Jayashree Sil Submit Questionnaire Supply and Demand First Week: Text: Lecture 1 Slides Lecture 2 Slides & Problem Set 1:

Transcription

1 epartment of Economics Economics, ummer Lecture, June, ubmit Questionnaire:To Front of Class (or to end of aisle if seated) First Week: Must be present for roll call each day. If you are trying to switch section, request GI of original section not to mark you absent Text: hould buy nd Edition. I always will refer to nd edition. Can only give rough guide about st vs nd edition Lecture lides: posted Lecture lides & Problem et : to be posted by P upply and emand Questions We Can Answer Why do the prices of some goods like airline tickets to Europe go up during months of heaviest consumption, while others, like sweet corn, go down? What will happen to the price of tortilla chips if consumers get information that corn is bad for health and there is unusually good weather that gives a bumper crop? Alfred Marshall (8-9) What determines price of a good? Picasso vs Pollock: what s the difference! Aristotle, Plato, Copernicus and Newton: don t have answer Adam mith and Karl Marx: Cost of production tanley Jevons: Valuation of good by buyers Alfred Marshall: Both! upply AN emand. Much of neo-classical analysis we do today due to his insight. Marshall chose to study economics because he saw it as a way to help poor and unfortunate in society. His definition of economics:study of individual and social action most connected with attainment and use of material requisites of well-being. Buyers & emand Curve emand curve: buyers marginal willingness to pay lope of emand Curve: As price rises quantity demanded falls and as price falls quantity demanded rises. At very high prices the the cost-benefit test is satisfied for few buyers, so in the market few units are demanded. Vice versa at low prices. For an individual buyer, the first unit has high value. As he gets more units of the good, the value of an extra unit (ie marginal unit) falls. ellers & upply Curve upply curve: sellers marginal willingness to accept lope of upply Curve: supplied rises only as price rises. ellers & upply Curve From the point of view of all sellers, the lowest cost sellers would be expected to produce the first units of the good, only then are higher cost sellers brought into production. For them a higher price is needed to justify production. For a firm, as more of a good is produced, more variable factors must be combined with fixed factors (like equipment) and the returns to those additional units of variable factors falls (in this sense they become more costly ). Only higher prices can justify producing more.

2 epartment of Economics Economics, ummer Lecture, June, Market: Buyers & ellers Market Equilibrium: price and quantity at which both buyers and sellers are satisfied with the quantity they buy and sell, respectively, at the market price. Out of Equilibrium: Excess emand: When price is below equilibrium, quantity demanded exceeds quantity supplied. Excess upply: When price is above equilibrium supplied exceeds quantity demanded. Pizza Market Excess $ per slice emanded upplied emand/upply 8 E Equilibrium 8 E E At $, E = - 8 or 8 slices, Must Fall At $, E = - or slices, Must Rise At $, Market is in equilibrium, E=E= Equilibrium price = $ per slice Equilibrium quantity =, slices per day Excess upply Excess emand ($ per slice) Excess supply = 8, slices per day upply ($ per slice) upply Excess demand =, slices per day emand emand 8 (s of slices per day) (s of slices per day) The Equilibrium and of Pizza in Chicago Problem to o ($ per slice) 8 upply Equilibrium at $ emanded = upplied emand (s of slices per day) World Tea Market (Billions of Pounds) cents/lb emanded upplied Equilibrium = cents per lb Equilibrium = 7 billion lb E/E 97

3 epartment of Economics Economics, ummer Lecture, June, Predicting and Explaining Changes in s and Quantities A change in the quantity demanded A movement along the demand curve that occurs in response to a change in price A change in demand A shift of the entire demand curve An Increase in emanded vs. an Increase in emand ($/can) Increase in quantity demanded (s of cans/day) An Increase in emanded vs. an Increase in emand Predicting and Explaining Changes in s and Quantities ($/can) Increase in demand (s of cans/day) Change in the quantity supplied A movement along the supply curve that occurs in response to a change in price Change in supply A shift of the entire supply curve An Increase in upplied vs. an Increase in upply An Increase in upplied vs. an Increase in upply ($/can) ($/can) Increase in quantity supplied Increase in supply 8 (s of cans/day) 8 (s of cans/day)

4 epartment of Economics Economics, ummer Lecture, June, emand hifters s of Other Goods Complements Two goods are complements in consumption if increase (decrease) in price of one causes decrease (increase) in the demand for the other eg. coffee & cream ubstitutes Two goods are substitutes in consumption if increase (decrease) in price of one causes an increase (decrease) in the demand for the other eg. tea & coffee emand hifters Change in Income Normal Good One whose demand increases (decreases) when the incomes of buyers increase (decrease) eg. restaurant meals? Inferior Good One whose demand decreases (increases) when the incomes of buyers increase (decrease) eg. macaroni and cheese? emand hifters Changes in Tastes from information on health effects Changes in Population of Potential Buyers Changes in Expectations From Recap (p. 79): emand hifters Rightward or upward shift in emand due to:. ecrease in the price of complements to good. Increase in the price of substitutes to good. Increase in income (for a normal good). Increased preference for good. Increase in the population of potential buyers. Expectation of higher prices in the future o buy more now (Reverse for Leftward downward shift) upply hifters Change in factor prices wages, materials prices Change in technology new high yield seeds, faster computer chip Change in Biological/Physical/Political factors weather, government regulations Change in number of suppliers Change in price expectations From Recap (p. 79): upply hifters Rightward or upward shift in upply due to:. decrease in cost of materials, labor, or other inputs used in production of good. improvement in technology that reduces the cost of producing good. improvement in the weather, especially for agricultural products. increase in the number of suppliers. expectation of lower prices in the future osell more now (Reverse for Leftward downward shift)

5 epartment of Economics Economics, ummer Lecture, June, The Effect of a Credible Rumor on the Market for Current Model Apple Macintosh Computers The Effect on the Market for New Houses of a Increase in Carpenters Wage Rates = demand after rumor of cheaper model soon to be released ($/house) P P 9 Q Q Current Model Apple Computers (units per month) (houses/month) easonal Variation in Air Travel and Corn Markets easonal Variation in Air Travel and Corn Markets ($/ticket) High Consumption due to High emand ($/bushel) High Consumption due to High upply W P W P P P W W Q W Q s of tickets Q W Q Millions of bushels Problem to o : Graph it. The Effects of imultaneous hifts in upply and emand What will happen to the equilibrium quantity and price of corn if the price of butter increases and unusually good weather brings bumper crop? Butter is a complement to corn (yum!). Good weather is a favorable biological factor. ($/lb) P Corn Market after bumper crop after rise in price of butter of complement increases so demand for corn shifts in. Increase in favorable biological factor, so supply of corn shifts out. Equilibrium price unambiguously falls. Equilibrium output may go up/down depending on relative sizes of supply and demand shift. P Q Q lb per month

6 epartment of Economics Economics, ummer Lecture, June, The Effects of imultaneous hifts in upply and emand ummary ($/lb) P Corn Market after bumper crop Market Equilibrium is determined by the reservation prices of buyers and sellers. A buyer must be willing to pay and a seller willing to accept the market price, at a given market quantity. With price above equilibrium, get excess supply. With price below equilibrium, get excess demand. P after butter price increase emand shift, given supply t change in quantity supplied. upply shift, given demand t change in quantity demanded. Q Q lb per month Change in supply due to change in factor prices, technology, price expectations, number of sellers, biological and political factors Change in demand due to change in prices of other goods, income, tastes, population of buyers, price expectations Elasticity The Effect of Extra Border Patrols on the Market for Illicit rugs Questions We Can Answer Total Expenditure = P x Q $ = $ x $ = $8 x Could reducing the supply of illegal drugs cause an increase in drug-relate burglaries? Why are gasoline prices so volatile? P($/ounce) 8 Q(,s of ounces/day) Elasticity Elasticity of emand Elasticity A measure of the extent to which quantity demanded and quantity supplied respond to variations in price, income, and other factors. efined Generally A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good Formally The percentage change in the quantity demanded that results from a percent change in its price

7 epartment of Economics Economics, ummer Lecture, June, Assume The price of pork falls by % and the quantity demanded increases by % Then the price elasticity of demand for pork is = Measuring Elasticity of emand Percentage Change in emanded Percentage Change in elasticity of demand will always be negative (recall slope of demand curve) We drop the negative sign in this class (without negative sign) A Graphical Interpretation of Elasticity of emand Assume The price of pork falls by % and the quantity demanded increases by % Then the price elasticity of demand for pork is P - P P P A P Pr ice elasticity at A = Q slope Q lope=<p + <Q = emand is Elastic Q Q + Q Elastic and Inelastic emand Elastic and Inelastic emand > : elastic Unit elastic When Percentage Change in emanded Percentage Change in is < : inelastic = : unit elastic Inelastic Elastic elasticity of demand 7

8 epartment of Economics Economics, ummer Lecture, June, Example What is the elasticity of season ski passes? Originally = $ demanded =, passes/year New = $8 demanded =, passes/year, then % Change in = :Elastic % Change in eterminants of Elasticity of emand ubstitution Possibilities Budget hare Time Elasticity Estimates for elected Products Elasticity and the teepness of the emand Curve Good or service elasticity Budget hr ubs Green peas.8 small yes,lots Restaurant meals. significant yes Electricity. Beer.9 Coffee. small (like salt?) Theater, opera.8 not no so for rich What is the price elasticity of demand when P = $? = = = = Elasticity and the teepness of the emand Curve Perfectly Elastic emand Curve Observation If two demand curves have a point in common, the steeper curve must be less elastic with respect to price at that point If price rises even shade above, buy nothing, price really matters Perfectly elastic demand (elasticity ) 8

9 epartment of Economics Economics, ummer Lecture, June, Perfectly Inelastic emand Curve Elasticity Regions along a traight-line emand Curve no matter the price, buy it eg. essential drug Observation elasticity varies at every point along a straightline demand curve Perfectly inelastic demand (elasticity = ) a ε > ε = a/ ε < b/ b Elasticity and Total Expenditure Elasticity and Total Expenditure Total Expenditure = P x Q Market demand measures the quantity (Q) at each price (P) Total Expenditure = Total Revenue Will increasing the market price always increase total revenue? The emand Curve for Movie Tickets The emand Curve for Movie Tickets Total Expenditure = $,/day Total Expenditure = $,/day ($/ticket) 8 ($/ticket) 8 (s of tickets/day) (s of tickets/day) 9

10 epartment of Economics Economics, ummer Lecture, June, Elasticity and Total Expenditure The emand Curve for Movie Tickets General Rule A price increase will increase total revenue when the % change in P is greater than the % change in Q. i.e. When elasticity < ($/ticket) 8 (s of tickets/day) Total Expenditure as a Function of Total Expenditure as a Function of ($/ticket) Total expenditure ($/day) Total revenue is at a maximum at the midpoint on a straight-line demand curve, 8,,8,, ($/ticket) 8 (s of tickets/day) Total expenditure ($/day),8,, 8 ($/ticket) Problem: to do Example: Rock band hould a rock band raise or lower its price to increase total revenue? Assume P=$ Q=, =. Total revenue = $ x, = $8,/week If P is increased %, Q will decrease % Total revenue = $ x, = $,/week If P is lowered %, Q will increase % Total revenue = $8 x = $9,/week

11 epartment of Economics Economics, ummer Lecture, June, Elasticity and Total Expenditure Rule When price elasticity is greater than, changes in price and changes in total expenditures always move in opposite directions. When price elasticity is less than, changes in price and changes in total expenditures always move in the same direction. Elasticity and Total Expenditure Cross- Elasticity of emand The percentage by which quantity demanded of the first good changes in response to a percent change in the price of the second good ubstitute Goods cross-price elasticity of demand is positive Complement Goods cross-price elasticity of demand is negative Elasticity and Total Expenditure Income Elasticity of emand The percentage by which quantity demanded changes in response to a percent change in income Normal Goods Income elasticity is positive Inferior Goods Income elasticity is negative The Elasticity of upply The percentage change in the quantity supplied that occurs in response to a percent change in price elasticity of elasticity of Q Q supply = P P P supply = Q slope Elasticity Along traight-line upply Curve A = ( )( ) = A B slope= ( )( ) B = = ($/acre) A Perfectly Inelastic upply Curve What is the price elasticity of supply of land within the borough limits of Manhattan? Elasticity = at every point along a vertical supply curve o not be too concerned with special case in F&B figure. of land in Manhattan (,s of acres)

12 epartment of Economics Economics, ummer Lecture, June, A Perfectly Elastic upply Curve The Elasticity of upply What is the price elasticity of supply of lemonade? (cents/cup) If MC is constant, then the price elasticity of supply at every point along a horizontal supply curve is infinite eterminants of upply Elasticity Flexibility of inputs Mobility of inputs Ability to produce substitute inputs Time of lemonade (cups/day) Greater Volatility in Gasoline s than in Car s ummary Gasoline ($/gallon) (millions of gallons/day) emand is more elastic for goods with many substitutes, that take a large share of budget and over time. upply is more elastic as flexibility with respect to input use is greater and over time Total revenue falls with a price increase when demand is elastic and vice versa when demand is inelastic Total revenue is maximum at the midpoint of a straight-line demand curve where elasticity is. At points below, elasticity < and at points above, elasticity >.