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YEAR # of Passenger cars sold In- tro- duc- tory Pe- riod Growth Period Mature Period Declining Period Factory Sales of Passenger Cars in the U.S.

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DEMAND What Buyers are Willing and Able to Buy, during a given Time Period, ceteris paribus.

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KEY POINTS ABOUT DEMAND l “WILLINGNESS AND ABILITY” (not stridently wanting) l “BUYERS” (not sellers) l “during a given time period” is a FLOW (not a STOCK) l “ceteris paribus”- all other things are held constant except price and quantity. l Whole set of P-Q combinations (not QUANTITY DEMANDED)

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GENERALIZED DEMAND FUNCTION f = f( Price: Taxes, Price of Complements Price of Substitutes Tastes for good/service Income, Buyer Expectations, Number of buyers) Q P

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SUPPLY What Buyers Sellers are Willing and Able to buy Sell, during a given Time Period, ceteris paribus. XXXXX XXX

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KEY POINTS ABOUT SUPPLY l “WILLINGNESS AND ABILITY” (not stridently wanting) l “BUYERS” (not sellers) l “during a given time period” is a FLOW (not a STOCK) l “ceteris paribus”- all other things are held constant except price and quantity. l Whole set of P-Q combinations (not QUANTITY DEMANDED) XXXXXXXXXXXXXXXXXXX Sellers (not buyers) XXXXXXXXXXX SUPPLIED

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GENERALIZED SUPPLY FUNCTION f = f( Price: Price of Resources Technology, Seller Expectations, Number of Sellers)

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HOW TO BE SHERLOCK HOLMES IN READING BETWEEN THE LINES If You Know P and Q then you know whether demand or supply is involved as well as the direction of the shift. If You Know the shift in demand or supply, then you know what is likely to happen to price and quantity If You Know the determinant that has changed and price, then you know what is happening to quantity demanded. If You Know the determinant that has changed and quantity demanded, then you know what is happening to price.

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Lower Price Higher Price Lower Output Higher Output Leftward (downward) Shift of Demand Rightward (upward) Shift of Demand Rightward (downward) Shift of Supply Leftward (upward) Shift of Supply Breakdown all shifts into their output and price vectors

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MARKET BOUNDARIES l BUYER POINT OF VIEW: No potential seller exists outside of the market boundaries (within a reasonable price range) l SELLER POINT OF VIEW: No potential buyer exists outside of the market boundaries (within a reasonable price range) l BOTH POINTS OF VIEW MUST HOLD l CROSS PRICE ELASTICITY measures

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MARKET BOUNDARIES X X X X X O O O X represents buyers O represents sellers

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MARKET DEMAND FOR CARS 30 15 Price ($1000/car) 7 9 4 5 11 14 U.S quantity (mill/yr) + Foreign Q (mill/yr) = Market Demand

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MUSTANG DEMAND DEMAND 150550 (000’s Mustangs/year) Price of Mustangs 9510 8000 TR= $1426 million TR= $4400 Million LOSS GAIN GAINS-LOSS=$2974 M.

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MARGINAL REVENUE (MR) MR DEMAND 150550 (000’s Mustangs/year) Price 9510 8000 GAINS-LOSS MR= CHANGE IN CARS $2974 M./400,000 CARS =$7,435 PER CAR LOSS 7435 GAIN

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REVENUE MAXIMIZATION MR DEMAND (000’s Mustangs/year) Price 5037 1,334,000 MUSTANGS

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(000’s Mustangs/year) MR=0 Price ($/car) 5037 1,334,000 MUSTANGS Q (000’s Mustangs/year) Total Revenue ($/year) $6.5 billion MAXIMUM REVENUE MR>0 |elas|>1 |elas|= 1 |elas|<1 MR<0

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MUSTANG DEMAND DEMAND 150 (000’s Mustangs/year) 9510 Price of Mustangs 550 1966 DEMAND 1970 DEMAND

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DEMAND ELASTICITY l ALWAYS THE PERCENTAGE CHANGE IN QUANTITY DIVIDED BY THE PERCENTAGE CHANGE IN A DETERMINANT OF DEMAND l NOT THE SAME AS MARGINAL REVENUE WHICH IS THE CHANGE IN REVENUE OVER THE CHANGE IN QUANTITY

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PRICE ELASTICITY E p = PERCENTAGE CHANGE IN QUANTITY PERCENTAGE CHANGE IN PRICE Q1-Q2 Q1+Q2 P1-P2 P1+P2 = Note: This formula requires the knowledge of two different situations; The price (P1) and quantity demanded (Q1) in an initial situation and A price (P2) and quantity demanded (Q2) after a change has occurred

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E p = Q1-Q2 Q1+Q2 P1-P2 P1+P2 IN EXCEL: Suppose you have the EXCEL worksheet: A B C D 1Quan tity 3 5 2Price 10 6 3E = 4 In C3, write the formula: =((B1-C1)/(B1+C1))/((B2-C2)/(B2+C2)) IT IS UNIT ELASTIC!

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E p = Q1-Q2 Q1+Q2 P1-P2 P1+P2 IN EXCEL: Suppose you have the EXCEL worksheet: A B C D 1Quan tity 3 5 to 6 2Price 10 6 3E = -1.333 4 In C3, write the formula: =((B1-C1)/(B1+C1))/((B2-C2)/(B2+C2)) XXX NOW IT IS ELASTIC!

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E p = Q1-Q2 Q1+Q2 P1-P2 P1+P2 IN EXCEL: Suppose you have the EXCEL worksheet: A B C D 1Quan tity 3 5 to 4 2Price 10 6 3E =-.57143 4 In C3, write the formula: =((B1-C1)/(B1+C1))/((B2-C2)/(B2+C2)) XXX NOW IT IS INELASTIC!

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TOTAL REVENUE RULE IF PRICE RISES THEN: IF PRICE FALLS THEN: ELASTIC (MR>0,|E|>1) UNIT ELASTIC (MR=0,|E|=1) INELASTIC (MR<0,|E|<1 IF ELASTI- CITY IS: TR TR stays same TR

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REVENUE MAXIMIZATION MR DEMAND 150550 (000’s Mustangs/year) Price 9510 8000 7435 5037 1,334,000 MUSTANGS LOSS GAIN 4000 BIG LOSS IN REVENUE IF PRICES BELOW REV- ENUE MAXIMIZING PRICE

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CROSS-PRICE ELASTICITY E X,Y = PERCENTAGE CHANGE IN QUANTITY (X) PERCENTAGE CHANGE IN PRICE OF ANOTHER GOOD (Y) Qx-Qx Qx+Qx Py-Py Py+Py =

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CROSS-PRICE ELASTICITY l Exy x and y are complements l Exy>0 ===> x and y are substitutes (or in same market) l Exy =0 ==> x and y are unrelated

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MARKET BOUNDARIES X X X X X O O O X represents buyers O represents sellers U represents your firm U N N represents a new firm Cross Price Elasticity w.r.t. New Firm?

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MARKET BOUNDARIES X X X X X O O O X represents buyers O represents sellers U represents your firm U N represents a new firm Cross Price Elasticity w.r.t. New Firm? N Positive, Negative, or Zero

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Percentage Change

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INCOME ELASTICITY E Y = PERCENTAGE CHANGE IN QUANTITY PERCENTAGE CHANGE IN INCOME Q1-Q2 Q1+Q2 Y1-Y2 Y1+Y2 =

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INCOME ELASTICITY l Ey An INFERIOR GOOD l Ey>0 ===> A NORMAL GOOD Ey >1 ==> A SUPERIOR GOOD 0 A NECESSITY

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Percentage Change

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MR=0 Price ($/car) Q (000’s Mustangs/year) MR>0 |elas|>1 |elas|= 1 |elas|<1 MR<0 Price ($/car) Q (000’s Mustangs/year) LIINEAR DEMAND MAXIMUM REVENUE MULTIPLICATIVE DEMAND CONSTANT REVENUE FLAT MARGINAL REVENUE CURVE

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Q MULTIPLICATIVE DEMAND Price ($/car) (000’s Mustangs/year)

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