Lecture 2

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The Basics of Supply and Demand

Supply and Demand

The Supply Curve


Supply Curve

Higher Price → Larger Quantity (upward)
Lower Production costs → Larger Quantity (that is the right shift of the curve)

The Demand Curve


Demand Curve

  • substitutes
  • complements

Higher Price → Smaller Quantity (downward)
High income → Larger Quantity (that is the right shift of the curve)

The Market Mechanism

Supply and Demand

  • equilibrium (or market clearing) price: Price that equates the quantity supplied to the quantity demanded.(P_0)
  • market mechanism: Tendency in a free market for price to change until the market clears.
  • surplus Situation: in which the quantity supplied exceeds the quantity demanded.
  • shortage Situation: in which the quantity demanded exceeds the quantity supplied.

This assumption makes sense only if a market is at least roughly competitive. Both sellers and buyers should have little market power (little ability individually to affect the market price)

Changes in Market Equilibrium

Elasticities of Supply and Demand

elasticity: Percentage change in one variable resulting from a 1-percent increase in another.

  • elastic: the change is great (<1)
  • inelastic: the change is minor (>1)

E_p=\dfrac{\%\Delta Q}{\%\Delta P} = \dfrac{\frac{\Delta Q}{Q}}{\frac{\Delta P}{P}}=\dfrac{P}{Q}\dfrac{\Delta Q}{\Delta P}

Talking about larger or smaller, we always talk about the absolute value.

  • Horizontal Demand Curve
    Horizontal Demand Curve
    Infinite elasticity

  • Vertiacal Demand Curve
    Vertiacal Demand Curve
    zero elasticity (inelastic)

income elasticity of demand
cross-price elasticity of demand

Short-Run versus Long-Run Elasticities

Not by a calendar length. The distinctions here are vague.
Short run: fixed cost
Long run: no fixed cost


Demand - Price elasticities

  • For necessities:
    In the short run, necessities have smaller price elasticity of demand;
    In the long run, necessities have larger price elasticity of demand.
  • For durables:
    In the short run, durables have larger price elasticity of demand;
    In the long run, durables have smaller price elasticity of demand;

Gasoline belongs to necessities, and automobiles are durables.


Secondary supply is therefore less elastic in the long run than in the short run.

Understanding and Predicting the Effects of Changing Market Conditions

A mathematical problem that is really a piece of cake.

Effects of Government Intervention - Price Controls

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