Lecture two © copyright ： qinwang 2013 [email protected] SHUFE school of international business.

Lecture two copyrightqinwang [email protected] school of international business

Demand, Supply, and Market EquilibriumDemand and demand functionSupply and supply functionMarket equilibrium

Demand and supply1DemandDemand definitionDemand and influencesDemand functionDemand curve (firm and industry)The rule of demandShift of demand2SupplySupply definitionSupply and influencesSupply functionSupply curve (firm and industry)The rule of supplyShift of supply

DemandQuantity demanded (Qd)Amount of a good or service consumers are willing & able to purchase during a given period of time

Demand is different from need

General Demand FunctionSome variables that influence QdPrice of good or service (P)Incomes of consumers (M)Prices of related goods & services (PR)Taste patterns of consumers (T)Expected future price of product (Pe)Number of consumers in market (N)

General demand function Qd = f(P, M, PR, T, Pe , N)

General Demand Function

b, c, d, e, f, & g are slope parametersMeasure effect on Qd of changing one of the variables while holding the others constantSign of parameter shows how variable is related to QdPositive sign indicates direct relationshipNegative sign indicates inverse relationship

Qd = a + bP + cM + dPR + eT + fPe + gN

General Demand FunctionInverse for complementsPPeNMPRInverseDirectDirectDirectDirect for normal goodsInverse for inferior goodsDirect for substitutesb = Qd/P is negativec = Qd/M is positivec = Qd/M is negatived = Qd/PR is positived = Qd/PR is negativef = Qd/Pe is positiveg = Qd/N is positivee = Qd/T is positiveT

VariableRelation to QdSign of Slope Parameter

Direct Demand FunctionThe direct demand function, or simply demand, shows how quantity demanded, Qd , is related to product price, P, when all other variables are held constant Qd = f(P)Law of DemandQd increases when P falls, all else constantQd decreases when P rises, all else constantQd/P must be negative

Demand curve Q1Q2Q3Q3=Q2+Q1firm1firm2industry

Graphing Demand CurvesChange in quantity demandedOccurs when price changesMovement along demand curveChange in demandOccurs when one of the other variables, or determinants of demand, changesDemand curve shifts rightward or leftward

Six variables that influence QsPrice of good or service (P)Input prices (PI )Prices of goods related in production (Pr)Technological advances (T)Expected future price of product (Pe)Number of firms producing product (F)General supply functionQs = f(P, PI, Pr, T, Pe, F)Supply

General Supply FunctionDirect for complementsPPeFPIPrDirectDirectDirectInverseInverseInverse for substitutesk = Qs/P is positivel = Qs/PI is negativem = Qs/Pr is negativem = Qs/Pr is positiver = Qs/Pe is negatives = Qs/F is positiven = Qs/T is positiveT

VariableRelation to QsSign of Slope Parameter

Direct Supply FunctionThe direct supply function, or simply supply, shows how quantity supplied, Qs , is related to product price, P, when all other variables are held constant Qs = f(P)Law of SupplyQs increases when P rises, all else constantQs decreases when P falls, all else constantQs/P must be positive

Supply curveQ1Q2Q3Q3=Q2+Q1firm1firm2industry

Supply curve of laborlabor

Graphing Supply CurvesChange in quantity suppliedOccurs when price changesMovement along supply curveChange in supplyOccurs when one of the other variables, or determinants of supply, changesSupply curve shifts rightward or leftward

Market EquilibriumEquilibrium price & quantity are determined by the intersection of demand & supply curvesAt the point of intersection, Qd = QsConsumers can purchase all they want & producers can sell all they want at the market-clearing or equilibrium price

Market EquilibriumExcess demand (shortage)Exists when quantity demanded exceeds quantity suppliedExcess supply (surplus)Exists when quantity supplied exceeds quantity demanded

Value of Market ExchangeEconomic valueMaximum amount any buyer in the market is willing to pay for the unit, which is measured by the demand price for the unit of the goodConsumer surplusDifference between the economic value of a good (its demand price) & the market price the consumer must payProducer surplusFor each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price)Social surplusSum of consumer & producer surplusArea below demand & above supply over the relevant range of output

Changes in Market EquilibriumQualitative forecastPredicts only the direction in which an economic variable will moveQuantitative forecastPredicts both the direction and the magnitude of the change in an economic variable

Demand Shifts (Supply Constant)D increase, ?D decrease, ?Case 1

Supply Shifts (Demand Constant)Supply increase, ?Supply decrease, ?Case two

Case threeWhen demand & supply increase simultaneouslyQuantity?Price?

Case fourWhen demand & supply decrease simultaneouslyQuantity,?Price,?

Case fiveSupply increasedemand decreaseQuantity?Price?

Case sixSupply decreasedemand increaseQuantity ?Price?

Example: House leasingIn a competitive market of house leasing, analyze the following market (other factors are given) :Consumers income increasedLevy rent tax for $100/unit/monthAn regulation: the rent is no more than 2000/unit/month.

Ceiling & Floor PricesCeiling priceMaximum price government permits sellers to charge for a goodWhen ceiling price is below equilibrium, a shortage occursFloor priceMinimum price government permits sellers to charge for a goodWhen floor price is above equilibrium, a surplus occurs

Ceiling & Floor Prices Qx QuantityQxPxPxQuantityPrice (dollars)SxDxPanel A Ceiling price

Cobweb Theorem

ElasticityElasticity and its calculation Price Elasticity of Demand (Ep)Income elasticity of demand(Em)Cross elasticity of demand(Exr)

ElasticityX & Y are related variables,The larger the absolute value of E, the more sensitive Y are to a change in XMeasures responsiveness or sensitivity of dependant variable Y to independent variable X

Calculating ElasticityPoint elasticityInterval (arc) elasticity

Price Elasticity of Demand (E)P & Q are inversely related by the law of demand so E is always negativeThe larger the absolute value of E, the more sensitive buyers are to a change in priceMeasures responsiveness or sensitivity of consumers to changes in the price of a good

CaseLevy JeansDemand of Levy Jeans in Sears

$price/unitSales(unit/week)2019181716121112141618202830

Table Price Elasticity of Demand (E)%Q> %P %Q= %P %Q< %P E> 1E= 1E< 1

ElasticityResponsivenessEElasticUnitary ElasticInelastic

Price Elasticity & Total RevenueTR fallsTR risesNo change in TR No change in TR TR risesTR falls%Q> %P %Q= %P %Q< %P

Elastic

Quantity-effect dominatesUnitary elastic

No dominant effectInelastic

Price-effect dominatesPrice risesPrice falls

CaseBasketball shoes pricing N is a company of basketball shoes. It sells 10000 pairs of shoes per month (shoes price is $100). Its competitor reduces the price of basketball shoes. After that N companys sale reduce to 8000 pairs. According to experience, the Ep in such range of price and quantity is about -2.00If N company want increase its sale to 10000 pairs per monthwhat price would N company set?

Ep of some goods in US economy

Industry EpElastic Finished food2.27Metal1.52Furniture wood1.25Auto1.14Logistics1.03

InelasticGaspowerwater0.92Oil0.91Chemical 0.89Drinks 0.78Tobacco 0.61Food0.58House/0.55Clothes0.49Book, magazine, newspaper0.34Meat 0.20

Demand & Marginal RevenueWhen inverse demand is linear, P = A + BQ (A > 0, B < 0)Marginal revenue is also linear, intersects the vertical (price) axis at the same point as demand, & is twice as steep as demand MR = A + 2BQ

Linear Demand, MR, & Elasticity

MR, TR, & Price ElasticityElastic (E> 1)TR decreases as Q increases (P decreases)TR is maximizedTR increases as Q increases (P decreases)Unit Elastic (E= 1)Inelastic (E< 1)

Marginal revenueTotal revenuePrice elasticity of demandMR > 0MR = 0MR < 0

Marginal Revenue & Price ElasticityFor all demand & marginal revenue curves, the relation between marginal revenue, price, & elasticity can be expressed as

ExamplePrice strategy of telecomFixed-line tollincreaseInternational telephone fee decrease

The government want to levy tax on luxuries to narrow the gap between the poor and rich?ExampleTax for luxuries

Income ElasticityIncome elasticity (EM) measures the responsiveness of quantity demanded to changes in income, holding the price of the good & all other demand determinants constantPositive for a normal goodNegative for an inferior good

EP And EM in US

productEPEMFood-0.210.28Auto-1.203.00Petrol-0.541.06Power-1.140.61Beer-1.130.93Flour-0.36Marijuana-1.500

Engel's Coefficient1989China

USJapan FranceBrazilianIndia 1316163552

1964198519901992199419992009City59.253.354.252.95041.937Rural 68.557.75856.85752.643

Cross-Price ElasticityCross-price elasticity (EXR) measures the responsiveness of quantity demanded of good X to changes in the price of related good R, holding the price of good X & all other demand determinants for good X constantPositive when the two goods are substitutesNegative when the two goods are complements

EXR In US

Goods YGoods XEXRpowergas0.20porkbeef0.14Orange from californiaOrange from fo0.14

EXR and decision Substitutes and Complements

Questions?

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