1. Demand & Supply
Dr. Alok Kumar Pandey
Dr. Alok Pandey

2. Agenda for Discussion Equilibrium: Demand and Supply
Change in the Equilibrium
Elasticity Demand, types of elasticity, effect of elasticity on revenue, effect of time on elasticity
Elasticity of Supply, effect of time on elasticity
Income elasticity
Cross elasticity
Dr. Alok Pandey

3. The Supply Function
Includes all variables that influence the quantity supply
Q = f( P, Pa, C, Nf, T, PE ………….)
P is price of the good
Pa is the price of alternative goods
C is the input price
Nf is number of firms, T Technological advancement
PE is the expected future price
Dr. Alok Pandey 4

4. The Supply Curve Price ↓ Move leftward along the supply curve Price ↑
Move rightward along
the supply curve P P S S A B P1 P2 P2 P1 B A Q2 Q1 Q Q1 Q2 Q
Dr. Alok Pandey

5. The Supply Curve The Supply curve shifts rightward P S1 S2
Price of input ↓
Price of alternatives ↓
Number of firms ↑
Expected price ↓
Technological advance
Favorable weather Q
Dr. Alok Pandey

6. The Supply Curve The Supply curve shifts leftward P S2 S1
Price of input ↑
Price of alternatives ↑
Number of firms ↓
Expected price ↑
Unfavorable weather Q
Dr. Alok Pandey

7. Supply and Demand Equilibrium Equilibrium price and quantity
both P and Q have settled into a state of rest
Equilibrium price and quantity
once achieved - remain constant
until either the demand curve or supply curve shifts
Dr. Alok Pandey

8. Equilibrium Quantity Price S E 3.00 1.00 D 25,000 50,000 75,000
Dr. Alok Pandey

9. Excess Demand
the amount by which quantity demanded exceeds quantity supplied - at a given price
Buyers compete with each other to get more of the good than is available
The price will rise
Equilibrium is reached
Dr. Alok Pandey

10. Excess Demand Quantity Price 2. causes the price to rise . . . S
3. shrinking the excess
demand until price
reaches its equilibrium
value of 3.00 E
3.00 H J
1.00
Excess Demand D
25,000
50,000
75,000
1. At a price of 1.00 per
Bottle, an excess demand
of 50,000 units . . .
Dr. Alok Pandey

11. Excess Supply
the amount by which quantity supplied exceeds quantity demanded - at a given price
Sellers compete with each other to sell more than buyers want
The price will fall
Equilibrium is reached
Dr. Alok Pandey

12. Excess Supply 1. At a price of 5.00 per bottle an excess supply
of 30,000 units . . .
3. shrinking the
excess supply . . .
Quantity
Price S
Excess Supply
5.00 L K
4. until price reaches
its equilibrium
value of 3.00
3.00 E D
2. causes the price
to drop…
35,000
50,000
65,000
Dr. Alok Pandey

13. What Happens When Things Change
Income rises
normal good
the demand increases (rightward shift of the demand curve)
Rightward movement along the supply curve
Equilibrium price rises
Equilibrium quantity rises
Dr. Alok Pandey

14. Income rises, causing an increase in D
Quantity
Price
4. equilibrium
price increases
3. to a new
equilibrium S
2. moves us along
the supply curve…
4.00 E'
1. An increase
in demand . . .
3.00 E D2 D1
5. equilibrium quantity
increases too
50,000
60,000
Dr. Alok Pandey

15. What Happens When Things Change
Example - Weather changes will shift the supply curve
Decrease in supply (the supply curve shifts leftward)
Equilibrium price rises
Equilibrium quantity falls
Dr. Alok Pandey

16. Bad weather hits, decreasing the S
Quantity
Price S2 S1
5.00 E'
3.00 E D
35,000
50,000
Dr. Alok Pandey

17. Both Curves Shift Just one curve shifts (D or S)
we can determine the direction that BOTH equilibrium price AND quantity will move
Both curves shift (D and S)
we can determine the direction that EITHER equilibrium price OR equilibrium quantity will move
direction of the other – which curve shifts by more
Dr. Alok Pandey

18. Income rises and Bad weather hits
Quantity
Price S2 S1
6.00 E'
3.00 E D2 D1
Dr. Alok Pandey

19. Price Elasticity of Demand
Degree of Responsiveness
Price elasticity of demand
Consumers’ responsiveness to a change in price
Percentage change in the quantity demanded divided by percentage change in price
Dr. Alok Pandey 19

20. Price Elasticity of Demand
Law of demand
ED negative
Absolute value of ED positive
Dr. Alok Pandey

21. Computing the Price Elasticity of Demand
Example: If the price of an ice cream cone increases from Rs to Rs and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:
Dr. Alok Pandey

22. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.
Dr. Alok Pandey

23. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
Example: If the price of an ice cream cone increases from Rs to Rs.2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:
Dr. Alok Pandey

24. Computing the Price Elasticity of Demand5 4
Demand 50
100
Quantity
Demand is price elastic
Dr. Alok Pandey

25. The Variety of Demand Curves on the basis of elasticity
Perfectly Inelastic
Quantity demanded does not respond to price changes.
Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
Unit Elastic
Quantity demanded changes by the same percentage as the price.
Dr. Alok Pandey

26. The Variety of Demand Curves on the basis of elasticity
Inelastic Demand
Quantity demanded does not respond strongly to price changes.
Price elasticity of demand is less than one.
Elastic Demand
Quantity demanded responds strongly to changes in price.
Price elasticity of demand is greater than one.
Dr. Alok Pandey

27. The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
100 5
1. An
increase
in price . . . 4
Quantity
leaves the quantity demanded unchanged.
Dr. Alok Pandey

28. The Price Elasticity of Demand
(b) Inelastic Demand: Elasticity Is Less Than 1
Price
Demand 5 90 4
100
Quantity
Dr. Alok Pandey

29. The Price Elasticity of Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price
Demand 5 75 4
100
Quantity
Dr. Alok Pandey

30. The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price
Demand 5 50 4
100
Quantity
Dr. Alok Pandey

31. The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above 4, quantity
demanded is zero. 4
Demand
2. At exactly 4,
consumers will
buy any quantity.
3. At a price below 4,
quantity demanded is infinite.
Quantity
Dr. Alok Pandey

32. Total Revenue and the Price Elasticity of Demand
Total revenue is the amount paid by buyers and received by sellers of a good.
Computed as the price of the good times the quantity sold.
TR = P x Q
Dr. Alok Pandey

33. Total Revenue Price 4 P × Q = 400 P (revenue) Demand 100 Quantity Q
Quantity Q
Dr. Alok Pandey

34. Elasticity and Total Revenue along a Linear Demand Curve
With a relatively inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.
Dr. Alok Pandey

35. How Total Revenue Changes When Price Changes: Inelastic Demand
An Increase in price from 1
to 3 …
… leads to an Increase in total revenue from 100 to 240
Demand
Demand 3 80
Revenue = 240 1
100
Revenue = 100
Quantity
Quantity
Dr. Alok Pandey

36. Elasticity and Total Revenue along a Linear Demand Curve
With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.
Dr. Alok Pandey

37. How Total Revenue Changes When Price Changes: Elastic Demand
An Increase in price from 4
to 5 …
… leads to an decrease in total revenue from 200 to 100 5 20
Demand
Demand
Revenue = 100 4 50
Revenue = 200
Quantity
Quantity
Dr. Alok Pandey
Copyright©2003 Southwestern/Thomson Learning

38. Summary of price elasticity of demand :Effects of a 10 percent increase in price
Absolute value
of price elasticity
Type of demand
What happens to
quantity demanded
total revenue
ED = 0
Perfectly inelastic
No change
Increases by
10 percent
0 < ED < 1
Inelastic
Drops by less than
Increases by less
than 10 percent
ED = 1
Unit elastic
Drops by 10 percent
1 < ED <∞
Elastic
Drops by more than
Decreases
ED = ∞
Perfectly elastic
Drops to 0
Dr. Alok Pandey

39. Determinants of Price Elasticity of Demand
ED is greater:
The greater the availability of substitutes, and the more similar the substitutes
The more important the good as a share of the consumer’s budget
The longer the period of adjustment (time)
Dr. Alok Pandey

40. Demand becomes more elastic over time
Dw: one week after the price increase Dw
Price per unit
1.25
1.00 Dm
Dm: one month after the price increase Dy
Dy: one year after the price increase e
Quantity
per day 95
100 75 50
Dy is more elastic than Dm , which is more elastic than Dw
Dr. Alok Pandey

41. Elasticity Estimates Short run Long run
Consumers have little time to adjust
Long run
Consumers can fully adjust to a price change
Demand is more elastic in the long run
Dr. Alok Pandey

42. Selected price elasticities of D (absolute values)
Product
Short run
Long run
Electricity (residential)
Air travel
Medical care and hospitalization
Gasoline
Milk
Fish (cod)
Wine
Movies
Natural gas (residential)
Automobiles
0.1
0.3
0.4
0.5
0.7
0.9
1.4
1.9
2.4
1.5 -
1.2
3.7
2.1
2.2
Dr. Alok Pandey

43. Price Elasticity of Supply
Responsiveness
Price elasticity of supply
Producers’ responsiveness to a change in price
Percentage change in quantity supplied divided by percentage change in price
Dr. Alok Pandey

44. Price Elasticity of Supply
Law of supply
ES positive
Dr. Alok Pandey

45. Price elasticity of supply
Price per unit p p’ S
If the price increases from p to p’, the quantity supplied increases from q to q’.
Price and quantity supplied move in the same direction, so the price elasticity of supply is a positive number.
Quantity per period q q’
Dr. Alok Pandey

46. Categories of ES If %∆q < %∆p If %∆q > %∆p If %∆q = %∆p
ES between 0 and 1
Less elastic S
If %∆q > %∆p
ES greater than 1
Elastic S
If %∆q = %∆p
ES = 1
Unit elastic S
Dr. Alok Pandey

47. Elasticity Supply Curves
Perfectly elastic S curve
Horizontal; ES = ∞
Producers supply 0 at a price below P
Perfectly inelastic S curve
Vertical; ES = 0
Goods in fixed supply
Unit-elastic S curve
%∆p causes an exact opposite %∆q
S curve starts from the origin.
Dr. Alok Pandey

48. Elasticity supply curves
(a) Perfectly elastic
(b) Perfectly inelastic
(c) Unit elastic S’
Price per unit p
Price per unit
Price per unit 10 5
S’’
ES’’ = 1
ES’ = 0
ES = ∞ S
Quantity
per period
Quantity
per period Q
Quantity
per period 10 20
Firms supply any amount
of output demanded at p,
but supply 0 at prices
below p.
Quantity supplied is
independent of the
price
Any %∆p results in the
same %∆q supplied.
Dr. Alok Pandey

49. Supply becomes more elastic over timeSw
Price per unit
1.00
1.25 Sy
Sw: one week after the price increase
Sm: one month after the price increase
Sy: one year after the price increase
Quantity per day
110
200
100
140
Sw is less elastic than Sm , which is less elastic than Sy
Dr. Alok Pandey

50. Income Elasticity of Demand
Demand responsiveness to a change in consumer income
Percentage change in demand divided by the percentage change in income.
Dr. Alok Pandey

51. Selected income elasticities of demand
Product
Income
Elasticity
Wine
Private education
Automobiles
Owner-occupied housing
Furniture
Dental service
Restaurant meals
Spirits (‘hard’ liquor)
Shoes
Chicken
Clothing
5.03
2.46
2.45
1.49
1.48
1.42
1.40
1.21
1.10
1.06
0.92
Physicians’ services
Coca-Cola
Beef
Food
Coffee
Cigarettes
Gasoline and oil
Rental housing
Pork
Beer
Flour
0.75
0.68
0.62
0.51
0.50
0.48
0.43
0.18
-0.09
-0.36
Dr. Alok Pandey

52. Cross-Price Elasticity of Demand
Responsiveness of D for one good to changes in P of another good
%∆ in demand for one good divided by %∆ in price of another good
If positive: substitutes
If negative: complements
If zero: unrelated
Dr. Alok Pandey

53. Price Elasticity and Tax Incidence
Decrease in S by the amount of tax
Tax incidence
Consumers : high P
Producers: net-of-tax receipt
Dr. Alok Pandey

54. Price Elasticity and Tax Incidence
The more price elastic the D:
The more tax producers pay
The less tax consumers pay
The more elastic the S:
The less tax producers pay
The more tax consumers pay
Dr. Alok Pandey

55. Effects of price elasticity of D on tax incidence
(a) Less elastic demand
(b) More elastic demand
Price
1.15
1.00
0.95
Price
1.05
1.00
0.85
0.20 Tax St St D
0.20 Tax S D’ S
Millions of ounces per day 10 9 10 7
The more elastic the D curve, the more tax is paid by producers
(lower net-of-tax receipt)
Dr. Alok Pandey

56. Effects of price elasticity of S on tax incidence
(a) More elastic supply
(b) Less elastic supply
St”
Price
1.15
1.00
0.95
0.20 Tax
Price
1.05
1.00
0.85
St’ S”
D’’
D’’
0.20 Tax S’
quantity 10 8 10 9
The more elastic the S curve, the more tax is paid by consumers
as a higher price.
Dr. Alok Pandey

57. Bandwagon Effect
Individual demand is influenced by number of other households consuming a commodity
The greater the number of households consuming a commodity
Key to marketing most toys and clothing is to create a bandwagon effect
Results in market demand curve shifting outward
Dr. Alok Pandey

58. Some instances where the law of demand does not hold good
Giffen Goods:
Example: when the price of bread increase consumer curtailed their consumption of meat.
Veblen effect:
Example: when the rise in price take place , consumer may be misguided to think that quality improved.
Expectation of rise in price:
Share Market:
Example: Price of particular share rise its demand will also increased.
Dr. Alok Pandey