ECO 105 1st Edition Lecture 6 Outline of Last Lecture I. The Model of Supply and DemandII. HomeworkOutline of Current Lecture I. Demand FunctionII. EquilibriumIII. SupplyIV. Consumer/Producer SurplusesCurrent LectureI. Demand Functiona. Q = Q(P) --> quantity demanded is a function of pricei. E.g. Q = α – βP [linear]b. Demand can be a function of many variablesi. y = incomeii. Po (Pnaught) = price of another good, Qoiii. E = expectations about the futureiv. T = tastes/preferencesv. N = number of producersc. Q = Q (y, P, Po, E, T, N) --> function of all variablesd. Q = (y, P, Po, N) --> the ones we focus one. Q = α + βP + γy + δPo + εi. α, β, γ, δ, ε are parametersii. Q, P, Y, Po, N are variablesf. We can define Q by the values of γ and δi. γ is the same as ∆Q/∆y1. ∆Q/∆y tells us how Q changes when y changes by 12. γ > 0, Q is a normal goodThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.3. γ < 0, Q is an inferior goodii. δ is the same as ∆Q/∆Po1. ∆Q/∆Po tells us how Q changes when Po changes by 12. δ > 0, substitutes3. δ < 0, complementsg. So what is the point of this?i. The change in variables that affect demand with the exception of P shift the demand curve1. Shifts of the demand curvea. Income (y) goes up, demand goes up, if the good Q is normalb. D --> D’ represents an increase in demandii. If y increases and Q is an inferior good, then demand ______.1. a) increases2. b) decreases3. c) does not change4. d) ?iii. If Po decreases and Q and Qo are complements, then demand for Q ____.1. ∆Q/∆Po < 0a. (+)/(-) > 02. What happens to Q? Q increasesiv. If Q and Qo are complements and Po increases, what happens to demand for Q?1. ∆Q/∆Po < 0a. (-)/(+) < 0v. If Q and Qo are substitutes and Po increases, then ∆Q > 0 (Q increases)1. ∆Po > 02. ∆Q > 0 (Q’ – Q = ∆Q)II. Assume a market in equilibriuma. Assume Q is normal. What happen to P*, Q* when ∆y > 0?i. Both increaseIII. Supply – Shifts in supplya. QS = QS(P) --> quantity is a function of priceb. QS = Q (P, w, r, x, Pi)i. w = wagesii. r = interest (cost of capital)iii. x = technologyiv. Pi = price of some good Qi (related to production)c. Changes in the prices for factors of production/inputsi. ∆Q/∆w < 0ii. ∆Q/∆r < 0d. Technologyi. ∆Q/∆x > 0ii. EXAMPLES1. The onset of genetically modified seeds, ∆x > 0a. S --> S’ = increase in supply2. The onset of horizontal drilling technology has increased the supply of natural gase. The price of related goodsi. If the price (Pi) of compliments (Qi) in production increases, then supply of Q increases1. ∆Q/∆Pi) > 0ii. If the price of leather (Pi) increases, then the supply of steak increasesiii. If the price (Pi) of substitutes (Qi) in production increases, then supply of Q decreasesiv. EXAMPLE: Let’s say fractioning wells become illegal. What happens to theprice of a dekatherm of natural gas that you use for your furnaces, stove, hot water and quantity too?1. Price for production increases, quantity decreases (reduction in technology)IV. Consumer and producer surpluses (CS and PS)a. CS + PS = SSi. SS = social surplusii. Consumer surplus = difference between what consumers are willing to pay and what they have to/must pay1. (Demand curve – price) * (Q* - 0)iii. Producer surplus = difference between what producers are willing to produce and the price1. (Price – supply curve) * (Q* -