1-2 Introduction Demand Supply Equilibrium Elasticity
1-2 Introduction Demand Supply Equilibrium Elasticity
Introduction to Economics
Fundamental of Economics
Wants vary greatly among individuals and over time for the same
individual.
Some people like sports, others like books; some want to travel,
others want to putter in the yard.
Microeconomics
It deals with the magnitudes such as the total output level in the
economy, national income of the country, total employment
level in the economy, the general price level of goods and
services in the economy.
Scarcity
Choice
Opportunity Cost
Factors of Production
Payments
to factors
Land Labor Capital Enterprise
of
Productio
n
INCOME
Production Possibilities Frontier (PPF)
PPF shows the various possible combinations of goods and services
that the society can produce given its resources and technology.
Resource Market
Firm Household
Flow of payments
Product market
45
Comparative Advantage and Absolute Advantage
Now suppose that Country A has very little fertile land and an
abundance of steel for car production.
The opportunity cost of producing both cars and cotton is high for
Country A, which will have to give up a lot of capital in order to
produce both.
A $0.50 9 3.50 G
3.00 D
B 1.00 8 Demand for
C
C 2.00 6 2.00 DVDs
D 3.00 4 1.00
F B
A
E 4.00 2 .50
0
1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of DVDs demanded (per week)
A Sample Demand Curve
Price (per unit)
PA A
D
0
QA
Quantity demanded (per unit of time)
Demand Schedule and
Demand Curve for DVDs
Other Things Constant
• Other things constant places a limitation
on the application of the law of demand.
– All other factors that affect quantity demanded
are assumed to remain constant, whether
they actually remain constant or not.
Other Things Constant
• Other things constant places a limitation
on the application of the law of demand.
– These factors may include changing tastes,
prices of other goods, income, even the
weather.
Shifts in Demand Versus
Movements Along a Demand
Curve
• Demand refers to a schedule of
quantities of a good that will be bought
per unit of time at various prices, other
things constant.
• Graphically, it refers to the entire
demand curve.
Shifts in Demand Versus
Movements Along a
Demand Curve
• Quantity demanded refers to a specific
amount that will be demand per unit of
time at a specific price.
$2 B
Price (per unit)
A
$1
D1
0
100 200
Quantity demanded (per unit of time)
Shift in Demand
Change in demand
(a shift of the curve)
$2
Price (per unit)
B A
$1
D0
D1
100 200 250
Quantity demanded (per unit of time)
Determinants of Demand
Number of buyers
Income
Tastes
Expectations
Prices of related goods
Shift Factors of Demand
• Shift factors of demand are factors that
cause shifts in the demand curve:
– Society's income.
– The prices of other goods.
– Tastes.
– Expectations.
– Number of Buyers
– Taxes on subsidies to consumers.
Income
• An increase in income will increase
demand for normal goods.
• An increase in income will decrease
demand for inferior goods.
Price of Other Goods
• When the price of a substitute good falls,
demand falls for the good whose price has
not changed.
• When the price of a complement good
falls, demand rises for the good whose
price has not changed.
Tastes
• A change in taste will change demand with
no change in price.
Expectations
• If you expect your income to rise, you may
consume more now.
• If you expect prices to fall in the future,
you may put off purchases today.
Individual and Market Demand
Curves
• A market demand curve is the horizontal
sum of all individual demand curves.
– This is determined by adding the individual
demand curves of all the demanders.
Individual and Market Demand
Curves
• Sellers estimate total market demand for
their product which becomes smooth and
downward sloping curve.
From Individual Demands
to a Market Demand Curve
Demand
Tastes
And Expectations
Preferences
Demographics
Taxes and Subsidies
• Taxes levied on consumers increase the
cost of goods to consumers, thereby
reducing demand.
• Subsidies have an opposite effect.
Changes in Demand
and Quantity Demanded
• Change in Quantity Demanded -
movement along the same demand curve
in response to a price change.
A
PA
0
QA
Quantity supplied (per unit of time)
Supply Curve DVDs
Shifts in Supply Versus Movements
Along a Supply Curve
Change in quantity
A supplied (a movement
$15
along the curve)
1,250 1,500
Quantity supplied (per unit of time)
Shift in Supply
S0
Price (per unit) S1
A B
$15
Shift in Supply
(a shift of the curve)
1,250 1,500
Quantity supplied (per unit of time)
Shift Factors of Supply
• Other factors besides price affect how
much will be supplied:
– Prices of inputs used in the production of a
good.
– Technology.
– Suppliers’ expectations.
– Taxes and subsidies.
Factors that Shift Supply
Resource
Prices
Technology
Prices of Related
Goods and Services
And
Productivity
Supply
Number Expectations
Of Of
Producers Producers
Price of Inputs (Resource Prices)
• When costs go up, profits go down, so that
the incentive to supply also goes down.
Technology
• Advances in technology reduce the
number of inputs needed to produce a
given supply of goods.
• Costs go down, profits go up, leading to
increased supply.
Expectations
• If suppliers expect prices to rise in the
future, they may store today's supply to
reap higher profits later.
Number of Suppliers
• As more people decide to supply a good
the market supply increases (Rightward
Shift).
Individual and Market Supply
Curves
• The market supply curve is derived by
horizontally adding the individual supply
curves of each supplier.
From Individual Supplies to a Market
Supply
(1) (2) (3) (4) (5)
Quantities Price Ann's Barry's Charlie's Market
Supplied (per DVD) Supply Supply Supply Supply
A $0.00 0 0 0 0
B 0.50 1 0 0 1
C 1.00 2 1 0 3
D 1.50 3 2 0 5
E 2.00 4 3 0 7
F 2.50 5 4 0 9
G 3.00 6 5 0 11
H 3.50 7 5 2 14
I 4.00 8 5 2 15
From Individual Supplies to a Market
Supply
Charlie Barry Ann Market Supply
$4.00 I
3.50 H
3.00 G
Price per DVD
2.50 F
2.00 E
1.50 D
1.00 C
0.50 B CA
0 A
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Quantity of DVDs supplied (per week)
Aggregation of Supply (I)
Aggregation of Supply (II)
Price of Related Goods or Services
• The opportunity cost of producing and
selling any good is the forgone opportunity
to produce another good.
• If the price of alternate good changes then
the opportunity cost of producing changes
too!
• Example Mc Don selling Hamburgers vs.
Salads.
Taxes and Subsidies
• When taxes go up, costs go up, and profits
go down, leading suppliers to reduce
output.
• When government subsidies go up, costs
go down, and profits go up, leading
suppliers to increase output.
Decrease in Supply
Increase in Supply
Change in Supply vs.
a Change in the Quantity Supplied
The Interaction of Supply and Demand
$5.00
S
4.00 Excess supply
Price per DVD
3.50 A
3.00
2.50 E
2.00 C
1.50
Excess demand
1.00 D
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of DVDs supplied and demanded
The Graphical Interaction of Supply and
Demand
S0
B
$2.50 Excess demand
A
2.25
D0 D1
0 8 9 10
Quantity of DVDs (per week)
The Effects of a Shift
of the Demand Curve
Decrease in Supply
• A decrease in supply creates excess
demand at the original equilibrium price.
• The excess demand pushes price upward
until a new higher price and lower quantity
are reached.
Decrease in Supply
S1
S0
C
$2.50 Excess demand
B
2.25 A
D0
0 8 9 10
Quantity of DVDs (per week)
The Limitations Of Supply And Demand
Analysis
In general, the more substitutes, the more elastic the demand will
be.
Income elasticity
Product Short Run Long Run
Motion pictures 0.81 3.41
Foreign travel 0.24 3.09
Tobacco products 0.21 0.86
Furniture 2.60 0.53
Jewelry and watches 1.00 1.64
Hard liquor — 2.50
Private university tuition — 1.10
Other Demand Elasticities
• Income Elasticity of Demand: the
percentage change in the quantity
demanded divided by the percentage
change in income.
– Normal goods: goods for which the income
elasticity of demand is positive.
– Inferior goods: Goods for which the income
elasticity of demand is negative.
Necessities and Luxuries
• Goods with lower income elasticities are often
called necessities, since the quantities
demanded don’t vary much with income.
– Typical income elasticities are 0.4 or 0.5.
(26 - 20)
2 (26 20) 26
1
Eincome 1.3
20 20
P0 P0
Shift due to
20% rise in
D0 D1 income
20 26 Quantity
Calculating Cross-Price Elasticity
(108 - 104)
2 (108 104 ) .038
1
D1 Ecross .12
.33 .33
D0
P0 P0
Shift due to 33% rise
in price of pork
104 108
Quantity of Beef
Price elasticity of supply
Definition and measurement
It measures the percentage change in quality supplied of a
product due to a % change in the price of the same product,
ceteris paribus.
Percentage change in quantity Supplied of a product
(€s) = Percentage change in price of the same product
Till now we know only a positively sloped supply curve. But there
are also some special types of supply curves.
I. A perfectly inelastic supply curve [when €s=0] price
S0
Price
P0 S0
0 Q0
Quantitysupplied
Cont…
A Perfectly inelastic supply curve is a vertical line above a
certain minimum price.
Price
P0 S0
Quantity supplied
Cont...
A perfectly elastic supply curve is a horizontal supply curve.
This usually happens if the unit cost of production [cost per unit]
doesn’t change as the firm produces more and more of the
product
Determinants of price elasticity of supply
What makes price elasticity of supply more or less elastics?