Lecture two © copyright ： qinwang 2013 SHUFE school of international business

Demand, Supply, and Market Equilibrium  Demand and demand function  Supply and supply function  Market equilibrium

Demand and supply 1 、 Demand Demand definition Demand definition Demand and influences Demand and influences Demand function Demand function Demand curve (firm and industry) Demand curve (firm and industry) The rule of demand The rule of demand Shift of demand Shift of demand 2 、 Supply Supply definition Supply definition Supply and influences Supply and influences Supply function Supply function Supply curve (firm and industry) Supply curve (firm and industry) The rule of supply The rule of supply Shift of supply Shift of supply

Demand  Quantity demanded ( Q d ) Amount of a good or service consumers are willing & able to purchase during a given period of time Demand is different from need

General Demand Function  Some variables that influence Q d Price of good or service (P) Incomes of consumers (M) Prices of related goods & services (P R ) Taste patterns of consumers ( T ) Expected future price of product (Pe) Number of consumers in market (N) General demand function Q d = f(P, M, P R, T, P e, N)

General Demand Function  b, c, d, e, f, & g are slope parameters Measure effect on Q d of changing one of the variables while holding the others constant  Sign of parameter shows how variable is related to Q d Positive sign indicates direct relationship Negative sign indicates inverse relationship Q d = a + bP + cM + dP R + e T + fP e + gN

VariableRelation to Q d Sign of Slope Parameter General Demand Function Inverse for complements P PePe N M PRPR Inverse Direct Direct for normal goods Inverse for inferior goods Direct for substitutes b =  Q d /  P is negative c =  Q d /  M is positive c =  Q d /  M is negative d =  Q d /  P R is positive d =  Q d /  P R is negative f =  Q d /  P e is positive g =  Q d /  N is positive e =  Q d /  T is positive T

Direct Demand Function  The direct demand function, or simply demand, shows how quantity demanded, Q d, is related to product price, P, when all other variables are held constant Q d = f(P)  Law of Demand Q d increases when P falls, all else constant Q d decreases when P rises, all else constant  Q d /  P must be negative

Demand curve Q1Q2 Q3 Q3=Q2+Q1 firm1firm2 industry

Graphing Demand Curves  Change in quantity demanded Occurs when price changes Movement along demand curve  Change in demand Occurs when one of the other variables, or determinants of demand, changes Demand curve shifts rightward or leftward

 Six variables that influence Q s Price of good or service (P) Input prices (P I ) Prices of goods related in production (P r ) Technological advances (T) Expected future price of product (P e ) Number of firms producing product (F)  General supply function Q s = f(P, P I, P r, T, P e, F) Supply

VariableRelation to Q s Sign of Slope Parameter General Supply Function Direct for complements P PePe F PIPI PrPr Direct Inverse Inverse for substitutes k =  Q s /  P is positive l =  Q s /  P I is negative m =  Q s /  P r is negative m =  Q s /  P r is positive r =  Q s /  P e is negative s =  Q s /  F is positive n =  Q s /  T is positive T

Direct Supply Function  The direct supply function, or simply supply, shows how quantity supplied, Q s, is related to product price, P, when all other variables are held constant Q s = f(P)  Law of Supply Q s increases when P rises, all else constant Q s decreases when P falls, all else constant  Q s /  P must be positive

Supply curve Q1Q2 Q3 Q3=Q2+Q1 firm1firm2 industry

 Supply curve of labor labor

Graphing Supply Curves  Change in quantity supplied Occurs when price changes Movement along supply curve  Change in supply Occurs when one of the other variables, or determinants of supply, changes Supply curve shifts rightward or leftward

Market Equilibrium  Equilibrium price & quantity are determined by the intersection of demand & supply curves At the point of intersection, Q d = Q s Consumers can purchase all they want & producers can sell all they want at the “ market-clearing ” or “ equilibrium ” price

Market Equilibrium  Excess demand (shortage) Exists when quantity demanded exceeds quantity supplied  Excess supply (surplus) Exists when quantity supplied exceeds quantity demanded

Value of Market Exchange  Economic value Maximum amount any buyer in the market is willing to pay for the unit, which is measured by the demand price for the unit of the good  Consumer surplus Difference between the economic value of a good (its demand price) & the market price the consumer must pay  Producer surplus For each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price)  Social surplus Sum of consumer & producer surplus Area below demand & above supply over the relevant range of output

Changes in Market Equilibrium  Qualitative forecast Predicts only the direction in which an economic variable will move  Quantitative forecast Predicts both the direction and the magnitude of the change in an economic variable

Demand Shifts (Supply Constant) – D increase, ? – D decrease, ? Case 1

Supply Shifts (Demand Constant) – Supply increase, ? – Supply decrease, ? Case two

Case three  When demand & supply increase simultaneously Quantity? Quantity? Price? Price?

Case four  When demand & supply decrease simultaneously Quantity,? Quantity,? Price,? Price,?

Case five  Supply increase ， demand decrease Quantity? Quantity? Price? Price?

Case six  Supply decrease ， demand increase Quantity ? Quantity ? Price? Price?

Example: House leasing  In a competitive market of house leasing, analyze the following market (other factors are given) : Consumers income increased Levy rent tax for $100/unit/month An regulation: the rent is no more than 2000/unit/month.

Ceiling & Floor Prices  Ceiling price Maximum price government permits sellers to charge for a good When ceiling price is below equilibrium, a shortage occurs  Floor price Minimum price government permits sellers to charge for a good When floor price is above equilibrium, a surplus occurs

Ceiling & Floor Prices QxQx Quantity QxQx PxPx PxPx Price (dollars) SxSx DxDx Panel A – Ceiling price SxSx DxDx 2 50 Panel B – Floor price

Cobweb Theorem

Elasticity  Elasticity and its calculation  Price Elasticity of Demand ( Ep )  Income elasticity of demand(Em)  Cross elasticity of demand(Exr)

Elasticity  X & Y are related variables, The larger the absolute value of E, the more sensitive Y are to a change in X Measures responsiveness or sensitivity of dependant variable Y to independent variable X

Calculating Elasticity  Point elasticity  Interval (arc) elasticity

Price Elasticity of Demand ( E )  P & Q are inversely related by the law of demand so E is always negative The larger the absolute value of E, the more sensitive buyers are to a change in price Measures responsiveness or sensitivity of consumers to changes in the price of a good

Case ： Levy Jeans $price （ /unit ） Sales(unit/week) Demand of Levy Jeans in Sears

ElasticityResponsiveness EE Elastic Unitary Elastic Inelastic Table Price Elasticity of Demand ( E )  %∆Q  >  %∆P   %∆Q  =  %∆P   %∆Q  <  %∆P   E  > 1  E  = 1  E  < 1

Price Elasticity & Total Revenue Elastic Quantity- effect dominates Unitary elastic No dominant effect Inelastic Price-effect dominates Price rises Price falls TR falls TR rises No change in TR TR rises TR falls  %∆Q  >  %∆P  %∆Q  =  %∆P  %∆Q  <  %∆P 

Case ： Basketball shoes’ pricing N is a company of basketball shoes. It sells pairs of shoes per month (shoes price is $100). Its competitor reduces the price of basketball shoes. After that N company ’ s sale reduce to 8000 pairs. According to experience, the Ep in such range of price and quantity is about 。 If N company want increase its sale to pairs per month ， what price would N company set?

Ep of some goods in US economy IndustryEp Elastic Finished food2.27 Metal1.52 Furniture 、 wood 1.25 Auto1.14 Logistics1.03

Inelastic Gas 、 power 、 water 0.92 Oil0.91 Chemical0.89 Drinks0.78 Tobacco0.61 Food0.58 House/0.55 Clothes0.49 Book, magazine, newspaper0.34 Meat0.20

Demand & Marginal Revenue  When inverse demand is linear, P = A + BQ (A > 0, B < 0) Marginal revenue is also linear, intersects the vertical (price) axis at the same point as demand, & is twice as steep as demand MR = A + 2BQ

Linear Demand, MR, & Elasticity

MR, TR, & Price Elasticity Marginal revenue Total revenue Price elasticity of demand MR > 0 MR = 0 MR < 0 Elastic (│ E│ > 1) TR decreases as Q increases ( P decreases) TR is maximized TR increases as Q increases ( P decreases ) Unit Elastic (│ E│= 1) Inelastic (│ E│< 1)

Marginal Revenue & Price Elasticity  For all demand & marginal revenue curves, the relation between marginal revenue, price, & elasticity can be expressed as

Example ： Price strategy of telecom Fixed-line toll ： increase International telephone fee ： decrease

The government want to levy tax on luxuries to narrow the gap between the poor and rich? Example ： Tax for luxuries

Income Elasticity  Income elasticity ( E M ) measures the responsiveness of quantity demanded to changes in income, holding the price of the good & all other demand determinants constant Positive for a normal good Negative for an inferior good

 E M >1 ： high-grade products  0< E M <=1 ： normal product  E M <0 ： inferior EM ＝0：EM ＝0： EM ＝1：EM ＝1：

E P And E M in US product EPEP EMEM Food Auto Petrol Power Beer Flour-0.36 Marijuana-1.500

Engel's Coefficient USJapanFranceBrazilianIndia City Rural China

Cross-Price Elasticity  Cross-price elasticity ( E XR ) measures the responsiveness of quantity demanded of good X to changes in the price of related good R, holding the price of good X & all other demand determinants for good X constant Positive when the two goods are substitutes Negative when the two goods are complements

 E XR >0 ： substitute  E XR <0) ： complement  E XR =0 ：

E XR In US Goods YGoods X E XR powergas0.20 porkbeef0.14 Orange from california Orange from fo 0.14

E XR and decision Substitutes and Complements

 Questions?