Lecture 3

1. Lecture 3

2. Changes in Demand and Supply Movement along the curve • If there is change in price then there will be a movement along the demand and supply curve. Shift of the curve • If there is a change in any factor/ variable other than price (such as: income, taste, price of other goods like substitute and complementary good etc.) then there will be a shift in the curve.

3. Determination of Equilibrium • The point at which demand curve cuts supply curve is the equilibrium. Equilibrium price and quantity are determined from equilibrium point. • It shows stability. • Any price greater than equilibrium price will create excess supply which is a unstable situation. In this case price needs to fall to attain equilibrium. • Any price lower than equilibrium price will create excess demand. In this case price needs to increase to attain equilibrium.

4. Excess Supply • If price is higher than equilibrium price then quantity supplied will be greater than quantity demanded. So in this case there will an excess supply in the market that is producers can’t sell their products. • Competition among producers to increase sales leads to a downward pressure on price and so they need to lower the price to sell out their product. • If the price decreases then the quantity demanded increases and quantity supplied decreases. So the excess supply decreases ( the gap between supply and demand curve decreases). This process will continue until equilibrium price is reached where quantity demanded is equal to quantity supplied.

5. Excess Demand • If price is lower than equilibrium price then quantity demanded will be greater than quantity supplied. So in this case there will an excess demand in the market. • To meet the excess demand, producer will increase the supply but they will do this if they get a higher price. So there is an upward pressure on price. • When the price increases the quantity demanded decreases and quantity supplied increases. So the excess demand decreases. This process will continue until equilibrium price is reached where quantity demanded is equal to quantity supplied.

6. Change in equilibrium due to shift in demand • If there is a rightward shift in demand ( say for an increase in income) then a new equilibrium will restore at a higher price and higher quantity.

7. Change in equilibrium due to shift in Supply • If there is a rightward shift in Supply ( say for an increase in production due to good weather) then a new equilibrium will restore at a lower price and higher quantity.

8. Change in equilibrium due to shift in both demand and supply • Suppose there is a shift in demand which leads to a new equilibrium at E2. This leads to a higher price P2 and a higher quantity Q2. To stabilize the price we can increase the supply which will change the equilibrium to E3 where the price has got back to its initial value of P1 and quantity is increased further to Q3.

9. Demand and Supply Equation and Determination of Equilibrium Price and Quantity • Demand: Qd= 286 − 20p • Supply: Qs = 88 + 40p • In Equilibrium: Qd = Qs 286 − 20p = 88 + 40p 60p = 198 P = 3.30 So Equilibrium Price = 3.30 And Q = 286 – 20(3.3) = 220 So Equilibrium Quantity=220

10. ElasticityGeneral Concept • Elasticity means responsiveness. It shows how responsive one variable is due to the change in another variable. • In economics, elasticity is the measurement of how changing one economic variable affects others. For example: • "If I lower the price of my product, how much more will I sell?“ • Or, "If I raise the price, how much less will I sell?”

11. Suppose, X is the independent variable and Y is the dependent variable. So when X changes it leads to a change in Y. Elasticity shows how responsive Y is to the change of X. • How to calculate elasticity? • Elasticity is the percentage change in Y due to 1% percentage change in X. • Formula: • Elasticity =

12. Elasticity in Economics Price Elasticity: Here we consider how a change in the price of a good affects the quantity ( demanded or supplied) of that good. Def: It is the percentage change of quantity due to the 1% change in its own price. Formula: Price Elasticity=

13. Value of Elasticity Price Elasticity of Demand: Price elasticity of demand is always negative. Why? • Because of negative relationship between price and quantity demanded. • The range of value of price elasticity of demand is from 0 to negative infinity. Price Elasticity of Supply: Price elasticity is supply always positive. Why? • Because of positive relationship between price and quantity supplied. - The range of value of price elasticity of supply is from 0 to positive infinity.

14. Elastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by more than 1%. The value of elastic demand is between -1 and negative infinity. • Inelastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by less than 1%. The value of inelastic demand is in between 0 and -1. • Unit Elastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by exactly 1%. The value of inelastic demand is exactly -1.

15. Elastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by more than 1%. The value of elastic supply is between 1 and positive infinity. • Inelastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by less than 1%. The value of elastic supply is in between 0 and 1. • Unit Elastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by exactly 1%. The value of unit elastic supply is exactly 1.