Economics Doc

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ECONOMICS

Chapter 2 .Managerial Economics & Business Strategy

Market Forces: Demand and Supply

Overview1. Market Demand Curve

o The Demand Functiono Determinants of Demando Consumer Surplus

2. Market Supply Curveo The Supply Functiono Supply Shifterso Producer Surplus

3. Market Equilibrium4. Price Restrictions5. Comparative Statics

Market Demand Curve

Shows the amount of a good that will be purchased at alternative prices. Law of Demand

o The demand curve is downward sloping.

Determinants of Demand

o Incomeo Prices of substituteso Prices of complementso Advertisingo Populationo Consumer expectations


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The Demand Function

An equation representing the demand curve

Qxd = f(Px ,PY , M, H,)o Qxd = quantity demand of good X.o Px = price of good X.o PY = price of a substitute good Y.o M = income.o H = any other variable affecting demand

Change in Quantity Demanded

Change in Demand


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Consumer Surplus:

The value consumers get from a good but do not have to pay for.

I got a great deal!

That company offers a lot of bang for the buck! Gateway 2000 provides good value. Total value greatly exceeds total amount paid. Consumer surplus is large.

I got a lousy deal!

That car dealer drives a hard bargain! I almost decided not to buy it! They tried to squeeze the very last cent from me! Total amount paid is close to total value. Consumer surplus is low.

Consumer Surplus: The Discrete Case


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Consumer Surplus:The Continuous Case

Market Supply Curve

The supply curve shows the amount of a good that will be produced at alternativeprices.

Law of Supplyo The supply curve is upward sloping

Supply Shifters

Input prices Technology or government regulations Number of firms Substitutes in production Taxes Producer expectations


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The Supply Function

An equation representing the supply curve: QxS = f(Px ,PR ,W, H,)

o QxS = quantity supplied of good X.o Px = price of good X.o PR = price of a related goodo W = price of inputs (e.g., wages)o H = other variable affecting supply

Change in Quantity Supplied

Change in Supply


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Producer Surplus

The amount producers receive in excess of the amount necessary to induce them toproduce the good.

Market Equilibrium

Balancing supply and demando QxS = Qxd

Steady-state

If price is too low


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If price is too high

Price Restrictions

Price Ceilingso The maximum legal price that can be chargedo Examples:

Gasoline prices in the 1970s Housing in New York City Proposed restrictions on ATM fees

Price Floorso The minimum legal price that can be charged.o Examples:

Minimum wage Agricultural price supports

Impact of a Price Ceiling


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Full Economic Price

The dollar amount paid to a firm under a price ceiling, plus the nonpecuniary price. PF = Pc + (PF - PC) PF = full economic price PC = price ceiling PF - PC = nonpecuniary price

An Example from the 1970s

Ceiling price of gasoline - $1 3 hours in line to buy 15 gallons of gasoline

o Opportunity cost: $5/hro Total value of time spent in line: 3 $5 = $15o Non-pecuniary price per gallon: $15/15=$1

Full economic price of a gallon of gasoline: $1+$1=2

Impact of a Price Floor

Comparative Static Analysis

How do the equilibrium price and quantity change when a determinant of supplyand/or demand change?

Applications of Demand and Supply Analysis

Event: The WSJreports that the prices of PC components are expected to fall by 5-8percent over the next six months.

Scenario 1: You manage a small firm that manufactures PCs. Scenario 2: You manage a small software company.


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Use Comparative Static Analysis to see the Big Picture!

Comparative static analysis shows how the equilibrium price and quantity willchange when a determinant of supply or demand changes.

Scenario 1: Implications for a Small PC Maker

Step 1: Look for the Big Picture Step 2: Organize an action plan (worry about details)

Big Picture: Impact of decline in component prices on PC market

So, the Big Picture is:o PC prices are likely to fall, and more computers will be sold

Use this to organize an action plano contracts/suppliers?o inventories?o human resources?o marketing?o do I need quantitative estimates?o etc.

Scenario 2: Software Maker More complicated chain of reasoning to arrive at the Big Picture Step 1: Use analysis like that in Scenario 1 to deduce that lower component prices

will lead too a lower equilibrium price for computerso a greater number of computers sold.

Step 2: How will these changes affect the Big Picture in the software market?


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Big Picture: Impact of lower PC prices on the software market

The big picture for the software maker:o Software prices are likely to rise, and more software will be sold

Use this to organize an action planSummary

Use supply and demand analysis too clarify the big picture (the general impact of a current event on equilibrium

prices and quantities)o organize an action plan (needed changes in production, inventories, raw

materials, human resources, marketing plans, etc.)


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Chapter 7. The Elasticity of Demand

The Concept of Elasticity:Elasticity is a measure of the responsiveness of one variable to another.

The greater the elasticity, the greater the responsiveness.

Laugher Curve

Q. Whats the difference between an economist and a befuddled old man with Alzheimers?

A. The economist is the one with a calculator.

Price Elasticity

Theprice elasticity of demandis the percentage change in quantity demandeddivided by the percentage change in price.

Sign of Price Elasticity

According to the law of demand, whenever the price rises, the quantity demandedfalls. Thus the price elasticity of demand is always negative.Because it is always negative, economists usually state the value without the sign.

What Information Price Elasticity Provides

Price elasticity of demand and supply gives the exact quantity response to a change inprice.

Classifying Demand and Supply as Elastic or Inelastic

Demand is elasticif the percentage change in quantity is greater than the

percentage change in price.E >1

Classifying Demand and Supply as Elastic or Inelastic

Demand is inelasticif the percentage change in quantity is less than the percentagechange in price.

E


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Elastic Demand

Elastic Demand means that quantity changes by a greater percentage than the percentagechange in price.

Inelastic Demand

Inelastic Demand means that quantity doesn't change much with a change in price.

Defining elasticities

When price elasticity is between zero and -1 we say demand is inelastic.When price elasticity is between -1 and - infinity, we say demand is elastic.When price elasticity is -1, we say demand is unit elastic.

Elasticity Is Independent of Units

Percentages allow us to have a measure of responsiveness that is independent of units.This makes comparisons of responsiveness of different goods easier.

Calculating Elasticities

To determine elasticity divide the percentage change in quantity by the percentage changein price.

The End-Point Problem

The end-point problem the percentage change differs depending on whether you viewthe change as a rise or a decline in price.Economists use the average of the end points to calculate the percentage change.

2112

12

12

P+P)P-(P

QQ)Q-(Q

=Elasticity


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Graphs of Elasticities

Elasticity of demand between A and B = 1.27

Calculating Elasticities: Price elasticity of Demand

Price Elasticity: SupplyPrice elasticity of supply is the percentage change in quantity supplied divided by thepercentage change in


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Price Elasticity: Supply

Supply is elastic if the percentage change in quantity isgreater than the percentage changein price

Elastic supply is when ES > 1

Supply is inelastic if the percentage change in quantity is less than the percentage changein price

Inelastic supply is when ES < 1

Calculating Elasticities: Price elasticity of Supply

Graphs of Elasticities


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Calculating Elasticity

Calculating Elasticity of Demand Between Two Points

Calculating Elasticity of Supply Between Two Points

)(

)(

P%

Q%

2121

12

2121

12

PP

PP

QQ

QQ

E


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Calculating Elasticity at a Point

Let us now turn to a method of calculating the elasticity at a specific point, rather than overa range or an arc.To calculate elasticity at a point, determine a range around that point and calculate the arc

elasticity.




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Elasticity and Demand Curves

Two important points to consider:Elasticity is related (but is not the same as) slope.Elasticity changes along straight-line demand and supply curves.


Elasticity Is Not the Same as Slope

The steeper the curve at a given point, the less elastic is supply or demand.There are two limiting examples of this.When the curves are flat, we call the curves perfectly elastic.

The quantity changes enormously in response to a proportional change in price (E =innfinity).When the curves are vertical, we call the curves perfectly inelastic.The quantity does not change at all in response to an enormous proportional change inprice (E = 0).

Perfectly Inelastic Demand Curve


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Perfectly Elastic Demand Curve

Demand Curve Shapes and Elasticity

Perfectly Elastic Demand Curve

The demand curve is horizontal, any change in price can and will cause consumersto change their consumption.

Perfectly Inelastic Demand Curve

The demand curve is vertical, the quantity demanded is totally unresponsive to theprice. Changes in price have no effect on consumer demand.

In between the two extreme shapes of demand curves are the demand curves for mostproducts.

Demand Curve Shapes and Elasticity


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Elasticity Changes Along Straight-Line Curves

Elasticity is not the same as slope. Elasticity changes along straight line supply and demand curvesslope does not.

Elasticity Along a Demand Curve

The Price Elasticity of Demand Along a Straight-line Demand Curve


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Substitution and Elasticity

As a general rule, the more substitutes a good has, the more elastic is its supply anddemand.

Substitution and Demand

The less a good is a necessity, the more elastic its demand curve.Necessities tend to have fewer substitutes than do luxuries.Demand for goods that represent a large proportion of one's budget are more elastic thandemand for goods that represent a small proportion of one's budget.Goods that cost very little relative to your total expenditures are not worth spending a lotof time figuring out if there is a good substitute.The larger the time interval considered, or the longer the run, the more elastic is the goods

demand curve.

There are more substitutes in the long run than in the short run.The long run provides more options for change.

Determinants of the Price Elasticity of Demand

The degree to which the price elasticity of demand is inelastic or elastic depends on:How many substitutes there areHow well a substitute can replace the good or service under considerationThe importance of the product in the consumers total budgetThe time period under consideration.

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