Chapter 3. Applying the Supply and Demand Model

Supply and Demand Curves

How shapes of demand curves matter

Sensitivity of quantity demanded to price • Importance of sensitivity of quantity demanded to price • Price elasticity of demand – Percentage change in the quantity demanded in response to a given percentage change in the price 

Percentage change in quantity demanded Q / Q  Percentage changein price p / p



Q / Q Q p  p / p p Q

Price elasticity of demand 

Q / Q Q p  p / p p Q

Q  a  bp 

Q / Q p b p / p Q

Q  286  20 p, given p 3.3and Q  220 b

p 3.30  20   0.3 Q 220

• 1% increase in price of pork leads to 0.3% decrease in the quantity demanded – A price increase causes a less than proportionate fall in the quantity of pork demanded

Elasticity along the demand curve

Constant-elasticity demand curves

Quiz #2 1. Draw supply curve for the supply function for the processed pork, Q=88+40p (or P=1/40Q-88/40), Find two points on x and y axis (when p=0, Q=?; when Q=0, p=?) and connect the two points 2. What happens to the supply curve for the processed pork if hog price increases? •

Using a linear downward-sloping demand curve and a linear upward-sloping supply curve for gasoline: 3. Illustrate the effect of reduction of supply of crude oil in the gasoline market (Graph new supply curve, find new equilibrium point, and explain). 4. If the government issues price ceiling at the original price before the reduction of supply of crude oil, illustrate the effect on the graph and explain. •

The price elasticity of demand for gasoline is estimated to be -0.2. Two gallons are sold daily at a price of $1. Use this information to obtain a demand equation for gasoline, assuming it is linear(In other words, calculate a & b in Q  a  bp ). To calculate a & b, 5. Write mathematical expression for the price elasticity of demand. 6. Using the elasticity expression and given information in the question above, calculate ‘b’ first. 7. Using the demand equation, Q  a  bp and ‘b’, calculate ‘a’.

Quiz #2 1. Draw supply curve for the supply function for the processed pork, Q=88+40p (or P=1/40Q-88/40), Find two points on x and y axis (when p=0, Q=?; when Q=0, p=?) and connect the two points Answer)

2. What happens to the supply curve for the processed pork if hog price increases? Answer)

•

Using a linear downward-sloping demand curve and a linear upward-sloping supply curve for gasoline: 3. Illustrate the effect of reduction of supply of crude oil in the gasoline market (Graph new supply curve, find new equilibrium point, and explain).

Answer: The supply curve for the gasoline shifts from S1 to S2. Without governmental intervention, new equilibrium from e1 to e2 will be achieved and equilibrium quantity will be down and the equilibrium price will be up to p2.

4. If the government issues price ceiling at the original price before the reduction of supply of crude oil, illustrate the effect on the graph and explain.

Answer: Government prohibited gasoline price greater than pbar. So, at the pbar, supply will be at Qs and demand will be at Qd. As a result, there would be Qd-Qs, excess demand. With excess demand, the price goes up normally because consumers are willing to pay more to get gasoline. However, at the price is arbitrarily controlled at pbar. Gas station can’t sell the gasoline more than pbar, causing the excess demand continues. We call this shortage of gasoline, a persistent excess demand. At this circumstance, suppliers would make decision who gets gasoline, eg., friends, old customers, and others do not.

The price elasticity of demand for gasoline is estimated to be -0.2. Two gallons are sold daily at a price of $1. Use this information to obtain a demand Q  a  bp a & b in equation for gasoline, assuming it is linear(In other words, calculate ). To calculate a & b, 5. Write mathematical expression for the price elasticity of demand. 6. Using the elasticity expression and given information in the question above, calculate ‘b’ first. Q  a  bp 7. Using the demand equation, and ‘b’, calculate ‘a’. Answer) 5. 6.

7.