ECON2150A-003_outline_ch02

Chapter 2: Demand, Supply, and Market Equilibrium

1. Course Outline

  • Title: Intermediate Microeconomic Theory I ECON2150A

  • Instructor: Kun Zhu

  • Institution: Western University

  • Date: July 22, 2024

  • Core Sections: Chapter 2 (2.1 - 2.3)

  • Exercises for Chapter 2: 3, 6, 9, 11, 12, 13, 18, 20, 21, 29

2. Key Points

2.1 Demand, Supply, and Market Equilibrium

  • Demand Curve

    • Characterizes quantity demanded (Qd) based on economic variables.

    • Mathematical expression: Qd = Qd(P_x; P_y, I, ...).

    • Focus on Qd(P_x) for relationship between quantity demanded and price.

    • Law of Demand: Inverse relationship between Qd and P when holding other factors constant.

  • Supply Curve

    • Characterizes quantity supplied (Qs) based on economic variables.

    • Mathematical expression: Qs = Qs(P_x; P_K, P_L, ...).

    • Focus on Qs(P_x) for relationship between quantity supplied and price.

    • Law of Supply: Positive relationship between Qs and P when holding other factors constant.

  • Market Equilibrium

    • Defined as the point where quantity supplied equals quantity demanded (Q_s(P) = Q_d(P)).

    • Equilibrium Price (P*) and Quantity (Q*) are determined under this condition.

    • Excess Supply (Q_s > Q_d): Leads to price reductions, increasing Qd and decreasing Qs until equilibrium is reached.

    • Excess Demand (Q_s < Q_d): Leads to price increases, decreasing Qd and increasing Qs until equilibrium is achieved.

  • Shifts in Demand/Supply

    • Right/Left shifts indicate increases/decreases in quantity demanded/supplied at the same price.

    • Shifts occur due to changes in economic conditions affecting demand/supply variables (e.g., P_y, I, P_K, P_L).

    • Distinguish between shifts and movements along the curve: Shifts involve changes in variables other than price.

2.2 Price Elasticity of Demand

  • Measures sensitivity of one variable (Y) to changes in another (X).

    • Mathematically defined:

      • ϵ_{Y,X} = (%ΔY / %ΔX) = (ΔY/Y)/(ΔX/X) = (ΔY/ΔX)(X/Y) = dY/dX (X/Y).

    • Application for price elasticity of demand:

      • ϵ_{Q_d,P} = (%ΔQ_d / %ΔP) = (ΔQ_d / ΔP)(P/Q_d).

  • Sign and Scale of Elasticity

    • Generally negative due to law of demand (Qd increases when P decreases).

    • Elasticity classifications:

      • Perfectly Inelastic (|ϵ| = 0)

      • Inelastic (0 < |ϵ| < 1)

      • Unitary Elastic (|ϵ| = 1)

      • Elastic (1 < |ϵ| < ∞)

      • Perfectly Elastic (|ϵ| = ∞)

  • Elasticity and Total Revenue

    • Total Revenue (TR) = P * Qd.

    • Relationship with elasticity:

      • dTR/dP > 0 when |ϵ| < -1 (elastic).

      • dTR/dP = 0 when |ϵ| = -1 (unitary).

      • dTR/dP < 0 when -1 < |ϵ| < 0 (inelastic).

  • Examples

    • Linear Demand: Qd(P) = a - bP; elasticity varies along the demand curve.

    • Constant Elasticity: Qd(P) = aP^{-b}, elasticity remains constant.

    • Zero Elasticity: Demand is constant irrespective of price.

    • Perfectly Elastic Demand: Demand is only available at one price.

2.3 Other Elasticities

  • Income Elasticity of Demand: Measures how Qd changes in response to changes in consumer income (Y = Qd, X = I).

  • Cross Price Elasticity: Measures responsiveness of Qd of one good to the price change of another (Y = Qd_x, X = P_y).

  • Price Elasticity of Supply: Measures responsiveness of Qs to price changes (Y = Qs, X = P).

3. Answers to Exercises in Last Chapter

  • 1.3:(a) Demand shifts right.(b) Demand shifts left.(c) Supply shifts right.

  • 1.4:(a) Total Cost: TC(E, L) = PE * E + PL * L.(b) √EL = 200.(c) Q, PE, PL are exogenous; E, L are endogenous.(d) Min TC = PE * E + PL * L subject to √EL = 200.

  • 1.8: Data for demand and supply listed, equilibrium found.

  • 1.12: Graph not provided, equilibrium conditions described.

  • 1.16: Concepts of optimization discussed.