1. ECON 100 Lecture 12
Monday, October 27

2. Announcements
Course webpage
Class participation records are updated. Announcements section
PS#5 is posted. Assignments section
Answer key to Problem Set #4 is posted. Assignments section
Midterm Exam #1 for the last three years (Spring 2014, 2013, and 2012) are posted. The answer keys will be posted later. Announcements section
Problem sets are an important resource for exam preparation.
Problem sets are not graded.

3. Problem Session / KOLT tutors
PS1: FRIDAY B4 (at 13:00) in room SOS B21 PS2: FRIDAY B5 (at 14:30) in room SOS B08 No attendance is taken at the PSs.
Econ 100 KOLT tutors: Sonkurt, Jülide, and Ilgaz

4. Please turn off your phones.
Class participation
You must attend the section where you are registered.
Your in-class exercise is your participation record. I collect them at the end of the lecture.
Please turn off your phones.

5. The Market Forces of Supply and Demand
Economics
P R I N C I P L E S O F
N. Gregory Mankiw

6. Demand, Supply, and Market Equilibrium
Read Chapter 4
Web link to PDF file of Chapter 4 (publisher’s website, perfectly legal)

7. A “real world” application
Demand and Supply

8. The food vs. fuel dilemma
A study in demand and supply

10. All scarce goods must be rationed!
Food vs. bio-fuel debate

11. The food vs. fuel dilemma is about using farmland or crops (wheat, corn, maize, etc.,) for bio-fuels (ethanol) production rather than food production. This threatens the food supply on a global scale.
Ethanol is used as a motor fuel, mainly as a biofuel additive for gasoline.

12. A few facts (from wiki!)
From 1974 to 2000 food prices (adjusted for inflation) dropped by 75%.

14. More facts (from wiki!)
Prices started to rise after 2000, more sharply after despite record production levels worldwide.
From January 2005 until June 2008, maize prices almost tripled, wheat increased 127 percent, and rice rose 170 percent.

15. A few facts (from wiki!)
MAIZE (looks like corn)

16. Prices after 2008?

18. Long tem trends in agricultural prices
Long tem trends in agricultural prices

19. http://www. ers. usda. gov/data-products/chart-gallery/detail. aspx

20. So…

21. Paul Bulcke, the chief executive of Nestlé

22. Nestlé is the world's largest food and beverage company
Nestlé is the world's largest food and beverage company. In 2013: 336,000 workers around the world $100billion total sales revenues Value of the company $234billion

23. http://www. guardian. co
"We say no food for fuel," said Paul Bulcke, chief executive of Nestlé, at the end of the World Water Week conference in Sweden. "Agricultural food-based bio-fuel is an aberration. We say that the EU and US should put money behind the right bio-fuels."

24. Nestlé has added its weight to calls by the UN and development groups for the US and EU to change their bio-fuel targets because of food shortages and price rises.

25. This from Guardian Sept 2012
Because bio-fuels help reduce carbon emissions,
40% of US maize (corn) harvest must be used to make bio- fuels. This is the law.
The EU countries are expected to move towards drawing % of their energy supply from bio-fuels.

26. All scarce goods must be rationed!
Food vs. bio-fuel debate:
A simple numerical example

27. There are 4 buyers and 3 sellers in a competitive market.
The individual demand schedule P Qd 1 5 2 4 3
The individual supply schedule P QS 1 2 3 4 6
Compute the equilibrium price, and the equilibrium quantity.
Compute the quantity demanded by the individual buyer in equilibrium.
Compute the quantity supplied by the individual seller in equilibrium.

28. Answers

29. These are the market demand & market supply schedules
There are 4 buyers and 3 sellers.
INDIVIDIAL P
demand
supply 1 5 2 4 3 6
MARKET P
demand
supply 1
5 x 4 = 20
0 x 3 = 0 2
4 x 4 = 16
2 x 3 = 6 3
3 x 4 = 12
4 x 3 = 12 4
2 x 4 = 8
6 x 3 = 18
MARKET P
demand
supply 1 20 2 16 6 3 12 4 8 18

30. These are the market demand & market supply schedules
There are 4 buyers and 3 sellers.
INDIVIDIAL P
demand
supply 1 5 2 4 3 6
MARKET P
demand
supply 1
5 x 4 = 20
0 x 3 = 0 2
4 x 4 = 16
2 x 3 = 6 3
3 x 4 = 12
4 x 3 = 12 4
2 x 4 = 8
6 x 3 = 18
MARKET P
demand
supply 1 20 2 16 6 3 12 4 8 18
The equilibrium price is P = 3.
The equilibrium quantity is Q = 12.

31. These are the market demand & market supply schedules
There are 4 buyers and 3 sellers.
INDIVIDIAL P
demand
supply 1 5 2 4 3 6
MARKET P
demand
supply 1
5 x 4 = 20
0 x 3 = 0 2
4 x 4 = 16
2 x 3 = 6 3
3 x 4 = 12
4 x 3 = 12 4
2 x 4 = 8
6 x 3 = 18
The individual buyer demands 3 units at the equilibrium price.
The individual seller produces 4 units at the equilibrium price.
MARKET P
demand
supply 1 20 2 16 6 3 12 4 8 18

32. Now, a big buyer enters the market.

33. Now there are 4 +1 buyers + 3 sellers.
Individual demand schedule of the existing buyers P Qd 1 5 2 4 3
Demand schedule of the “big buyer” P Qd 1 16 2 14 3 12 4 10
The new market demand is the sum of the 4 buyers’ and the newcomer’s demand.
Please compute the new equilibrium price and quantity.
How do the price and quantity change with the new buyer?
How many units are now consumed by each of the original 4 buyers? How many units are now supplied by each seller?
Who is better off and who is worse off when the new buyer is included?

34. Answers

35. Sum of the four buyers demand The big buyer’s demandP
Sum of the four buyers demand
The big buyer’s demand 1 20 16 2 14 3 12 4 8 10
The equilibrium price is P = 4.
The 4 buyers buy 2 units each, and pay a higher price. They are worse off.
Each seller produces 6 units, and receives a higher price. They are better off.
Market demand and market supply schedules P Qd Qs 1
=36 2
= 30 6 3
= 24 12 4
= 18 18
The new market demand is the sum of the demands of the 4 initial buyers and the newcomer.

36. Elasticity
PART II

37. Elasticity and Its Applications5

38. “As the price of a good rises, the quantity demanded falls
“As the price of a good rises, the quantity demanded falls. ” But how much does it fall? A little or a lot?

39. How responsive is quantity demanded to changes in the price?

40. The price elasticity of demand
Price elasticity of demand is a “measure” of how responsive the quantity demanded is to a change in price.

41. More generally… Elasticity is a measure of the responsiveness of
the quantity demanded or
the quantity supplied
to a change in one of their determinants.

42. In today’s lecture we will focus on the price elasticity of demand.

43. …has no effect on the quantity demanded.
Case 1
Price
Demand
$5.00
$4.00
The increase in price…
100
Quantity
…has no effect on the quantity demanded.

44. Case 2 Demand 50 100 $4.25 $4 a small increase in price…50
100
Quantity
leads to a large decrease in quantity demanded.

45. Case 1:
“Demand is inelastic”
Case 2:
“Demand is elastic .”

46. What makes the demand more elastic?
Demand tends to be more elastic if, …
there are close substitutes.
the market is more narrowly defined (food versus milk).
more time is allowed after the price change.
the good is a luxury. (Necessities have inelastic demand.)

47. Substitutes?
The patent expires on a brand-name drug and five generic drugs come on the market.
As a result, the demand for the original drug becomes…
more price elastic
less price elastic
The demand for the original drug becomes more price elastic.

48. Demand for food v. demand for lettuce
The more general the classification, the fewer substitutes there are and this makes demand less elastic. Demand for food is less price elastic than demand for lettuce.
vs.
Instructor Notes:

49. Time is on our side… More time to adjust means higher elasticity!
Over time consumers can adjust their behavior by finding substitutes (Thus makes their demand more price elastic).
Instructor Notes:

50. Luxuries vs. necessities
Demand for necessities is price inelastic. Demand for luxuries is price elastic.
Instructor Notes:

51. The Price Elasticity of Demand, EP
The degree of responsiveness of quantity demanded to a change in price is quantified in a single number EP
EP is computed as follows:
The percentage change in quantity demanded divided by the percentage change in price.

52. How to calculate a percentage change in 3 easy steps:
Step 1: Calculate the change (the new value minus the initial value), Step 2: Divide the change by the initial value, Step 3: Multiply by 100 and add the "%" sign.

53. The USD/TL exchange rate in October 2014
October 1, 2014: $1 = TL October 24, 2014: $1 = TL Please compute the percentage change in the $/TL exchange rate.

55. The USD/TL exchange rate in October 2014
October 1, 2014: $1 = TL October 24, 2014: $1 = TL Please compute the percentage change in the $/TL exchange rate from October 1st to October 24th.

56. Answers

57. The USD/TL exchange rate in October 2014
October 1, 2014: $1 = TL October 24, 2014: $1 = TL Compute the change: new value – initial value = TL – TL = – TL Dividide the change by the initial value change / initial value = – TL/ TL = Multiply by 100 add % – 1,70%

58. We will now compute the price elasticity of demand
The formula:
When the price of ice cream is ₺2, quantity demanded is 10 units (cones of ice-cream).
When the price of ice-cream is ₺2.20, quantity demanded is 8 units.
Please compute the price elasticity of demand at P = ₺2!

59. Computing the EP When P = ₺2.00,  QD = 10 When P = ₺2.20,  QD = 8
Change in QD (ΔQD) is (8 – 10) = –2.
% change in QD is –(2/10)x100 = –20%.
Change in price (ΔP) is (2.20 – 2.00) = +0.20
% change in price is (0.20/2)x100 = +10%
EP = {% change in QD}/{% change in P}
EP = –20/10 = –2.

60. Learning activity

61. When P = ₺5, you buy 20 units. When P = ₺4, you buy 23 units
When P = ₺5, you buy 20 units. When P = ₺4, you buy 23 units. Please compute the price elasticity of demand at P = ₺5.

62. Answers

63. When P = ₺5, you buy 20 units.
When P = ₺4, you buy 23 units.
Change in QD: (23 – 20) = 3.
% change in QD is (‒3)/20x100 = 15%.
Change in price: (4.00 – 5.00) = ‒1.00
% change in price: (1.00/5.00)x100 = ‒20%
EP = {% change in QD}/{% change in P}
EP = 15/(‒20) = –3/4 = –0.75.

64. What does the EP number mean?
Suppose the price elasticity of demand for gasoline is -0.2.
This means:
When the price of gasoline rises by 1%, the quantity demanded falls by 0.2%
When the price of gasoline rises by 5%, the quantity demanded falls by 1%
Gasoline demand is not very price sensitive.
Some examples.

65. What does the EP number mean?
Suppose the price elasticity of demand for gold jewelry is -2.5.
This means:
When the price of gold jewelry rises by 5%, the quantity demanded falls by 12.5%.
Jewelry demand is price sensitive.
Some examples.

66. Please note that
Because price and quantity are negatively related (price↑, QD↓, and price ↓, QD↑), the price elasticity EP is always a negative number. We will occasionalyy refer to the price elasticity of demand EP by its absolute value (we will ignore the negative sign).

67. Elastic vs. inelastic demand
When the price elasticity EP is between 0 and 1 in absolute value, we say that demand is inelastic.
Inelastic demand means that the quantity demanded is not very responsive to the price.
When the price elasticity EP is greater than 1 in absolute value, we say that demand is elastic.
Elastic demand means that the quantity demanded is responsive to the price.

68. One more time Unit elastic: │EP│ = 1 Inelastic: │EP│ < 11 2 3 4 5 6
Unit elastic
???
Inelastic
Elastic
│EP│
Unit elastic: │EP│ = 1
Inelastic: │EP│ < 1
Elastic: │EP│ > 1

69. Some real price elasticity numbers
On average, in the United States, a 10% increase in the price of water can be expected to diminish demand in the urban residential sector by about 3 to 4 %.
This is equivalent to saying that U.S. residential water price elasticity EP is in the range of –0.3 to –0.4.
?????

70. Price Elasticity Estimates in New England

71. Oil price demand elasticity: on
More recent numbers collected from scientific studies by the Bank of England (6/2008)
Price elasticity is close to zero in short term.
It increases with time, but remains low.

72. More computations!
Learning activity

73. Total revenue is defined as the price times quantity demanded at that price.
At P = $20, quantity demanded is 800 units.
At P = $22, quantity demanded is 740 units.
Compute the total revenue at P = $20, and then at P = $22.
True or false: when P increases from $20 to $22, total revenues decreases.
Compute the price elasticity of demand at P = $20.

74. Solutions

75. At P = $20, quantity demanded is 800 units
At P = $20, quantity demanded is 800 units. At P = $22, quantity demanded is 740 units.
Total revenue at P = $20 is $20 x 800 = $16,000. Total revenue at P = $22 is $22 x 740 = $16,280. Price elasticity of demand at P = $20 is computed as follows: 60/800 times 100 divided by 2/20 times /800 =  times 100 = -7.5% 2/20 = 0.10  times 100 = 10% Price elasticity of demand at P = $20 is EP = -7.5/10 =
% change in Q
% change in P

76. End of the lecture