HcWjnyVHiTd8hN_8STvJ2rWaXvhPz4wXYCNGvD4qDkU
 
 
 

Demand and Supply Functions
Lecture 2

 

Supply and Demand

 

  1. Supply and Demand

    • Modified to include trade

    • Gains and losses from international trade

    • Welfare effects

  2. Demand - shows the quantity and price of a good, which consumers are willing to buy

    • Consumers max. utility relative to their limited income

    • Law of Demand – as market price increases, quantity demanded decreases

The Demand Function
Demand Function
  1. Characteristics

    • Assumes competitive market – many buyers in market

    • Price Elasticity of Demand – how sensitive consumers are to changes in the market price

      • Has no units

        • Can compare apples to oranges

        • Expressed as a percentage

      • Inelastic demand – consumers are not sensitive to price changes

An Inelastic Demand Function
Inelastic Demand Function
          • Elasticity lies between 0 and -1

          • Examples

            • Cigarettes

            • Gasoline

            • Alcohol

            • If cigarettes are ed = -0.5; if the market price increases by 1%, then quantity demanded falls by 0.5%

        • Elastic demand – consumers are sensitive to price changes

An Elastic Demand Function
Elastic Demand Function
          • Elasticity lies between -1 and negative infinity

          • Examples – many products

          • Private education, ed = -4.0; if the market price increases by 1%, then quantity demanded falls by 4%

  1. Demand curves shifts

    1. Price of other products

      • Substitute goods

      • Complement goods

    2. Income

      • Normal goods – consumers buy more as their income increases; most products

      • Inferior goods – consumers buy less as their income increases

    3. Taste and preferences

  2. Consumers' surplus – the area below the demand curve but above the actual price paid

    • Measure of social welfare

    • An aggregate benefit to all consumers in the market

    • Example

      • The market price of coffee is $1.50 and consumers buy 15 (million) pounds of coffee.

      • I place a $2.50 value on this soda, but bought it for $1.50

      • I received a benefit of $1.00

Consumer Surplus
Consumer Surplus
      • If the market price of the soda decreases to $0.50, consumers' surplus increases!

      • Social welfare increases

Change in Consumer Surplus when Price Decreases
Consumer Surplus for a market price decrease
  1. Supply - shows the quantity and price of a good that firms are willing to produce/sell

The Supply Function
Supply Function
    • Producers produce if P >= MC

      • P is market price

        • Gain in revenue for selling one more unit

        • Determined by consumers

      • MC is marginal cost

        • Change in cost as production increases by one more unit

        • Does not include fixed costs

    • Profits

      • Competitive firm maximize profits when P = MC, which equals zero in the long run

      • Assume competitive market; many firms in market

      • Firms earning profits (P > MC)

        • Firms enter the market

        • Industry expands

        • Marginal costs increase, while market price decreases

      • Firms earning losses (P < MC)

        • Firms exit the industry

        • Industry contracts

        • Market price increases, while marginal costs decrease

    • Elasticity – applied to supply function

    • Supply shifts

      1. Input cost

        • Labor

        • Materials

        • Resources and energy

      2. Technology

      3. Taxes and regulations

    • Producers' surplus – the area above the supply curve but below the actual sales price

      • Measure of social welfare

      • An aggregate benefit to all producers in the market

      • Producers' surplus is total fixed costs + profits

      • Example - market price is $1.50. If a firm can produce the product for $0.50, then it earns profits

Producer Surplus
Producer Surplus
  1. Social Welfare – consumers' plus producers' surpluses

    • No international trade

    • A competitive market maximizes social welfare

Social Welfare-Consumers' plus Producers' Surpluses
Social Welfare-Consumers' plus producers' surpluses

 

International Trade

 

  1. Excess Demand (ED) function –

    • Above market price, ED = 0

    • Below market price, ED = Quantity demanded – quantity supplied

Derivation of an Excess Demand (ED) Function
Derivation of the Excess Demand (ED) function
    • Note – Domestic industry declines, while domestic consumers benefit

    • Money flows out of the country

  1. Excess Supply (ES) function

    • Above market price, ES = Quantity supplied – quantity demanded

    • Below market price, ES = 0

Derivation of an Excess Supply (ES) Function
Derivation of the Excess Supply (ES) Function
    • Note – Export industry expands, while foreign consumers are harmed

    • Money flows into the country

  1. Example – U.S. imports petroleum from Kazakhstan

    • United States import Q2 – Q1 = T

      • U.S. gains petroleum

    • Kazakhstan exports Q4 – Q3 = T

      • Kazakhstan gains U.S. dollars

Free Trade Between the U.S. and Kazakhstan
Free trade between the United States and Kazakhstan
  1. Welfare effects

    1. Autarky - countries do not engage in trade

      • Consumers' surplus is c

      • Producers' surplus is a + e

      • Total social welfare is a + c + e

The Welfare Effects of Free Trade
Welfare Effects of Free Trade
    1. Country imports s product

      • Consumers' surplus is c + a + b + d

      • Producers' surplus is e

      • Total social welfare is a + b + c + d + e

      • Gains for trade = a + b + c + d + e - (a + c + e) = b + d

    2. Autarky for exporting country

      • Consumers' surplus is m + j + k

      • Producers' surplus is p + q

      • Total social welfare is m + j + k + p + q

The Welfare Effects of Free Trade
Welfare Effects of Free Trade
    1. Country exports a product

      • Consumers' surplus = m

      • Producers' surplus = p + q + j + k + n

      • Social welfare = m + p + q + j + k + n

      • Gains in trade = m + p + q + j + k + n - (m + j + k + p + q) = n

    2. Gains more from trade

      • Exporting nation gains n

      • Importing nation gains b + d

      • Compare n to b + d

      • Note - both the domestic industry for importing country and foreign consumers for exporting country are harmed from trade

 

FOLLOW ME