1. Created by Tad Mueller Northeast Iowa Community College

2. “Anyone can be an economist, All you must learn are two words, Supply and Demand” Chapter 8

3. Consumer Demand Various quantities of a commodity that an individual is willing and able to buy as the price of the commodity varies holding all other factors constant. Various quantities of a commodity that an individual is willing and able to buy as the price of the commodity varies holding all other factors constant.

4. Consumer Demand Demand begins with individual consumer Demand begins with individual consumer Inverse relationship between quantity and price Inverse relationship between quantity and price Two dimensional, Price and Quantity Two dimensional, Price and Quantity

5. Downward sloping demand As price goes up demand goes down As price goes up demand goes down Begin with individual’s utility function and a budget constraint Begin with individual’s utility function and a budget constraint Substitution effect Substitution effect consumers buy what’s cheaper consumers buy what’s cheaper Income effect Income effect “income” increases if prices fall “income” increases if prices fall Allows me to buy better (higher priced) items Allows me to buy better (higher priced) items

6. Per Capita Consumption in Pounds

9. Demand is a function of Price of substitutes Price of substitutes Kraft Cheese vs. Generic Kraft Cheese vs. Generic Price of complements Price of complements Pizza is a complement to cheese Pizza is a complement to cheese Consumer income Consumer income Higher income allows me to buy better products Higher income allows me to buy better products Taste and preferences Taste and preferences IS NOT FUNCTION OF THE GOOD’S OWN PRICE IS NOT FUNCTION OF THE GOOD’S OWN PRICE

10. Change in Demand or in Quantity Demanded Px Qx D1 D2 A B Moving from A to B due to a price decline is a change in quantity demand. A shift of the demand curve from D1 to D2 is a change in demand. C

11. Five factors effecting aggregate demand for a product Exports Exports China China New product development New product development Ethanol Ethanol Advertising Advertising New information New information Dairy products help you loose weight Dairy products help you loose weight Product differentiation Product differentiation Kraft vs. Generic Kraft vs. Generic

12. Income effect on food demand Food is normal good Food is normal good Income demand Income demand Particularly important for meats Particularly important for meats Emerging economies Emerging economies Services are a normal good Services are a normal good Income services Income services

13. Inverse Demand Price is a function of quantity Price is a function of quantity P = f(Q) P = f(Q) Important in agriculture Important in agriculture Short run supplies are relatively fixed Short run supplies are relatively fixed Prices change to clear the market Prices change to clear the market

14. Supply The amount of a given commodity that will be offered for sale per unit time as the price varies, other factors held constant. The amount of a given commodity that will be offered for sale per unit time as the price varies, other factors held constant.

15. Supply Derived from cost function Derived from cost function Production function Production function Input - output relationship Input - output relationship Assume that firms seek to Assume that firms seek to Maximize profits Maximize profits Minimize costs Minimize costs Supply starts with individual firm Supply starts with individual firm

16. Production Function Total Product Input Output Increasing returns to the input Decreasing returns to the input

17. Opportunity cost The opportunity cost of commodity A is income forgone by not producing commodity B. The opportunity cost of commodity A is income forgone by not producing commodity B. Measures of opportunity cost Measures of opportunity cost Market value of input Market value of input Expected return over other cost of not producing commodity B. Expected return over other cost of not producing commodity B.

18. Cost Curves Average variable cost = AVC Average variable cost = AVC Total variable cost / Q Total variable cost / Q Variable costs change with Q Variable costs change with Q Average fixed cost = AFC Average fixed cost = AFC Total fixed cost / Q Total fixed cost / Q Fixed costs do not change with Q Fixed costs do not change with Q Average total cost = ATC Average total cost = ATC = AVC+AFC

19. Cost curves Cost Q AVC

20. Cost curves Cost Q ATC AVC AFC

21. Cost Curves Marginal cost = MC Marginal cost = MC Change in total cost by producing 1 more Change in total cost by producing 1 more TC / Q TC / Q

22. Cost curves Cost Q MC ATC AVC

23. Supply curve Upward sloping curve Upward sloping curve Optimal output @ MC = MR Optimal output @ MC = MR MR = Price => Optimal at MC=Price MR = Price => Optimal at MC=Price The last unit of input just pays for itself The last unit of input just pays for itself

24. Optimal Q at P=MC MC ATC AVC P1P1 P2P2 Cost QQ1Q1 Q2Q2

25. Cost curves and supply Shut down if P < AVC Shut down if P < AVC Lose on every unit produced Lose on every unit produced P>AVC make some payment to fixed cost P>AVC make some payment to fixed cost In the long run everything is variable In the long run everything is variable Short run defined by having fixed cost Short run defined by having fixed cost

26. Market supply curves Qx Px S1S1 S2S2 A B C Move from A to B is a change in quantity supplied due to a price decline. Move from B to C is a shift in supply.

27. Supply shifts from change... in input prices in input prices in returns for competing enterprises in returns for competing enterprises in technology on yields or costs in technology on yields or costs in price of joint products in price of joint products in yield and/or price risk in yield and/or price risk institutional constraints institutional constraints

28. Worksheet General Economics – Supply and Demand General Economics – Supply and Demand

29. Economies of scale u Average total costs changes as the output of a firm changes u You can have increasing, decreasing or constant economies of scale. u Need to consider u Short run cost curve (SRATC) u Long run cost curve (LRATC)

30. US Pork Sector Study Financial results for 2000 1000 hd Net ProfitBreakevenNet Loss 1-265%24%11% 2-377%15%8% 3-579%16%5% 5-1078%13%9% 10-5077%12%11% 50-50090%5%5% 500+95%5%0%

31. US Pork Sector Study Stay in price until 2003 (%) 1000 hd$36$39$42$45$48 1-21636698690 2-31842718797 3-51839709094 5-101639759298 10-502249749196 50-500461889799 500+28508994100

33. Processing cost curves Specialized plants High fixed cost SRATC Q Cost

34. So what??? Short run price implications Short run price implications Supply chain management Supply chain management Open market or contract Open market or contract Packing plants Packing plants Ethanol plants Ethanol plants Soybean processing Soybean processing Biodiesel Biodiesel

35. Supply and Demand Summary Demand originates with individual consumer’s utility and budget constraint Demand originates with individual consumer’s utility and budget constraint Supply originates with individual firm’s marginal cost curve Supply originates with individual firm’s marginal cost curve

36. Consumption is not demand Consumption = Consumption = Beginning stocks + production + imports Beginning stocks + production + imports – exports – ending stocks – exports – ending stocks Per capita consumption = Per capita consumption = consumption / population consumption / population

38. Equilibrium P and Q Q P S D QeQe PePe Equilibrium price is where Qs = Qd.

39. Price elasticity A measure of responsiveness of the quantity supplied or demanded to changes in prices. A measure of responsiveness of the quantity supplied or demanded to changes in prices. Percentage change in quantity for a 1% change in price. Percentage change in quantity for a 1% change in price.

40. Relative measures Elastic Elastic |Ep| > 1 |Ep| > 1 Changes in quantity are greater than changes in price Changes in quantity are greater than changes in price Unit Elasticity Unit Elasticity |Ep| = 1 |Ep| = 1 Changes in quantity are the same as changes in price Changes in quantity are the same as changes in price Inelastic Inelastic |Ep| < 1 |Ep| < 1 Changes in quantity are less than changes in price Changes in quantity are less than changes in price

41. In other words If the price would decrease by 10% If the price would decrease by 10% With elastic demand amount bought would increase by more than 10% With elastic demand amount bought would increase by more than 10% With unit elasticity amount purchased would increase by exactly 10% With unit elasticity amount purchased would increase by exactly 10% With inelastic demand amount purchased would increase by less than 10% With inelastic demand amount purchased would increase by less than 10%

42. Price elasticity & total revenue TR (total revenue) = P (price) x Q (quantity) TR (total revenue) = P (price) x Q (quantity) Elastic demand Elastic demand P and TR inversely related P and TR inversely related Inelastic demand Inelastic demand P and TR directly related P and TR directly related

43. Income elasticity Percentage change in quantity for a 1% change in income Percentage change in quantity for a 1% change in income Positive for most food items Positive for most food items Relatively small i.e., 0.2 Relatively small i.e., 0.2 Ei Ei

44. Cross-price elasticity Percentage change in quantity for a 1% change in price of a substitute or complement Percentage change in quantity for a 1% change in price of a substitute or complement Positive or negative Positive or negative Much smaller than Ep Much smaller than Ep

45. Examples of Ag elasticities EpEi Beef-.62.45 Pork-.73.44 Chicken-.53.36 Milk-.26-.22 Grapes-1.38.44 Lettuce-.14.23

46. Own and Cross Price Elasticities Ep of demand for beef Beef-.62 Pork.11 Lamb.01 Chicken.06 Other-.01 Income.45

47. Net change in quantity Net effect of changes in own price, cross price, and income multiplied by the appropriate elasticities. Net effect of changes in own price, cross price, and income multiplied by the appropriate elasticities. Addresses the fact that not all else is equal. Addresses the fact that not all else is equal.

48. Elasticities at various markets The greater the number of substitutes the more elastic the demand. The greater the number of substitutes the more elastic the demand. For a given Q, look at % change in P (price) For a given Q, look at % change in P (price) More elastic at retail level More elastic at retail level

49. Elasticities at market levels P Q All food All meatAll beef All T-bone Hy-Vee T-bone Hy-Vee T-bone in Ames

51. Derived Demand The demand for inputs that are used to produce the final products. The demand for inputs that are used to produce the final products. Examples: Examples: Flour => wheat Flour => wheat Soybean meal => soybeans Soybean meal => soybeans Fed cattle => feeder cattle Fed cattle => feeder cattle

52. Derived Demand P Q Retail pork chop demand Wholesale pork demand Farm level demand for hogs Demand for corn to feed hogs Demand for inputs to produce corn

54. Food for Thought Should food prices be determined by supply and demand or by the government? Should food prices be determined by supply and demand or by the government?

55. Law Of One Price “Under competitive market conditions all prices within a market are uniform, after taking into account the costs of adding place, time, and form to the products.” “Under competitive market conditions all prices within a market are uniform, after taking into account the costs of adding place, time, and form to the products.”