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Chapter 2 Review of S and D

Chapter 2 Review of S and D. Supply Curve : Shows quantity supplied at each possible price, ceteris paribus (c.p.). Slopes upward (positive relationship) Qs = Qs(P) Shift S Curve if change c.p. factor Movement along vs shift

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Chapter 2 Review of S and D

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  1. Chapter 2Review of S and D • Supply Curve: • Shows quantity supplied at each possible price, ceteris paribus (c.p.). • Slopes upward (positive relationship) • Qs = Qs(P) • Shift S Curve if change c.p. factor • Movement along vs shift • C.P. factors: change in cost of production; change S from bad weather. • Interpret shift S curve: change willingness to supply at each price.

  2. Demand Curve • Shows quantity demanded at each possible price, ceteris paribus (c.p.) • Slopes downward (negative relationship) • Qd = Qd(P) • Movement along versus shift. • C.P. factors: change income; change demand for related good. • Interpret shift D curve: change willingness to buy at each price.

  3. Substitutes and Complements • Given two goods X and Y, if they are consumed together they are called complements and if one is used instead of the other, they are called substitutes. • Substitutes: Px  Dy • When price of X , the demand for X falls. So demand for Y . • Example: beef and chicken • Complements: Px   Dy • When price of X , its demand . So demand for Y  also. • Example: bread and butter

  4. Market Mechanism • Put Supply and Demand Together • Equilibrium • Point at which Qs=Qd; • Market-clearing P; • Describe re-equilibrating process by changing C.P. factor: • Increase in income causes increase in demand (shift D rightward) • At old P, Qd greater than Qs: so individuals bid up price till reach new equilibrium.

  5. Example of Shifts in S and D • Effects of 9/11: Example 2.4 in text. • Much destruction of office space; suggests shortage (lower vacancy rate) should drive up rental rates. • Result was different because as supply fell, demand fell also. • See Figure 2.10

  6. In-Class Exercise • Note in text on pg. 28: • Fact: top 20% of income distribution had 40% increase in real take-home earnings; bottom 10% of distribution had decline of  10%. • Consider: two separate labor markets for skilled and unskilled workers. Start in equilibrium for both; then show: • Unskilled workers: big S, small D • Skilled workers: small S, big D. • Outcome will explain observed trend: big increase in inequality in 1980s and 1990s; or, increase in working poor.

  7. Homework Assignment • Consider the two separate markets for peanut butter and jelly. Assume that the two products are complements for consumers. • 1. Sketch and describe the initial equilibrium in both markets. • 2. Show the effect of new health warnings about all the fat in peanut butter in first the market for peanut butter and then in the market for jelly. • 3. Draw and label completely and describe in words.

  8. Elasticity • Definition: %Qd in response to a 1% P • Or: %Qd / %P • What is %? Absolute change in variable divided by original level of variable. • Ep = (Qd/Q) / (P/P) • = (P/Q) (Q/P) • Remember: (Q/P) is 1/slope. • Ep = price elasticity of demand; usually negative.

  9. Relate Elasticities to S and D Equations • Demand: Q = a – bP • Supply: Q = c + dP • E = (P/Q )*(Q/P) • (Q/P) = constant = d for supply = –b for demand. • Demand: ED = -b(P*/Q*) • Supply: ES = d(P*/Q*)

  10. More About Elasticities • Elastic: Ep 1 • Inelastic: Ep 1 • Unitary Elastic: Ep 1 • Fact: While slope is constant along a linear demand curve, elasticity is not. • Fact: At top of demand curve, when P is high and Q is low, Ep is big negative number so D curve is very elastic. • Fact: As move down D curve to right, Ep falls (because P is  while Q is , so P/Q is ).

  11. Example • Price Demand Supply • 60 22 14 • 80 20 16 • 100 18 18 • 120 16 20 • 1. What is P*, Q*? • 2. When P=$80, what is ED? • Homework:. • Textbook page 58; Exercises #1 and #2.

  12. Relative Elasticities • Rule: the steeper the slope of the curve, the less elastic. • Completely horizontal demand curve: infinitely elastic: consumers will buy as much as they can at a single P* • Completely vertical demand curve: completely inelastic: consumers will buy fixed quantity, no matter what the P.

  13. Nearly Horizontal Demand Curve • Elasticity approaches infinity: Recall: 1/slope = Q/P • If nearly flat curve: small  P causes a huge Q. This is same as: huge  / small  , which equals a very big number. • This will help you remember elasticity for completely flat versus completely vertical.

  14. Income Elasticity of Demand • Measure responsiveness of Qd to change in income (note this is a ceteris paribus factor). • EI = %in Qd resulting from a 1%  in income. • EI = (Q/Q) / (I/I) • = I/Q  (Q/I).

  15. Cross-Price Elasticity of Demand • Measures responsiveness in Qd of one good to change in price of a related good (note this is a change in a c.p. factor). • Cross-price elasticity of demand = % in Qd resulting from a 1%  in the price of a related good. • EQ1P2 = (Q1/Q1) / (P2/P2) •  P2/Q1  Q1/P2. • EQP  0: the two goods are substitutes. • EQP  0: the two goods are complements.

  16. Price Elasticity of Supply • Price Elasticity of Supply: Responsiveness of Qs to P. • ESP = %Qs / %P • = (Qs/Qs) / (P/P) •  P/Qs  Qs/P • Usually positive.

  17. Wage Elasticity of Supply • Measures responsiveness of Qs to changes in the cost of labor (a ceteris paribus factor). • ESW = %Qs / %W • = (Qs/Qs) / (W/W) •  W/Qs  Qs/W. • Usually negative. • Remember: W   cost of production.

  18. Example • Qs = 3 + 12P • Qd = 19 – 4P • 1. Find P* by setting Qs=Qd. • 2. Find Q* by putting P* into either Qs or Qd. • Solve for Ep of demand at equilibrium: • EDP* = (P*/Q*)  (Q/P)

  19. Short-Run versus Long-run Elasticities • Focal point: how much time do sellers and consumers have to respond (in their Qs and Qd) to changes in price? • In general: LR adjustment is more full, free adjustment so that LR elasticity is larger; BUT not true all the time. • Key factors: • Durability. • Availability of substitutes • % of consumer’s budget

  20. Government Price Controls • Key: If government sets P so that there is no single P for which Qs=Qd, then there will be a shortage or surplus. • Be able to show the Qs and Qd for any price. • Price ceiling: prevents price from rising above the ceiling. • Price floor: prevents price from falling below floor.

  21. In-Class Exercise • Rent control in NYC: • Qd = 100 – 5P • Qs = 50 + 5P • 1. Find P* and Q*. • 2. What if rent control agency sets Price ceiling at $1? • A. What is Qd? • B. What is Qs? • C. What is resulting Q sold? • D. What is # newly homeless?

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