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Demand and Supply

Demand and Supply. Headlines:.

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Demand and Supply

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  1. Demand and Supply

  2. 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.

  3. 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

  4. 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)

  5. 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)

  6. Change in Demand Price 6 D1 D0 Quantity 7 13 D0 to D1: Increase in Demand (due to change in demand determinants)

  7. 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

  8. 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)

  9. 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

  10. Price S0 5 Quantity Change in Supply S0 to S1: Increase in supply (due to change in supply determinants) S1 8 6 7

  11. 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

  12. If price is too low… S 7 6 5 D Shortage 12 - 6 = 6 6 12 Price Quantity

  13. If price is too high… Surplus 14 - 6 = 8 S 7 8 9 D 6 8 14 Price Quantity

  14. 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

  15. 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

  16. 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

  17. 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)

  18. 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

  19. Surplus Price S P* D Quantity Qd Q* Qs Impact of a Price Floor PF Cost of purchasingexcess supply

  20. 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 = ?.

  21. 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)

  22.  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 + 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

  23.  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

  24. 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)

  25. 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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