Econ 301

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					  Econ 301

January 16, 2008
                Class Plan
• Demand
• Supply
• Market Equilibrium
• Shifts in Supply and Demand (Comparative
• Elasticities
• Quantity Demanded depends on
  – price of the good
  – prices of substitutes and complements
  – Income
  – Other factors…
  – Demand function is given by
Demand Curve
             Demand Curve
• Example from Moschini and Meilke, 1992
  (demand for pork in Canada)
• Need econometric techniques to estimate
  coefficients of the demand function
• Can you guess how demand depends on the
  price of pork, price of beef and price of
  chicken? (hint: are beef and chicken
  substitutes or complements?)
Estimating Demand for Pork
      Movement Along vs Shift
• A change in P causes movement along
  demand curve
• Change in other factors affecting demand,
  shift the curve
• The Law of Demand: dQ/dP <0
• dQ/dP = -20 (quantity demanded falls by 20
  times as much as the price rises)
      Shift in the demand curve
• Increase in the price of substitute (beef)

• Pinot Noir vs Merlot (after movie Sideways)
• (US sales of Pinot Noir increased 16% and 34%
  in CA)
• Other examples?
• Quantity supplied depends on the price of the
  good and other factors such as prices of inputs
• Processed pork example
       Movement Along Supply
• No such thing as “the Law of Supply”
• But still can find out what happens to quantity
  supplied as P increases
• dQ/dP =?
• In our example, dQ/dP=40 (upward sloping
          Shift of Supply Curve
• Change in a price of an input (increase in price
  of hog)
Market Equilibrium
Equilibrium Adjustment
      What Shifts Demand Curves?
•   Change in income
•   Change in a price of a substitute
•   Change in a price of a complement
•   Change in composition of population
•   Change in tastes
•   Change in information
•   Change in availability of credit
•   Change in expectations

        What Shifts Supply Curve?
•   Change in price of inputs
•   Change in technology
•   Change in natural environment
•   Change in availability of credit
•   Change in expectations

• The effect of a change in a supply curve
  depends on the shape of the demand curve
              How to measure elasticity?
• It is important to measure how sensitive Demand is to changes in Prices
• Preferably, this measure should not depend on units: are we counting in dollars,
  cents, or euros? Pounds, Kilograms or Tons?
• The price elasticity of demand provides such a measure:

                                 Q / Q       D        D
                            Ep 
                                  P / P
 In words, it is the % change in quantity for (or divided by) a given % change in prices
(sometimes, the elasticity is defined as the opposite number: the precise convention
    does not matter, as long as one realizes that the law of demand applies)


Price elasticity of demand: percent change in
quantity over percent change in price
Elasticity along Linear Demand Curve
      The Importance of Elasticity
• The Concept of Elasticity is used for other concepts:

    - Income    elasticity of Demand:        Q D / Q D
                                        EI 
                                              I / I

    - Price   Elasticity of Supply:          Q / Q
                                                  S       S
                                        ES 
                                              P / P

•   What affects the Slope? When is it steep? It is steep
    when there is no good substitute

             Using Calculus
% change in quantity demanded dQ / Q P dQ
                                     x
     % change in price         dP / P Q dP

% change in quantity demanded dQ / Q I dQ
                                     
     % change in income        dI / I   Q dI

• Linear Demand
• Q = a – bP
• Elasticity =

   dQ / Q   P dQ   P          bP
                   ( b) 
   dP / P   Q dP   Q         bP  a

•   Q=a-bp
•   Elasticity= -b p/Q
•   Plug in for p and Q to find point elasticity
•   Note that while slope is constant, elasticity is
    different at every point of a linear demand
                 Elasticity - Intuition
• Elastic – responsive to price changes
• Inelastic – not responsive to price changes
  - An unconscious bleeding man is brought to the hospital
  emergency room.
 - Among hospital patients whose insurance will pay all charges,
  what would the demand be like for nurse-administered
  propoxyphene (Darvon), a pain-killer?
 - Now suppose that the patients are in managed care plans that
  pressure physicians to use lower-price drugs. What might demand
  for the Darvon be?
 - A patient is given a presciption for a drug to control high blood
   pressure. The patient's insurance doesn't cover drugs, so the
   patient must pay out of pocket.

• Demand is more elastic
  if the decision-maker has an incentive to save money
  if there is an adequate substitute for the product or