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Lecture # 04a Demand and Supply (end) Lecturer: Martin ParedesPowerPoint Presentation

Lecture # 04a Demand and Supply (end) Lecturer: Martin Paredes

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Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Broilers in the U.S., 1990

- In general, for the elasticity of “Y” with respect to “X”:
- Y,X= (% Y) = (Y/Y) = dY . X
- (% X) (X/X) dX Y

- Price elasticity of supply: measures curvature of supply curve
- (% QS) = (QS/QS) = dQS . P
- (% P) (P/P) dP QS

- Income elasticity of demand measures degree of shift of demand curve as income changes…
- (% QD) = (QD/QD) = dQD . I
- (% I) (I/I) dI QD

- Cross price elasticity of demand measures degree of shift of demand curve when the price of another good changes
- (% QD) = (QD/QD) = dQD . P0
- (% P0) (P0/P0) dP0 QD

- Source: Berry, Levinsohn and Pakes,
- "Automobile Price in Market Equilibrium,"
- Econometrica 63 (July 1995), 841-890.
- Example: The Cross-Price Elasticity of Demand for Cars

- Source: Gasmi, Laffont and Vuong, "Econometric Analysis of Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.

- Example: Elasticities of Demand for Coke and Pepsi

How to Estimate Demand and Supply Equations Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.

Use Own Price Elasticities and Equilibrium Price and Quantity

Use Information on Past Shifts of Demand and Supply

Use Own Price Elasticities and Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.

Equilibrium Price and Quantity

- Choose a general shape for functions
- Linear
- Constant elasticity

- Estimate parameters of demand and supply using elasticity and equilibrium information
- We need information on ε, P* and Q*

- Example Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.: Linear Demand Curve
- Suppose demand is linear: QD = a – bP
- Then, elasticity is Q,P = -bP/Q
- Suppose P = 0.7 Q = 70 Q,P = -0.55
- Notice that, if = -bP/Q b = -Q/P
- Then b = -(-0.55)(70)/(0.7) = 55
- …and a = QD + bP = (70)+(55)(0.7) = 108.5
- Hence QD = 108.5 – 55P

- Example Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.: Constant Elasticity Demand Curve
- Suppose demand is: QD = APε
- Suppose again P = 0.7 Q = 70 Q,P = -0.55
- Notice that, if QD = APε A = QP-ε
- Then A = (70)(0.7)0.55 = 57.53
- Hence QD = 57.53P-0.55

Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Broilers in the U.S., 1990

Price

•

Observed price and quantity

.7

0

70

Quantity

Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Broilers in the U.S., 1990

Price

•

Observed price and quantity

.7

Linear demand curve

0

70

Quantity

Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Broilers in the U.S., 1990

Price

•

Observed price and quantity

.7

Constant elasticity demand curve

0

70

Quantity

Price

•

Observed price and quantity

.7

Constant elasticity demand curve

Linear demand curve

0

70

Quantity

Use Information on Past Shifts Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.

of Demand and Supply

A shift in the supply curve reveals the slope of the demand curve

A shift in the demand curve reveals the slope of the supply curve.

- Example Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311.: Shift in Supply Curve
- Old equilibrium point: (P1,Q1)
- New equilibrium point: (P2,Q2)
- Both equilibrium points would lie on the same (linear) demand curve.
- Therefore, if QD = a - bP
- b = dQ/dp = (Q2 – Q1)/(P2 – P1)
- a = Q1 - bP1

Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Identifying demand by a shift in supply

Price

Supply

Market Demand

0

Quantity

Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Identifying demand by a shift in supply

Price

New Supply

Old Supply

Market Demand

0

Quantity

Example: Collusive Behavior in a Soft Drink Market," Journal of Economics and Management Strategy 1 (Summer, 1992) 278-311. Identifying demand by a shift in supply

Price

New Supply

Old Supply

•

P2

•

P1

Market Demand

0

Q2

Q1

Quantity

- This technique only works if the curve we want to estimate stays constant.
- Example: Shift in Supply Curve
- We require that the demand curve does not shift

Summary stays constant.

- 1. Example of a simple micro model of supply and demand (two equations and an equilibrium condition)
- 2. Elasticity as a way of characterizing demand and supply
- Factors that determined elasticity
- Estimating demand and supply
- From own price elasticity and equilibrium price and quantity
- From information on past shifts, assuming that only a single curve shifts at a time.

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