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# Demand and Supply - PowerPoint PPT Presentation

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• On August 2, 1990, when Iraq invaded Kuwait, market price of crude petroleum jumped from \$21.54 to \$30.50 per barrel (almost 42% increase) before any physical reduction in the current amount of oil available for sale. One year later, the price of oil was \$21.32 per barrel.

• In August 1987, a 386 PC sold at \$6,995.In March 1992, the same computer sold at \$1,495.Today Pentiums are cheaper then original 386 PCs.

Inverse demand: maximum price paid for given quantity

Law of Demand (ceteris paribus)

Downward demand due to income and wealth effects

Downward inverse demand due to diminishing MU

Demand Curve

Quantity

Price

D

ID

Price

Quantity

• An equation representing the demand curve

Qxd = f(Px ,PY , I, N, A, Z)

Qxd = a0+a1Px+a2Py+a3I+a4N+a5A+a6Z

• Qxd = quantity demand of good X.

• Px = price of good X.

• PY = price of a substitute good Y.

• I = income.

• N = population

• Z = any other variable affecting demand (expectations, credit conditions)

A

10

B

6

D0

4

7

Quantity

Change in Quantity Demanded

A to B: Increase in quantity demanded (due to change in the price of the good)

Price

6

D1

D0

Quantity

7

13

D0 to D1: Increase in Demand (due to change in demand determinants)

Quantity

IS

S

Quantity

Price

Supply Curve

• Amounts of a good produced at alternative prices

• Inverse supply: minimum price to produce given amounts

• Law of Supply (ceteris paribus)

• Upward supply due to substitution effect

• An equation representing the supply curve:

QxS = f(Px ,PR ,PVI, PFI, Z) Qxs = a0+a1Px+a2PR+a3PVI+a4PFI+a5Z

• QxS = quantity supplied of good X.

• Px = price of good X.

• PR = price of a related good (substitutes in production)

• PVI = price of variable inputs (labor, material, utilities)

• PFI = price of fixed inputs (land, buildings, machines)

• Z = other variable affecting supply (technology, government, number of firms, expectations)

S0

Quantity

Change in Quantity Supplied

A to B: Increase in quantity supplied(due to change in the price of the good)

B

20

A

A

10

5

10

S0

5

Quantity

Change in Supply

S0 to S1: Increase in supply (due to change in supply determinants)

S1

8

6

7

Demand curve: Qd = 400 - ½P,Supply curve: Qs = 200 + P

Price (P)

a=800

P = dQs - c = Qs - 200

Market

equilibrium

Inverse Supply

Slope is d = 1

P* = 133.33

Slope is -b = -2

Inverse Demand

P = a - bQd = 800 - 2Qd

0

Q* = 333.33

Quantity supplied (Qs) and

Quantity demanded (Qd)

c=-200

S

7

6

5

D

Shortage

12 - 6 = 6

6

12

Price

Quantity

Surplus

14 - 6 = 8

S

7

8

9

D

6

8

14

Price

Quantity

10

8

6

Consumer

Surplus

4

2

Total Cost of 4 units

D

1 2 3 4 5

Quantity

Consumer Surplus:The Continuous Case

Value

of 4 units

• The amount producers receive in excess of the amount necessary to induce them to produce the good.

Price

S0

P*

Producer

Surplus

Cost of Production

Q*

Quantity

• Price Ceilings

• The maximum legal price that can be charged

• Examples:

• Gasoline prices in the 1970s

• Housing in New York City

• Price Floors

• The minimum legal price that can be charged.

• Examples:

• Minimum wage

• Agricultural price supports

Price

S

PF

P*

Ceiling

Price

D

Shortage

Quantity

Q*

Qs

Qd

Opportunity Cost (Search &

Black Market)

• The dollar amount paid to a firm under a price ceiling, plus the nonpecuniary price:

PF= PC+ (PF - PC)

• PF= full economic price

• PC= price ceiling

• PF - PC= nonpecuniary price

• In 1970s ceiling price of gasoline = \$1

• 3 hours in line to buy 15 gallons of gasoline

• Opportunity cost: \$5/hr

• Total value of time spent in line: 3  \$5 = \$15

• Non-pecuniary price per gallon: \$15/15 = \$1

• Full economic price of a gallon of gasoline: \$1 + \$1 = \$2

Price

S

P*

D

Quantity

Qd

Q*

Qs

Impact of a Price Floor

PF

Increase in D increases both Q and P.

Increase in S increases Q and decreases P.

Increase in D and S increases Q and P = ?.

Decrease in D and increase in S decreases P and Q = ?.

Consumer Supply

surplus

\$10 tax

loss

Tax Revenue

Producer

surplus

The Excise Tax

Price (\$/CD player)

130

S + tax

S

P2=105

Price beforetax

P1=100

P2-T=95

P1 - (P2 - T) Seller tax burden

75

D

D

0 1 2 3 4 5 6 7 8 9 10

Quantity (thousands of CD players per week)

Supply Inelastic D

Seller pays

entire tax

Price

P

S + tax

S

P1 = 2.00

100

Thousands of insulin doses

Excise Tax and the Demand

Price

S + tax

S

P1=P2=1.00

P2=P1+T=2.20

 Elastic D

P2-T=0.90

1 4

Thousands of pencils

• The more inelastic D, the more buyer pays: P2 = P1 + T Buyer burden: P2 - P1 = (P1 + T) - P1 = TSeller burden: P1 - (P2 - T) = P1 - (P1 + T - T) = 0

• The more elastic D, the more seller pays: P2 = P1Buyer burden: P2 - P1 = P1 - P1 = 0Seller burden: P1 - (P2 - T) = P1 - (P1 - T) = T

Supply Inelastic S

Price

Price

S + tax

P1=P2=50

Seller pays

entire tax

P1=10

P2-T=45

 Elastic S

100

3 5

Bottles of spring water

Thousands of pounds of sendfor computer chips

Excise Tax and the Supply

P2=P1+T=11

D

D

The more inelastic S, the more seller pays: P2 = P1

The more elastic S, the more buyer pays: P2 = P1 + T

Consumer Supply

surplus

\$10 tax

loss

Tax Revenue

Producer

surplus

The Ad Valorem Tax (% of Value)

Price (\$/CD player)

130

S(1 + tax)

S

P2=105

Price beforetax

P1=100

P2-T=95

P1 - (P2 - T) Seller tax burden

75

D

D

0 1 2 3 4 5 6 7 8 9 10

Quantity (thousands of CD players per week)

MR Supply

Demand and Revenue

P or AR

• Demand FunctionQ = 70,000 – 100P

• Inverse Demand FunctionP = 700 – .01Q

• Total RevenueTR = P * Q = 700Q – .01Q2

• Average RevenueAR = TR / Q = 700 – .01Q = P

• Marginal RevenueMR = dTR / dQ = 700 – .02Q

For linear demand MR has the sameintercept and twice the slope of AR

• ARC Marginal RevenueArc MR = TR / Q = (TR2-TR1) / (Q2-Q1)