Chapter 3_Week 1 (1).pptx

Part 2 THE THEORY OF COMPETITIVE MARKETS FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 3 THE MARKET FORCES OF SUPPLY AND DEMAND FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CE...

Part 2 THE THEORY OF COMPETITIVE MARKETS FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 3 THE MARKET FORCES OF SUPPLY AND DEMAND FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 I. Market Forces Of Supply And Demand FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Introduction to Supply and Demand o Supply and demand are the forces that make market economies work. o Supply and demand determine prices in a market economy and how prices, in turn, allocate the economy’s scarce resources. o The model of the market based on supply and demand, like any other model, is based on a series of assumptions. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 II. The Assumptions of the Competitive Market Model FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Supply and Demand The terms supply and demand refer to the behaviour of people as they interact with one another in markets. A market is a group of buyers and sellers of a particular good or service. A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price. (none of them can set or change prices). FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Assumption for Efficient Outcomes o The model of supply and demand which leads to this ‘efficient’ outcome is based on the following: o Many buyers and sellers. o Perfect information for all buyers and sellers. o Freedom of entry and exit. o Identical goods. o Buyers and sellers act in self interest. o Clearly defined property rights. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Competitive Markets A market in which there are many buyers and many sellers so that each has a negligible impact on the market price. Characteristics of a perfectly competitive market: o All goods for sale are the same. o No buyer or seller can influence market price on their own. Because buyers and sellers must accept the market price as given, they are often called "price takers." FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Market Spectrum Four types of market structures considering the market power and the concentration of production and distribution:     Perfect Monopolisti Oligopoly Monopoly competitiv c e market Competitio n FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 III. Demand FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Demand Curve: The Relationship between Price and Quantity Demanded Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand is the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises. Demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Demand Curve: The Relationship between Price and Quantity Demanded Price of milk per litre (€) Quantity of milk Figure 3.1 demanded (litres per month) (Table 1). 0.00 20 Rachel’s 0.10 18 Demand 0.20 16 Schedule 0.30 14 0.40 12 0.50 10 0.60 8 0.70 6 0.80 4 0.90 2 1.00 0 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 1. Rachel’s Demand Schedule and Demand Curve The demand curve is a graph of the relationship between the price of a good and the quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Movement Along the Demand Curve Assume the price of milk falls. o More will be demanded because of the income and substitution effects. o The income effect. Assume that incomes remain constant. A fall in the price of milk means that consumers can now afford to buy more with their income. o The substitution effect. Milk is lower in price compared to other similar products, so some consumers will choose to substitute the more expensive drinks with the now cheaper milk. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Market Demand Versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 IV. Shifts Versus Movements Along the Demand Curve FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Introduction to Shifts and Movements o Ceteris paribus - other factors affecting demand are held constant so that we can analyze the effect of a change in price on demand. o A shift in the demand curve is caused by a factor affecting demand other than a change in price. (exogenous variables) o Movement along the demand curve. o Caused by a change in the price of the product. (endogenous variable) FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 A Shift in the Demand Curve o A shift in the demand curve, to the left or right. o Caused by any change that alters the quantity demanded at every given price. o Shifts caused by factors other than price. 1) Prices of related goods (substitutes and complements). o Substitutes: two goods for which an increase in the price of one good leads to an increase in the demand for the other. o Complements: two goods for which an increase in the price of one good leads to a decrease in the demand for the other. Continued on next slide FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 A Shift in the Demand Curve 2) Income o A lower income means that you have less to spend in total, so you would have to spend less on some – and probably most – goods. o If the demand for a good falls when income falls or rises, as income rises, the good is called a normal good. o If the demand for a good rises when income falls, the good is called an inferior good. 3) Tastes. More people may like something. 4) Size and structure of the population. 5) Advertising. 6) Expectations of consumers: where demand is influenced by expectations of future income and future prices. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 2. Shifts in the Demand Curve FORUSE FOR USEWITH WITHMANKIW MANKIWAND ANDTAYLOR, TAYLOR,ECONOMICS ECONOMICS4TH 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 EDITION 9781473725331 © CENGAGE EMEA 2017 Figure 3. Consumer Income Inferior Good Price inferior good € 1.50 An increase 1.0 in income... 0 Decrease in demand 0.5 0 D2 D1 Quantity of inferior 0 1 2 3 4 5 6 7 8 9 10 11 12 good FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Table 1 Variables That Influence Buyers Copyright Copyright©2010 © 2014 Cengage Cengage Learning V. Supply FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Supply Curve: The Relationship between Price and Quantity Supplied Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of supply is the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Supply Curve: The Relationship between Price and Quantity Supplied The supply curve is the graph of the relationship between the price of a good and the quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Supply Curve: The Relationship between Price and Quantity Supplied Price of milk per litre (€) Quantity of milk supplied (litres per month) Figure 3.4 0.00 0 (Table 2): 0.10 0 Richard’s 0.20 2 Supply 0.30 4 Schedule 0.40 6 0.50 8 0.60 10 0.70 12 0.80 14 0.90 16 1.00 18 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 4. Richard’s Supply Curve FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Table 3. Market Supply Versus Individual Supply Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 5. The Market Supply Graphically, individual supply curves are summed horizontally to obtain the market supply curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Movement along the Supply Curve Change in Quantity Supplied ◦Movement along the supply curve. ◦A change in the price of a product from one price level to another causes the quantity supplied to change from one level to another illustrated by a movement along the supply curve). (endogenous variable) FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Change in Quantity Supplied Price of S milk C €1.50 A rise in the price milk results in a movement along the supply curve. A €0.6 0 Quantity of 0 milk 1 5 Shifts in the Supply Curve o The supply curve shows how much producers offer for sale at any given price, holding constant all other factors that may influence producers’ decisions about how much to sell. o When any of these other factors change, the supply curve will shift. (exogenous variables) o These are shown on the next slide. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Shifts in the Supply Curve 1) Profitability of other goods in production and prices of goods in joint supply. 2) Technology. 3) Natural/Social Factors such as the weather and changing attitudes. 4) Input prices – the prices of the factors of production. 5) Expectations of producers about the future state of the market. 6) A change in the number of sellers in the market. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Shifts in the Supply Curve Change in Supply o A shift in the supply curve, either to the left or right. o Caused by a change in a determinant other than price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 6. Shifts in the Supply Curve Price of milk Supply curve, S3 Supply curve, S1 Supply Decrease curve, S2 in supply Increase in supply 0 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Table 2 Variables That Influence Sellers Copyright © 2014 Cengage Learning VI. Supply And Demand Together FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Equilibrium Equilibrium Price o The price that balances quantity supplied and quantity demanded. o On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity o The quantity supplied and the quantity demanded at the equilibrium price. o On a graph it is the quantity at which the supply and demand curves intersect. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 7. The Equilibrium of Supply and Demand FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Equilibrium Surplus o When price > equilibrium price, then quantity supplied > quantity demanded. o There is excess supply or a surplus. o Suppliers will lower the price to increase sales, thereby moving toward equilibrium. Shortage o When price < equilibrium price, then quantity demanded > the quantity supplied. o There is excess demand or a shortage. o Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 8. Markets Not in Equilibrium FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Equilibrium Law of supply and demand o The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 VII. Prices as Signals FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Prices as Signals to Buyers and Sellers The main function of price in a free market is to act as a signal to both buyers and sellers. o For buyers, price tells them something about what they have to give up (usually an amount of money) to acquire the benefits. o Price rise changes the nature of the trade-off buyers face. o For sellers, price acts as a signal in relation to the profitability of production. o Price rises for sellers indicates a shortage so will increase production. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 VIII. Analyzing Changes in Equilibrium FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Three Steps to Analyzing Changes in Equilibrium Shifts in Curves versus Movements along Curves. o A shift in the supply curve is called a change in supply. o A movement along a fixed supply curve is called a change in quantity supplied. o A shift in the demand curve is called a change in demand. o A movement along a fixed demand curve is called a change in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Three Steps to Analyzing Changes in Equilibrium 1) Decide whether the event shifts the supply or demand curve (or both). 2) Decide whether the curve(s) shift(s) to the left or to the right. 3) Use the supply and demand diagram to see how the shift affects equilibrium price and quantity. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 9. How an Increase in Demand Affects the Equilibrium FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 10. How a Decrease in Supply Affects the Equilibrium FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Table 4: What Happens to Price and Quantity When Supply or Demand Shifts? FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 VX. Elasticity FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Elasticity: An Introduction Elasticity: o Allows us to analyze supply and demand with greater precision. o Is a measure of how much buyers and sellers respond to changes in market conditions. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 IX. The Price Elasticity of Demand FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  The Price Elasticity of Demand and its Determinants Price elasticity of demand is a Determinants of price elasticity measure of how much the of demand include: quantity demanded of a good responds to a change in the o Availability of close price of that good. substitutes. Price elasticity of demand is the o Necessities versus luxuries. percentage change in quantity demanded given a one percent o Definition of the market. change in the price. o Proportion of income devoted to the product. o Time horizon. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Price Elasticity of Demand and its Determinants Demand tends to be more elastic: o the larger the number of close substitutes. o if the good is a luxury. o the more narrowly defined the market. o the longer the time period. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Computing the Price Elasticity of Demand The price elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in price. o Example: The price of breakfast cereal rises by 10% and quantity demanded falls by 20%. Price elasticity of demand = (20%)/(10%) = 2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Calculating Price Elasticity The midpoint method is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. o Example: the price rises from €4 to €6 and quantity demanded falls from 120 to 80. o % change in price = (6 - 4)/5 × 100% = 40% o % change in quantity demanded = (120-80)/100 = 40% o price elasticity of demand = 40/40 = 1 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Calculating Price Elasticity The point elasticity of demand method measures elasticity at a particular point on the demand curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Variety of Demand Curves Price Inelastic Demand o Quantity demanded does not respond strongly to price changes. o Price elasticity of demand is less than one. Price Elastic Demand o Quantity demanded responds strongly to changes in price. o Price elasticity of demand is greater than one. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  The Variety of Demand Curves 1. Perfectly Price Inelastic o Quantity demanded does not respond to price changes. 2. Perfectly Price Elastic o Quantity demanded changes infinitely with any change in price. 3. Unit Price Elastic o Quantity demanded changes by the same percentage as the price. Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve. o This is shown in the next few slides. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 gure 11. a Perfectly Price Inelastic Demand: Elasticity Equals Price Demand €5 4 1. An increase in price... 0 100 Quantity 2.... leaves the quantity demanded unchanged. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 12 (b) Price Inelastic Demand: Elasticity is Less Than 1 Price €5 4 1. A 22% Demand increase in price... 0 90 100 Quantity 2.... leads to an 11% decrease in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 13 c. Unit Elastic Demand: Elasticity Equals 1 Price €5 4 1. A 22% Demand increase in price... 0 80 100 Quantity 2.... leads to a 22% decrease in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 14d. Price Elastic Demand: Elasticity Is Greater Than Price €5 4 Demand 1. A 22% increase in price... 0 50 100 Quantity 2.... leads to a 67% decrease in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 ure 15e. Perfectly Price Elastic Demand: Elasticity Equals Infi Price 1. At any price above €4, quantity demanded is zero. €4 Demand 2. At exactly €4, consumers will buy any quantity. 0 Quantity 3. At a price below €4, quantity demanded is infinite. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Total Expenditure, Total Revenue and the Price Elasticity of Demand Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 16. Total Revenue Price €4 P × Q = €400 P (revenue) Demand 0 100 Quantity Q FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Price Elasticity and Total Revenue along a Linear Demand Curve With a price inelastic demand curve: o An increase in price…. o …leads to a decrease in quantity that is proportionately smaller. o Thus, total revenue increases. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 17. Total Revenue Changes When Price Changes: Price Inelastic Demand Price Price An Increase in price from €1 … leads to an Increase in to €3 … total revenue from €100 to €240 €3 Revenue = €240 €1 Revenue = €100 Demand Demand 0 100 Quantity 0 80 Quantity FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 18. How Total Revenue Changes When Price Changes: Price Elastic Demand Price Price An Increase in price from €4 … leads to a decrease in to €5 … total revenue from €200 to €100 €5 €4 Demand Demand Revenue = €200 Revenue = €100 0 50 Quantity 0 20 Quantity FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Table 5. Elasticity and Total Revenue along a Linear Demand Curve o At points with a low price and a high quantity, demand is inelastic. o At points with a high price and a low quantity, demand is elastic. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 X. Other Demand Elasticities FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Income Elasticity of Demand Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income. Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Income Elasticity of Demand Demand for goods consumers regard as necessities tends to be income inelastic. o Examples include food, fuel, clothing, utilities, and medical services. Demand for goods consumers regard as luxuries tends to be income elastic. o Examples include sports cars, furs, and expensive foods. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Cross-Price Elasticity of Demand The cross-price elasticity of demand measures how much the quantity demanded of one good responds to a change in the price of another good. It is computed as the percentage change in quantity demanded of the first good, divided by the percentage change in the price of the second good. o Substitutes have positive cross-price elasticities. o Complements have negative cross-price elasticities. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 XI. Price Elasticity of Supply FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Price Elasticity of Supply and its Determinants Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied, resulting from a one percent change in price. Determinants: o Time period. Supply is more price elastic in the long run. o Productive capacity and the ability of sellers to change the amount of the good they produce. o Size of the firm or industry. o Mobility of the factors of production. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Example: A rise in price of bicycles of 10 per cent increases supply by 15 per cent. Price elasticity of supply = (15%)/(10%) = 1.5 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Computing the Price Elasticity of Supply The midpoint method measures the price elasticity of supply between two points, denoted (Q1, P1) and (Q2, P2): The point elasticity of supply method measures elasticity at a particular point on the supply curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 The Variety of Supply Curves In general, the flatter the slope of the supply curve that passes through a given point, the more elastic the supply. This is best shown diagrammatically as in the next few slides. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 19 a. Perfectly Priced Inelastic Supply: Elasticity Equa Price Supply €5 4 1. An increase in price... 0 100 Quantity 2.... leaves the quantity supplied unchanged. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 19 b. Price Inelastic Supply: Elasticity is Less Than 1 Price Supply €5 4 1. A 22% increase in price... 0 100 110 Quantity 2.... leads to a 10% increase in quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 19c. Unit Elastic Supply: Elasticity Equals 1 Price Supply €5 4 1. A 22% increase in price... 0 100 125 Quantity 2.... leads to a 22% increase in quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 19d. Price Elastic Supply: Elasticity is Greater Than 1 Price Supply €5 4 1. A 22% increase in price... 0 100 200 Quantity 2.... leads to a 67% increase in quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 gure 19e. Perfectly Price Elastic Supply: Elasticity Equals Infi Price 1. At any price above €4, quantity supplied is infinite. €4 Supply 2. At exactly €4, producers will supply any quantity. 0 Quantity 3. At a price below €4, quantity supplied is zero. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 20. Total Revenue and the Price elasticity of Supply When studying changes in supply in a market, we are often interested in the resulting changes in the total revenue received by producers. Total revenue received by sellers is P × Q, the price of the good times the quantity of the good sold. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 XII. Applications of Supply and Demand Elasticity FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023  Figure 21. Why does the Price of Train Travel Vary at Different Times of the Day? o Figure 21 Panel a) Peak time travel: Demand is price inelastic, so tickets are expensive. o Figure 21 Panel b) Off peak time travel: Demand is price elastic, so to maximize revenues ticket prices are lowered. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Figure 22. Why Have Farmers’ Incomes Fallen Despite Increases in Productivity? Figure 22: Increased productivity in farming has lead to… o Considerable rise in supply S1 to S2, but only a small rise in demand from D1 to D2 o Result = lower prices for farmers. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Useful Advice 1) Examine whether the supply or demand curve shifts. 2) Determine the direction of the shift of the curve. 3) Use the supply and demand diagram to see how the market equilibrium changes. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Summary 1) Economists use the model of supply and demand to analyze competitive markets. 2) In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price. 3) The demand curve shows how the quantity of a good depends upon the price. 4) The supply curve shows how the quantity of a good supplied depends upon the price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Summary 5) Market equilibrium is determined by the intersection of the supply and demand curves. 6) At the equilibrium price, the quantity demanded equals the quantity supplied. 7) The behaviour of buyers and sellers naturally drives markets toward their equilibrium. To analyze how any event influences a market, we use the supply and demand diagram to examine how the even affects the equilibrium price and quantity. 8) In market economies, prices are the signals that guide economic decisions and thereby allocate resources. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Summary 9) Price elasticity of demand measures how much the quantity demanded responds to changes in the price. 10) Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. 11) If a demand curve is elastic, total revenue falls when the price rises. 12) If it is inelastic, total revenue rises as the price rises. 13) The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023 Summary 14) The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. 15) The price elasticity of supply measures how much the quantity supplied responds to changes in the price. 16) In most markets, supply is more price elastic in the long run than in the short run. 17) The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. 18) The tools of supply and demand can be applied in many different types of markets. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 6TH EDITION 9781473786981 © CENGAGE EMEA 2023