Promoting active learning

1
Supply and Demand
2
Supply and Demand

• Demand

3
DEMAND

• Relationship between demand and price
• the law of demand
• the income effect
• the substitution effect
• The demand curve
• assumptions
• other things being equal (ceteris paribus)
• a given time period
• the axes
• individual's and market demand curves

4
The demand curveThe demand for potatoes
(monthly)
5
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700
Price (pence per kg) 20
Point
A
Price (pence per kg)
A
Demand
Quantity (tonnes 000s)
6
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500
Price (pence per kg) 20 40
Point
A B
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
7
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350
Price (pence per kg) 20 40 60
Point
A B C
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
8
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350 200
Price (pence per kg) 20 40 60 80
Point
A B C D
D
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
9
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350 200 100
Price (pence per kg) 20 40 60 80 100
Point
E
A B C D E
D
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
10
DEMAND

• Other determinants of demand
• tastes
• number and price of substitute goods
• number and price of complementary goods
• income
• distribution of income
• expectations

11
DEMAND

• Movements along and shifts in the demand curve
• change in price
• ? movement along D curve
• change in any other determinant of demand
• ? shift in D curve
• increase in demand ? rightward shift
• decrease in demand ? leftward shift

12
An increase in demand
P
Price
D0
O
Q0
Q1
Quantity
13
DEMAND

• Demand functions
• simple demand functions
• Qd a bP
• more complex demand functions
• Qd a bP cY dPs ePc
• estimated demand equations
• problems of estimating demand equations
• demand functions and the demand curve

14
Demand curve for equation Qd 10 000 200P
P
D
Q (000s)
15
Demand curve for equation Qd 10 000 200P
P 5
Qd (000s) 9
P
D
Q (000s)
16
Demand curve for equation Qd 10 000 200P
P 5 10
Qd (000s) 9 8
P
D
Q (000s)
17
Demand curve for equation Qd 10 000 200P
P 5 10 15
Qd (000s) 9 8 7
P
D
Q (000s)
18
Demand curve for equation Qd 10 000 200P
P 5 10 15 20
Qd (000s) 9 8 7 6
P
D
Q (000s)
19
Supply and Demand

• Supply

20
SUPPLY

• Relationship between supply and price
• short-run supply
• long-run supply
• The supply curve
• assumptions
• other things remain equal (ceteris paribus)
• a given time period
• the axes
• individual's and market supply curves

21
The supply curveThe supply of potatoes (monthly)
22
Market supply of potatoes (monthly)
Supply
P 20
Q 100
a
Price (pence per kg)
a
Quantity (tonnes 000s)
23
Market supply of potatoes (monthly)
Supply
P 20 40
Q 100 200
a b
Price (pence per kg)
b
a
Quantity (tonnes 000s)
24
Market supply of potatoes (monthly)
Supply
P 20 40 60
Q 100 200 350
a b c
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
25
Market supply of potatoes (monthly)
Supply
d
P 20 40 60 80
Q 100 200 350 530
a b c d
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
26
Market supply of potatoes (monthly)
e
Supply
d
P 20 40 60 80 100
Q 100 200 350 530 700
a b c d e
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
27
SUPPLY

• Relationship between supply and price
• short-run supply
• long-run supply
• The supply curve
• assumptions
• other things remain equal (ceteris paribus)
• a given time period
• the axes
• individual's and market supply curves
• why supply curves generally slope up

28
SUPPLY

• Other determinants of supply
• costs of production
• profitability of alternative products
  (substitutes in supply)
• profitability of goods in joint supply
• nature and other random shocks
• aims of producers
• expectations of producers

29
SUPPLY

• Movements along and shifts in the supply curve
• change in price
• ? movement along S curve
• change in any other determinant of supply
• ? shift in S curve
• increase in supply ? rightward shift
• decrease in supply ? leftward shift

30
SUPPLY

• Supply functions
• simple supply functions
• Qs a bP
• more complex supply functions
• Qs a bP cC dPs ePj
• estimated supply equations
• problems of estimating supply equations

31
Shifts in the supply curve
P
S0
Increase
Q
O
32
Shifts in the supply curve
P
S0
S1
Increase
Decrease
Q
O
33
Supply and Demand

• Price and output determination

34
PRICE AND OUTPUT DETERMINATION

• Equilibrium price and output
• response to shortages and surpluses
• shortage (D gt S)
• ? price rises
• surplus (S gt D)
• ? price falls
• significance of equilibrium

35
Equilibrium price and outputThe Market Demand
and Supply of Potatoes (Monthly)
36
The determination of market equilibrium
(potatoes monthly)
E
e
Supply
d
D
c
C
Price (pence per kg)
a
A
Demand
Quantity (tonnes 000s)
37
The determination of market equilibrium
(potatoes monthly)
E
e
Supply
d
D
c
C
Price (pence per kg)
b
B
a
A
Demand
Quantity (tonnes 000s)
38
The determination of market equilibrium
(potatoes monthly)
E
e
Supply
c
C
Price (pence per kg)
b
B
a
A
Demand
Quantity (tonnes 000s)
39
The determination of market equilibrium
(potatoes monthly)
E
e
Supply
d
D
Price (pence per kg)
b
B
a
A
Demand
Qe
Quantity (tonnes 000s)
40
PRICE AND OUTPUT DETERMINATION

• Effects of shifts in the demand curve
• movement along the supply curve and the new
  demand curve

41
Effect of a shift in the demand curve
P
S
g
Pe1
D1
O
Qe1
Q
42
Effect of a shift in the demand curve
P
S
g
Pe1
D1
O
Qe1
Q
43
Effect of a shift in the demand curve
P
S
g
Pe1
D2
D1
O
Qe1
Q
44
Effect of a shift in the demand curve
P
S
Pe2
g
Pe1
D2
D1
O
Qe1
Qe2
Q
45
PRICE AND OUTPUT DETERMINATION

• Effects of shifts in the demand curve
• movement along the supply curve and the new
  demand curve
• Effects of shifts in the supply curve
• movement along demand curve and new supply curve

46
Effect of a shift in the supply curve
P
S1
g
Pe1
D
O
Qe1
Q
47
Effect of a shift in the supply curve
P
S1
g
Pe1
D
O
Qe1
Q
48
Effect of a shift in the supply curve
P
S2
S1
g
Pe1
D
O
Qe1
Q
49
Effect of a shift in the supply curve
P
S2
S1
Pe3
g
Pe1
D
O
Qe3
Qe1
Q
50
PRICE AND OUTPUT DETERMINATION

• Effects of shifts in the demand curve
• movement along the supply curve and the new
  demand curve
• Effects of shifts in the supply curve
• movement along demand curve and new supply curve
• Identifying the position of demand and supply
  curves

51
Problems in identifying the position and shape of
the demand curve shift in supply curve
P
S1
20p
a
O
Q
1000
52
Problems in identifying the position and shape of
the demand curve shift in supply curve
P
S2
S1
b
30p
20p
a
O
Q
800
1000
53
Problems in identifying the position and shape of
the demand curve shift in supply curve
P
S2
S1
b
30p
20p
a
D
O
Q
800
1000
54
Problems in identifying the position and shape of
the demand curve shift in supply and demand
curves
P
S1
a
20p
O
Q
1000
55
Problems in identifying the position and shape of
the demand curve shift in supply and demand
curves
P
S2
S1
b
30p
a
20p
O
Q
800
1000
56
Problems in identifying the position and shape of
the demand curve shift in supply and demand
curves
P
S2
S1
b
30p
a
20p
D2
D1
O
Q
800
1000
57
Supply and Demand

• Elasticity

58
ELASTICITY

• Defining elasticity
• the responsiveness of demand and supply
• Price elasticity of demand
• the responsiveness of demand to a change in price

59
Market supply and demand
S1
Price
a
P1
D
Q1
O
Quantity
60
Market supply and demand
S2
S1
b
P2
Price
a
P1
D
Q1
Q2
O
Quantity
61
Market supply and demand
S2
S1
b
P2
Price
a
D'
P1
D
Q1
Q2
O
Quantity
62
Market supply and demand
S2
S1
b
P2
Price
c
P3
a
D'
P1
D
Q1
Q3
Q2
O
Quantity
63
ELASTICITY

• Price elasticity of demand
• measurement
• proportionate (or ) ?Qd / proportionate (or )
  ?P
• use of proportionate or percentage changes
• the sign (positive or negative)
• the value (greater or less than one)

64
ELASTICITY

• Determinants of price elasticity of demand
• number and closeness of substitute goods
• the proportion of income spent on the good
• time
• Price elasticity of demand and consumer
  expenditure (P x Q)

65
Total expenditure
P()
Consumers total expenditure firms total
revenue 2 x 3m 6m
D
Q (millions of units per period of time)
66
ELASTICITY

• Price elasticity of demand and consumer
  expenditure (P x Q)
• effects of a price change on expenditure elastic
  demand

67
Elastic demand between two points
P()
a
D
0
Q (millions of units per period of time)
68
ELASTICITY

• Price elasticity of demand and consumer
  expenditure (P x Q)
• effects of a price change on expenditure elastic
  demand
• effects of a price change on expenditure
  inelastic demand

69
Inelastic demand between two points
P()
D
0
Q (millions of units per period of time)
70
ELASTICITY

• Price elasticity of demand and consumer
  expenditure (P x Q)
• effects of a price change on expenditure elastic
  demand
• effects of a price change on expenditure
  inelastic demand
• special cases

71
Totally inelastic demand (PÎD 0)
P
D
a
P1
Q1
O
Q
72
Infinitely elastic demand (PÎD )
P
a
D
P1
Q1
O
Q
73
Unit elastic demand (PÎD 1)
P
a
20
D
40
O
Q
74
ELASTICITY

• Price elasticity of demand and consumer
  expenditure (P x Q)
• effects of a price change on expenditure elastic
  demand
• effects of a price change on expenditure
  inelastic demand
• special cases
• applications to price decisions

75
Elastic demand between two points
Expenditure falls as price rises
P()
b
5
a
4
D
0
20
10
Q (millions of units per period of time)
76
Inelastic demand between two points
Expenditure rises as price rises
c
8
P()
a
4
D
0
15
20
Q (millions of units per period of time)
77
ELASTICITY

• Price elasticity of demand and consumer
  expenditure (P x Q)
• effects of a price change on expenditure elastic
  demand
• effects of a price change on expenditure
  inelastic demand
• special cases
• applications to price decisions
• different elasticities along a demand curve

78
Different elasticities along different portions
of a demand curve
P
a
P1
D
O
Q1
Q
79
Different elasticities along different portions
of a demand curve
P
a
P1
b
P2
D
O
Q1
Q2
Q
80
Different elasticities along different portions
of a demand curve
P
a
P1
b
P2
c
P3
D
O
Q1
Q3
Q2
Q
81
ELASTICITY

• Measurement of elasticity arc elasticity
• the formula for price elasticity of demand
• ?Q/Q ?P/P
• using the average or 'mid-point' method

82
Measuring elasticity using the arc method
P ()
Demand
Q (000s)
83
Measuring elasticity using the arc method
DQ DP
Ped

mid Q mid P
P ()
Demand
Q (000s)
84
Measuring elasticity using the arc method
DQ DP
Ped

mid Q mid P
10 -2 15 7


P ()
Demand
Q (000s)
85
Measuring elasticity using the arc method
DQ DP
Ped

mid Q mid P
10 -2 15 7


10/15 x -7/2
P ()
Demand
Q (000s)
86
Measuring elasticity using the arc method
DQ DP
Ped

mid Q mid P
10 -2 15 7


10/15 x -7/2 -70/30
P ()
Demand
Q (000s)
87
Measuring elasticity using the arc method
DQ DP
Ped

mid Q mid P
10 -2 15 7


10/15 x -7/2 -70/30 -7/3
-2.33
P ()
Demand
Q (000s)
88
ELASTICITY

• Measurement of elasticity point elasticity
• the formula for price elasticity of demand
• dQ/dP x P/Q
• the elasticity of a straight-line demand curve
  (constant dQ/dP)
• the elasticity of a curved demand curve
• dQ/dP is the tangent to the curve

89
Measuring elasticity at a point
r
P
D
0
Q
90
Measuring elasticity at a point
Ped (1 / slope) x P/Q
r
30
P
D
0
40
Q
91
Measuring elasticity at a point
50
Ped (1 / slope) x P/Q -100/50 x
30/40
r
30
P
D
0
40
100
Q
92
Measuring elasticity at a point
50
Ped (1 / slope) x P/Q -100/50 x
30/40 -60/40
r
30
P
D
0
40
100
Q
93
Measuring elasticity at a point
50
Ped (1 / slope) x P/Q -100/50 x
30/40 -60/40 -1.5
r
30
P
D
0
40
100
Q
94
ELASTICITY

• Measurement of elasticity point elasticity
• the formula for price elasticity of demand
• dQ/dP x P/Q
• the elasticity of a straight-line demand curve
  (constant dQ/dP)
• the elasticity of a curved demand curve
• dQ/dP is the tangent to the curve
• different elasticities along a straight-line
  demand curve

95
Different elasticities along a straight-line
demand curve
Ped (1 / slope) x P/Q
n
m
P
l
Demand
k
Q
96
Different elasticities along a straight-line
demand curve
Ped (1 / slope) x P/Q (1 / slope) is
constant -50/10 -5
n
m
P
l
Demand
k
Q
97
Different elasticities along a straight-line
demand curve
Ped (1 / slope) x P/Q (1 / slope) is
constant -50/10 -5 But P/Q
varies at n, P/Q 8/10
n
m
P
l
Demand
k
Q
98
Different elasticities along a straight-line
demand curve
Ped (1 / slope) x P/Q (1 / slope) is
constant -50/10 -5 But P/Q
varies at n, P/Q 8/10 at m, P/Q 6/20 at l,
P/Q 4/30
n
m
P
l
Demand
l
k
Q
99
ELASTICITY

• Price elasticity of supply
• measurement
• determinants
• applications

100
Supply in different time periods
P
P1
a
D1
O
Q1
Q
101
Supply in different time periods
P
P1
a
D2
D1
O
Q1
Q
102
Supply in different time periods
P
Si
P1
a
D2
D1
O
Q1
Q
103
Supply in different time periods
P
Si
SS
b
P2
P1
a
D2
D1
O
Q1
Q
104
Supply in different time periods
P
Si
SS
b
P2
c
SL
P3
P1
a
D2
D1
O
Q1
Q3
Q
105
ELASTICITY

• Income elasticity of demand
• measurement
• determinants
• applications
• Cross-price elasticity of demand
• measurement
• determinants
• applications

106
Supply and Demand

• The Time Dimension

107
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply

108
Response of supply to an increase in demand
P
P1
a
D1
Q1
O
Q
109
Response of supply to an increase in demand
P
P1
a
D2
D1
Q1
O
Q
110
Response of supply to an increase in demand
P
S short-run
b
P2
P1
a
D2
D1
Q1
Q2
O
Q
111
Response of supply to an increase in demand
P
S short-run
S long-run
b
P2
c
P3
P1
a
D2
D1
Q1
Q2
Q3
O
Q
112
Response of demand to an increase in supply
P
S1
a
P1
Q1
O
Q
113
Response of demand to an increase in supply
P
S1
S2
a
P1
Q1
O
Q
114
Response of demand to an increase in supply
P
S1
S2
a
P1
b
P2
D short-run
Q1
Q2
O
Q
115
Response of demand to an increase in supply
P
S1
S2
a
P1
c
P3
b
P2
D long-run
D short-run
Q3
Q1
Q2
O
Q
116
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation

117
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation
• stabilising speculation

118
Stabilising speculation initial price fall
P
S1
P1
a
D1
O
Q
119
Stabilising speculation initial price fall
P
S1
P1
a
D1
b
P2
D2
O
Q
120
Stabilising speculation initial price fall
P
S1
P1
a
D1
b
P2
D2
O
Q
121
Stabilising speculation initial price rise
P
S1
a
P1
D1
O
Q
122
Stabilising speculation initial price rise
P
S1
b
P2
a
P1
D2
D1
O
Q
123
Stabilising speculation initial price rise
P
S1
b
P2
a
P1
D2
D1
O
Q
124
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation
• stabilising speculation
• destabilising speculation

125
Destabilising speculation initial price fall
P
S1
a
P1
D1
O
Q
126
Destabilising speculation initial price fall
P
S1
a
P1
P2
b
D1
D2
O
Q
127
Destabilising speculation initial price fall
P
S1
a
P1
P2
b
D1
D2
O
Q
128
Destabilising speculation initial price rise
P
S1
a
P1
D1
O
Q
129
Destabilising speculation initial price rise
P
S1
b
P2
a
P1
D2
D1
O
Q
130
Destabilising speculation initial price rise
P
S1
b
P2
a
P1
D2
D1
O
Q
131
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation
• stabilising speculation
• destabilising speculation
• Uncertainty and risk

132
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation
• stabilising speculation
• destabilising speculation
• Uncertainty and risk
• defining risk and uncertainty

133
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation
• stabilising speculation
• destabilising speculation
• Uncertainty and risk
• defining risk and uncertainty
• reducing risks by holding stocks

134
THE TIME DIMENSION

• Short-run and long-run price adjustment
• short- and long-run demand and supply curves
• short- and long-run adjustment to a change in
  demand or supply
• Speculation
• stabilising speculation
• destabilising speculation
• Uncertainty and risk
• defining risk and uncertainty
• reducing risks by holding stocks
• futures markets