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# Intermed Micro Theory ECN 100

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## Popular in Economcs

This 6 page Class Notes was uploaded by Madie Schinner on Tuesday September 8, 2015. The Class Notes belongs to ECN 100 at University of California - Davis taught by Staff in Fall. Since its upload, it has received 28 views. For similar materials see /class/191887/ecn-100-university-of-california-davis in Economcs at University of California - Davis.

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Date Created: 09/08/15
University of CalifomiaDavis TA Jason Lee ECN lOOSpring 2008 Quarter Email jawleeucdavisedu Handout 2 1 Review of Demand and Supply A Demand Curve De nition The demand curve shows how much product is purchased at every given price holding all other factors constant The demand curve shows a negative relationship between price and quantity demanded the demand curve is downward sloping o If the price of a good changes we move along the demand curve for that good 0 If any other factor that affects demand changes we shift the demand curve Other factors that affect demand besides price 1 Population Growth The higher the population growth the greater the demand 2 Consumer Income The higher the consumer income the greater the demand 3 Consumer Preferences If consumers prefer a good they will increase demand for that product 4 Prices of other goods a Substitutes If an increase in the price of good x leads to an increase in quantity demanded of good y we say that these goods are substitutes Pepsi and CocaCola are examples of substitutes b Complements If an increase in the price of good x leads to a decrease in quantity demanded of good y we say that these goods are complements Hot Dogs and relish are examples of complementary goods 5 Government Taxes and Regulations B Supply Curve Definition The supply curve shows how much product is purchased at every given price holding all other factors constant The supply curve shows a positive relationship between the price and quantity supplied the supply curve is upward sloping o If the price of a good changes we move along the supply curve for that good 0 If any other factor that affects supply changes we shift the supply curve Other factors that affect supply besides price 1 Technology An increase in technology allows suppliers to supply more at the same price 2 Price of Inputs An increase in the price of inputs will reduce supply 3 Prices of Other Possible Products An increase in the price of other goods will reduce the supply of a particular goods as suppliers switch to produce the good with the higher price 4 Government taxes and regulations Equilibrium price and quantity can be determined wherever the demand and supply curves intersect C Shifting the Demand and Supplv Curves The following chart summarizes what happens to the equilibrium price and quantity if you shifted either the demand or supply curve You should verify the results by drawing the supply and demand diagram and shifting each curve as indicated You ll nd it will be a lot easier to draw the changes on a graph than memorize this table The following chart summarizes what would happen to price and quantity if both curves shifted Note in each case the effect of price or quantity will be ambiguous Again you should verify the results by drawing the supply and demand diagram and shifting the curves as indicated Table 2 Effect of Price and Quantity if both Demand and Supply Simultaneously II Elasticity From the previous section we have seen that changes in demand and supply results in changes in equilibrium price and quantity However in our analysis we could only show in which direction price and quantity would change We could not tell anything about the magnitude of the change Economists have introduced a concept called elasticity to provide a unitfree measure of the change In general if X causes a change in Y the elasticity of Y with respect to X measures the size of the change AY AX Mathematically we can represent this as g A Price Elasticity of Demand Price elasticity of demand measures the change in quantity demanded caused by a change in price AQL 0oAP Mathematically we can represent this as g which we can rewrite as 1 AQ Q 1 a a SP W AQ APXPQ Note that the rst term AQ 1 AP is the slope of the demand function The price elasticity of demand will always be negative because we know that an increase in price should result in a reduction in the quantity demanded Some de nitions If a 00 we say that demand for a good is perfectly elastic In other words a small change in price will have an in nite change in quantity demanded Quantity demanded is extremely responsive to price changes If a lt 1 we say that demand for a good is elastic In other words the percentage change in quantity demanded is greater than the percentage change in price Quantity demanded is responsive to price changes If a 1 we say that demand for a good is unit elastic In other words the percentage change in quantity demanded is equal to the percentage change in price If 1lt ad lt 0 we say that demand for a good is inelastic In other words the percentage change in quantity demanded is less than the percentage change in price Quantity demanded is less responsive to price changes If ad 0 we say that demand for a good is perfectly inelastic In other words any change in price will lead to no change in quantity demanded Quantity demanded is not responsive at all to price changes Rule on total expenditures How much we spend on a good depends on the price elasticity of demand Consider a case where we have an inelastic good A 1 increase in price will result in a decrease in quantity demanded lower than 1 Thus our total expenditure will go up Now consider a case where we have an elastic good A 1 increase in price will result in a decrease in quantity demanded greater than 1 Thus our total expenditure will go down Total expenditure will be at its greatest where the price elasticity of demand is 1 See Section III in this handout for some workedout problems showing how to calculate elasticity B Other Elasticities Another important elasticity is the price elasticity of supply 3 AQS g P AP The price elasticity of supply shows the percentage change in the quantity supplied given a percentage change in the price of the good Like price elasticity of demand we have some de nitions If aS 00 we say that the supply curve is perfectly elastic If aS gt 1 we say that the supply curve is elastic If 0 lt aS lt 1 we say that the supply curve is inelastic If aS 0 we say that the supply curve is perfectly inelastic Another elastrcrty ls the income elasticity or demand nnAQ 5 m1 change m lmome If ers posrnye we say agoodls normal If ers negatwe we say agoodls inferior Fmally we have crossprlce elasticity of demand 1 1 y 5 P39 quotnAPX gwen apercentage change In goodX If egt 0 we say that the goods are substitutes If elt 0 we say that the goods are complements III Practice Problems Quesnon 1 a Wnte an equanon for the demand curve 1 gt 1b Wnte an equatron for the supply curve 1c Solve forthe equlllbnum andlabel thrs on the graph 1d dlssatls ed7 Explam 1a How many golflessons wdl be gwen lfthe pncers 307 W111 buyers or sellers be dlssatls ed7 Explam Quest on 2 Conslder the followmg supply and demand tunctron for the corn market The demand curve is represented by the following function Q51 5 7 2Pwm 4Ppamm 7 025ng 00003M Where Q01 is measured in billions of bushels of corn The supply curve is represented by the following function QED 9 5P5 7 2PM 7125Pmybm Where Q5 is measured in billions of bushels of com a Suppose that the price ofpotatoes is equal to 075 the price ofbutter is 4 and average yearly income M is 40000 a year Graph the corresponding demand curve b Using algebra determine at what price does the quantity demanded equals 15 billion bushels of corn c Suppose that the price of fuel equals 275 and the price of soybeans is 10 Graph the corresponding supply curve d Using algebra determine at what price does the quantity supplied equals 21 billion bushels of corn e What is the equilibrium price and quantity f Suppose that the price of fuel increases to 450 Calculate the new equilibrium price and quantity using algebra Question 3 Suppose the demand function for corn is Q51 20 7 2Pwm and the supply function is Qim 16Pm 7 a At the equilibrium price calculate the price elasticity of demand b At the equilibrium price calculate the price elasticity of supply Question 4 Suppose the market for oranges is represented by the gure below 1b Orange market 5 21211374 Price 8 Der box 150 Boxes per year millions a What is the price elasticity of demand for oranges at a price of 235 a box b What is the price elasticity of demand for oranges at a price of 349 a box Question 5 Suppose that the equation for a linear demand function was Qd 4316 7 807P At what price will the total expenditure on oranges be the largest

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