SLIDE 1 Economics 2 Professor Christina Romer Spring 2017 Professor David Romer LECTURE 4 EXTENSIONS OF SUPPLY AND DEMAND ANALYSIS January 26, 2017 I. OVERVIEW
- II. REVIEW OF THE SUPPLY AND DEMAND FRAMEWORK
- A. Two sides of the market (example: SUVs)
- B. Equilibrium
- C. What shifts the demand curve?
- D. What shifts the supply curve?
- III. ELASTICITY
- A. Price elasticity of demand
- B. Relationship between elasticity and the slope of the demand curve
- C. Impact of elasticity on the market outcome
- D. Demand elasticity and expenditure (example: illegal opioid drugs)
- 1. Comparison of supply-side and demand-side policies
- 2. What the simple analysis may be missing
- E. Price elasticity of supply
- IV. EFFECTS OF A TAX
- A. Terminology and set-up (example: gas tax)
- B. Effects on price and quantity
- C. Who pays the tax?
- D. Interaction with demand elasticity
- E. Government tax revenue
SLIDE 2 LECTURE 4
Extensions of Supply and Demand Analysis
January 26, 2017
Economics 2 Christina Romer Spring 2017 David Romer
SLIDE 3 Announcements
- Problem Set 1 is due next Tuesday (January 31).
- Problem Set Work Session this Friday (January 27)
- 4:00–6:00 in 648 Evans Hall
- Ground Rules:
- Answers must be in your own words,
handwritten, and with acknowledgements to the people you worked with.
- Graded on a scale of 1 to 10.
SLIDE 4 Announcements
- Collecting the Problem Sets:
- They are due at the beginning of lecture.
- We will have boxes with your GSIs’ names on
them outside the main doors.
SLIDE 5 Announcements
- Journal article reading for Thursday (by Esther Duflo):
- Can access for free through any campus
computer, or from off campus using the library proxy server (see http://www.lib.berkeley.edu/using-the- libraries/connect-off-campus).
- Don’t stress over every word or parts you don’t
understand.
- Read for approach and findings; think about
relevance to consumer behavior.
SLIDE 6 Announcements
- Please do not eat nuts, eggs, or fish in the
- classroom. We have a student with a severe
allergy.
SLIDE 8 Plan for the Lecture
- Review the supply and demand framework.
- Discuss elasticity.
- Examine the effect of another government
intervention in the market (a tax).
SLIDE 9
- II. REVIEW OF SUPPLY AND DEMAND
SLIDE 10
Equilibrium in the Market for SUVs
D1 Q P S1 P1 Q1 Equilibrium
SLIDE 11 What Causes the Demand Curve to Shift?
- In general, anything that changes the desirability
- f the good at a given price.
- Change in the price of a complement.
- Change in tastes; news.
- Change in the price of a substitute.
- Change in demographics.
- Change in income.
SLIDE 12 Retail Price of Gasoline
Source: Bureau of Labor Statistics.
100 150 200 250 300 350 400
2011-01 2012-01 2013-01 2014-01 2015-01 2016-01
Index, 1982-84 = 100
SLIDE 13 Effect of a Fall in the Price of Gasoline
D1 Q P S1 P1 Q1 D2 P2 Q2
SLIDE 14 Source: www.goodcarbadcar.net.
SLIDE 15 What Causes the Supply Curve to Shift?
- In general, anything that changes the additional
cost associated with supplying one more unit at a given quantity of the good.
- Change in the price of an input.
- Change in technology.
SLIDE 16 Effect of a Fall in the Price of Steel
D1 Q P S1 P1 Q1 S2 P2 Q2
SLIDE 18
Price Elasticity of Demand (εD)
Percentage change in quantity demanded εD = Percentage change in price (In absolute value) Elastic
εD > 1
Inelastic
εD < 1
Perfectly inelastic
εD = 0
Perfectly elastic
εD = ∞
SLIDE 19
Relationship between Demand Elasticity and the Slope of the Demand Curve ΔQD / QD εD = ΔP / P
ΔQD P
= • ΔP QD
1 P
= • Slope QD
SLIDE 20
Slope of the Demand Curve
Q P ΔP Slope = ΔQD ΔP ΔQD D
1 P
εD = •
Slope QD
SLIDE 21
Demand Curves
Q P Q P Inelastic Elastic D1 D1
1 P
εD = •
Slope QD
SLIDE 22
Demand Elasticity Matters for Market Outcomes
Q P Q P Inelastic Elastic D1 D1
P1 Q1Q2
S1
P1 Q1 Q2
S1 S2
P2
S2
P2
SLIDE 23 Demand Elasticity Matters for Market Outcomes
- If demand is highly inelastic, a shift in the supply
curve leads mainly to a change in price, with little change in quantity.
- If demand is highly elastic, a shift in the supply
curve leads mainly to a change in quantity, with little change in price.
SLIDE 24 Source: National Institute on Drug Abuse; Center for Disease Control.
SLIDE 25
Market for Illegal Opioid Drugs
D1 Q P S1 P1 Q1
Market for Illegal Opioid Drugs
SLIDE 26
Market for Illegal Opioid Drugs (Supply Restriction)
D1 Q P S1 P1 Q1 S2 Q2 P2
SLIDE 27 Total Expenditure Total Expenditure = Price • Quantity
- Total expenditure and total revenue are the same
thing.
SLIDE 28 Demand Elasticity and Expenditure
- Inelastic (εD < 1): Total expenditure rises when the
supply curve shifts back.
- Elastic (εD > 1): Total expenditure falls when the
supply curve shifts back.
SLIDE 29
Market for Illegal Opioid Drugs (Increased Drug Treatment)
D1 Q P S1 P1 Q1 Q2 P2 D2
SLIDE 30
What are some of the complexities that we are ignoring with this analysis?
SLIDE 31
Price Elasticity of Supply (εS) Percentage change in quantity supplied
εS = Percentage change in price Elastic
εS > 1
Inelastic
εS < 1
Perfectly inelastic
εS = 0
Perfectly elastic
εS = ∞
SLIDE 32
Supply Curves
Q P Q P Inelastic Elastic S1 S1
SLIDE 34
Effect of a New 50¢ per Gallon Tax on Gasoline (Levied on Sellers)
D1 Q P S1 P1 Q1 S2 Tax (50¢) Q2 P2 P2−tax
SLIDE 35 Typical Effects of a Tax
- Quantity bought and sold declines.
- Production and consumption are still allocated by
price.
- Price rises by less than the amount of the tax.
- Both sides pay some of the tax.
SLIDE 36 Demand Elasticity and the Effects of a Tax
Inelastic Elastic Q P Q P D1 D1
P1 Q1
S1
P1 Q1
S1 S2
P2 P2
S2
Tax Tax
Q2 P2−tax P2−tax Q2
SLIDE 37 Two Ways of Visualizing Tax Revenues
(1) (2) Q P Q P D1
P2 Q2
S1
P2 Q2
S1 S2 S2
Tax Tax
P2−tax
D1
SLIDE 38 Demand Elasticity and the Effects of a Tax
- A tax will change the equilibrium quantity more,
the more elastic demand is.
- Buyers will pay more of the tax, the less elastic
demand is.
- Government revenue from the tax will be larger,
the less elastic demand is.
