3-Shifts in Curves, Elasticity of Supply and Demand

7/28/2019 3-Shifts in Curves, Elasticity of Supply and Demand

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ENGINEERING ECONOMICS

Lecture 3



In this class

• Supply

• Law of Supply

• Market equilibrium

o Surplus

o Shortage

• Elasticity of Demand



SUPPLY

The willingness of producers to supply the good, over a range

of prices, over a given period of time, other things remaining

the same.



Supply Schedule

• A supply schedule showshow much of a good orservice would besupplied at different

prices.

Supp ly Schedu le for Coffee Beans

Price of coffee beans(per pound)

Quantity of coffee beans

supplied(billions of pounds)

$2.00 11.6

1.75 11.5

1.50 11.2

1.25 10.7

1.00 10.0

0.75 9.1

0.50 8.0



Supply Curve

Quantity of coffee beans (billions of pounds)

Price of coffeebeans (per pound)

7 0 9 11 15 13 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

As price rises, the

quantity supplied rises.

A supply curve shows

graphically how much of agood or service people are willing to sell at any givenprice.

Supplycurve, S



LAW OF SUPPLY

• The law of supply states that, the quantity supplied of a good

rises when the price of the good rises, and vice-versa, as long

as all other factors that affect suppliers’ decisions are unchanged



DETERMINANTS OF SUPPLY

1. Production cost

Higher production cost will lower profit, thus hinder supply

2. State of technology used

Technological improvements help reduce production cost and increase

profit, thus stimulate higher supply.

3. Number of sellers

More sellers in the market increase the market supply

4. Expectation of future prices

If producers expect future price to be higher, they will try to hold on to

their inventories and offer the products to the buyers in the future.



Supply, Demand and Equilibrium

• Equilibrium in a competitive market: when the quantity demanded of agood equals the quantity supplied of that good.

• The price at which this takes place is the equilibrium price.

o Every buyer finds a seller and vice versa.

o The quantity of the good bought and sold at that price is the equilibriumquantity.





Market equilibriumoccurs at point E,where the supplycurve and the demandcurve intersect.

Price of coffee beans

(per pound)

Quantity of coffee beans(billions of pounds)

7 0 10 15 13 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

E EquilibriumEquilibriumprice

Equilibriumquantity

Market Equilibrium



SUPPLY AND DEMAND TOGETHER

• Equilibrium refers to a situation in which

the price has reached the level where

quantity supplied equals quantity

demanded.



Equilibrium

• Equilibrium Price

o The price that balances quantity supplied

and quantity demanded.

o On a graph, it is the price at which thesupply and demand curves intersect.

• Equilibrium Quantity

o The quantity supplied and the quantity

demanded at the equilibrium price.

o On a graph it is the quantity at which

the supply and demand curves intersect.



At $2.00, the quantity

demanded is equal to the

quantity supplied!

Demand Schedule Supply Schedule

Equilibrium



Equilibrium

price

Demand

Supply

$2.00

6 8 100

Equilibri

um

Equilibrium

quantity

Quantity of Ice-

Cream Cones

Price of

Ice-CreamCone

421 3 5 7 9 11

The Equilibrium of Supply and Demand



Equilibrium

• Surplus o When price > equilibrium price, then quantity

supplied > quantity demanded.

• There is excess supply or a surplus.

• Suppliers will lower the price to increase

sales, thereby moving toward equilibrium.• Shortage

o When price < equilibrium price, then quantity

demanded > the quantity supplied.

• There is excess demand or a shortage.

• Suppliers will raise the price due to too

many buyers chasing too few goods, therebymoving toward equilibrium.



Demand

Supply

$2.00

6 8 100 Quantity of

Ice-Cream

Cones

Price of

Ice-Cream

Cone

421 3 5 7 9 11

$2.50

Surplus

Quantity

Demanded

Quantity

Supplied

a): Excess Supply



Demand

Supply

$2.00

6 8 100 Quantity of

Ice-Cream

Cone

Price of

Ice-Cream

Cone

421 3 5 7 9 11

$1.50

Shortage

Quantity

Supplied

Quantity

Demanded

b): Excess Demand



D1

Supply

$2.00

6 100 Quantity of

Ice-Cream

Cone

Price of

Ice-Cream

Cone

421 3 5 7 11

D2

$2.50

1. Hot weather increases thedemand for ice cream…

2. …

resulting ina higher price …

3. … and a higher quantity

sold.

New equilibrium

Initialequilibrium

How an Increase in Demand Affects the Equilibrium



Demand

S1

$2.00

100 Quantity of

Ice-Cream

Cones

Price of

Ice-Cream

Cone

421 3 7 11

S2

$2.50

1. An earthquake reduces thesupply of ice cream…

2. …

resulting ina higher price …

3. … and a lower quantity

sold.

New

equilibrium

Initial

equilibrium

How a Decreased Supply Affects the Equilibrium



D1

S1

0 Quantity of

Ice-Cream

Cone

Price of

Ice-Cream Cone

Q 1

D2

Large increasein demand

P 2

S2

Q 2

Newequilibrium

Smalldecrease in

supply

Initial equilibriumP 1

a): A Shift in Both Supply and Demand



D1

S1

0 Quantity of

Ice-Cream

Cone

Price of

Ice-Cream Cone

Q 1

D2

Large

decrease insupply

P 2

S2

Q 2

Newequilibrium

Small increase

in demand

Initial

equilibrium

P 1

b): A Shift in Both Supply and Demand



ELASTICITY OF DEMAND (Ed)

Elasticity of demand is defined as the percentage change in quantity

demanded caused by 1 percent change in Price, Income etc..( that is,

the demand determinant).

Price elasticities are almost always negative, except for Giffen goods (

exceptions to the law of demand).



PERFECTLY INELASTIC DEMAND

In general, the demand for a good is

said to be inelastic (or relatively

inelastic) when the PED is less than one

(in absolute value): that is, changes in

price have a relatively small effect on

the quantity of the good demanded.

PERFECTLY ELASTIC DEMAND

The demand for a good is said to be

elastic (or relatively elastic) when its

PED is greater than one (in absolute

value): that is, changes in price have a

relatively large effect on the quantity of a good demanded.



Types of elasticities of demand

• Price elasticity

• Income elasticity

• Cross elasticity



Price elasticity of demand

The measure of relative responsiveness of quantity demanded to price

along a given demand curve.

=

,

=(Q2 − Q1)/Q1

(P2 − P1)/P1



Problem: Price elasticity of demand

If 2000 units of X are demanded at a price of Rs. 10/unit and 2500

units of it are demanded at a price of Rs. 9 / unit, Determine Price

elasticity of demand. Interpret its meaning.



Income elasticity of demand

The ratio of percentage change in quantity demanded of good X to the

percentage change in the income of the consumer.

=

= (Q2 − Q1)/Q1(Y2 − Y1)/Y1



If the consumer’s demand for the commodity increases from 100 units

to 200 units a week when his income rises from Rs.2000 to Rs. 3000.

Find his income elasticity.

Problem: Income elasticity of demand



Cross elasticity of demand

The ratio of percentage change in demand one good due to a change in

price of some other related good.

= ΔQx ∗ Py (ΔPy)∗Qx



What Cross elasticity of Demand?

• Changes in the Prices of Related Goodso Substitutes: Two goods are substitutes if a fall in the price of one of the

goods makes consumers less willing to buy the other good .

o Complements: Two goods are complements if a fall in the price of one

good makes people more willing to buy the other good.



Problem: Cross elasticity of demand

The price of coffee increases from Rs.50 to Rs. 70 per kg and as a result

demand for tea increases from 5kg to 10 kg. What is the cross elasticity

of demand of tea to coffee?

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3-Shifts in Curves, Elasticity of Supply and Demand

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