift in the supply curve P
S1
g Pe1
D O
Qe1
Q
Effect of a shift in the supply curve P
S2 S1
g Pe1
D O
Qe1
Q
Effect of a shift in the supply curve P
S2 S1 k
Pe3
j
g
Pe1
D O
Qe3
Qe1
Q
PRICE AND OUTPUT DETERMINATION ■
Effects of shifts in the demand curve ✜
■
Effects of shifts in the supply curve ✜
■
movement along the supply curve and the new demand curve
movement along demand curve and new supply curve
Identifying the position of demand and supply curves
Problems in identifying the position and shape of the demand curve: shift in supply curve P
S1
20p
O
a
1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply curve P
S2
30p
20p
O
S1
b
a
800 1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply curve P
S2
30p
20p
S1
b
a
D O
800 1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply and demand curves P
S1
20p
O
a
1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply and demand curves P
30p
20p
O
S2
S1
b
a
800 1000
Q
Problems in identifying the position and shape of the demand curve: shift in supply and demand curves P
30p
20p
S2
S1
b
a D2 D1
O
800 1000
Q
Supply and Demand
Elasticity
ELASTICITY ■
Defining elasticity ✜
■
the responsiveness of demand and supply
Price elasticity of demand ✜
the responsiveness of demand to a change in price
Market supply and demand
Price
S1
a P1
D O
Q1 Quantity
Market supply and demand S2 S1
Price
b P2
a P1
D O
Q2
Q1 Quantity
Market supply and demand S2 S1
Price
b P2
a D'
P1
D O
Q2
Q1 Quantity
Market supply and demand S2 S1
Price
b P2
c P3
a D'
P1
D O
Q3
Q2
Q1 Quantity
ELASTICITY ■
Price elasticity of demand ✜
measurement proportionate (or %) ∆Qd / proportionate (or %) ∆P
✜
use of proportionate or percentage changes
✜
the sign (positive or negative)
✜
the value (greater or less than one)
ELASTICITY ■
■
Determinants of price elasticity of demand ✜
number and closeness of substitute goods
✜
the proportion of income spent on the good
✜
time
Price elasticity of demand and consumer expenditure (P x Q)
Total expenditure
4
3
P(£) 2
Consumers’ total expenditure = firms’ total revenue = £2 x 3m = £6m
1
D
0 0
1
2
3
4
Q (millions of units per period of time)
5
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
Elastic demand between two points Expenditure falls as price rises P(£) 5
b a
4
0
D
10
20
Q (millions of units per period of time)
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
Inelastic demand between two points Expenditure rises as price rises 8
c
P(£)
a
4
D 0
15
20
Q (millions of units per period of time)
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
✜
special cases
Totally inelastic demand (P∈ D = 0) P
D
P2
b
P1
a
O
Q1
Q
Infinitely elastic demand (P∈ D = ∞) P
a
b
Q1
Q2
P1
O
D
Q
P
20
Unit elastic demand (P∈ D = –1)
a
b
8
O
D 40
100
Q
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
✜
special cases
✜
applications to price decisions
Elastic demand between two points
Expenditure falls as price rises P(£) 5
b a
4
0
D
10
20
Q (millions of units per period of time)
Inelastic demand between two points Expenditure rises as price rises 8
c
P(£)
a
4
D 0
15
20
Q (millions of units per period of time)
ELASTICITY ■
Price elasticity of demand and consumer expenditure (P x Q) ✜
effects of a price change on expenditure: elastic demand
✜
effects of a price change on expenditure: inelastic demand
✜
special cases
✜
applications to price decisions
✜
different elasticities along a demand curve
Different elasticities along different portions of a demand curve P
a P1
D
O
Q1
Q
Different elasticities along different portions of a demand curve P
a P1
Elastic demand
b P2
D
O
Q1
Q2
Q
Different elasticities along different portions of a demand curve P
a P1
b P2
Inelastic demand
c P3
D
O
Q1
Q2
Q3
Q
ELASTICITY ■
Measurement of elasticity: arc elasticity ✜
the formula for price elasticity of demand ∆ Q/Q ÷ ∆ P/P
✜
using the average or 'mid-point' method
10
Measuring elasticity using the arc method m
8
n
6
P (£) 4
Demand
2
0 0
10
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
7 ∆P = –2
mid Q
∆P
÷ mid P
n
6
P (£)
∆Q
∆Q = 10
Mid P 4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
mid Q 10 15
∆P
÷ mid P ÷
−2 7
n
6
P (£)
∆Q
∆Q = 10
Mid P 4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
n
6
P (£)
=
∆Q mid Q 10 15
∆P
÷ mid P ÷
−2 7
10/15 x −7/2
∆Q = 10
Mid P 4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
n
6
P (£)
∆Q = 10
Mid P
∆Q mid Q 10 15
∆P
÷ mid P ÷
−2 7
=
10/15 x −7/2
=
−70/30
4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
10
Measuring elasticity using the arc method Pεd =
m
8
=
7 ∆P = –2
n
6
P (£)
∆Q = 10
Mid P
∆Q mid Q 10 15
∆P
÷ mid P ÷
−2 7
=
10/15 x −7/2
= =
−70/30 −7/3 = −2.33
4
Demand
2
0 0
10
15 Mid Q
20
30
Q (000s)
40
50
ELASTICITY ■
Measurement of elasticity: point elasticity ✜
the formula for price elasticity of demand dQ/dP x P/Q
✜
the elasticity of a straight-line demand ‘curve’ (constant dQ/dP)
✜
the elasticity of a curved demand curve dQ/dP is the tangent to the curve
Measuring elasticity at a point Pεd = (1 / slope) x P/Q
r P
D
0 Q
Measuring elasticity at a point 50
30
Pεd = (1 / slope) x P/Q
r
P
D
0
100
40 Q
Measuring elasticity at a point 50
Pεd = (1 / slope) x P/Q =
30
−100/50 x 30/40
r
P
D
0
100
40 Q
Measuring elasticity at a point 50
Pεd = (1 / slope) x P/Q = =
30
−100/50 x 30/40 −60/40
r
P
D
0
100
40 Q
Measuring elasticity at a point 50
30
Pεd = (1 / slope) x P/Q = = =
r
−100/50 x 30/40 −60/40 − 1.5
P
D
0
100
40 Q
ELASTICITY ■
Measurement of elasticity: point elasticity ✜
the formula for price elasticity of demand dQ/dP x P/Q
✜
the elasticity of a straight-line demand ‘curve’ (constant dQ/dP)
✜
the elasticity of a curved demand curve dQ/dP is the tangent to the curve
✜
different elasticities along a straight-line demand curve
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
m
6
P
l
4
Demand k
2
0 0
10
20
30
Q
40
50
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
(1 / slope) is constant = −50/10 = −5
m
6
P
l
4
Demand k
2
0 0
10
20
30
Q
40
50
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
(1 / slope) is constant = −50/10 = −5
m
6
But P/Q varies: at n, P/Q = 8/10
P
l
4
Demand k
2
0 0
10
20
30
Q
40
50
Different elasticities along a straight-line demand curve 10
Pεd = (1 / slope) x P/Q
n
8
(1 / slope) is constant = −50/10 = −5
m
6
But P/Q varies: at n, P/Q = 8/10 at m, P/Q = 6/20 atl l, P/Q = 4/30
P 4
l
Demand k
2
0 0
10
20
30
Q
40
50
ELASTICITY ■
Price elasticity of supply ✜
measurement
✜
determinants
✜
applications
Supply in different time periods P
P1
a
D1 O
Q1
Q
Supply in different time periods P
P1
a
D2 D1 O
Q1
Q
Supply in different time periods P
P2
Si b
P1
a
D2 D1 O
Q1
Q
Supply in different time periods P
P2
Si
SS
b c
P3 P1
a
D2 D1 O
Q1
Q3
Q
Supply in different time periods P
P2
Si
SS
b c
P3 P4
SL d
P1
a
D2 D1 O
Q1
Q3 Q4
Q
ELASTICITY ■
■
Income elasticity of demand ✜
measurement
✜
determinants
✜
applications
Cross-price elasticity of demand ✜
measurement
✜
determinants
✜
applications
Supply and Demand
The Time Dimension
THE TIME DIMENSION ■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Response of supply to an increase in demand P
P1
a
D1 O
Q1
Q
Response of supply to an increase in demand P
P1
a
D2 D1 O
Q1
Q
Response of supply to an increase in demand P
S short-run
b P2 P1
a
D2 D1 O
Q1
Q2
Q
Response of supply to an increase in demand P
S short-run
S long-run
b P2 P3 P1
c a
D2 D1 O
Q1
Q2 Q3
Q
Response of demand to an increase in supply P
S1
a P1
O
Q1
Q
Response of demand to an increase in supply P
S1 S2 a P1
O
Q1
Q
Response of demand to an increase in supply P
S1 S2 a P1
b
P2
D short-run
O
Q1
Q2
Q
Response of demand to an increase in supply P
S1 S2 a P1 P3 P2
c b D long-run D short-run
O
Q1
Q2 Q3
Q
THE TIME DIMENSION ■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation
THE TIME DIMENSION ■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
Stabilising speculation: initial price fall P
S1
P1
a
D1
O
Q
Stabilising speculation: initial price fall P
S1
P1
P2
a
D1
b D2
O
Q
Stabilising speculation: initial price fall P
S2 S1
P1
a c
P3
P2
D1
b D2
O
D3 Q
Stabilising speculation: initial price rise P
P1
S1
a
D1 O
Q
Stabilising speculation: initial price rise P
S1
b
P2
P1
a D2 D1
O
Q
Stabilising speculation: initial price rise P
S1 S2 b
P2
c
P3 P1
a D2 D1
O
D3 Q
THE TIME DIMENSION ■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Destabilising speculation: initial price fall P
P1
S1
a
D1
O
Q
Destabilising speculation: initial price fall P
S1
a
P1 P2
b
D1 D2 O
Q
Destabilising speculation: initial price fall P
S1 S2 a
P1 P2
b
P3
c D1 D3
O
D2 Q
Destabilising speculation: initial price rise P
S1
P1
a
D1 O
Q
Destabilising speculation: initial price rise P
S1
b
P2 P1
a
D1 O
D2 Q
Destabilising speculation: initial price rise P
S2 S1
P3
c
P2
b
P1
a D3 D1
O
D2 Q
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk ✜
defining risk and uncertainty
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk ✜
defining risk and uncertainty
✜
reducing risks by holding stocks
THE TIME DIMENSION ■
■
■
Short-run and long-run price adjustment ✜
short- and long-run demand and supply curves
✜
short- and long-run adjustment to a change in demand or supply
Speculation ✜
stabilising speculation
✜
destabilising speculation
Uncertainty and risk ✜
defining risk and uncertainty
✜
reducing risks by holding stocks
✜
futures markets
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