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Understanding Market Dynamics and Elasticity of Demand

Learn about the interaction of buyers and sellers in markets and the impact of price changes on demand and supply. Explore concepts such as elasticity, equilibrium, and factors influencing price responsiveness.

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Understanding Market Dynamics and Elasticity of Demand

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  1. ECON 160 Week 5 February 16-18, 2010

  2. Review • Markets are the interaction of buyers and sellers. • Focus on buyers and sellers separately. • Ceteris paribus: look at one thing at a time; All other things held equal.

  3. Demand for X $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx Demand shows the amounts purchased at alternative prices(horizontal distances at each price) Demand x Dx Qtyx /T 1 2 3 4 5 6 7 8 9 10

  4. Supply Curve $Price $10 8 6 4 2 2 4 6 8 10 12 14 16 Qty x/ T

  5. $Price $ 4 3 2.50 2.00 1.50 1.00 .50 .25 Demand Surplus at this $ Price Supply 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

  6. $Price $ 4 3 2.50 2.00 1.50 1.00 .50 .25 Demand Supply Shortage at this $ Price 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

  7. Market Equilibrium $Price 4 3 2.50 2.00 1.50 Pe 1.00 .50 .25 Demand Supply Qty D = Qty S 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T Qe

  8. Total Revenue = P X Q $ P x Demand $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Supply Pe $6x5 = $30 Dx Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe

  9. Effects of Increase in Demand on Price and Quantity $ P x D1 Do $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Supply Increases Price and Quantity Pe D1 Sx Do Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe

  10. Effects of an Increase in Supply on Price and Quantity $ P x S0 Demand $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 S1 Pe Price decreases and Quantity increases S0 Dx S1 Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe

  11. Slope Shows Responsiveness of Quantity to a Change in Price B A Px Px P0 P0 Dx P1 P1 Dx Q0Q1 Qx/T Q0 Qx/T Q1

  12. Slope of Supply Shows responsiveness of quantity to a change in Price A B Px Px P1 P1 P0 P0 Qx/T Q0 Qx/T Q1 Q0 Q1

  13. Elasticity: a Measure of responsiveness of Quantity to a Change in Price • Ed = % Δ Qd/ % Δ price • Es = %  Qs / %  price

  14. Measures of Elasticity • Demand is Elastic : %Δ Qd > %Δ P; ie |Ed| >1. A decrease in Price  an increase in Total Revenue. • Demand is Unitary Elastic: %ΔQd = %ΔP; ie |Ed| = 1. A Change in price  no change in Total Revenue. • Demand is Inelastic: %ΔQd < %ΔP; i.e. |Ed| < 1. An increase in Price  an increase in Total Revenue.

  15. Elasticity, Price Change & Total Revenue Elastic Inelastic $Px $Px P1 P0 P0 P1 Qty/T Q0 Q1 Q1 Q0

  16. Increased Demandwith elastic Supply $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx Pe` Pe Sx Sx Dx` Dx Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qe`

  17. Increased Demand ,Inelastic Supply $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Sx Dx Pe’ Pe Dx’ Sx Dx Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe Qe’

  18. Decrease in Supply, Elastic Demand $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Sx’ Dx Sx Pe` Pe Dx Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe` Qe

  19. Decrease in Supply, Inelastic Demand $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx Sx’ Sx Pe’ Pe Dx Qtyx /T 1 2 3 4 5 6 7 8 9 10 11 12 Qe’ Qe

  20. Determinants of Price Elasticity of Demand • Number & Closeness of Substitutes. • Information about price change and availability of substitutes. • Percentage of Income Spent on good. • Period of time: Second Law of Demand: Demand is more elastic over a longer period of time.

  21. Other Elasticity's A Measure of responsiveness of Quantity to a Change in some other factor

  22. Income Elasticity: Measure of responsiveness of Quantity to a Change in Income • EdI = % Δ Qd/ % Δ income • EdI = 100 * ΔQ/Q = I * ΔQ 100 * ΔI/I Q * ΔI • Normal Goods: Positive • Clothing: .95: 10%  income → 9.5%  • Stereo: 27.2: 10%  income → 27.2%  • Increase may be Quantity or Quality • Inferior Goods: Negative

  23. Cross Price Elasticity: Measure of responsiveness of Quantity to a Change Price of other good • Exy = % Δ Qx/ % Δ Py • EdI = 100 * ΔQx/Qx = Py * ΔQx 100 * ΔPy/Py Qx * ΔPy • Substitutes: Positive • Complements: Negative

  24. Uses of Cross Price Elasticity • Magnitude of cross price elasticity reflects closeness of substitutes or complements • Able to identify your closest competitors • Courts use cross-price to measure monopoly power

  25. Transaction Costs of Exchange • Information Costs • Search Costs • Quality Identification Cost • Negotiating Costs: Cost of agreeing on what and how much will be exchanged • Transportation Costs: Cost of moving goods between parties

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