Download Supply and Demand Interactions

SUPPLY AND
DEMAND
INTERACTIONS
THE INTERACTION OF SUPPLY AND DEMAND
The primary function of the market is to bring
buyers and sellers together in order to establish a
price and to make an exchange.
Suppliers would find that as they lower the price
for sandwiches they would be able to sell more
sandwiches.
At $3.30 there would be a surplus of sandwiches
because suppliers would be producing 500, but
consumers would be purchasing only 300.
If the suppliers decided to sell their sandwiches for
$3.30, consumers would be willing to purchase 300
per week.
Similarly if suppliers charge a price that is too low
they will be faced with a shortage of sandwiches,
they will then continue to increase the price until
an equilibrium price is reached.
Suppliers will continue to reduce prices until they
reach a price at which the quantity demanded is
equal to the quantity supplied, the equilibrium
price.
The equilibrium price changes if changes take place
in the factors that affect the demand or supply
sides of the market.
What effect does an increase in the price of
hamburgers (competition)have on the equilibrium
price of sandwiches?
How will an increase in the price of butter used in the
production of sandwiches, affect the equilibrium price
of sandwiches?
OPERATION OF A FREE MARKET SYSTEM
 Choosing how to best handle scarce resources is a
challenge for many markets. Decisions have to be made:
 What products and services are these resources going to produce?
 Who will receive these products and services when they are available?
 These questions can be answered by the price system
technique.
The price system is the technique by which scarce
resources are allocated to the production of those
products and services that provide the greatest
return to the resource owner.
In this way, the system of prices, rents, wages, and
interest organizes economic activity.
 The price system has two distinct advantages in
allocating resources:
1. It is efficient in allowing thousands of individuals to
cooperate in making economic decisions, and
2. It transmits information to buyers and sellers
which assists consumers in allocating their limited
income to various purchases and encourages
sellers to adopt the least costly and most efficient
means of production.
The free-market system and its establishment of
prices through the interaction of demand and
supply provides insight into the concept of value.
What is the value of a diamond ring?
a new car?
a glass of water?
ELASTICITY
The law of downward-sloping demand states that, all
other factors remaining constant, the quantity
demanded of a product increases as the price falls.
Price elasticity of demand measures the extent to
which the quantity of a product demanded responds
to a change in price.
 Price Elasticity of Demand Coefficient =
Elastic demand is one in which a price change
brings about a greater than proportional change in
the quantity that consumers demand.
 %ΔQs > % ΔP thus Es > 1
 Ex. A small increase in the price of chocolate bars will likely have a
large impact in the number of bars sold.
If a supplier is not able to adjust supply readily when
the price changes, the supply is referred to as
inelastic.
%ΔQs < % ΔP thus Es < 1
 Milk has an inelastic demand curve as price changes have little impact on
the amount of milk sold.
Unitary elastic supply is one in which a price
change brings about a proportional change in the
quantity supplied.
 %ΔQs = % ΔP thus Es =
1
Demand for elastic products (chocolate bars) often
have flatter demand curves. Inelastic demand
curves are often steeper.
CHARACTERISTICS THAT AFFECT ELASTICITY
1. Luxury or necessity
2. The number if close substitutes
3. Percentage of budget spent on the product
4. Length of time since price change
TOTAL REVENUE APPROACH TO PRICE
ELASTICITY OF DEMAND
The total amount of money that people spend on a
product is referred to as Total Revenue.
TR = P x Qd
 If the demand for a product is elastic, any decrease in price
will increase total revenue; conversely any increase in price
will decrease total revenue.
TR
when P
P
TR
If the demand for a product is inelastic, any decrease in
price will decrease total revenue; conversely any
increase in price will increase total revenue.
when P
P
TR
TR
When the elasticity of demand is unitary, any change in
price leaves total revenue unchanged.
SPECIAL CASES OF PRICE ELASTICITY OF
DEMAND
 There are two special cases of a demand curve where the
price and quantity demanded are not inversely related.
 The first is where the price is set and the quantity
demanded is unlimited, a perfectly elastic demand (Ed = ∞).
 An example of a perfectly elastic demand curve is when
U.S. citizens were required to sell all their gold to the
government at a price of $35 an ounce.
The second is where a certain quantity is
demanded and any price will be paid to acquire
that amount, a perfectly inelastic demand (Ed = 0).
This curve may reflect the demand for a necessary
drug in which individuals will pay any price to
acquire it.
PRICE ELASTICITY OF SUPPLY
 The law of upward-sloping supply states that, all other
factors remaining constant, the quantity supplied of a
product increases as the price increases.
 Price elasticity of supply measures the extent to which
the quantity of a product supplied responds to a
change in price.
 Price Elasticity of Supply Coefficient =
 If the coefficient is greater than one, supply is elastic, if it is
less than one it is inelastic and if the coefficient is equal to
one the supply is unitary elastic.
 Three major characteristics help determine price elasticity
of supply:
1. Time
2. Ability to store product
3. Ability to substitute during production
OTHER TYPES OF ELASTICITY
 Income elasticity measures the responsiveness of the
change in quantity demanded to changing income
levels.
 Products with negative income elasticity are inferior
goods.
 Products with positive income elasticity are normal
goods.
 Cross-elasticity of demand measures the impact that
changes in the price of one product have on the
quantity demanded of another product. It is measured as
the percentage change in demand for the first good that
occurs in response to a percentage change in price of the
second good.
 Products with negative cross-elasticity are
complementary.
 Products with positive cross-elasticity are substitutes.
 Chapter Review Questions (pg 77)
 1, 2, 4, 7, 8, 9, 11, 14, 15, 18, 20,22