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Law of demand
Quantity demanded varies inversely with price, other things remaining constant The higher the price, the smaller the quantity demanded The lower the price, the larger the quantity demanded
Consumer expectations Number and composition of other consumers in the market Tastes of the consumers Weather, population, etc
Supply
Example of a farmer having 2 pieces of land; valley and hillside Either he could rear sheep or grow vegetables or a mix of both What if price of vegetables starts rising? Obviously, the farmer will allocate more piece of land to grow vegetables A further increase in price induces him to allocate more land to vegetable production
When the price of a good rises, the quantity supplied will also rise and vice versa
Price determination
Shortage and surplus P
SURPLUS
SHORTAGE
Change in demand
P d2
d1
Change in supply
P
D S2 S1
Identification problem
P
D2 D1 S2 S1
With the demand curve shifting to the right, the quantity demanded increases for all prices.
Factors that lead consumers to change demand quantities at the same price are referred to as demand shifters.
20
30
Qd
Inferior goods
Demand decreases when income increases & vice versa
A few commodities such as dry beans and potato are called inferior goods.
As income increases consumers tend to buy less of the inferior goods as they can now afford more expensive normal goods.
That is, an increase in income shifts the demand curve for an inferior good to the left.
$3
20
30
Qd
Elasticity
Elasticity is a measure of responsiveness. The most common elasticity measurement is that of price elasticity of demand. It measures how much consumers respond to a change in price. The basic formula used to determine price elasticity is e= (percentage change in quantity) / (percentage change in price).
The flatter the demand curve, the more price elastic is the demand.
flatter
steeper
Qd
Qd
The flatter the demand curve, the more room there is for the quantity to adjustment.
Hence, the flatter the demand curve, the more responsive is the quantity to a price change.
Elasticity
Price
Total revenue is of price x The importance elasticity quantity sold. In this is the information it example, TR = 5 x 100,000 provides on the effect on = 500,000. total revenue of changes in price. This value is represented by the grey shaded rectangle.
Total Revenue
Elasticity
Price
If the firm decides to decrease price to (say) 3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
Total Revenue
D
100 140 Quantity Demanded (000s)
Elasticity
Price () 10
% Price = -50% % Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall
Elasticity
Price ()
Producer decides to reduce price to increase sales % in Price = - 30% % in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D
10 7
Quantity Demanded
20
Giffen good
A Giffen good is an extreme type of inferior good. The negative income effect of changes in price of a giffen good is stronger than the substitution effect. This leads to its special quality: when the price of a giffen good rises, consumers actually buy more of it.