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Lesson 1: Introduction to Demand and Demand curves Learning objectives: 1. Define the terms ‘demand’, and ‘utility’ 2. Identify and describe the factors Influencing demand 3. Explain the nature of demand curves. 4. Explain movements along and shifts in demand curves 1 Demand - Definition • Demand is the amount of a good that consumers are willing and able to buy at a given price. • Desire refers to people's willingness to own a good. 2 Utility defined • Utility is the satisfaction people get from consuming (using) a good or a service. Utility varies from person to person. • Some people get more satisfaction from eating chips than others. Even the same person can gain greater satisfaction by eating chips when hungry than when he has lost his appetite. 3 Factors Influencing Demand The amount of a good demanded depends on: 1. the price of the good; 2. the income of consumers; 3. the demand for alternative goods which could be used (substitutes); 4. the demand for goods used at the same time (complements); 5. whether people like the good (consumer taste). 4 Demand curves • The demand curve indicates how many consumers will buy the product at a given price. 5 Movements Along and Shifts in Demand Curves • In the figure an increase in price results in a movement up the demand curve. • A change in price never shifts the demand curve for that good. 6 Contraction of demand • The demand curve shows the amount of a good one or more consumers are willing and able to buy at different prices. • The fall in the quantity demanded from Q1 to Q2 is sometimes called a contraction in demand. 7 Shifts in the demand curve • A demand curve shifts only if there is a change in income, in taste or in the demand for substitutes or complements. • In other words, in some factor other than price. 8 Shifts in the demand curves • In the diagram, a decrease in demand has shifted the demand curve to the left. 9 End of lesson 1 Questions: Reference: Hosein & Stanlake – Chap: 6 1. Identify and describe those factors which would cause a movement of or shift in the demand curve. 2. Research the following terms: - Competitive demand - Joint demand - Joint supply 10 Lesson 2: Introduction to Supply and Supply Curves Learning Objectives: 1. Define the term ‘supply’ 2. Identify and describe the factors influencing supply 3. Explain the nature of supply curves 4. explain movements along and shifts in supply curves 11 Supply defined: Supply is the amount of a good producers are willing and able to sell at a given price. 12 Factors Influencing Supply Supply depends on: 1. the price of the good; 2. the cost of making the good; 3. the supply of alternative goods the producer could make with the same resources (competitive supply); 4. the supply of goods actually produced at the same time (joint supply); 5. unexpected events that affect supply. 13 Supply curves • The supply curve shows the amount of a good one or more producers are prepared to sell at different prices. 14 Movements Along the Supply Curve • An increase in price results in a movement up the supply curve. • The increase in quantity supplied from Q1 to Q2 is sometimes called an expansion in supply. 15 Shifts in the supply curve A change in price never shifts the supply curve for that good. A supply curve shifts only if there is: 1. a change in costs; 2. a change in the number of goods in competitive or joint supply; or 3. some unforeseen event which affects production. 16 End of lesson 2 Questions: 1. Identify and describe those factors which would cause a movement of or shift in the supply curve. 17 Lesson 3: Equilibrium Price and Quantity Learning Objectives: 1. Define equilibrium price and equilibrium quantity 2. Draw demand and supply curves 18 Introduction to Demand and Supply curves: Equilibrium Price • The price where the amount consumers want to buy equals the amount producers are prepared to sell is the equilibrium price. 19 Equilibrium price and quantity • At prices above the equilibrium (P*) there is excess supply while at prices below the equilibrium (P*) there is excess demand. The effect of excess supply is to force the price down, while excess demand creates shortages and forces the price up. 20 Demand and Supply Curves • By drawing the two curves together, it is possible to calculate the equilibrium price for the product. 21 Drawing demand and supply curves • The downward sloping line is the demand curve, while the upward sloping line is the supply curve. The demand curve indicates that if the price were $10, the demand would be zero. 22 Drawing demand and supply curves • However, if the price dropped to $8, the demand would increase to 4 units. Similarly, if the price were to drop to $2, the demand would be for 16 units. 23 Drawing demand and supply curves • The supply curve indicates how much producers will supply at a given price. If the price were zero, no one would produce anything. As the price increases, more producers would come forward. 24 Drawing demand and supply curves • At a price of $5, there would be 5 units produced by various suppliers. At a price of $10, the suppliers would produce 10 units. 25 Equilibrium Price and Equilibrium Quantity • The intersection of the supply curve and the demand curve, shown by (P*, Q*), is the equilibrium condition. • In this example, the equilibrium price is P*= 6.67 26 • The equilibrium quantity is Q*=6.67. At the price of $6.67, various producers supply a total of 6.67 units, and various consumers demand the same quantity. 27 Drawing demand and supply curves • There is no reason why the curves have to be straight lines. They could be different shapes such in the examples below. However, for the sake of simplicity, we will work with straight line demand and supply functions. 28 Demand Schedule Price Quantity demanded per week 10 9 8 20 30 50 7 6 5 70 90 120 4 3 2 150 190 240 29 Effect of Change in Quantity demanded Price 10 9 Quantity demanded after increase in demand 50 70 8 7 6 5 4 3 2 90 110 140 170 220 270 340 30 Supply Schedule Price Quantity supplied per week (units) 10 9 8 80 70 60 7 6 5 50 40 30 4 3 2 20 10 5 31 Supply Schedule 2 Price Quantity supplied per week (units) 10 9 8 160 140 120 7 6 5 100 80 60 4 3 2 40 20 10 32 Supply Schedule 3 Price Quantity supplied per week (units) 10 9 8 300 250 225 7 6 5 200 175 150 4 3 2 125 100 75 33 Effect of Indirect Taxes • An indirect tax has been added to SS. This has the effect of shifting the supply curve up vertically by the amount of the tax. 34 Effect of Subsidies • A subsidy has been given to the firm. This has the effect of making firms willing to supply more at each price and so shifts the supply curve downwards. The shift is equivalent to the value of the subsidy. 35 End of lesson 3 Questions: 1. Page 105 – 107, question numbers 1 – 7 2. Page 108 Case Study #6. 36 Lesson 4: Elasticity Learning Objectives: 1. Define the term ‘elasticity’ 2. Identify and describe the types of elasticity 3. Identify and describe the factors affecting elasticity of demand 37 Elasticity defined • Elasticity is the degree of responsiveness of one variable to another. Or • The degree to which a demand or supply curve reacts to a change in price is the curve's elasticity. 38 Elasticity, necessary goods and normal goods • Elasticity varies among products because some products may be more essential to the consumer. • Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases. 39 Elasticity, necessary goods and normal goods • A price increase of a good or service that is considered less of a necessity will deter more consumers because the opportunity cost of buying the product will become too high. 40 Elastic vs Inelastic • A good or service is considered to be highly elastic if a slight change in price leads to a sharp change in the quantity demanded or supplied. Usually these kinds of products are readily available in the market and a person may not necessarily need them in his or her daily life. 41 Elastic vs Inelastic • An inelastic good or service is one in which changes in price witness only modest changes in the quantity demanded or supplied, if any at all. These goods tend to be things that are more of a necessity to the consumer in his or her daily life. 42 Elastic and Inelastic • If elasticity is greater than or equal to one, the curve is considered to be elastic. If it is less than one, the curve is said to be inelastic. 43 Elasticity • Elasticity = (% change in quantity / % change in price) 44 Elasticity of demand • If there is a large decrease in the quantity demanded with a small increase in price, the demand curve looks flatter, or more horizontal. This flatter curve means that the good or service in question is elastic. 45 Elasticity of demand • Inelastic demand is represented with a much more upright curve as quantity changes little with a large movement in price. 46 Types of Elasticity 1. Price elasticity of demand (PED) 2. Income elasticity of demand (YED) 3. Cross elasticity of demand (XED) 4. Price elasticity of supply (PES) 47 Price Elasticity of Demand • Price elasticity of demand measures the responsiveness of demand to a given change in price and is found using the equation: • PED = Percentage change in quantity demanded/Percentage change in price 48 Features of price elasticity of demand Feature Elastic goods Inelastic goods PED value Greater than 1 Less than 1 A rise in price means A larger fall in demand A smaller fall in demand Slope of demand curve Flat Steep Number of substitutes Many Few Type of good Luxury Necessity Price of good Expensive Cheap Example Maestro cars Petrol 49 HOMEWORK • PAGE 129 • CASE STUDY #7 (1) AND (2) 50 Income Elasticity of Demand • If price increases while income stays the same, demand will decrease. • It follows, then, that if there is an increase in income, demand tends to increase as well. • The degree to which an increase in income will cause an increase in demand is called income elasticity of demand. 51 Income Elasticity of Demand • Income elasticity of demand (YED) measures the responsiveness of demand to a given change in income: • YED = Percentage change in quantity demanded/Percentage change in income 52 Income Elasticity of Demand • If YED is greater than one, demand for the item is considered to have a high income elasticity. If however YED is less than one, demand is considered to be income inelastic. • Luxury items usually have higher income elasticity because when people have a higher income, they don't have to forfeit as much to buy these luxury items. 53 An example of a luxury good: air travel. Bob has just received a $10,000 increase in his salary, giving him a total of $80,000 per annum. With this higher purchasing power, he decides that he can now afford air travel twice a year instead of his previous once a year. With the following equation we can calculate income demand elasticity: 54 Income elasticity of demand • Income elasticity of demand for Bob's air travel is seven - highly elastic. YED = Percentage change in quantity demanded/Percentage change in income Change in Q demanded: from 1 to 2 Change in income: from $70,000 to $80,000 Thus: YED? 55 Income elasticity of demand • With some goods and services, we may actually notice a decrease in demand as income increases. These are considered goods and services of inferior quality that will be dropped by a consumer who receives a salary increase. 56 Income elasticity of demand and inferior goods Example • The increase in the demand of DVDs as opposed to video cassettes, which are generally considered to be of lower quality. 57 Income elasticity of demand • Products for which the demand decreases as income increases have an income elasticity of less than zero. • Products that witness no change in demand despite a change in income usually have an income elasticity of zero these goods and services are considered necessities. 58 Income Elasticity of Demand • If YED is negative then the good is inferior. People use an increase in income to buy less of this good and more of a superior substitute. • If YED is positive then the good is normal. Consumers use an increase in income to buy more of the good. 59 Cross Elasticity of Demand • Cross elasticity of demand (XED) measures the responsiveness of demand for one good (z) to a given change in the price of a second good (w): • XED = Percentage change in quantity demanded of good z/Percentage change in the price of good w 60 Cross Elasticity of Demand • If XED is positive then the two goods are substitutes. If XED is negative then the two goods are complements. 61 Price Elasticity of Supply • Price elasticity of supply (PES) measures the responsiveness of supply to a given change in price. • PES = Percentage change in quantity supplied/Percentage change in price 62 Price Elasticity of Supply • If a change in price results in a big change in the amount supplied, the supply curve appears flatter and is considered elastic. Elasticity in this case would be greater than or equal to one. 63 Price elasticity of Supply • If a big change in price only results in a minor change in the quantity supplied, the supply curve is steeper and its elasticity would be less than one or Inelastic. 64 Features of elasticity of supply Feature Elastic goods Inelastic goods PES value Greater than 1 Less than 1 A rise in price means A larger rise in supply A smaller rise in supply Slope of supply curve Flat Steep The good is produced Rapidly Slowly The time period is Months Days The firm has Large stocks Limited stocks Example Screws Beef 65 HOME WORK SEE TEXT. 66 Factors Affecting Demand Elasticity There are three main factors that influence a demand's price elasticity: 1. The availability of substitutes 2. Amount of income available to spend on the good 3. Time 67 The availability of substitutes • This is probably the most important factor influencing the elasticity of a good or service. In general, the more substitutes, the more elastic the demand will be. • For example, if the price of a cup of coffee went up by $0.25, consumers could replace their morning caffeine with a cup of tea. This means that coffee is an elastic good because a raise in price will cause a large decrease in demand as consumers start buying more tea instead of coffee. 68 The availability of substitutes • Therefore, caffeine can be considered as an inelastic product because of its lack of substitutes. Thus, while a product within an industry is elastic due to the availability of substitutes, the industry itself tends to be inelastic. Usually, unique goods such as diamonds are inelastic because they have few if any substitutes. 69 Amount of income available to spend on the good • This factor affecting demand elasticity refers to the total a person can spend on a particular good or service. Thus, if the price of a can of Coke goes up from $0.50 to $1 and income stays the same, the income that is available to spend on coke, which is $2, is now enough for only two rather than four cans of Coke. 70 Amount of income available to spend on the good • In other words, the consumer is forced to reduce his or her demand of Coke. • Thus if there is an increase in price and no change in the amount of income available to spend on the good, there will be an elastic reaction in demand; demand will be sensitive to a change in price if there is no change in income. 71 Time • The third influential factor is time. • If the price of cigarettes goes up $2 per pack, a smoker with very few available substitutes will most likely continue buying his or her daily cigarettes. This means that tobacco is inelastic because the change in price will not have a significant influence on the quantity demanded. 72 Time However, if that smoker finds that he or she cannot afford to spend the extra $2 per day and begins to kick the habit over a period of time, the price elasticity of cigarettes for that consumer becomes elastic in the long run. 73 Lesson 5: Elasticity of demand 2 Learning objectives: 1. Explain the following terms: • Perfectly inelastic demand, • Inelastic demand, • Unitary elastic demand, • Perfectly elastic demand. • Elastic demand. 74 Perfectly inelastic demand • If a good has a perfectly inelastic demand, the quantity demanded will remain unchanged regardless of price changes. Thus elasticity of demand = zero (0) 75 Inelastic demand • When demand is inelastic, the change in quantity demanded will be less than the proportionate change in price. 76 Perfectly elastic demand • Where the quantity demanded is highly responsive to change in price, demand is said to be perfectly elastic. This type of elasticity of demand exist only in theory. • With perfectly elastic demand, the elasticity of demand = infinity 77 Unitary elastic demand This means that a change in price will bring about a proportionate change in quantity demanded. Thus elasticity of demand = 1 78 Elastic demand • This means that a change in price will lead to a more than proportionate change in quantity demanded. 79 Lesson 6: Elasticity of supply 2 Learning objectives: Explain the following terms: • Perfectly inelastic supply • Perfectly elastic supply • Unitary elastic supply • Inelastic supply • Elastic supply 80 Perfectly inelastic supply • When the price of a good changes but the supply does not respond to the change in price, it is known as perfectly inelastic supply. The elasticity of supply = zero (0) 81 Perfectly elastic supply • Where the quantity supplied is highly responsive to the change in price, supply is said to be perfectly elastic, and = infinity. • This type of elasticity of supply exists only in theory. 82 Unitary elastic supply • This means that a change in price will bring about a proportionate change in quantity supplied. Thus elasticity = 1 83 Inelastic supply • When supply is inelastic, this means that the change in quantity supplied is less than the change in price. Here elasticity of supply is greater than zero but less than 1. 84 Elastic supply • This means that a change in price will lead to a more than proportionate change in quantity supplied. • Elastic supply is greater than 1 but less than infinity. 85 Evaluation QUESTION 1 Moonbucks, a national coffee house franchise, moves into your village. They face the following demand schedule. 86 Cups of coffee demanded per week Price per cup ($) Quantity demanded 6 80 5 100 4 120 3 140 2 160 1 180 0 200 87 Required 1. Represent the information on a graph. 2. What is the price elasticity of demand when price changes from $1 to $2? 3. What is the price elasticity of demand when price changes from $5 to $6? 4. Is demand elastic, unitary elastic or inelastic? Explain. 88 QUESTION 2 Figure 1 shows the supply schedule for cups of coffee in a particular market. You are required to sketch the supply curves on the same graph as the demand curve, and answer the questions which follow. 89 Supply schedule Quantity (Millions) 50 Supply price before tax ($ per unit) .10 Supply price after tax ($ per unit) .24 100 .15 .30 150 .20 .335 200 .25 .40 250 .30 .45 300 .35 .50 90 Questions 1. Are the supply curves elastic, unitary elastic or inelastic? Explain. 2. Label all equilibrium points and state the equilibrium prices at those points. 3. What is the price elasticity of supply when price changes from $0.15 to $0.15 before tax? 4. What is the price elasticity of supply when price changes from $.40 to $.45 after tax? 91 END OF LESSON END OF SLIDE PRESENTATION 92