Demand and Supply Analysis

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• Demand and Supply Analysis

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Headlines

• On August 2, 1990, when Iraq invaded Kuwait,
  market price of crude petroleum jumped from
  21.54 to 30.50 per barrel (almost 42 increase)
  before any physical reduction in the current
  amount of oil available for sale. One year later,
  the price of oil was 21.32 per barrel.
• In August 1987, a 386 PC sold at 6,995.In March
  1992, the same computer sold at 1,495.Today
  Pentiums are cheaper then original 386 PCs.

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Market Demand Curve

• Amounts of a good purchased at alternative
  prices.
• Inverse demand shows the maximum price paid for
  given quantity of a good.
• Law of Demand (ceteris paribus)
• Downward demand due to income and wealth effects.
• Downward inverse demand diminishing marginal
  utility.
• Giffen's Paradox

Price
Quantity
ID
D
Quantity
Price
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The Demand Function

• An equation representing the demand curve
• Qxd f(Px , PY , I, N, A, Z)
• Qxd a0a1Pxa2Pya3Ia4Na5Aa6Z
• Qxd quantity demand of good X.
• Px price of good X.
• PY price of a substitute good Y.
• I income.
• N population
• A advertisement
• Z any other variable affecting demand
  (expectations, credit conditions)

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Change in Quantity Demanded
A to B Increase in quantity demanded (due to
change in the price of the good)
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Change in Demand
D0 to D1 Increase in Demand (due to change
in demand determinants)
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Market Supply Curve

• Amounts of a good produced at alternative prices.
• Inverse supply shows the minimum price required
  to produce given quantity of a good.
• Law of Supply (ceteris paribus)
• The supply curve is upward sloping

Price
S
Quantity
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The Supply Function

• An equation representing the supply curve
• QxS f(Px , PR ,PVI, PFI, Z) Qxs
  a0a1Pxa2PRa3PVIa4PFIa5Z
• QxS quantity supplied of good X.
• Px price of good X.
• PR price of a related good (substitutes in
  production)
• PVI price of variable inputs (labor, material,
  utilities)
• PFI price of fixed inputs (land, buildings,
  machines)
• Z other variable affecting supply (technology,
  government, number of firms, expectations)

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Change in Quantity Supplied
A to B Increase in quantity supplied(due to
change in the price of the good)
B
20
A
10
5
10
10
Change in Supply
S0 to S1 Increase in supply (due to change
in supply determinants)
S1
8
6
7
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Mathematics of Equilibrium
Demand curve Qd 400 - ½P,Supply curve Qs
200 P
Price (P)
a800
P dQs - c Qs - 200
Market equilibrium
Supply
Slope is d 1
P 133.33
Slope is -b -2
Demand
P a - bQd 800 - 2Qd
0
Q 333.33
Quantity supplied (Qs) and
Quantity demanded (Qd)
c-200
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Consumer SurplusThe Continuous Case
Price
10

8
6
Consumer Surplus
Value of 4 units
4
2
Total Cost of 4 units
D
1 2 3 4 5
Quantity
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Producer Surplus

• The amount producers receive in excess of the
  amount necessary to induce them to produce the
  good.

Price
S0
P
Producer Surplus
Cost of Production
Q
Quantity
14
If price is too low
Price
Quantity
15
If price is too high
Price
Quantity
16
Comparative Statics Effects of Changes in Demand
and/or Supply

• Increase in D increases both Q and P.
• Increase in S increases Q and decreases P.
• Increase in D and S increases Q and ?P ?.
• Decrease in D and increase in S decreases P and
  ?Q ?.

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Price Restrictions

• Price Ceilings
• The maximum legal price that can be charged
• Examples
• Gasoline prices in the 1970s
• Housing in New York City
• Proposed restrictions on ATM fees
• Price Floors
• The minimum legal price that can be charged.
• Examples
• Minimum wage
• Agricultural price supports

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Impact of a Price Ceiling
Deadweight loss ofconsumer andproducer surplus
Opportunity Cost (Search Black Market)
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Full Economic Price

• The dollar amount paid to a firm under a price
  ceiling, plus the nonpecuniary price
• PF PC (PF - PC)
• PF full economic price
• PC price ceiling
• PF - PC nonpecuniary price
• In 1970s ceiling price of gasoline 1
• 3 hours in line to buy 15 gallons of gasoline
• Opportunity cost 5/hr
• Total value of time spent in line
  3 ? 5 15
• Non-pecuniary price per gallon
  15/15 1
• Full economic price of a gallon of gasoline 1
  1 2

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Impact of a Price Floor
Price
PF
Cost of purchasingexcess supply
P
IncreasedSupply
DecreasedDemand
Quantity
Qs
Qd
Q
21
The Excise Tax (Fixed per Unit)
Price (/CD player)
130
S tax
S
Buyer pays (with tax)
P2 - P1 Buyer tax burden
P2105
Price beforetax
P1100
P2-T95
P1 - (P2 - T) Seller tax burden
Seller receives(without tax)
75
D
D
0 1 2 3 4 5 6 7 8 9
10
Quantity (thousands of CD players per week)
22
Excise Tax and the Demand
Price
S tax
S
P1P21.00
P2P1T2.20
? Elastic D
P2-T0.90
1 4
Thousands of pencils
The more inelastic D, the more buyer pays
P2 P1 T Buyer burden P2 - P1
(P1 T) - P1 TSeller burden P1 - (P2 -
T) P1 - (P1 T - T) 0
The more elastic D, the more seller pays
P2 P1 Buyer burden P2 - P1 P1 - P1
0Seller burden P1 - (P2 - T) P1 - (P1
- T) T
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Excise Tax and the Supply
P2P1T11
D
D
The more inelastic S, the more seller pays P2
P1
The more elastic S, the more buyer pays P2
P1 T
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The Ad Valorem Tax ( of Value)
Price (/CD player)
130
S(1 tax)
S
Buyer pays (with tax)
P2 - P1 Buyer tax burden
P2105
Price beforetax
P1100
P2-T95
P1 - (P2 - T) Seller tax burden
Seller receives(without tax)
75
D
D
0 1 2 3 4 5 6 7 8 9
10
Quantity (thousands of CD players per week)
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Static Effects of a Tariff
Sus
P
Pt
Tt
PIt
G
CIt
PW
Dus
QSt
QDt
Mt
QSW
QDW
MW
Loss of Consumer Surplus Tt PIt
G CIt Transfer to Producer Surplus
Tt Government Revenues from Tariff G Dead
Weight Loss due to Tariff PIt
CIt Production Inefficiencies
PIt Consumption Inefficiencies CIt
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Static Effects of a Quota
Sus
Sus Quota
P0
PQ
Tq
PIq
W
CIq
PW
Dus
QSq
QDq
Quota
QSW
QDW
MW
Loss of Consumer Surplus Tq PIq W
CIq Transfer to Producer Surplus Tq Windfall to
Importer W Dead Weight Loss due to Quota PIq
CIq Production Inefficiencies
PIq Consumption Inefficiencies CIq