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Chapter 2 Review of S and D • Supply Curve: • Shows quantity supplied at each possible price, ceteris paribus (c.p.). – Slopes upward (positive relationship) – Qs = Qs(P) – Shift S Curve: – Clarify movement along vs shift. – C.P. factors: – Interpret shift S curve: Demand Curve • Shows quantity demanded at each possible price, ceteris paribus (c.p.) – Slopes downward (negative relationship) – Qd = Qd(P) – Movement along versus shift. – C.P. factors: – Interpret shift D curve: Market Mechanism • Put Supply and Demand Together • Equilibrium – 1. – 2. • Describe re-equilibrating process by changing C.P. factor: – Increase in income causes increase in demand (shift D rightward) – At old P, Qd greater than Qs: so individuals bid up price till reach new equilibrium. Elasticity • Definition: %Qd in response to a 1% P • Or: %Qd / %P • What is %? Absolute change in variable divided by original level of variable. • Ep = (Qd/Q) / (P/P) • = (P/Q) (Q/P) • Remember: (Q/P) is 1/slope. • Ep = price elasticity of demand; usually negative. More About Elasticities Elastic: Ep 1 Inelastic: Ep 1 Unitary Elastic: Ep 1 Fact: While slope is constant along a linear demand curve, elasticity is not. • Fact: At top of demand curve, when P is high and Q is low, Ep is big negative number so D curve is very elastic. • Fact: As move down D curve to right, Ep falls (because P is while Q is , so P/Q is ). • • • • Example • • • • • Price 60 80 100 120 Demand 22 20 18 16 Supply 14 16 18 20 • 1. What is P*, Q*? • 2. When P=$80, what is ED? Relative Elasticities • Rule: the steeper the slope of the curve, the less elastic. • Completely horizontal demand curve: infinitely elastic: • So: • Completely vertical demand curve: completely inelastic: • So: Nearly Horizontal Demand Curve • Elasticity approaches infinity: Recall: 1/slope = Q/P • If nearly flat curve: small P causes a huge Q. This is same as: huge / small , which equals a very big number. Income Elasticity of Demand • Measure responsiveness of Qd to change in income (note this is a ceteris paribus factor). • EI = %in Qd resulting from a 1% in income. • EI = (Q/Q) / (I/I) • = I/Q (Q/I). Cross-Price Elasticity of Demand • Measures responsiveness in Qd of one good to change in price of a related good (note this is a change in a c.p. factor). • Cross-price elasticity of demand = % in Qd resulting from a 1% in the price of a related good. • EQ1P2 = (Q1/Q1) / (P2/P2) • P2/Q1 Q1/P2. • EQP 0: the two goods are substitutes. • EQP 0: the two goods are complements. Price Elasticity of Supply • Price Elasticity of Supply: Responsiveness of Qs to P. • ESP = %Qs / %P • = (Qs/Qs) / (P/P) • P/Qs Qs/P • Usually positive. Wage Elasticity of Supply • Measures responsiveness of Qs to changes in the cost of labor (a ceteris paribus factor). • ESW = %Qs / %W • = (Qs/Qs) / (W/W) • W/Qs Qs/W. • Usually negative. • Remember: W cost of production. Short-Run versus Long-run Elasticities • Focal point: how much time do sellers and consumers have to respond (in their Qs and Qd) to changes in price? • In general: LR adjustment is more full, free adjustment so that LR elasticity is larger; BUT not true all the time. • Key factors: – Durability. – Availability of substitutes Government Price Controls • Key: If government sets P so that there is no single P for which Qs=Qd, then there will be a shortage or surplus. • Be able to show the Qs and Qd for any price. • Price ceiling: • Price floor: