Demand and supply
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Demand and supply

Demand and Supply


Headlines

Headlines:

  • 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.


Demand curve

Amounts of a good purchased at alternative prices

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

Giffen's Paradox

Demand Curve

Quantity

Price

D

ID

Price

Quantity


The demand function

The Demand Function

  • 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

    • A = advertisement

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


Change in quantity demanded

Price

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)


Change in demand

Change in Demand

Price

6

D1

D0

Quantity

7

13

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


Supply curve

Price

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


The supply function

The Supply Function

  • 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)


Change in quantity supplied

Price

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


Change in supply

Price

S0

5

Quantity

Change in Supply

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

S1

8

6

7


Demand and supply

Mathematics of Equilibrium

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


If price is too low

If price is too low…

S

7

6

5

D

Shortage

12 - 6 = 6

6

12

Price

Quantity


If price is too high

If price is too high…

Surplus

14 - 6 = 8

S

7

8

9

D

6

8

14

Price

Quantity


Consumer surplus the continuous case

Price $

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


Producer surplus

Producer Surplus

  • 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 restrictions

Price Restrictions

  • 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


Impact of a price ceiling

Impact of a Price Ceiling

Price

S

PF

P*

Ceiling

Price

D

Shortage

Quantity

Q*

Qs

Qd

Deadweight loss ofconsumer andproducer surplus

Opportunity Cost (Search &

Black Market)


Full economic price

Full Economic Price

  • 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


Impact of a price floor

Surplus

Price

S

P*

D

Quantity

Qd

Q*

Qs

Impact of a Price Floor

PF

Cost of purchasingexcess supply


Comparative statics effects of changes in demand and or supply

Comparative Statics: Effects of Changes in Demand and/or Supply

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 = ?.


The excise tax

Consumer

surplus

$10 tax

Deadweight

loss

Tax Revenue

Producer

surplus

The Excise Tax

Price ($/CD player)

130

S + tax

S

Buyer pays (with tax)

P2 - P1Buyer tax burden

P2=105

Price beforetax

P1=100

P2-T=95

P1 - (P2 - T) Seller tax burden

Seller receives(without tax)

75

D

D

0 1 2 3 4 5 6 7 8 9 10

Quantity (thousands of CD players per week)


Excise tax and the demand

 Inelastic D

Seller pays

entire tax

Buyer paysentire 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 + TBuyer 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


Excise tax and the supply

 Inelastic S

Price

Buyer paysentire tax

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


The ad valorem tax of value

Consumer

surplus

$10 tax

Deadweight

loss

Tax Revenue

Producer

surplus

The Ad Valorem Tax (% of Value)

Price ($/CD player)

130

S(1 + tax)

S

Buyer pays (with tax)

P2 - P1Buyer tax burden

P2=105

Price beforetax

P1=100

P2-T=95

P1 - (P2 - T) Seller tax burden

Seller receives(without tax)

75

D

D

0 1 2 3 4 5 6 7 8 9 10

Quantity (thousands of CD players per week)


Demand and revenue

MR

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)


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