4 Demand and Supply Flashcards
Difference between supply-side and demand-side effects
- Factors influencing the number of goods and services on offer = supply-side effects.
- Factors affecting the number of goods and services people might want to purchase = demand-side effects.
What is the objective of the basic “supply and demand” model?
To provide a simple, useful analytical framework to understand price and quantity fluctuations.
It abstracts from the particular idiosyncratic institutional features of each market and tries to focus on features which are common to all (or at least most) markets.
What is the basic supply and demand model based on?
A population of homogeneous potential buyers and potential sellers.
Assumption that the only significant differences in this model are their individual valuations of the product on offer.
Valuations of products on offer are called…
Willingness to pay (WTP) of buyers and
Willingness to accept (WTA) of sellers.
How do WTP and WTA measure the value of something?
By what we are prepared to give up to get it.
WTA/P are marginal concepts, so they measure the value of one extra, given what you have already.
WTP: the value of an extra unit acquired. WTA: the value of an extra unit parted with.
How is WTP determined?
Assumption: WTP for marginal units is independent of the price and of other people’s valuations (depend purely on personal preferences).
How/when does WTP change?
As a marginal concept, the WTP of the 1st unit may different from that of the second and so on.
Hence, we write write is as a function of quantity: WTP(q)
How can we calculate the overall WTP for n units?
Overall WTP for n units is the WTP of the 1st, plus WTP of the 2nd plus…
I.e. sum.
Plot WTP
lot of goods (not necessarily all) exhibit diminishing marginal value. Plotting WTP against quantity would show a falling line (not necessarily linearly).
WTP diagram explained
Vertical intercept: reservation price.
Horizontal intercept: satiation point, after which value of further units would be negative (or flatline at 0).
Demand curve for Giffen goods
Giffen goods: goods with increasing marginal value (e.g. goods which are addictive).
Positively sloped (again not necessarily linear).
Where does demand derive from?
Willingness to pay with ability to pay.
What is effective WTP?
WTP plus the ability to act on this willingness.
How do we calculate consumer/producer surplus? What is our rule?
Surplus is the difference between the price paid and WTP/A for every given quantity.
Maximise quantity to the point while WTP/A ≥ price
Relationship between market price and WTP?
At market quantity, q : p = WTP(q)
Derive equation for quantity from WTP
q = WTP-1(p)
By reading it backwards.
Equations for an individual’s demand and inverse demand curve
Suppose that the individual’s WTP is p(q) = a + bq, what is the equation for their demand curve?
Suppose that the individual’s demand curve is log(q) = c + d log(p), what is the inverse demand curve/WTP?
Suppose inverse demand curve is p = a + bq, q = q*and p = p*. What is the consumer surplus?
Aggregate demand diagrammatically
Sum the demand in the horizontal direction.
Vertical intercept reflects the reservation price of the person with the highest WTP for the initial unit.
Horizontal intercept reflects the maximum possible aggregate demand.
For market price p, how can we show individual demand and aggregate demand diagrammatically?
Surpluses and aggregate demand
How do the principles of WTP relate to WTA?
Essentially the same but opposite.
Plotting WTA
Again, as a function of quantity (marginal concept).
How do we calculate producer surplus? What is our rule?
Formulae for price elasticity
For linear demand q<em>D</em> = a + bp
What part of this equation relates to changes in quantity and price?
For linear demand q<em>D</em> = a + bp
Formula for elasticity
For linear demand q<em>D</em> = a + bp
How does elasticity vary along the demand curve?
For linear demand q<em>D</em> = a + bp
Where is elasticity -∞ and 0? (diagrammatically)
-∞ at reservation price. 0 at max demand.
What is meant by perfectly elastic demand? Diagram?
The demand curve is such that small price changes cause very large demand responses.
What is meant by perfectly inelastic demand? Diagram?
The demand curve is such that even large price changes cause very small demand responses (or none at all).
For linear supply q<em>S</em> = c + dp
What part of this equation relates to changes in quantity and price?
For linear supply q<em>S</em> = c + dp
Formula for elasticity?
For linear supply q<em>S</em> = c + dp
How does elasticity vary along the supply curve?
For linear supply q<em>S</em> = c + dp
Where is elasticity -∞ and 0? (diagrammatically)
∞ at reservation price. 0 as supply increases.
What is meant by perfectly elastic supply? Diagram?
The supply curve is such that small price changes cause very large supply responses.
What is meant by perfectly inelastic supply? Diagram?
The supply curve is such that even large price changes cause very small supply responses (or none at all).
