Supply and Demand chapter 2 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-2 Learning Objectives Explain what supply and demand curves for a good, and supply and demand functions, represent. Identify various market forces that shift supply and demand curves. Use the concept of market equilibrium to calculate the equilibrium price and the amount bought and sold. Evaluate how changes in demand or supply affect market equilibrium. Understand elasticity and the way economists use it to measure the responsiveness of demand or supply. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-3 Market Equilibrium DemandSupply Elasticities Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-4 Overview Demand curves – Concept, representation, shifts Supply curves – Concept, representation, shifts Market equilibrium Elasticities – Responsiveness of demand or supply Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-5 Demand Curve The demand curve shows how much buyers of a product want to purchase at each possible price holding fixed all other factors that affect demand. Q P D Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-6 Demand Shifts Prices of related products – Substitutes  P 1  D substitute shifts right D Q P D’D’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-7 Demand Shifts Prices of related products – Substitutes  P good 1  D substitute shifts right – Complements  P good 1  D complement shifts left P Q D D’D’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-8 Demand Shifts Prices of related products – Substitutes  P good 1  D substitute shifts right – Complements  P good 1  D complement shifts left Income – Normal good  M  D shifts right Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. P Q D D’D’

2-9 Demand Shifts Prices of related products – Substitutes  P good 1  D substitute shifts right – Complements  P good 1  D complement shifts left Income – Normal good  M  D shifts right – Inferior good  M  D shifts left P Q D D’D’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-10 Movements along vs. Shifts Change in price of the product  movement along the curve P Q D Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-11 Movements along vs. Shifts Change in price of the product  movement along the curve Change in some other factor  shift of the entire curve P Q D D’D’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-12 Demand function Quantity Demanded = D(Price, Other factors) Holding other factors constant at P potatoes = $0.50 per pound, P butter = $4 per pound, and income at $30,000: Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-13 Supply Curve The supply curve shows how much sellers of a product want to sell at each possible price holding fixed all other factors that affect supply. P Q S Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-14 Supply shifts Prices of inputs Technology Taxes/regulations Other factors P Q S S’S’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-15 Supply shifts Prices of inputs Technology Taxes/regulations Other factors P Q S S’S’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-16 Movements along vs. Shifts Change in price of the product  movement along the curve P Q S Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-17 Change in price of the product  movement along the curve Change in some other factor  shift of the entire curve P Q S S’S’ Movements along vs. Shifts Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-18 Supply function Quantity Supplied = S(Price, Other factors) Holding other factors constant at P fuel = $2.50 per gallon, P soybeans = $8 per bushel: Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-19 Market Equilibrium Demand Supply At the equilibrium price the amounts supplied and demanded are equal. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-20 Market equilibrium Excess supply  sellers lower their prices  Q s decreases and Q d increases  lower excess supply, until it disappears P Q D S P high QdQd QsQs Excess supply Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-21 Market equilibrium P Q D S QdQd QsQs P low Excess demand  buyers increase their bids  Q s increases and Q d decreases  lower excess demand, until it disappears Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-22 Market equilibrium P Q D S Q d = Q s Equilibrium Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-23 Changes in market equilibrium P Q D S P Q Example: demand shift D’D’ P’ Q’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-24 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-25 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-26 Effect of hurricanes on market equilibrium Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-27 Effect of increase on demand and supply Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-28 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-29 Responsiveness of equilibrium price and quantity to changes in supply (a) Horizontal demand curve P Q S S’ P = P’ D Q Q’ P Q S S’ (a) Vertical demand curve D Q = Q’ Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-30 Steeper demand curve – Larger change in price – Smaller change in quantity Responsiveness of equilibrium price and quantity to changes in supply P Q S S’ P Q D1D1 D2D2 Q2Q2 P2P2 Q1Q1 P1P1 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-31 Responsiveness of equilibrium price and quantity to changes in demand Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-32 Steeper supply curve – Larger change in price – Smaller change in quantity Responsiveness of equilibrium price and quantity to changes in demand Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-33 Elasticity measures responsiveness Elasticity measures the percentage change in Y caused by a percentage change in X Why use elasticity instead of slope? – Slopes depend on units – Elasticities are unit- free measures Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-34 Price elasticity of demand Measures how responsive the quantity demanded is to changes in prices Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-35 Price elasticity for linear demand curves where -B is the slope of the linear demand curve Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-36 Elasticities along a linear demand curve Inelastic Elastic Unit elasticity Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-37 Two extreme demand curves Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-38 Total expenditure and elasticity of demand Elastic  ∆TE/∆P < 0 Unit elasticity  ∆TE/∆P = 0 Inelastic  ∆TE/∆P > 0 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-39 Price and total expenditure (linear demand) Elastic  ∆TE/∆P < 0 Unit elasticity  ∆TE/∆P = 0 Inelastic  ∆TE/∆P > 0 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-40 Price elasticity of supply Measures how responsive the quantity supplied is to changes in prices Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-41 Two extreme supply curves Perfectly elasticPerfectly inelastic Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-42 Income elasticity of demand Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-43 Cross-price elasticity of demand Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-44 Review The demand curve shows how much of the product consumers want to buy at each possible price, holding fixed all other factors that affect demand. The supply curve shows how many units firms want to sell at each possible price, holding fixed all other factors that affect supply. Movement along a curve vs. shift of the entire curve. At the market equilibrium the amounts supplied and demanded are equal. Elasticity measures the responsiveness of one variable to changes in another variable. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-45 Looking forward In the future we will study how consumers and firms make decisions Next we will focus on weighing benefits and costs, introducing several key concepts such as opportunity cost, and economic methods such as the marginal approach Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.