Chapter 2 Review of S and D Supply Curve: Shows quantity supplied at each possible price, ceteris paribus (c.p.). Slopes upward (positive relationship) Qs = Qs(P) Shift S Curve: Clarify movement along vs shift. C.P. factors: Interpret shift S curve:

Demand Curve Shows quantity demanded at each possible price, ceteris paribus (c.p.) Slopes downward (negative relationship) Qd = Qd(P) Movement along versus shift. C.P. factors: Interpret shift D curve:

Market Mechanism Put Supply and Demand Together Equilibrium 1. 2. Describe re-equilibrating process by changing C.P. factor: Increase in income causes increase in demand (shift D rightward) At old P, Qd greater than Qs: so individuals bid up price till reach new equilibrium.

Elasticity Definition: %Qd in response to a 1% P Or: %Qd / %P What is %? Absolute change in variable divided by original level of variable. Ep = (Qd/Q) / (P/P) = (P/Q) (Q/P) Remember: (Q/P) is 1/slope. Ep = price elasticity of demand; usually negative.

More About Elasticities Elastic: Ep 1 Inelastic: Ep 1 Unitary Elastic: Ep 1 Fact: While slope is constant along a linear demand curve, elasticity is not. Fact: At top of demand curve, when P is high and Q is low, Ep is big negative number so D curve is very elastic. Fact: As move down D curve to right, Ep falls (because P is  while Q is , so P/Q is ).

Example Price Demand Supply 60 22 14 80 20 16 100 18 18 120 16 20 60 22 14 80 20 16 100 18 18 120 16 20 1. What is P*, Q*? 2. When P=$80, what is ED?

Relative Elasticities Rule: the steeper the slope of the curve, the less elastic. Completely horizontal demand curve: infinitely elastic: So: Completely vertical demand curve: completely inelastic:

Nearly Horizontal Demand Curve Elasticity approaches infinity: Recall: 1/slope = Q/P If nearly flat curve: small  P causes a huge Q. This is same as: huge  / small  , which equals a very big number.

Income Elasticity of Demand Measure responsiveness of Qd to change in income (note this is a ceteris paribus factor). EI = %in Qd resulting from a 1%  in income. EI = (Q/Q) / (I/I) = I/Q  (Q/I).

Cross-Price Elasticity of Demand Measures responsiveness in Qd of one good to change in price of a related good (note this is a change in a c.p. factor). Cross-price elasticity of demand = % in Qd resulting from a 1%  in the price of a related good. EQ1P2 = (Q1/Q1) / (P2/P2)  P2/Q1  Q1/P2. EQP  0: the two goods are substitutes. EQP  0: the two goods are complements.

Price Elasticity of Supply Price Elasticity of Supply: Responsiveness of Qs to P. ESP = %Qs / %P = (Qs/Qs) / (P/P)  P/Qs  Qs/P Usually positive.

Wage Elasticity of Supply Measures responsiveness of Qs to changes in the cost of labor (a ceteris paribus factor). ESW = %Qs / %W = (Qs/Qs) / (W/W)  W/Qs  Qs/W. Usually negative. Remember: W   cost of production.

Short-Run versus Long-run Elasticities Focal point: how much time do sellers and consumers have to respond (in their Qs and Qd) to changes in price? In general: LR adjustment is more full, free adjustment so that LR elasticity is larger; BUT not true all the time. Key factors: Durability. Availability of substitutes

Government Price Controls Key: If government sets P so that there is no single P for which Qs=Qd, then there will be a shortage or surplus. Be able to show the Qs and Qd for any price. Price ceiling: Price floor: