Part 2Markets: Demand, Supply, and ElasticityWhat determines the price of a good or service and the uantity !ought and sold"Demand and supply model of a marketThis simple model of a market assumes competitive conditionsDistinguish !et#een a demand side and a supply side of the market$ogether they determine the euili!rium price and uantityDemandDemand is the uantity of a good peoplepurchase over a given time $he uantity of a good a person #ill plan to purchase #ill depend on:% Preferences &tastes'% Price of the good% Prices of other goods% E(pected future prices% )ncome)n the aggregate, demand #ill also depend on:% Population and demographics$he *a# of Demand+ther things remaining the same, the higher the price of a good, the smaller is the uantity demandedSu!stitution effect,the effect of the change inrelative price)ncome effect,the effect of the change in overall purchasing po#erDemand -unction and Demand .urvesDemand function,demand as a function of a num!er of varia!lesDemand curve,demand as a function of price, everything else held constantWhat is held constant along a demand curve"Changes in the quantity demanded,movements along the demand curve.hanges in /uantity DemandedP/P0PP1/0 //1Decrease in uantity demanded)ncrease in uantitydemanded.hange in uantity demanded,a movement along the demand curveDemand .urves.an !e linear or non%linear2 linear demand curveP/2343P 5 23 % 264/P 5 a 7 !/Where a is the P intercept and ! is the slopevaria!le and is negativeDemand .urves2 demand curve is more usually #ritten #ith / as the dependent varia!leP/2343/ 5 a 7 !PWhere a is the / intercept and ! is the inverse of the slope and is negative/ 5 43 8 462P.hanges in DemandShift in a demand curve is a Change in Demand.hange in tastes or preferences.hange in the prices of other goods- su!stitutes% complements.hanges in e(pected future prices.hanges in income% normal goods% inferior goods.hanges in population6demographics2n )ncrease in Demand2n increase in demand,a right#ard shiftP/DD02n )ncrease in DemandPrice of a su!stitute risesPrice of a complement fallsE(pected future price rises)ncome rises &normal good' or income falls &inferior good'Preferences move to#ard the goodPopulation increases 2 Decrease in Demand2 decrease in demand,a left#ard shiftP/DD02 Decrease in DemandPrice of a su!stitute fallsPrice of a complement risesE(pected future price falls)ncome falls &normal good' or income rises &inferior good'Preferences move a#ay from the goodPopulation falls9SupplySupply is the uantity of a good firms produce over a given time$he firm has to have the resources and technology to produce the good$he firm has to think it can produce the good at a profit &at least in the long run'Short run and long run supply decisionsSupply$he amount of any particular good or service supplied !y a firm #ill depend on:% $he price of the good% $he prices of inputs needed to produce the good% $he availa!le technology% $he availa!le capital &short run' % Prices of other goods% E(pected future prices)n the aggregate, supply #ill also depend on:% $he num!er of firms in the market$he *a# of Supply+ther things remaining the same, the higher the price of a good, the greater #ill !e the uantity supplied:igher prices mean it #ill !e profita!le to e(pand productionWith rising marginal costs higher prices are reuired for firms to !e #illing to increase productionSupply -unctions and Supply .urvesSupply functionSupply curve,shapeSupply curves can only !e defined for competitive industries here price is a given to the firm'What is held constant along a supply curve"Changes in the quantity supplied,movements along the supply curve.hanges in /uantity SuppliedP/P/0 //1.hange in uantity supplied,a movement along the supply curveP1P0S)ncrease in uantitysuppliedDecrease in uantity suppliedSupply .urvesP/S;3P 5;3 7 2/Slope is 5 2 2 linear supply curve: P 5 a 7 !/ #here a is the P intercept2nd ! is the slope #hich is positiveSupply .urvesSupply curves are more usually #ritten #ith / as the dependent varia!le: / 5 a 7 !P #here a is the / intercept and ! is the inverse of the slope and positiveP/S%e ?um!er of firms in the industry shrinksMarket Euili!riumMarket euili!rium is #here demand 5 supplyEuili!rium priceEuili!rium uantityPrice ad@usts to !ring a!out an euili!rium)f DAS price rises #hich reduces uantity demanded and increases uantity supplied)f SAD price falls #hich increases uantity demanded and reduces uantity suppliedMarket Euili!riumP/SDEPB/BSurplus%price fallsShortage%Price risesMarket Euili!riumin EuationsDemand curve D 5 a 7 !P #here a is the / intercept and ! is the inverse of the slope &and negative'Supply .urve S 5 c 7 dP #here c is the / intercept &usually >ero or negative' and ! the inverse of the slope and positive )n euili!rium D 5 S Solve for PB then /BMarket Euili!riumin EuationsDemand curve D 5 C33 8 9