Chapter 2 Demand and Supply AnalysisOutlineExample: Oil MarketExample: Oil Market (cont’d)Competitive MarketsCompetitive Market AssumptionsSlide 7Slide 8Note:Law of DemandSome Demand ShiftersRuleSlide 13Slide 14Slide 15Supply ShiftersSlide 17Example: Canadian WheatSlide 19Slide 20Slide 21Market EquilibriumExample: Finding Equilibrium Price and Quantity The Market for CranberriesSlide 24Slide 25ElasticityElasticity is not the slopeSlide 28Elasticity ContinuedTypes of ElasticityExample: Linear Demand CurveSlide 32Slide 33Example: Determining ElasticitySlide 35Slide 36Slide 37How Elastic are these Curves?What Affects Elasticity?Slide 40Importance of BrandsSlide 42Slide 43Slide 44Slide 45The Cross-Price Elasticity of CarsElasticities of Demand for Coke and PepsiLong-run vs Short-run Elasticity Crude Oil ExampleBack of the Envelope Calculations: Estimating Supply and Demand FunctionsBack of the Envelope Calculations ExampleE.G: Broiler in the US, 1990Broiler Linear Demand ExampleBroiler: Constant Elasticity ExampleEstimating Demand and Supply for a Supply ShiftSlide 55Slide 56Slide 57Slide 58Slide 59Chapter 2 Demand and Supply Analysis21. Competitive Markets Defined2. The Market Demand Curve3. The Market Supply Curve4. Equilibrium5. Characterizing Demand and Supply: Elasticity6. Back of the Envelope TechniquesOutline3Why? Weather, Hurricanes in Gulf China and India economies boomingPolitical Crisis with Iran, Iraq, Russia, NigeriaOil production per day in Non-OPEC countries decliningUncertainty over OPEC production capabilitiesExample: Oil MarketCrude oil prices 1947 – 2004Crude oil prices 1947 – 2004OPEC oil productionOPEC oil production•Some experts predict that prices will rise Some experts predict that prices will rise to 100to 1004Example: Oil Market (cont’d)How could we bring prices down?• Reduce Demand – short-run• Find new reserves – short-run• Develop new technologies that are not reliant on oil  Forward thinking solution These become feasible as oil prices rise. Many are now feasible5Definition: Are those with sellers and buyers that are small and numerous enough that they take the market price as given when they decide how much to buy and sell.Competitive Markets6Competitive Market Assumptions1. Fragmented market: many buyers and sellers Implies buyers and sellers are price takers2. Undifferentiated Products: consumers perceive the product to be identical so don’t care who they buy it from3. Perfect Information about price: consumers know the price of all sellers4. Equal Access to Resources: everyone has access to the same technology and inputs.Free entry into the market, so if profitable for new firms to enter into the market they will7tells us how the quantity of a good demanded by the sum of all consumers in the market depends on various factors.Qd =(Q,p,po, I,…)Plots the aggregate quantity of a good that consumers are willing to buy at different prices, holding constant other demand drivers such as prices of other goods, consumer income, quality.Qd=Q(p)80Quantity (millions ofautomobiles per year)Price (thousands of dollars)Demand curve for automobiles in the United States in 200053 5.3The Demand for New Automobiles in the United States4029Note:We always graph P on vertical axis and Q on horizontal axis, but we write demand as Q as a function of P… If P is written as function of Q, it is called the inverse demand.Normal Form: Qd=100-2PInverse form: P = 50 - Qd/2- Markets defined by commodity, geography, time.10Empirical regularityLaw of Demand states that the quantity of a good demanded decreases when the price of this good increases.-If the change increases the willingness of consumers to acquire the good, the demand curve shifts rightThe demand curve: shifts when factors other than own price change…-If the change decreases the willingness of consumers to acquire the good, the demand curve shifts leftLaw of Demand11Some Demand ShiftersConsumer incomesConsumer tastesAdvertisingWhat would a rise in tax rate do?Note: For a given demand curve we assume everything else but price is held fixed.12A move along the demand curve for a good can only be triggered by a change in the price of that good. Any change in another factor that affects the consumers’ willingness to pay for the good results in a shift in the demand curve for the good.Rule13tells us how the quantity of a good supplied by the sum of all producers in the market depends on various factorsQs=Q(p,po,w, …)Plots the aggregate quantity of a good that will be offered for sale at different prices. Qs=Q(P)Po = price of other goods14Example: Supply Curve for Wheat in Canada0Quantity (billions ofbushels per year)Price (dollars per bushel)Supply curve for wheat in Canada in 20000.1515Definition: The Law of Supply states that the quantity of a good offered increases when the price of this good increases.Empirical regularityEmpirical regularityThe supply curve shifts when factors other than own price change…-If the change increases the willingness of producers to offer the good at the same price, the supply curve shifts right-If the change decreases the willingness of producers to offer the good at the same price, the supply curve shifts left16Supply ShiftersPrice of factors of production e.g. wageTechnology changesWeather conditionsHurricane Katrina reduced supply of oilNumber of producers changeWhat is the effect of a rise in the minimum wage?17A move along the supply curve for a good can only be triggered by a change in the price of that good. Any change in another factor that affects the producers’ willingness to offer for the good results in a shift in the supply curve for the good.Rule18 QS = p + .05r QS = quantity of wheat (billions of bushels) p = price of wheat (dollars per bushel) r = average rainfall in western Canada, May – August (inches per month)Example: Canadian Wheat19QS = p + .05ra. Quantity of wheat supplied at price of $2 and rainfall of 3 inches per month = 2.15b. Supply curve when rainfall is 3 inches per month: QS = p + 0.15c. Law of supply holds: we know because the constant in front of p is positived. As rainfall increases, supply curve shifts right (e.g., r = 4 => Q = p + 0.2)20Price ($)Quantity, Billion bushels0r = 0Supply withno rainQS = p + .05r21Price ($)Quantity, Billion bushels0r = 0r = 3.15Supply withno rainSupply with 3” rainQS = p + .05r22Definition: A market