Chapter 2 Suppy and Demand Analysis MicroEconomics

2.1 Demand, Supply, and Market Equilibrium 3 building blocks of supply and demand analysis Demand curves Supply curves Concept of market equilibrium Effect on market equilibrium when supply and demand shift Learn about the price elasticity of demand and how it varies along different types of demand curves Relationship between price elasticity of demand and total revenue Determinants of price elasticity of demand Distinction between market-level and brand-level price elasticities of demand Elasticities Income elasticity of demand Cross-price elasticity of demand Price elasticity of supply How they differ long run and short run

Demand Curves Market demand curve: tells us the quantity that buyers are willing to purchase at different prices Derived demand: demand for a good that is derived from the production and sale of other goods. Ex. Corn to corn syrup to soda producers Direct demand: demand for the good itself -The demand curve also tells us what the “market will bear” for given quantities and or supply of output. -Demand curve decreases on the Quantity (x-axis), Price (y-axis) graph. As price increase, quantity decreases. Law of Demand: The inverse relationship between the price of a good and the quantity demanded, when all the other factors that influence demand are held.

Supply Curves Market supply curves: a curve that shows us the total quantity of goods that their suppliers are willing to sell at different prices Law of supply: The positive relationship between price and quantity supplied, when all other factors that influence supply are held fixed. -The supply curve slopes upward. Suppliers are willing to offer more quantity at higher prices. Factors of production: resources such as labor and raw materials that are used to produce a good. This will affect the quantity of the good that sellers are willing to supply.

Market Equilibrium The point at which the supply and demand curves intersect. A point at which there is no tendency for the market price to change as long as outside variables (rainfall affect corn) remain unchanged. Excess supply: quantity supplied at a given price exceeds the quantity demand Excess demand: quantity demanded exceeds the quantity supplied

Shifts in Supply and Demand Examples An increase in consumers’ disposal income increase demand for a particular good An increase in the price of labor shifts the supply curve left, equilibrium price goes up but the equilibrium quantity goes down. Demand Supply Equilibrium Price Equilibrium Quantity +   - ?

2.2 Price Elasticity of Demand Measure of the rate of % change of quantity demanded with respect to price, holding all other determinants of demand constant. Price elasticity of demand = ΕQ,P ΕQ,P = percentage change in quantity/percentage change in price Percentage change in quantity = ΔQ/Q x 100% Percentage change in price = ΔP/P x 100%

Price Elasticity of Demand Value of ΕQ,P = %ΔQ/ %ΔP Classification Meaning Perfectly inelastic demand Quantity demanded is completely insensitive to price between 0 and -1 Inelastic demand Quantity demanded is relatively insensitive to price -1 Unitary elastic demand Percentage increase in quantity demanded is equal to percentage decrease in price between -1 and -infinity Elastic demand Quantity demanded is relatively sensitive to price -infinity Perfectly elastic demand Any increase in price results in quantity demanded decreasing in zero, and any decrease in price results in quantity demanded increasing to infinity

Linear demand curve Q=a-bP a and b are positive constants a is the effect of all factors (income, price of other goods b reflects how the price of the good affects the quantity demanded Any downward-sloping demand curve has a corresponding inverse demand curve that expresses price as a function of quantity P=(a/b)-(1/b)Q (a/b) = choke price, price at which quantity demanded falls to 0 ΕQ,P = %ΔQ/ %ΔP = (ΔQ/ ΔP)(Q/P) = -b(P/Q)

Constant Elasticity Demand Curves Q=aP-b a and b are positive constants For the constant elasticity demand curve, the price elasticity is always equal to the exponent –b.

Price Elasticity of Demand and Total Revenue Factors Demand tends to be more price elastic (quantity is sensitive to price) when there are good substitutes for a product Demand tends to be more price elastic when a consumer’s expenditure on the product is large Demand tends to be less price elastic when the product is seen by consumers as being a necessity Market-Level versus Brand-Level Price Elasticities of Demand If the price of one brand increases for a product market that is inelastic, the market demand for that one brand could possibly drop. The reasons this is that there are other providers of the product and the brand may not be enough to hold the customer. Ex. Salem cigarettes increase their pricing, but smokers can easily switch to another brand

Other Elasticities Income Elasticity of Demand: ratio of the percentage change of quantity demanded to the percentage change of income, holding price and all other determinants of demand constant = ΕQ,P = [(ΔQ/Q)*100] / [(ΔI/I)*100] = (ΔQ/ΔI)(I/Q) Cross-Price Elasticity of Demand: for good i with respect to the price of good j is the ratio of the percentage change of the quantity of good I demanded to the percentage change of good j = ΕQi,Pj = [(ΔQi/Qi)*100%]/ [(ΔPj/Pj)*100%] = (ΔQi/ Δ Pj)/ (Pj/Qi) Cross-supply elasticities can be positive or negative ΕQi,Pj > 0, a higher price for good j increases the demand for good I In this case, goods i and j are demand substitutes. Demand substitutes are related goods that if one increases, demand for the other increases ΕQi,Pj < 0, a higher price of good j decreases the demand for good i. In this case, goods i and j are demand complements Demand complements are related goods that if one increases, demand for the other decreases Price Elasticity of Supply: measures the sensitivity of quantity supplied QS to price. The percentage change in quantity supplied for each percentage change in price, holding all other determinants of supply constant ΕQS,P = [(ΔQS/QS)*100%]/ [(ΔP/P)*100%] = (ΔQS/ Δ P)/ (P/QS)

2.4 Elasticity in the Long Run vs Short Run Long-run demand curve: the demand curve that pertains to the period of tie in which consumers can fully adjust their purchase decisions to changes in price Short-run demand curve: the demand curve that pertains to the period of time in which consumers cannot fully adjust their purchase decisions to changes in price Long-run supply curve: the demand curve that pertains to the period of tie in which producers can fully adjust their suppy decisions to changes in price Short-run supply curve: the supply curve that pertains to the period of time in which sellers cannot fully adjust their supply decisions in response to changes in price

5.4 Market Demand The market demand curve is the horizontal sum of the demands of the individual consumers