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supply and demand function in economics

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Dohan

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Graphing Straight Line Demand and Supply Equations 1. The Basics of Graphing Demand Functions: Many students have problems graphing simple straight-line demand and supply equations. There are many shapes of demand curves, but in Eco 101 and 102 we usually use straight line demand curves, like the one below. n high s!hool you learned that y m! " #" and graphed the #dependent variable$ y on the verti!al a%is &ith # often being the intercept on the verti!al a%is. $ &as the independent variable on the hori'ontal a%is &ith !oeffi!ient m determining ho& fast y !hanged &ith a !hange in !. (hus" m is also the slope of the line y m! " # &ith respe!t to the !%a!is. &. 'hy is ( )the apparently independent variable* on the )%a!is and * )the apparently dependent variable* on the $%a!is+ (he &ay e!onomists have graphed demand and supply fun!tions in e!onomi!s often !onfuses students. t seems that e!onomists have reversed the verti!al and hori'ontal a%es. (his is be!ause &hen &e graph a demand fun!tion su!h as *d 1,,% &(- the quantity variable" #*d. &hi!h loo+s li+e a dependent variable is graphed on the hori'ontal a%is" and the pri!e variable #($ &hi!h loo+s li+e the independent variable is graphed on the verti!al a%es of a traditional graph. (his pra!ti!e started over 1,, years ago and persists to today.

n his 1!"0 essay #$n the %raphical &epresentation of 'upply and (emand#, )leeming *enkin drew for the first time the popular graphic of supply and demand which, through Marshall, eventually would turn into the most famous graphic in economics. /lfred 0arshall )born -. /uly 101- in 2ermondsey" London" England" died 13 /uly 14-1 in 5ambridge" England* &as an English e!onomist and one of the most influential e!onomists of his time. 6is boo+" +rinciples of Economics )104,*" brings the ideas of supply and demand" of marginal utility and of the !osts of produ!tion into a !oherent &hole. t be!ame the dominant e!onomi! te%tboo+ in England for a long period. This essay in www.wikipedia.com is very informative.

(hin+ of the demand equation as only one blade of a pair of s!issors" the other blade being the supply equation. n fa!t" the a!tual pri!e and quantity in a mar+et are found by the intera!tion of the demand and equations )des!ribe belo&* &hi!h eventually give us an equilibrium pri!e )P7* and an equilibrium quantity )87*. n Prof. Dohan9s !ourses &hen you see an asteris1 27* after a variable denotes an 3equili#rium. 4alue of that variable. 5. Equili#rium in the mar1et place. n a perfe!tly !ompetitive mar+et &ith many buyers and sellers selling a homogeneous good" if the mar+et is in 3equili#rium. it means that at the equili#rium price (67 all the buyers &ho are &illing to pay that pri!e or higher are able to buy all they &ant at P7 and all the sellers &ho are offering to sell at P7 or less are able to sell all they &ant at the quantity demanded at that pri!e *d2(68 and sellers are able to sell the quantity they &ant to supply at *s2(68. (he quantity bought in that mar+et is equal to the quantity sold in that mar+et for the mar+et to be in equilibrium: *d2(68 *s2(68. ;ote: that all the buyers &ho are &illing to pay P7 or a higher pri!e are able to buy and all the sellers &ho are &illing to supply at P7 or less. 9o #uyer or seller is :elling to #uy more or sell more at that 3mar1et clearing price.. nitially &e assume that the pri!e paid by the buyer )P7b* is the pri!e re!eived by the seller )P7s*. <s =PE5" the oil !artel +no&s" !olluding to redu!e the quantity of !rude oil supplied to the mar+et in!reases its pri!e. 6ere it seems that 8 is the independent variable and P is the dependent variable. Maybe it is !learer if you +no&n that the equation *d 1,,% &( !an be re&ritten in its inverse form P ;, < 1=&*d. (his is often !alled the inverse form of a normally &ritten demand

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Prof. Dohan

fun!tion. t is useful for finding the #!ho+e pri!e$ at &hi!h all the buyers are #rationed out of this mar+et" that is &here at this pri!e or higher" no buyer &ants to buy any quantity of this produ!t at all" so that *d ,. (he pri!e has !ho+ed off all the demand? hen!e &e !all it the #!ho+e pri!e$.

,-ote. if you graph + / 0 on the other a1es, it is not wrong23 it 4ust won5t look like what you see in most te1tbooks and in class6

Graphing the Demand function for oil 2millions #arrels=day8 @ou need only t&o points to graph any equation for a straight line. Ainding t&o good points and plotting them" ho&ever" often presents a !hallenge to students. Aor demand fun!tions this pro!ess is usually quite easy. 6ere is a straight-line demand fun!tion for oil.

*d

1,,% &(

>ere are some hints for graphing and choosing scales. Airst of all" you need to !hoose the units for ea!h a%is. Set the lo&er left-hand !orner of the upper right quadrant equal to 'ero. Be use an arithmeti! s!ale" so that equal distan!es on the s!ale should equal the same arithmeti! !hanges in the variable. )Cnli+e log s!ales on graphsD* 1. (ut * on the hori?ontal a!is &. Find the ma!imum *d. >o:+ Since *d 1,, < &(7 set ( ,. This gi4es us our ma!imum *d of 31,,. :hen * is 3fre. for the ta1ing. So :e can place 1,, to:ard to right end of the 3*. a!es.

5. t9s easiest to divide the remaining distan!e in E )F,* and then subdivide the rest in to equally spa!ed units. f you have graph paper, *d ,7 ( ;, these units may be 2 or 7 or even 8 s9uares each, depending on how large you draw your graph. D ;,

*d @,7 ( 5, *s 1,,7 ( 5,

1. (o find the se!ond point of the demand !urve" if possible find the ma%imum #choke price$ at &hi!h 8d G , t is at the inter!ept on the y-a%is at &hi!h 8d G ,. Aind the choke:price 5, by setting 8dG, in the demand equation or in the #inverse demand e9uation$. <nd sol4e for (. Bhen 8d G ," P GF,. (6 &, ;o& !onne!t the t&o points. /ust to !he!+" you may &ant to !al!ulate another 8 for a P lo&er then F,: let9s try PG3,. S 8G 1,, - -73, G 1,. Plot the point. t should fall on your F demand !urve. , (lotting the supply function. 2Finding t:o point is a #it tric1ier78 Supply fun!tion for oil )millions barrels>day* *s %&, " @(

Ta1 ; <10

D 1,

*6 A,

1,,

f &e set P G , in order to find 8s" &e find that 8s is --, and is on the negative inter!ept of the %-a%is. (his is understandable if you thin+ that in the real &orld produ!ers usually need to get some pri!e at &hi!h they start to be &illing to produ!e and sell goods in this mar+et. (his is !alled the start-up pri!e. (o find the #start-up pri!e$" set 8s G , and solve for P. )@ou !ould rearrange the supply equation into an inverse supply function to ma+e it easier: Ps G F H I 8s.* Either &ay &e find that the start-up pri!e is F. (his is first point &e need for our supply graph. =f !ourse" to supply a positive quantity the produ!ers or suppliers have to get a bit more than this #start up pri!e$. Be need a se!ond point for 8s. Let9s try the choke price Ps G F, &hi!h ma+es 8sG 10, far beyond the right hand side of the graph )right off the page*. So &e try a lo&er pri!e su!h as P G 3, &hi!h gives us 8s G 1,,. (hat fits. ;o& &e have a good se!ond point: P G 3," 8s G 1,,. ;o& !onne!t the t&o points &ith your ruler and your supply !urve should interse!t the demand !urve at *6 A, and (6 &,. More pre!isely" 8d )P7G -,* G ., and 8s )P7G-,* G .,. ;o& dra& a hori'ontal line from the interse!tion point to the @-a%is and label it P7 G -,. Dra& a verti!al line from the interse!tion point do&n to the J-a%is and label it 87 G .,.

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Prof. Dohan

(hese should be the same ans&ers &e &ould find algebrai!ally. / quic1 re4ie: of the alge#raic solution. Demand equation: *d 1,,% &( Supply equation: *s %&, " @( (he mar+et equilibrium !ondition: *d 2(8 *s2(8 Step 1: Substitute in the demand equation for 8d )P* and substitute in the supply equation for 8s)P* &hi!h gives us: 1,, K -P G --, H 1P Step &: Subtra!t 1,, from both sides and 1,P from both sides" &hi!h leaves us &ith: .,, G 3,P Step 5: @ou have one equation and one un+no&n" so solve for P: /ns:er P G -, Step @: Substitute in P G -, into the demand equation to get 8d G ., Step ;: Substitute in P G -, and you get that: 8s G ., Bonclusion: P is a mar+et-!learing pri!e" be!ause the quantity demanded at -, equals the quantity supplied at -, &hi!h equals .,. 9o: try some pro#lems to hand in: 2lueberries" a homogeneous produ!t" are sold in a perfe!tly !ompetitive mar+et. (he marginal !ost in!urred by the seller rises is they try to produ!e more blueberries )less good land is available and they use more labor on their available land*. So the supply !urve slopes up&ard. (he demand !urve is a normal do&n&ard sloping demand !urve &ith both an %-inter!ept and a y- inter!ept. (hat means that at some )high* pri!e" people stop buying blueberries" and even if the pri!e fell to 'ero" people &ould not eat an infinite number of blueberries. <ssume that the pri!e paid by the buyer Pb is the same as the pri!e re!eived by the seller Ps" so &e !an tal+ about one pri!e #P$. 1. (he demand and supply equations are the follo&ing: 8d G 1,, K -,P 8s G - -,, H 1,P Solve algebrai!ally and graphi!ally for the mar+et-!learing pri!e )equilibrium pri!e and quantity* and hand in. Did you get a #strange ans&erD @es" P G -, and 8 G 'ero. (he pri!e &as higher than anybody9s &illingness to pay. -. (ry this oneD 6ere the demand !urve has shifted out&ard by four hundred units at every pri!e. 8d G 0,, --,P 8s G --,, H 1,P Solve algebrai!ally L graphi!ally for the mar+et-!learing pri!e )equilibrium pri!e and quantity*. 3. Loo+ing at problem-" let9s assume that plant breeders have made an ne& better tasting" hardier" better storing blueberry hybrid blueberry bush )e.g." a ne& te!hnology* that allo&s them to e%pand produ!tion by -, units instead of 1, inits for every dollar in!rease in pri!e. (he supply !urve is #flatter or #more elasti!$ 8d G 0,, --,P 8s G --,, H &,P a* Solve algebrai!ally and graph the ne& supply !urve on the same one you did for problem. b* Sho& the ne& mar+et-!learing pri!e )equilibrium pri!e and quantity* on the same graph as problem -. 1. Loo+ing at problem - L 3" &e see that the pri!e has fallen as a result of the ne& te!hnology. (he blueberry gro&ers unite in a !artel and !ollude to raise the pri!e ba!+ up to near the old #fair$ pri!e. (he gro&ers agree that total output supplied to the mar+et should redu!ed ba!+ to *s &,,. Sho& the ne& mar+et-!learing pri!e )equilibrium pri!e and quantity* on the same graph as problem -.

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