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The Basics of
Supply and
Demand
Topics to Be Discussed
Slide 2
Topics to Be Discussed
Slide 3
Introduction
Analyzing
Slide 4
Introduction
Slide 5
Slide 6
Qs QS (P )
Slide 7
Price
($ per unit)
Vertical axis measures
price (P) received
per unit in dollars
Slide 8
The
TheSupply
Supply
Curve
CurveGraphically
Graphically
P2
The supply curve slopes
upward demonstrating that
at higher prices firms
will increase output
P1
Q1
Q2
Quantity
Slide 9
of Production
Labor
Capital
Raw Materials
Slide
At P1, produce Q2
At P2, produce Q1
P1
P2
Q1
Q2
Slide
Supply - A Review
Supply
Changes
Slide
Supply - A Review
Changes
Slide
This
QD QD(P)
Chapter 2: The Basics of Supply and
Slide
Quantity
Slide
D
Quantity
Slide
Tastes
of Related Goods
Substitutes
Complements
Slide
Income Increases
P2
At P1, produce Q2
At P2, produce Q1
Q0
Q1
Q2
Slide
Demand - A Review
Demand
Changes
Changes
Slide
S
The curves intersect at
equilibrium, or marketclearing, price. At P0 the
quantity supplied is equal
to the quantity demanded
at Q0 .
P0
D
Q0
Quantity
Slide
= QS
No
shortage
No
excess supply
No
Slide
S
Surplus
P1
P0
D
Q0
Quantity
Slide
is excess supply
Producers
lower prices
Quantity
The
Slide
Surplus
P1
P2
D
Q1
Q3
Q2 Quantity
Slide
is excess supply
Producers
lower prices
Quantity
The
Slide
P3
P2
Shortage
Q1
Q3
D
Q2 Quantity
Slide
is a shortage
Producers
raise prices
Quantity
The
Slide
Slide
Slide
S shifts to S
Surplus
@ P1 of Q1,
Q2
Equilibrium
P1
P3
@ P3, Q3
Q1 Q3 Q2
Slide
Income Increases
Demand
Shortage
shifts to D1
@ P1 of Q1, Q2 P3
Equilibrium
@ P3 , Q 3
P1
Q2 Q1 Q3
Slide
The
P2
P1
Equilibrium
price and
quantity increase to P2,
Q2
Q1
Q2
Slide
Slide
Slide
S1970
(1970
dollars per
dozen)
S1998
$0.61
$0.26
D1970
5,300 5,500
D1998
Q (million dozens)
Slide
Slide
S1995
(annual cost
in 1970
dollars)
$4,248
S1970
$2,530
D1970
8.6
14.9
D1995
Slide
Slide
Slide
Observations
Consumption
The
Slide
S1900
S1950
S1998
Long-Run Path of
Price and Consumption
D1900
D1950
D1998
Quantity
Slide
Conclusion
Decreases
Slide
Observation
To accurately
1970
Slide
Slide
Slide
EP (%Q)/(%P)
Slide
Slide
Q/Q P Q
EP
P/P Q P
Slide
Slide
Slide
Slide
EP -
Q = 8 - 2P
Ep = -1
2
Slide
P*
EP -
Quantity
Slide
EP 0
Q*
Quantity
Slide
Slide
Q/Q
I Q
EI
I/I
Q I
Chapter 2: The Basics of Supply and
Slide
Slide
Qb/Qb Pm Qb
EQbPm
Pm/Pm Qb Pm
Slide
Slide
Slide
= 1,800 + 240P
= 3,550 - 266P
Slide
Equilibrium: Q S = Q D
Slide 62
P QD
3.46
E
P QS
3.46
E
Slide 63
4.00
Q
( 266) 0.43
2,486
D
P
Slide
1981
1800 + 240P
3550 - 266P
1800+240P = 3550-266P
506P = 1750
P1981 = $3.46/bushel
1998
1,944 + 207P
3,244 - 283P
1,944+207P = 3,244-283P
P1998 = $2.65/bushel
Slide
Short-Run Versus
Long-Run Elasticities
Demand
Demand
Slide
Short-Run Versus
Long-Run Elasticities
Demand
Demand
Slide
DSR
People tend to
drive smaller and
more fuel efficient
cars in the long-run
Gasoline
DLR
Quantity
Slide
DLR
People may put
off immediate
consumption, but
eventually older cars
must be replaced.
Automobiles
DSR
Quantity
Slide
Short-Run Versus
Long-Run Elasticities
Income
IncomeElasticities
Elasticities
Slide
Short-Run Versus
Long-Run Elasticities
Income
IncomeElasticities
Elasticities
Slide
Short-Run Versus
Long-Run Elasticities
Income
IncomeElasticities
Elasticities
Slide
Short-Run Versus
Long-Run Elasticities
The
TheDemand
Demandfor
for
Gasoline
Gasolineand
andAutomobiles
Automobiles
Slide
Short-Run Versus
Long-Run Elasticities
The
TheDemand
Demandfor
for
Gasoline
Gasolineand
andAutomobiles
Automobiles
Gasoline
The
Automobiles
The
Slide
Short-Run Versus
Long-Run Elasticities
The
TheDemand
Demandfor
forGasoline
Gasoline
Price
Income
0.07 0.13
0.20
0.32
0.54
0.78
Slide
Short-Run Versus
Long-Run Elasticities
The
TheDemand
Demandfor
forAutomobiles
Automobiles
1.88
1.38
1.02
1.00
Slide
Short-Run Versus
Long-Run Elasticities
The
TheDemand
Demandfor
for
Gasoline
Gasolineand
andAutomobiles
Automobiles
Data Explains:
1) Why the price of oil did not continue to
rise above $30/barrel even though it
rose very rapidly in the early 1970s.
2) Why automobile sales are so sensitive
to the business cycle.
Chapter 2: The Basics of Supply and
Slide
Short-Run Versus
Long-Run Elasticities
Supply
Supply
Slide
Short-Run Versus
Primary
and
PrimaryCopper:
Copper:Short-Run
Short-Run
and
Long-Run
Elasticities
Long-Run
Long-RunSupply
SupplyCurves
Curves
Price
SSR
SLR
Due to limited
capacity, firms
are limited by
output constraints
in the short-run.
In the long-run, they
can expand.
Quantity
Slide
Short-Run Versus
Secondary
Copper:
and
Secondary
Copper:Short-Run
Short-Run
and
Long-Run
Elasticities
Long-Run
Long-RunSupply
SupplyCurves
Curves
Price
SLR
SSR
Price increases
provide an incentive
to convert scrap
copper into new supply.
In the long-run, this
stock of scrap copper
begins to fall.
Quantity
Slide
Short-Run Versus
Long-Run Elasticities
Supply
Supplyof
of Copper
Copper
Short-run
Long-run
Primary supply
0.20
1.60
Secondary supply
0.43
0.31
Total supply
0.25
1.50
Slide
Short-Run Versus
Long-Run Elasticities
Weather
Weatherin
in Brazil
Brazil and
and
the
theprice
priceof
of Coffee
Coffee
in
inNew
New York
York
Slide
Slide
Short-Run Versus
Long-Run Elasticities
Coffee
Coffee
S S
Price
A freeze or drought
decreases the supply
of coffee
P1
P0
Short-Run
1) Supply is completely inelastic
2) Demand is relatively inelastic
3) Very large change in price
D
Q1
Q0
Quantity
Slide
Short-Run Versus
Long-Run Elasticities
Coffee
Coffee
Price
P2
P0
Intermediate-Run
1) Supply and demand are
more elastic
2) Price falls back to P2.
3) Quantity falls to Q2
D
Q2 Q0
Quantity
Slide
Short-Run Versus
Long-Run Elasticities
Coffee
Coffee
Price
Long-Run
1) Supply is extremely elastic.
2) Price falls back to P0.
3) Quantity increase to Q0.
P0
D
Q0
Quantity
Slide
Slide
Available Data
Equilibrium
Price, P*
Equilibrium
Quantity, Q*
Price
Slide
Supply: Q = c + dP
a/b
ED = -bP*/Q*
ES = dP*/Q*
P*
-c/d
Demand: Q = a - bP
Q*
Quantity
Slide
QS = c + dP
Slide
Step 1:
Recall:
E (P/Q)( Q/P)
Slide
Slide
ED - b(P * /Q*)
ES d(P * /Q*)
Chapter 2: The Basics of Supply and
Slide
QD a bP
QS c dP
Slide
Q* = 7.5 mmt/yr.
P* = 75 cents/pound
ES = 1.6
ED = -0.8
Slide
Es = d(P*/Q*)
Ed = -b(P*/Q*)
1.6 = d(75/7.5)
= 0.1d
-0.8 = -b(.75/7.5)
= -0.1b
d = 1.6/0.1 = 16
b = 0.8/0.1 = 8
Slide
7.5 = c + 16(0.75)
7.5 = a -(8)(.75)
7.5 = c + 12
7.5 = a - 6
c = 7.5 - 12
a = 7.5 + 6
c = -4.5
a =13.5
Q = -4.5 + 16P
Q = 13.5 - 8P
Slide
Slide
a/b
.75
-c/d
Demand: QD = 13.5 - 8P
7.5
Mmt/yr
Slide
Q a bP fI
Slide
= 1.0
P*
= 0.75
Q*
= 7.5
=8
Income
elasticity: E = 1.3
Slide
E ( I / Q)(Q / I )
and
f Q / I
Chapter 2: The Basics of Supply and
Slide
Slide
Q a bP fI
*
Slide
Slide
Slide
Slide
Slide
Slide
Slide
Slide
In 1995:
P*
= $18/barrel
World
OPEC
supply = 10 bb/yr.
Non-OPEC
supply = 13 bb/yr
Slide
World Demand:
Competitive Supply
(non-OPEC)
-0.05
-0.40
0.10
0.40
Slide
D = 24.08 - 0.06P
Short-run
Demand
Competitive Supply
SC = 11.74 + 0.07P
Slide
ST = 21.74 + 0.07P
Short-run
ST = 18.74 + 0.07P
Slide
Slide
D ST ST
Price 45
($ per
barrel) 40
Short-Run
Effect
35
30
25
20
18
15
10
5
0
10
15
20 23 25
30
Quantity
35 (billions barrels/yr)
Slide
D = 32.18 - 0.51P
Long-run
Demand
Total Supply
S = 17.78 + 0.29P
Slide
Slide
SC
($ per
barrel) 40
ST ST
Long-run Effect
Due to the elasticity
of the long-run
supply and demand
curves, the long-run
effect of a cut
in production is
much less.
35
30
25
20
18
15
10
5
0
10
15
20 23 25
30
35
Quantity
(billions barrels/yr)
Slide
Slide
P0
Pmax
D
Excess demand
Q0
Quantity
Slide
Slide
Slide
The
TheData:
Data: Natural
NaturalGas
Gas
PES 0.2
Cross elasticity of supply for oil 0.1
D
PE
0.5
Slide
The
TheData:
Data: Natural
NaturalGas
Gas
Slide