Lecture Microeconomics: Chapter 2 - Besanko, Braeutigam

Chapter 2 - Demand and supply analysis. This chapter presents the following content: Motivation – U.S. corn markets, competitive markets defined, the market demand curve, the market supply curve, equilibrium, characterizing demand and supply – elasticity, back of the envelope techniques.

Chapter Two Overview

1. Motivation – U.S corn markets

3 Competitive Markets Defined

5 The Market Demand Curve

7 The Market Supply Curve

Example: U.S Corn Market

Historical price:

$2.00 per bushel

Why do prices vary so much?

Changes in Supply and Demand conditions

Prices fell below $2.00 per bushel

2003­2004:

2004­2005:

Prices rose to $3.00 per bushel

• Increase in production costs due to oil price increases

and rains and flooding wiped out corn crop

Competitive Markets

Competitive Markets are those with sellers and buyers that are small and numerous enough that they take the market price as given when they decide how much to buy

The Market Demand Function

The Market Demand Function

tells us that the quantity of a good all consumers in the market are willing to buy is a function of various factors.

Market Demand

• The part of demand for a good that is derived from the production and sale of other goods.

• The part of demand for a good that comes from the desire of buyers to directly consume the good itself. Copyr

The Market Demand Curve

The Market Demand Curve plots the

aggregate quantity of a good that consumers are willing to buy at different prices, holding constant other demand

drivers such as prices of other goods,

consumer income, quality

The Law of Demand

The Law of Demand states that the

quantity of a good demanded decreases when the price of this good increases

Demand Curve Rule

A move along the demand curve for a good can only be triggered by a change in the price of that good Any change in another factor that affects the consumers’ willingness to pay for

the good results in a shift in the

demand curve for the good.

Shifts of the Demand Curve

The Demand Curve shifts when factors other than own

price change

ü If the change increases the willingness of

consumers to acquire the good, the demand curve

shifts right

ü If the change decreases the willingness of

consumers to acquire the good, the demand curve

The Demand for Cars

The Demand for Cars

We always graph P on vertical axis and Q on horizontal axis,

but we write demand as Q as a function of P… If P is written

as function of Q, it is called the inverse demand

Plots the aggregate quantity of a good that producers are willing to sell at

Supply Curve for Wheat

The Law of Supply

The Law of Supply states that the

quantity of a good offered increases when the price of this good increases

Supply Curve Rule

A move along the supply curve for a good can only be triggered by a change in the price of that good Any change in another factor that affects the producers’ willingness to offer for

the good results in a shift in the

supply curve for the good.

The Law of Supply

The Supply Curve shifts when factors other than own price change

ü If the change increases the willingness of producers

to offer the good at the same price, the supply curve

shifts right

ü If the change decreases the willingness of producers

to offer the good at the same price, the supply curve

Market Equilibrium

• Market Equilibrium

• is a price such that, at this price, the quantities

demanded and supplied are the same

• is a point at which there is no tendency for the

market price to change as long as exogenous variables remain unchanged

Demand and supply curves intersect at equilibrium

Example: Market Equilibrium for Cranberries

Qd = 500 – 4p

Qs = -100 + 2p

p = price of cranberries (dollars per barrel)

Q = demand or supply in millions of barrels per year

The equilibrium price of cranberries is calculated by equating demand to supply:

Qd = Qs … or…

500 – 4p = -100 + 2p … solving

Market Equilibrium for Cranberries

Excess Demand/Supply

Excess Demand: A situation in which the quantity

demanded at a given price exceeds the quantity

supplied

Excess Supply: A situation in which the quantity

supplied at a given price exceeds the quantity

demanded

If there is no excess supply or excess demand, there is no pressure for prices

to change and thus there is equilibrium.

When a change in an exogenous variable causes the demand curve or the supply yr

8 9 11 13 14

D

S

Excess supply when price is $5

Excess demand when price is $3

Price Elasticity

The Price Elasticity of Demand is the

percentage change in quantity demanded brought about by a one-percent change in the price of the good

      Q,P= ( Q/Q) = ( Q/ p)(p/Q)       ( p/p)

• Slope is the ratio of absolute changes in quantity and price (= Q/ P).

• Elasticity is the ratio of relative (or percentage) changes in quantity and price.

Price Elasticity

• When a one percent change in price leads to a

greater than one-percent change in quantity

demanded, the demand curve is elastic ( Q,P < -1)

• When a one-percent change in price leads to a less

than one-percent change in quantity demanded, the

demand curve is inelastic (0 > Q,P > -1)

• When a one-percent change in price leads to an

exactly one-percent change in quantity demanded, the

demand curve is unit elastic ( Q,P = -1)

Elasticity – Linear Demand Curve

Elasticity – Linear Demand Curve

Constant Elasticity vs Linear Demand Curve

Price

Constant elasticity demand curve

Linear demand curve

Linear Demand Curve:

Qd = a -bP εQ,P = (ΔQ/ ΔP)(P/Q) = -b(P/Q)

Constant Elasticity Demand Curve:

Qd = aP-b εQ,P = -b

Price Elasticity and Total Revenue

Demand

• Availability of Substitutes

– More substitutes → more price elastic

– Goods which have price inelastic at the market level,

like cigarettes, can be highly price elastic at the brand level

• Necessities versus Luxuries

– Necessities → less price elastic

• Importance in Buyer’s Budget

– More important → more price elastic

run

consumers can fully adjust their purchase decisions

to changes in price

consumers can fully adjust their purchase decisions

to changes in price

fully adjust their supply decisions to changes in price

Durable Goods

The Durable Good is a good

that provides valuable services

over a long time (usually many years).

Demand for non-durables is less elastic

in the short run when consumers can

only partially adapt their behavior

Demand for durables is more elastic in

the short run because consumers can

Elasticities & the Cola Wars

Estimating Demand & Supply

Estimating Elasticity

Estimating Demand & Supply

Example:

U.S. Boilers 1990

Estimating Demand & Supply

From Past Shifts

We can “identify” the slope of supply by a shift in demand

We can “identify” the slope of demand by a shift in supply

This technique only works if one or the other of the curves Cop

Chapter Two Main Points

• Market Supply Function and Curve