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Chapter 2

Chapter 2. The Basics of Supply and Demand. Qustion: Suppose you bought an apple for 1,000 Won. Why 1,000 Won? Who determined it?. S. Price ($ per unit). P 0. D. Quantity. Q 0. Supply and Demand. The Supply Curve

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Chapter 2

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  1. Chapter 2 The Basics of Supply and Demand

  2. Qustion: Suppose you bought an apple for 1,000 Won. • Why 1,000 Won? • Who determined it? Chapter 2

  3. S Price ($ per unit) P0 D Quantity Q0 Chapter 2

  4. Supply and Demand • The Supply Curve • The relationship between the quantity of a good that producers are willing to sell and the price of the good. • Measures quantity on the x-axis and price on the y-axis Chapter 2

  5. S P2 P1 Q1 Q2 The Supply Curve Price ($ per unit) Quantity Chapter 2

  6. The Supply Curve • Other Variables Affecting Supply • Costs of Production • Lower costs of production allow a firm to produce more at each price and vice versa Chapter 2

  7. S S’ P1 P2 Q0 Q1 Q2 Change in Supply P • The cost of raw materials falls Q Chapter 2

  8. The Supply Curve • Change in Quantity Supplied • Movement along the curve caused by a change in price • Change in Supply • Shift of the curve caused by a change in something other than price Chapter 2

  9. Supply and Demand • The Demand Curve • The relationship between the quantity of a good that consumers are willing to buy and the price of the good. • Measures quantity on the x-axis and price on the y-axis Chapter 2

  10. P2 P1 D Q2 Q1 The Demand Curve Price ($ per unit) Quantity Chapter 2

  11. The Demand Curve • Other Variables Affecting Demand • Income • Consumer Tastes • Price of Related Goods • Substitutes • Complements Chapter 2

  12. D P D’ P2 P1 Q0 Q1 Q2 Q Change in Demand • Income Increases Chapter 2

  13. The Demand Curve • Changes in quantity demanded • Movements along the demand curve caused by a change in price. • Changes in demand • A shift of the entire demand curve caused by something other than price. Chapter 2

  14. The Market Mechanism • Markets clear when quantity demanded equals quantity supplied at the prevailing price • Market Clearing price – price at which markets clear Chapter 2

  15. S Price ($ per unit) P0 D Quantity Q0 The Market Mechanism Chapter 2

  16. S Price ($ per unit) P0 D Quantity Q0 The Market Mechanism Chapter 2

  17. The Market Mechanism • In equilibrium • There is no shortage or excess demand • There is no surplus or excess supply • Quantity supplied equals quantity demanded • What if P > Po? Or P < Po? Chapter 2

  18. Price ($ per unit) S Surplus P1 P0 D Quantity QD Q0 QS The Market Mechanism Chapter 2

  19. Price ($ per unit) S P3 P2 D Shortage Quantity QS QD Q3 The Market Mechanism Chapter 2

  20. D P S S’ P1 P3 Q1 Q3 Q Q2 Changes In Market Equilibrium • When raw material prices fall Chapter 2

  21. D D’ P S P1 P3 Q1 Q3 Q2 Q Changes In Market Equilibrium • When income increases Chapter 2

  22. P2 P1 D P D’ S S’ Q1 Q2 Q Changes In Market Equilibrium • When income increases & raw material prices fall Chapter 2

  23. Changes In Market Equilibrium Question: Why do the prices of some goods, like apples, go down during the months of heaviest consumption while others, like beachfront cottages, go up? Chapter 2

  24. Q: KORAIL’s Problem • Seoul-Chuncheon line: Deficit • What to do? • Raise the price? Chapter 2

  25. Price Elasticity of Demand • Measures the sensitivity of quantity demanded to price changes. • It measures the percentage change in the quantity demanded of a good that results from a one percent change in price. Chapter 2

  26. Price Elasticity of Demand • The percentage change in a variable is the absolute change in the variable divided by the original level of the variable. • Therefore, elasticity can also be written as: Chapter 2

  27. Price Elasticity of Demand • EP: Usually a negative number • When EP > 1, the good is price elastic • %Q > % P • When EP < 1, the good is price inelastic • %Q < % P Chapter 2

  28. EP = - Price 4 Elastic Ep = -1 2 Inelastic Ep = 0 4 8 Q Price Elasticity of Demand Demand Curve Q = 8 – 2P Chapter 2

  29. Price Elasticity of Demand • Two extreme cases of demand curves • Completely inelastic demand – vertical • Infinitely elastic demand - horizontal Chapter 2

  30. Price D P* Quantity Infinitely Elastic Demand EP =  Chapter 2

  31. Price Quantity Completely Inelastic Demand D EP = 0 Q* Chapter 2

  32. Other Demand Elasticities • Income Elasticity of Demand • Measures how much quantity demanded changes with a change in income. Chapter 2

  33. Other Demand Elasticities • Cross Elasticity of Demand • Measures the percentage change in the quantity demanded of one good that results from a one percent change in the price of another good. Chapter 2

  34. Other Demand Elasticities • Complements: Cars and Tires • Cross elasticity of demand is negative • Substitutes: Butter and Margarine • Cross elasticity of demand is positive Chapter 2

  35. Price Elasticity of Supply • Measures the sensitivity of quantity supplied given a change in price • Measures the percentage change in quantity supplied resulting from a 1 percent change in price. Chapter 2

  36. Q: Rent Control • Chuncheon City decided to control rent around KNU campus for students. • Are KNU students going to be better off? Chapter 2

  37. Price S P0 Pmax Shortage D Q0 QD QS Quantity Effects of Price Controls Chapter 2

  38. Effects of Price Controls • Markets are rarely free of government intervention • Imposed taxes and granted subsidies • Price controls • Price controls usually hold the price above or below the equilibrium price • Excess demand – shortage • Excess supply - surplus Chapter 2

  39. Effects of Price Controls • Excess demand sometimes takes the form of queues • Lines at gas stations during 1974 shortage • Sometimes get curtailments and supply rationing • Natural gas shortage of the mid ’70’s • Producers typically lose, but some consumers gain. Some consumers lose. hapter 2

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