The Demand Curve

● demand curve Relationship between the quantity of a good

that consumers are willing to buy and the price of the good.
QD  QD ( P)

The Demand Curve

The demand curve, labeled D, shows

how the quantity of a good demanded
by consumers depends on its price.
The demand curve is downward
sloping; holding other things equal,
consumers will want to purchase
more of a good as its price goes
down.
The quantity demanded may also
depend on other variables, such as
income, the weather, and the prices
of other goods. For most products,
the quantity demanded increases
when income rises.
A higher income level shifts the
demand curve to the right (from D to
D’).
Shifting the Demand Curve

If the market price were held constant, we would expect to

see an increase in the quantity demanded as a result of
consumers’ higher incomes. Because this increase would
occur no matter what the market price, the result would be a
shift to the right of the entire demand curve.
Substitute and Complementary Goods
● substitutes Two goods for which an increase
in the price of one leads to an increase in the
quantity demanded of the other.

● complements Two goods for which an

increase in the price of one leads to a decrease
in the quantity demanded of the other.
The Supply Curve
● supply curve Relationship between the quantity of a good
that producers are willing to sell and the price of the good. QS  QS ( P)

The Supply Curve

The supply curve, labeled S in the

figure, shows how the quantity of a
good offered for sale changes as
the price of the good changes. The
supply curve is upward sloping: The
higher the price, the more firms are
able and willing to produce and sell.

If production costs fall, firms can

produce the same quantity at a
lower price or a larger quantity at
the same price. The supply curve
then shifts to the right (from S to
S’).
Supply Function = f (Pn, Pr, T, F, C,N,O)

Other Variables That Affect Supply

The quantity that producers are willing to sell depends not only on the
price they receive (Pn) but also on their production costs (F),
including wages, interest charges, and the costs of raw materials,
Climate (C), Natural resources (N), State of technology (T), prices of
other commodities(Pr), and Others like Political Situations or Tax
policies etc (O)

When production costs decrease, output increases no matter what

the market price happens to be. The entire supply curve thus shifts to
the right.

Economists often use the phrase change in supply to refer to shifts in

the supply curve, while reserving the phrase change in the quantity
supplied to apply to movements along the supply curve.
THE MARKET MECHANISM
Equilibrium
● equilibrium (or market clearing) ● market mechanism Tendency
price Price that equates the in a free market for price to
quantity supplied to the quantity change until the market clears.
demanded.

Supply and Demand

The market clears at price P0 and quantity Q0.

At the higher price P1, a surplus develops, so

price falls.
At the lower price P2, there is a shortage, so
price is bid up.

● surplus Situation in which the quantity

supplied exceeds the quantity demanded.
● shortage Situation in which the quantity
demanded exceeds the quantity supplied.
Questions for Practice 1
Consider the market for apple juice. In this market, the supply curve
is given by
QS = 10PJ − 5PA
and the demand curve is given by
QD = 100 − 15PJ + 10PT,
where J denotes apple juice, A denotes apples, and T denotes tea.
(a)Assume that PA is fixed at $1 and PT = $5. Calculate the
equilibrium price and quantity in the apple juice market.
(b)Suppose that a poor harvest season raises the price of apples to
PA = $2. Find the new equilibrium price and quantity of apple juice.
Draw a graph to illustrate your answer.
(c)Suppose PA = $1 but the price of tea drops to PT = $3. Find the
new equilibrium price and quantity of apple juice.
Changes in the Market Equilibrium
OR
Shift in the Demand-Supply Curves
Questions for Practice 3
1. It becomes known that an electronics store is going to have a sale on their
computer games 3 months from now.
2. The workers who produce the computer games go on strike for over two
months
3. When the average price of movie tickets rises, it has an effect on the
purchase of computer games.
4. The workers who produce the computer games negotiate a $20 per hour
wage increase
5. A reputable private research institute announces that children who play
computer games also improve their grades in school.
6. The price of home computers increases significantly. (Analyze computer
games.)
7. In order to promote American production, Congress provides a subsidy to
game producers.
8. The popularity of the computer games increases in the world markets. At
the same time new technology lower production costs.
Government regulations and Prices

• Price Ceiling
A Price Ceiling is a government-imposed maximum price for a
product. It keeps prices from rising too high, which in theory allows
consumers to afford the product or service, but can result in
shortages and rationing.

• Price Flooring

A price floor keeps prices from falling too low, which can protect
producers, but can generate excess supply and waste.
Questions for Practice 2

Consider the market for apple juice. In this market, the supply curve is
given by
QS = 10PJ − 5PA
and the demand curve is given by
QD = 100 − 15PJ + 10PT,
where J denotes apple juice, A denotes apples, and T denotes tea.
(a)Suppose PA = 1, PT = 5, and there is a price ceiling on apple juice
of P∗ = 5. What is J the excess demand for apple juice as a result?
Draw a graph to illustrate your answer.
ELASTICITIES OF SUPPLY AND DEMAND
● elasticity Percentage change in one variable resulting
from a 1-percent increase in another.

Price Elasticity of Demand (Proportionate method)

● price elasticity of demand Percentage change in

quantity demanded of a good resulting from a 1-percent
increase in its price.

-
Properties of Price Elasticity of Demand
Linear Demand Curve

(a) Infinitely Elastic Demand

For a horizontal demand curve,

ΔQ/ΔP is infinite. Because a tiny
change in price leads to an
enormous change in demand,
the elasticity of demand is
infinite.

● infinitely elastic demand Principle that consumers will buy as

much of a good as they can get at a single price, but for any higher
price the quantity demanded drops to zero, while for any lower
price the quantity demanded increases without limit.
Linear Demand Curve

(b) Completely Inelastic Demand

For a vertical demand curve,

ΔQ/ΔP is zero. Because the
quantity demanded is the same
no matter what the price, the
elasticity of demand is zero.

● completely inelastic demand Principle that consumers will buy

a fixed quantity of a good regardless of its price.
Questions for Practice 4

1.
Q(P) = 8 − 2P
When the price changes from 2 to 1, the price elasticity of demand is

2. Quantity Price
20 3
15 4
11 5
9 6
7 7

Calculate point price elasticity of demand for decrease in price from Rs 6 to 5.

Compute point price elasticity of Demand for a increase in price from Rs 5 to 6.
Compute point price elasticity at price Rs 4
 Geometric Method

● linear demand curve Demand curve that is a straight line.

Given a linear demand curve,

Ed is not a constant along the
curve.
For example, for curve in the
adjacent figure , Ed = −∞ at
top portion, but zero at bottom
portion
This method is also known as
geometric method of Price
elasticity of Demand.
Also known as ‘Graphic
Method’ or ‘Point Method’

−
Total outlay method
• It is also known as expenditure method.
• It is measured as the responsiveness of change in expenditure
to changes in price.
• When prices falls:

Price Quantity Total Expenditure Elasticity

10 200 500 Unit Elastic

8 250 500 e=1

10 200 500 More Elastic

8 280 560 e >1

10 200 500 Less Elastic

8 240 480 e <1
• When price rises

Price Quantity Total Expenditure Elasticity

8 250 500 Unit Elastic

 
10 200 500 e=1
8 250 500 Less Elastic
10 240 600 e <1
8 250 500 More Elastic
10 180 450 e >1
Point versus Arc Elasticities

● point elasticity of demand Price elasticity at a particular point on the

demand curve.

Arc Elasticity of Demand

● arc elasticity of demand Price elasticity calculated over a range of

prices. It is also known as mid-point method.
Questions for Practice 5

1. Find the elasticity at point B

and D

2. Find the arc elasticity when price

changes from 15 to 12 and
quantity demanded changes from
10 to 12
Quantity
Price Per Pen (Rs)
3. Find out elasticity when Demanded
following details are given (table) 10 30
5 60
4. A consumer buys 10 units of a good at price 6 per unit. The elasticity of
demand is -1. At what price will he buy 12 units? (Use expenditure
method.)
5. Difference between the quantities is 2 and sum is 16. Elasticity is given as
50% /(-100%). Find the change in prices, when sum of prices is 8.
Other Demand Elasticities

● income elasticity of demand Percentage change in the quantity

demanded resulting from a 1-percent increase in income.
● The responsiveness of demand to changes in income
Types
Elasticity and goods types
Examples

Normal Normal Luxury Inferior Sticky Goods

Necessity
Vegetables Air travel Cigarettes *
Coffee Fine wine Tinned Meat
Fruit Juice Luxury Canned Food
Chocolate
Rail Travel Private Bus Travel *
Education
Utilities eg- Private Health Coarse grains
Shampoo, Tooth
paste
Medicine Antique Furniture Anchovies
Housing Designer Clothes
Public
Education/
Public Health
Power
Cross-price elasticity of demand
● cross-price elasticity of demand Percentage change in the quantity
demanded of one good resulting from a 1-percent increase in the price
of another.

e > 0 = Substitutes
e < 0 = Compliments
e = 0 = Unrelated
Graphical comparison between compliments
and substitutes
Questions for Practice 6
1. Which type of goods can be observed assuming the following income
elasticities of demand?
a) Good X: + 0.5
b) Good Y: + 2.6
c) Good Z: - 0.4
2. The income elasticities of demand of two goods, A and B, are as follows:
Good A: + 3.0; Good B: - 0.2 Now income rises by 5 %. By how much
quantities demanded of A and B will change?
3. Find the elasticity when:
Y1= 2500; Qd = 20 units
Y2 = 3000; Qd = 25units
4. A 6 percent decrease in the price of ibuprofen causes a 10 percent
decrease in the quantity demanded of Tylenol. What is the cross price
elasticity of demand for Tylenol with respect to the price of Ibuprofin? Show
whether the two goods complements or substitutes?
Questions for Practice 6
5. You have been asked to analyze the market for steel. From public sources,
you are able to find that last year’s price for steel was $20 per ton. At this
price, 100 million tons were sold on the world market. From trade association
data you are able to obtain estimates for the own price elasticities of demand
and supply on the world markets as −0.25 for demand and 0.5 for supply.
(Assume that steel has linear demand and supply curves throughout.)
a) Solve for the equations of demand and supply in this market and sketch the
demand and supply curves.
b) Suppose that you discover that the current price of steel is $15 per ton and
the current level of worldwide sales of steel is 150 million tons. The most
recent elasticity estimates from the trade association this year are −0.125 for
demand and 0.25 for supply. Describe the change in the supply and demand
curves over the past year using your diagram from part (a). What sort of
event(s) might explain the change?
Factors affecting Demand Elasticity

• Nature of commodity:
– necessity = inelastic
– luxury = elastic
– Durable = elastic
– Perishable = inelastic

• Availability of substitutes: the greater the no. of

substitute, the greater the elasticity.
• Income Level: If a consumer has high income, then the
demand for products consumed by him/her would be
inelastic
• Number of Uses:
-multi-use good is more elastic.
-Eg: if the price of milk ↓= uses ↑
-(making curd, butter, cream, and ghee; demand= highly
elastic ) 

• Share in Total Expenditure:

-large portion of income = elastic.
-small portion of consumers’ income = inelastic for products. Eg,
goods, such as salt, newspaper, toothpaste

• Time Period

• Habits: less elastic. Eg: habit of Alcohol, tobacco, cigarettes,

etc.
Questions for Practice 7
1. Do you think the price elasticity of demand for Ford sport-utility vehicles
(SUVs) will increase, decrease, or remain the same when each of the
following events occurs? Explain your answer.

a) Other car manufacturers, such as General Motors, decide to make

and sell SUVs.
b) SUVs produced in foreign countries are banned from the American
market.
c) The time period over which you measure the elasticity lengthens.
During that longer time, new models such as four-wheel-drive cargo
vans appear.
2. Why is the demand for water inelastic?
3. In your college town, real estate developers are building thousands of new
student-friendly apartments close to campus. If you want to pay the lowest
rent possible, should you hope that demand for apartments is elastic or
inelastic? 
4. In your college town, the local government decrees that thousands of apartments
close to campus are uninhabitable and must be torn down next semester. If you
want to pay the lowest rent possible, should you hope that demand for apartments
is elastic or inelastic?  
5. Define whether Elastic/Inelastic: Chocolate, cigarettes, coffee, water, electricity,
Platinum jewelry.
6. Based on the Elasticity define the type of goods:
a) CPE = 1.25
b) YED = 2
c) YED = 0.46
d) CPE = -0.44
e) YED = -1.18
f) CPE = 0
Elasticities of Supply
● price elasticity of supply Percentage change in quantity supplied
resulting from a 1-percent increase in price.
Factors affecting Elasticity of Supply

(i) Time period. Time is the most significant factor which affects the elasticity of
supply. If the price of a commodity rises and the producers have enough time to
make adjustment in the level of output, the elasticity of supply will be more
elastic. If the time period is short and the supply cannot be expanded after a
price increase, the supply is relatively inelastic.
 
(ii) Ability to store output. The goods which can be safety stored have
relatively elastic supply over the goods which are perishable and do not have
storage facilities.
 
(iii) Factor mobility. If the factors of production can be easily moved from one
use to another, it will affect elasticity of supply. The higher the mobility of factors,
the greater is the elasticity of supply of the good and vice versa.
 
(iv) Changes in marginal cost of production. If with the expansion of output,
marginal cost increases and marginal return declines, the price elasticity of
supply will be less elastic to that extent.
(v) Excess Capacity. When there is excess capacity and the producer
can increase output easily to take advantage of the rising prices, the supply is
more elastic. In case the production is already up to the maximum from the
existing resources, the rising prices will not affect supply in the short period.
The supply will be more inelastic.
     
(vi) Availability of infrastructure facilities. If infrastructure facilities are
available for expanding output of a particular good in response to the rise in
prices, the elasticity of supply will be relatively more elastic.
 
(vii) Manufacturing time (Agricultural or industrial products). In agriculture,
time is required to increase output in response to rise in prices of goods. The
supply of agricultural goods is fairly inelastic. As regards the supply of
manufactured consumer goods, it is comparatively easy to increase production
in a short period.
 
Therefore, the supply of consumer goods is fairly more elastic; In case of
supply of aero planes or any other heavy machinery, the supply is relatively
inelastic as it takes time to manufacture heavy machinery
Questions for practice 8
1. An apartment rent amounts for Rs 15000 per month and, at that price,
10,00 units are rented. When the price increases to Rs 17000 per month,
1300 units are supplied into the market. By what percentage does
apartment supply increase? What is the price sensitivity?

2. Classify elasticity at each point

Price Qty Supplied

8 50
10 80
12 98
15 110

3. The equation for a supply curve is 4P = Q. What is the elasticity of supply

as price rises from 3 to 4? What is the elasticity of supply as the price rises
from 7 to 8?
SHORT-RUN VERSUS LONG-RUN ELASTICITIES
Demand It is much more price elastic in the long run than in the short run.

(a) Petrol: Short-Run and Long-Run

Demand Curves

In the short run, an increase in price

has only a small effect on the
quantity of petrol demanded.
Motorists may drive less, but they
will not change the kinds of cars
they are driving overnight.

In the longer run, however, because

they will shift to smaller and more
fuel-efficient cars, the effect of the
price increase will be larger.
Demand, therefore, is more elastic
in the long run than in the short run.
Demand and Durability

(b) Automobiles: Short-Run and

Long-Run Demand Curves

The opposite is true for

automobile (durable goods)
demand. If price increases,
consumers initially defer buying
new cars; thus annual quantity
demanded falls sharply.

In the longer run, however, old

cars wear out and must be
replaced; thus annual quantity
demanded picks up. Demand,
therefore, is less elastic in the
long run than in the short run.
 Income Elasticities and demand in short run and long run

Income elasticities also differ from the short run to the long run.
For most goods and services—foods, beverages, fuel, entertainment, etc.— the
income elasticity of demand is larger in the long run than in the short run.
For a durable good, the opposite is true. The short-run income elasticity of
demand will be much larger than the long-run elasticity.
Cyclical Industries
● cyclical industries Industries in which sales tend to magnify cyclical changes
in gross domestic product and national income.

GDP and Investment in Durable Equipment

Annual growth rates are compared for GDP and investment in durable equipment.
Because the short-run GDP elasticity of demand is larger than the long-run
elasticity for long-lived capital equipment, changes in investment in equipment
magnify changes in GDP. Thus capital goods industries are considered “cyclical.”
Petrol and automobiles is a very good example of complementary goods to
explain this effect
Supply
Supply and Durability

Copper: Short-Run and Long-Run

Supply Curves

Like that of most goods, the supply of primary

copper, shown in part (a), is more elastic in the long
run.
If price increases, firms would like to produce more
but are limited by capacity constraints in the short
run.
In the longer run, they can add to capacity and
produce more.
Another example is market for rental housing where
long response of supply of houses to increase in
rents is much higher as compared to short run
response.
Supply and Durability

Copper: Short-Run and Long-Run

Supply Curves

Part (b) shows supply curves for

secondary copper.

If the price increases, there is a greater

incentive to convert scrap copper into
new supply. Initially, therefore,
secondary supply (i.e., supply from
scrap) increases sharply.
But later, as the stock of scrap falls,
secondary supply contracts.

Secondary supply is therefore less

elastic in the long run than in the short
run.
To do
• Read the examples
• Do the questions at the back of the book
References

1. Microeconomics by Pindyck and Rubinfeld (8th Edition).

2. MIT Open course ware
3. IIT-NPTEL Open Courseware
4. Tutor2U
5. Khan academy