Econ 201 (02):

Principles of Microeconomics

Lecture 7
Associated Text Chapter 4 & 5
September 28, 2023
1
Roadmap for today’s lecture
• Announcement
• Chapter 4
• Changes in market equilibrium
• Chapter 5
• Elasticity
• Price elasticity
• Determinants of elasticity

2
Announcement
• Reminder: Problem Set 1 due on Friday at midnight
• Do both MC and SA portions
• Try to show as much work as you can. If you’re having issues showing your
work, provide an explanation for the logic you used

3
Equilibrium represented graphically
𝑃($)
S • 𝑃∗ is the price level
where 𝑄𝐷 = 𝑄𝑆 .
• This denote this as
𝑄∗ .
• What do we think
happens when the
𝑃∗ price is below or
above 𝑃∗ ?

𝑄∗ 𝑄
4
 Surplus in the market (excess supply)
𝑃($)
S
• 𝑃𝑠𝑢𝑟𝑝𝑙𝑢𝑠 is higher than equilibrium price
𝑃∗
𝑃𝑠𝑢𝑟𝑝𝑙𝑢𝑠
• At this price level, the quantity supplied
𝑠𝑢𝑟𝑝𝑙𝑢𝑠
𝑄𝑆 exceeds the quantity
𝑠𝑢𝑟𝑝𝑙𝑢𝑠
𝑃∗ demanded 𝑄𝐷
𝑠𝑢𝑟𝑝𝑙𝑢𝑠 𝑠𝑢𝑟𝑝𝑙𝑢𝑠
• 𝑄𝑆 > 𝑄𝐷
• This makes sense. At such a high price,
consumers demand fewer units of a
good while firms wish to sell many units
D • In other words, we have excess supply
𝑠𝑢𝑟𝑝𝑙𝑢𝑠 𝑠𝑢𝑟𝑝𝑙𝑢𝑠
• 𝑆𝑢𝑟𝑝𝑙𝑢𝑠 = 𝑄𝑆 − 𝑄𝐷
𝑠𝑢𝑟𝑝𝑙𝑢𝑠
𝑄𝐷 𝑄∗ 𝑠𝑢𝑟𝑝𝑙𝑢𝑠
𝑄𝑠 𝑄
5
 Shortage in the market (excess demand)
𝑃($)
S
• 𝑃𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒 is lower than equilibrium price
𝑃∗
• At this price level, the quantity
𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒
demanded 𝑄𝐷 exceeds the
𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒
𝑃∗ quantity supplied 𝑄𝑆
𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒 𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒
• 𝑄𝐷 > 𝑄𝑆
𝑃𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒 • This makes sense. At lower prices,
consumers demand a higher quantity of
a good while firms are less willing to sell
D • In other words, we have excess demand
𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒 𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒
• 𝑆ℎ𝑜𝑟𝑡𝑎𝑔𝑒 = 𝑄𝐷 − 𝑄𝑠
𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒
𝑄𝑆 𝑄∗ 𝑠ℎ𝑜𝑟𝑡𝑎𝑔𝑒
𝑄𝐷 𝑄
6
Comparative Statics
• Given some change in market conditions, what happens to demand,
supply, price, and quantity?

7
Let’s continue the example from Tuesday
Market for Cable TV Shift in D/S, ↑ or ↓ P ↑ or ↓ Q ↑ or ↓

Household income rises Demand ↑ P↑ Q↑

Movie prices rise Demand ↑ P↑ Q↑

Netflix announces price Demand ↓ P↓ Q↓

drop
Cost of cable wiring Supply ↓ P↑ Q↓
increases

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Look how far we’ve come!
• So far we’ve:
• Learned about scarcity, and how markets act as the economic
solution to this issue
• Learned about the role of an economist in explaining the world
• Built two basic models to understand the role of an economist
• Circular-Flow
• PPF
• Built the more elaborate supply and demand model…
• …and perform comparative statics to understand how price and
quantity are impacted by forces of supply and demand

12
Chapter 5 – Elasticity
• Now we’re looking at adding another dimension to our supply and
demand model
• Elasticity
• Elasticity adds more complexity – but also more richness – to our
economic model
• It is a measure of the responsiveness of quantity demanded or
quantity supplied to one of its determinants
• In other words – so far we have looked at the direction of the change
in quantity demanded or suppled
• Now, we will look at the size of the change as well

13
Market responses
• If we play the role of policy advisor, it is important to know the
direction and the magnitude of a change in quantity demanded
• This is easily done if we know the entire demand curve, but this is something
rare in reality
• We want to measure how buyers and sellers might respond to
changes in market conditions

14
Illustrative example
• Consider cigarettes
• Taxed to reduce consumption (health implications)
• Problematic among young consumers (addiction issues)
• What type of things affect the responsiveness of consumers to that
price increase (i.e., a new tax)?
• Addicted or not
• Income level
• Price of related goods
• Availability of substitutes
15
Price Elasticity of Demand
• Our first elasticity is the price elasticity of demand
• This measures how much the quantity demanded of a good responds
to a change in the price of that good
• It’s computed as the percentage change in quantity demanded
divided by the percentage change in price
• Determinants of elasticity (responsiveness)
• Availability of close substitutes
• Necessity vs. luxury
• Time horizon (short run vs. long run)
• Definition of the market (specific vs. nonspecific)
16
Determinants of elasticity
• Availability of close substitutes
• Goods with close substitutes tend to have more elastic demand
• Quantity demanded is more responsive to price changes
• It is easier for consumers to switch from that good to others
• Example: butter and margarine
• Increase in price of butter causes a relatively large drop in quantity demanded
because margarine is a close substitute (assuming price of margarine does not
change)
• Another example: eggs
• Not many close substitutes for eggs. Increase in price of eggs will cause a
relatively small drop in quantity demanded of eggs. Not much available to
substitute away to

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Determinants of elasticity
• Necessities vs. Luxuries
• Necessities tend to have inelastic demands
• Price changes tend to change quantity demanded by very little, if at all
• Example: insulin
• Price changes in insulin do not drastically change the quantity demanded of
insulin – it is a necessity to many
• Another example: boats
• Boats are an example of a luxury (for many). Price increases in boats will
cause a relatively large drop in quantity demanded of boats.
• Whether a good is a luxury depends on the individual consumer and their
preferences

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Determinants of elasticity
• Time horizon
• Goods tend to have more elastic demand over longer time horizons.
• Example: gasoline
• When the price of gasoline rises, quantity demanded of gasoline falls only
slightly in the immediate future as people still need to get around
• But over time, more consumers may move toward electric vehicles meaning a
more drastic response to the price change over the long run

19
Determinants of elasticity
• Market definition
• How do we define the market?
• The elasticity of demand depends on how we draw the boundaries of the
market
• Narrowly defined markets tend to have more elastic demands, where broader
markets have less elastic demands
• Example: food
• If we define the market as food, we observe a very inelastic demand as there
are no close substitutes for food
• If we define the market as ice cream, the demand becomes more elastic as
there are indeed close substitutes for ice cream (for many people)

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 Computing Price Elasticity of Demand
percentage change in quantity demanded
Price elasticity of demand =
percentage change in price

• Consider the example of a 10% increase resulting in the decrease in quantity

demanded of 20%

20%
Price elasticity of demand = =2
10%

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Credit goes to Jordan Bartsch for this slide