Cost Analysis

Slide 1: 

BASIC CONCEPTS: DEMAND, SUPPLY,ANDEQUILIBRIUM

The Law of Demand : 

© OnlineTexts.com p. 2 The Law of Demand The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls. The reverse is also true: as the price of a good or service falls, its quantity demanded increases.

Demand Curve : 

© OnlineTexts.com p. 3 Demand Curve The demand curve has a negative slope, consistent with the law of demand.

A fundamental principle:the Law of Demand : 

4 A fundamental principle:the Law of Demand P2 $ P1 Q2 Q1 Quantity The Law of Demand: When the cost of an item increases, less is demanded

A fundamental principle:the Law of Demand : 

5 A fundamental principle:the Law of Demand P2 $ P1 Q2 Q1 Quantity The Law of Demand: When the cost of an item increases, consumer will substitute other goods

Downward-sloping demand curves may take a variety of shapes : 

6 Downward-sloping demand curves may take a variety of shapes $ Quantity

Market Demand Curve : 

Market Demand Curve A market demand curve is defined as the alternative quantities of a good that all consumers in a particular market are willing and able to buy as price varies, holding all other factors constant.

Change in Quantity Demanded(Movement Along a Demand Curve) : 

Change in Quantity Demanded(Movement Along a Demand Curve) A movement along a demand curve occurs when own price changes, holding constant other factors. What are the other factors that we are holding constant?

Other Factors Affecting Demand : 

The factors holding constant are: the prices of other goods including substitutes and complements (PO), aggregate consumer money income (M), consumer population (POP), and noneconomic factors including social, physiological, psychological, and demographic factors unique to the consumers in the market (SPPD). Other Factors Affecting Demand

Reasons for Downward sloping Demand curve: : 

Reasons for Downward sloping Demand curve: Diminishing marginal utility Price effect Income effect Substitution effect.

Slide 11: 

Change in Demand(Shift in the Position of the Demand Curve) It is important to distinguish between: a movement along a demand curve (change in quantity demanded) and a shift in the position of the demand curve (change in demand). A movement along a demand curve occurs when own price changes, holding constant PO, M, POP, and SPPD. A shift in the demand curve occurs when we change one of those factors being held constant.

Shift in Demand: Population (POP) : 

Shift in Demand: Population (POP) With an increase in POP, the demand curve shifts to the right. With the demand curve shifting to the right, the quantity demanded increases for all prices. Factors that lead consumers to change demand quantities at the same price are referred to as demand shifters.

Demand Shifter: Noneconomic Factor (SPPD) : 

Demand Shifter: Noneconomic Factor (SPPD) Consider the consumption trend of moving away from foods that are perceived to be high in fat and cholesterol content. This can be thought of as a change in one component of the SPPD. As a result of this change in the dietary habit of consumers, the demand for red meat has shifted to the left.

Demand Shifter: Price of Other Good (PO) : 

Demand Shifter: Price of Other Good (PO) How about an increase in one of the prices of other goods? Well, it depends! With an increase in the price of a substitute, the demand curve shifts to the right. As the price of pork increases, consumers demand more beef even though the price of beef does not change. This is because beef is now relatively more inexpensive compared to pork.

Slide 15: 

On the other hand, with an increase in the price of a complement, the demand curve shifts to the left. As the price of bread increases, the demand for bread decreases. Hence the demand for butter decreases even though the price of butter stays the same. This is because butter is, in general, complementary to bread.

Demand Shifter: Money Income (M) : 

Demand Shifter: Money Income (M) How about an increase in income? Again, it depends! In most cases, an increase in income shifts the demand curve to the right. This is consistent with the idea that as income increases people buy more of the products. In this case, the good is called a normal good.

Slide 17: 

A few commodities such as dry beans and potato are called inferior goods. As income increases consumers tend to buy less of the inferior goods as they can now afford more expensive normal goods. That is, an increase in income shifts the demand curve for an inferior good to the left.

Exceptions to the Law of Demand: : 

Exceptions to the Law of Demand: Giffens’ Paradox Veblens’ effect Speculation Depression Ignorance of the customers.

Type of Demand: : 

Type of Demand: Price demand [ so far covered] Income demand – normal goods and inferior goods Cross- demand – substitutes and compliments

The PriceElasticity of Demand : 

The PriceElasticity of Demand A 10 percent increase in price is the same percentage increase whether the price is measured in American dollars or English pounds. Thus, measuring increases in percentage terms keeps the definition of elasticity unit-free.

Slide 21: 

A convenient way to think of an own-price elasticity of demand is as the percentage change in quantity demanded corresponding to a one percentage change in own price, holding other factors constant.

-Price Elastic VS. Inelastic : 

-Price Elastic VS. Inelastic Which of the two goods is more own-price elastic? Good 2 is more own-price elastic. The absolute value of its own price elasticity is larger than that pertains to good 1.

Slide 23: 

This good is own-price inelastic. This good is own-price elastic. The elasticity is unitary. -Price elastic VS. Inelastic

Slide 24: 

Notice that the flatter the demand curve, the larger in absolute value is (that is, the more price elastic is the demand). The flatter the demand curve, the smaller in absolute value is the slope, (e.g., - 2, instead of - 4). Hence, the flatter the demand curve, the larger in absolute value is the inverse of the slope, (e.g., - 0.5, instead of - 0.25). Hence

Slide 25: 

The flatter the demand curve, the more price elastic is the demand. flatter steeper The flatter the demand curve, the more room there is for the quantity to adjustment. Hence, the flatter the demand curve, the more responsive is the quantity to a price change.

Slide 26: 

slope = - 0 slope = - infinity elasticity = - infinity elasticity = - 0 Perfectly Elastic Perfectly Inelastic The flatter the demand curve, the more price elastic is the demand.

Types of Elasticity of Demand: : 

Types of Elasticity of Demand: Price elasticity demand [so far covered] Income elasticity of demand Cross- elasticity of demand Promotional[ Advertising] elasticity of demand Elasticity of substitution.

Supply Analysis: : 

Supply Analysis: Supply of a commodity may be defined as the amount of that commodity which the producers (sellers) are able and willing to offer for sale at a particular price during a certain period of time. Supply is a relative term. It is always referred to in relation to price and time. The ability of a seller to supply a commodity depends on available stock . Therefore the law of supply states that, the supply varies directly with the changes in price. So a large amount is supplied at a higher price than at a lower price in the market. The supply function----- S= f( p, pf, T, t, s, O ) P—price of the product, pf__ prices of factor inputs for producing the product, T-__technology, t- tax, s-subsidy,O- factors outside the company. The determinants of supply are the cost of production, the state of technology, factors outside the economic sphere, tax and subsidy.

Supply schedule & Supply curve: : 

Supply schedule & Supply curve: Price per unit(Rs.) Quantity supplied(units) 11 10 12 13 13 20 14 25 When this data is plotted through the graph a supply curve, which is upward sloping depicts a direct co-variation between price and supply. Under ceteris paribus assumption, the law of supply may stated as, other things remaining unchanged, the supply of a commodity expands with rise in price and contracts with a fall in its price. Extension and contraction of supply are based on changes in price i.e. increase or decrease in price respectively. Increase or decrease in supply is associated without any changes in price and other than changes in price. Elasticity of supply may be defined as the ratio of percentage change or proportionate change in quantity supplied to the percentage or proportionate change in price.

Assumptions of law of supply: : 

Assumptions of law of supply: Cost of production is unchanged No change in technique of production Fixed scale of production Government policies are unchanged No change in transport costs No speculation The prices of other goods are held constant. The supply can only be measured through Point method . The supply function—Qs =c+dp….. The types of elasticity of supply----e=@, e=0, e>1, e<1, e=1.

The Law of Supply : 

The Law of Supply The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. Why do producers produce more output when prices rise? They seek higher profits They can cover higher marginal costs of production

The Law of Supply : 

The Law of Supply The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. Why do producers produce more output when prices rise? They seek higher profits They can cover higher marginal costs of production

Supply Curve : 

Supply Curve The supply curve has a positive slope, consistent with the law of supply.

Equilibrium : 

Equilibrium In economics, an equilibrium is a situation in which: there is no inherent tendency to change, quantity demanded equals quantity supplied, and the market just clears.

Equilibrium : 

Equilibrium Equilibrium occurs at a price of $3 and a quantity of 30 units.

Equilibrium After a Demand Shift : 

Equilibrium After a Demand Shift The shift in the demand curve moves the market equilibrium from point A to point B, resulting in a higher price and higher quantity.

Shift in the Demand Curve : 

© Shift in the Demand Curve A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand. Factors that shift the demand curve include: Change in consumer incomes Population change Consumer preferences Prices of related goods: Substitutes: goods consumed in place of one another Complements: goods consumed jointly

Shift in the Supply Curve : 

Shift in the Supply Curve For an given rental price, quantity supplied is now lower than before.

Equilibrium After a Supply Shift : 

Equilibrium After a Supply Shift The shift in the supply curve moves the market equilibrium from point A to point B, resulting in a higher price and lower quantity.

Price Ceilings & Floors : 

Price Ceilings & Floors A price ceiling is a legal maximum that can be charged for a good. Results in a shortage of a product Common examples include apartment rentals and credit cards interest rates. A price floor is a legal minimum that can be charged for a good. Results in a surplus of a product Common examples include soybeans, milk, minimum wage

Price Ceiling : 

Price Ceiling A price ceiling is set at $2 resulting in a shortage of 20 units.

Price Floor : 

Price Floor A price floor is set at $4 resulting in a surplus of 20 units.