1 Chapter 2 Review of S and DSupply 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:

2 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:

3 Market Mechanism Put Supply and Demand Together Equilibrium1. 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.

4 Elasticity Definition: %Qd in response to a 1% P Or: %Qd / %PWhat 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.

5 More About ElasticitiesElastic: 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 ).

6 Example Price Demand Supply 60 22 14 80 20 16 100 18 18 120 16 20 1. What is P*, Q*? 2. When P=$80, what is ED?

7 Relative ElasticitiesRule: the steeper the slope of the curve, the less elastic. Completely horizontal demand curve: infinitely elastic: So: Completely vertical demand curve: completely inelastic:

8 Nearly Horizontal Demand CurveElasticity 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.

9 Income Elasticity of DemandMeasure 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).

10 Cross-Price Elasticity of DemandMeasures 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.

11 Price Elasticity of SupplyPrice Elasticity of Supply: Responsiveness of Qs to P. ESP = %Qs / %P = (Qs/Qs) / (P/P)  P/Qs  Qs/P Usually positive.

12 Wage Elasticity of SupplyMeasures 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.

13 Short-Run versus Long-run ElasticitiesFocal 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

14 Government Price ControlsKey: 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: