1. ECON 160
Week 5
February 16-18, 2010

2. Review Markets are the interaction of buyers and sellers.
Focus on buyers and sellers separately.
Ceteris paribus: look at one thing at a time; All other things held equal.

3. Demand for X $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx
Demand shows the amounts purchased at alternative prices (horizontal distances at each price)
Demand x Dx
Qtyx /T

4. Supply Curve
$Price
$10 8 6 4 2
Qty x/ T

5. $Price
$ 4 3
2.50
2.00
1.50
1.00
.50
.25
Demand
Surplus at this $ Price
Supply
Q x/ T

6. $Price
$ 4 3
2.50
2.00
1.50
1.00
.50
.25
Demand
Supply
Shortage at this $ Price
Q x/ T

7. Market Equilibrium
$Price 4 3
2.50
2.00
1.50
Pe 1.00
.50
.25
Demand
Supply
Qty D = Qty S
Q x/ T Qe

8. Total Revenue = P X Q $ P x Demand
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
Demand
Supply Pe
$6x5 = $30 Dx
Qtyx /T Qe

9. Effects of Increase in Demand on Price and Quantity
$ P x D1
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Do
Supply
Increases Price and Quantity Pe D1 Sx
Total Revenue = Price x Quantity $6 x 5 = $30 Do
Qtyx /T Qe

10. Demand Determines Price
$ P x D3
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
Supply: Response D2
Demand pulls forth output D1 D3 Sx D2
Total Revenue = Price x Quantity $6 x 5 = $30 D1
Qtyx /T

11. Effects of an Increase in Supply on Price and Quantity
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
Demand S0 S1 Pe
Price decreases and
Quantity increases S0
Total Revenue = Price x Quantity $6 x 5 = $30 Dx S1
Qtyx /T Qe

12. Transaction Costs of Exchange
Information Costs
Search Costs
Quality Identification Cost
Negotiating Costs: Cost of agreeing on what and how much will be exchanged
Transportation Costs: Cost of moving goods between parties

13. Slope Shows Responsiveness of Quantity to a Change in PriceB A Px Px P0 P0 Dx P1 P1 Dx
Q0Q1
Qx/T Q0 Q1
Qx/T

14. Slope of Supply Shows responsiveness of quantity to a change in PriceB Px Px P1 P1 P0 P0
Qx/T Q0 Q1
Qx/T Q0 Q1

15. Elasticity: a Measure of responsiveness of Quantity to a Change in Price
Ed = % Δ Qd/ % Δ price
Es = %  Qs / %  price

16. Measures of Elasticity
Demand is Elastic : %Δ Qd > %Δ P;
ie |Ed| >1. A decrease in Price  an increase in Total Revenue.
Demand is Unitary Elastic: %ΔQd = %ΔP;
ie |Ed| = 1. A Change in price  no change in Total Revenue.
Demand is Inelastic: %ΔQd < %ΔP;
i.e. |Ed| < 1. An increase in Price  an increase in Total Revenue.

17. Elasticity, Price Change & Total Revenue
$Px
Inelastic
$Px P1 P0 P0 P1
Qty/T Q0 Q1 Q1 Q0

18. Increased Demand with elastic Supply
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx
Pe` Pe Sx Sx
Dx`
1. If supply is highly elastic, an increase in demand has a lager quantity effect and a smaller price effect. Dx
Qtyx /T Qe
Qe`

19. Increased Demand , Inelastic Supply
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Sx Dx
Pe’ Pe
Dx’
If supply in inelastic, an increase in demand has a larger increase in price, and a smaller increase in quantity exchanged.
The increase in demand calls forth more production and total revenue increases. Sx Dx
Qtyx /T Qe
Qe’

20. Decrease in Supply, Elastic Demand
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1
Sx’ Dx Sx
Pe` Pe Dx
If demand is elastic, the decrease in supply has a larger quantity effect, and a smaller price increase.
The increase in price decreases total revenue.
Qtyx /T
Qe` Qe

21. Decrease in Supply, Inelastic Demand
$ P x
$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx
Sx’ Sx
Pe’ Pe
If demand is inelastic, a decrease in supply has a smaller quantity effect and a larger increase in Price.
If demand is inelastic, the increase in price increases total revenue. Dx
Qtyx /T
Qe’ Qe

22. Determinants of Price Elasticity of Demand
Number & Closeness of Substitutes.
Information about price change and availability of substitutes.
Percentage of Income Spent on good.
Period of time: Second Law of Demand: Demand is more elastic over a longer period of time.

23. Other Elasticity's
A Measure of responsiveness of Quantity to a Change in some other factor

24. Normal Goods: Positive Clothing: .95: 10%  income → 9.5% 
Income Elasticity: Measure of responsiveness of Quantity to a Change in Income
EdI = % Δ Qd/ % Δ income
EdI = 100 * ΔQ/Q = I * ΔQ
100 * ΔI/I Q * ΔI
Normal Goods: Positive
Clothing: .95: 10%  income → 9.5% 
Stereo: 27.2: 10%  income → 27.2% 
Increase may be Quantity or Quality
Inferior Goods: Negative

25. Substitutes: Positive Complements: Negative
Cross Price Elasticity: Measure of responsiveness of Quantity to a Change Price of other good
Exy = % Δ Qx/ % Δ Py
EdI = 100 * ΔQx/Qx = Py * ΔQx
100 * ΔPy/Py Qx * ΔPy
Substitutes: Positive
Complements: Negative

26. Uses of Cross Price Elasticity
Magnitude of cross price elasticity reflects closeness of substitutes or complements
Able to identify your closest competitors
Courts use cross-price to measure monopoly power

27. Transaction Costs of Exchange
Information Costs
Search Costs
Quality Identification Cost
Negotiating Costs: Cost of agreeing on what and how much will be exchanged
Transportation Costs: Cost of moving goods between parties