Transcript Slide 1
University of Greenwich Business school MSc in Financial Management and Investment Analysis Economics 1112 Economics for Finance and Investment Analysis October 2008 Doc. 1 – Demand and Supply Dr M. Pourhosseini Quantity demanded Quantity demanded The amount of a good a consumer is willing and able to buy at a given price over a given period of time. Demand curve A graph showing the relationship between the price of a good and the quantity of the good demanded over a given time period. Price is measured on the vertical axis; quantity demanded is measured on the horizontal axis. A demand curve can be for an individual consumer or group of consumers, or more usually for the whole market. Demand function Demand function An equation which shows the mathematical relationship between the quantity demanded of a good and the values of the various determinants of demand. Demand We show graphically, using a demand curve, how demand is related to price. Explain why demand curves are downward sloping, using the concepts of income and substitution effects of a price change. Distinguish the causes of shifts in and movements along the demand curve (and not confuse the two). Income effect (of a price change ) The effect of a change in price on quantity demanded arising from the consumer becoming better or worse off as a result of the price change. The difference between change in demand and change in quantity demanded Change in demand This is the term used for a shift in the demand curve. It occurs when a determinant of demand other than price changes. Change in the quantity demanded The term used for a movement along the demand curve to a new point. It occurs when there is a change in price. The difference between change in supply and change in quantity supplied Change in supply The term used for a shift in the supply curve. It occurs when a determinant other than price changes. Change in the quantity supplied The term used for a movement along the supply curve to a new point. It occurs when there is a change in price. 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 Other determinants of demand – tastes – number and price of substitute goods – number and price of complementary goods – income – distribution of income – expectations An increase in demand Price P D0 O Q0 Q1 Quantity D1 fig 2.2 DEMAND Demand functions – simple demand functions Qd = a – bP – more complex demand functions Qd = a – bP + cY + dPs – ePc – demand functions and the demand curve 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 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 Supply Show graphically, using a supply curve, how supply is related to price. Explain why supply curves are generally upward sloping. Distinguish the causes of shifts in and movements along the supply curve. Supply curve Supply curve A graph showing the relationship between the price of a good and the quantity of the good supplied over a given period of time. Supply schedule A table showing the different quantities of a good that producers are willing and able to supply at various prices over a given time period. A supply schedule can be for an individual producer or group of producers, or for all producers (the market supply schedule). 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 Supply functions – simple supply functions Qs = a + bP – more complex supply functions Qs = a + bP + cC + dPs – ePj – non-linear functions – estimated supply equations – problems of estimating supply equations Shifts in the supply curve P S2 Decrease S0 S1 Increase O Q fig Equilibrium price The price where the quantity demanded equals the quantity supplied: the price where there is no shortage or surplus. Equilibrium in a market : Price and output determination So far we have shown how price and output are determined by the interaction of demand and supply. the effects of changes in the determinants of demand and/or supply on equilibrium price and quantity. Supply and Demand We now turn to the concept of Elasticity Elasticity What is Elasticity A measure of the responsiveness of a variable (e.g. quantity demanded or quantity supplied) to a change in one of its determinants (e.g. price or income Elasticity the concept of elasticity is measured in proportionate or percentage terms. we also discuss how to measure the specific concepts of price, income and cross-price elasticities of demand and price elasticity of supply. Identify the determinants of the various elasticities and explain why they affect elasticity the way they do. Elastic demand Elastic demand (with respect to price) Where quantity demanded changes by a larger percentage than price. Ignoring the negative sign, it will have a value greater than 1. ELASTICITY Defining elasticity – the responsiveness of demand and supply Price elasticity of demand – the responsiveness of demand to a change in price Market supply and demand Price S1 a P1 The effect on price of a shift in supply depends on the responsiveness of demand to a change in price. D O Q1 Quantity fig Market supply and demand S2 S1 Price b P2 a P1 D O Q2 Q1 Quantity fig Market supply and demand S2 S1 Price b P2 c P3 a D' P1 D O Q3 Q2 Q1 Quantity fig 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) 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) Price elasticity of demand and supply Price elasticity of demand (PεD) The percentage (or proportionate) change in quantity demanded divided by the percentage (or proportionate) change in price: %ΔQD ÷ %ΔP. Price elasticity of supply (PεS) The percentage (or proportionate) change in quantity supplied divided by the percentage (or proportionate) change in price: %ΔQS ÷ %ΔP. Totally inelastic demand (PD = 0) P D P2 b P1 a O Q1 Q fig Infinitely elastic demand (PD = ) P a b D P1 O Q1 Q2 Q fig Unit elastic demand (PD = –1) P Expenditure stays the same as price changes 20 a b 8 D O 40 100 Q fig Arc elasticity What is arc elasticity The measurement of elasticity between two points on a curve Income elasticity of demand Income elasticity of demand – measurement QS/QS ÷ P/P – determinants degree of necessity proportion of income spent on the good – applications Cross-price elasticity of demand Cross-price elasticity of demand – – measurement QDa/QDa ÷ Pb/Pb determinants closeness as substitutes or complements Income elasticity of demand The percentage (or proportionate) change in quantity demanded divided by the percentage (or proportionate) change in income. Income elasticity of demand (arc formula) ΔQD/average QD ÷ ΔY/average Inelastic demand Where quantity demanded changes by a smaller percentage than price. Ignoring the negative sign, it will have a value less than 1. Price elasticity of demand and supply (arc formula) Price elasticity of supply (arc formula) ΔQS/average QS ÷ ΔP/average P. Price elasticity of demand (arc formula) ΔQ/average Q ÷ ΔP/average P. The average in each case is the average between the two points being measured. Unit elastic demand Unit elastic demand Where quantity demanded changes by the same percentage as price. Ignoring the negative sign, it will have a value equal to 1. MARGINAL UTILITY THEORY Total and marginal utility – meaning of total utility – marginal utility: TU/Q – diminishing marginal utility total and marginal utility curves Marginal Utilities Marginal means “incremental”. The marginal utility of commodity i is the rateof-change of total utility as the quantity of commodity i consumed changes; i.e. U MU i xi Diminishing marginal rate of substitution The more a person consumes of good X and the less of good Y, the less additional Y will that person be prepared to give up in order to obtain an extra unit of X: i.e. ΔY/ΔX diminishes.