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Understanding Markets: Demand, Supply, and Price Elasticity

Learn how buyers and sellers interact, analyze demand and supply curves, explore price elasticity concepts, and understand market equilibrium dynamics.

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Understanding Markets: Demand, Supply, and Price Elasticity

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  1. ECON 308 Week 4 September 14 - 16, 2010 Chapter 4

  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. 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

  9. 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

  10. 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

  11. 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

  12. 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

  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. 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.

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

  27. 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

  28. 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

  29. 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

  30. Network Effects • Demand for a good increases as the number of users of the good increases • fax machines • High Definition DVD versus Blu-Ray 4-30

  31. Product Attributes • Managers must understand consumer demand • What product attributes are important to consumers? • price • product design • packaging • promotion 4-31

  32. Product Life Cycle Q Introduction Growth Maturity Decline Industry quantity of output Product life cycle T Time 4-32

  33. Demand Estimation • Three general techniques • interviews • surveys, focus groups, questionnaires • price experimentation • track changes in sales when prices change • statistical analysis • must account for omitted variables and other issues 4-33

  34. 2006 2007 2008 Income (I) $3,000 $4,000 $3,500 Advertising (A) 2 3 2.5 Price (P) 10 10 10 Sales (S) 236 284 260 True demand S=120-2P+8A+0.04I Estimated demand S=140+48A Omitted Variables Problem 4-34

  35. Estimating DemandThe Identification Problem $ Three different equilibriums are not mapping out the demand curve S1 S2 Price (in dollars) P1 D1 P2 D2 S3 P3 D3 Estimateddemand Q Q1 Q2 Q3 4-35 Quantity

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