Lecture # 04a

Demand and Supply (end)

Lecturer: Martin Paredes

 In general, for the elasticity of Y with
respect to X:

Y,X= (% Y) = (Y/Y) = dY . X
(% X) (X/X) dX Y

2
 Price elasticity of supply: measures
curvature of supply curve

(% QS) = (QS/QS) = dQS . P

(% P) (P/P) dP QS

3
 Income elasticity of demand measures
degree of shift of demand curve as
income changes

(% QD) = (QD/QD) = dQD . I

(% I) (I/I) dI
QD

4
 Cross price elasticity of demand
measures degree of shift of demand curve
when the price of another good changes

(% QD) = (QD/QD) = dQD . P0

(% P0) (P0/P0) dP0
QD

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 Sentra Escort LS400 735i

Sentra -6.528 0.454 0.000 0.000

Escort 0.078 -6.031 0.001 0.000

LS400 0.000 0.001 -3.085 0.032

735i 0.000 0.001 0.093 -3.515

Source: Berry, Levinsohn and Pakes,

"Automobile Price in Market Equilibrium,"
Econometrica 63 (July 1995), 841-890.

Example: The Cross-Price Elasticity of Demand for

Cars
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 Elasticity Coke Pepsi

Price -1.47 -1.55

elasticity of
demand
Cross-price 0.52 0.64
elasticity of
demand
Income 0.58 1.38
elasticity of
demand
Source: Gasmi, Laffont and Vuong,
"Econometric Analysis of Collusive Behavior in
a Soft Drink Market," Journal of Economics and
Management Strategy 1 (Summer, 1992)
278-311.

Example: Elasticities of Demand for Coke and

Pepsi
7
1. Use Own Price Elasticities and Equilibrium
Price and Quantity
2. Use Information on Past Shifts of Demand
and Supply

8
1. Choose a general shape for functions
Linear
Constant elasticity
2. Estimate parameters of demand and
supply using elasticity and equilibrium
information
We need information on , P* and Q*

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Example: Linear Demand Curve

Suppose demand is linear: QD = a bP

Then, elasticity is Q,P = -bP/Q

Suppose P = 0.7 Q = 70
Q,P = -0.55

Notice that, if = -bP/Q b = -Q/P

Then b = -(-0.55)(70)/(0.7) = 55
and a = QD + bP = (70)+(55)(0.7) = 108.5

Hence QD = 108.5 55P

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Example: Constant Elasticity Demand Curve

Suppose demand is: QD = AP

Suppose again P = 0.7 Q = 70

Q,P = -0.55

Notice that, if QD = AP A = QP-

Then A = (70)(0.7)0.55 = 57.53

Hence QD = 57.53P-0.55

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 Example: Broilers in the U.S.,
1990
Price

Observed price and quantity

.7

0 70 Quantity

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 Example: Broilers in the U.S.,
1990
Price

Observed price and quantity

.7
Linear demand curve
0 70 Quantity

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 Example: Broilers in the U.S.,
1990
Price

Observed price and quantity

.7
Constant elasticity demand curve

0 70 Quantity

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 Example: Broilers in the U.S.,
1990
Price

Observed price and quantity

.7
Constant elasticity demand curve

Linear demand curve

0 70 Quantity

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1. A shift in the supply curve reveals the
slope of the demand curve

2. A shift in the demand curve reveals the

slope of the supply curve.

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Example: Shift in Supply Curve

Old equilibrium point: (P1,Q1)

New equilibrium point: (P2,Q2)

Both equilibrium points would lie on the same

(linear) demand curve.

Therefore, if QD = a - bP

b = dQ/dp = (Q2 Q1)/(P2 P1)

a = Q1 - bP1

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Example: Identifying demand by a shift in
supply
Price

Supply

Market Demand

0
Quantity

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Example: Identifying demand by a shift in
supply
Price

New Supply

Old Supply

Market Demand

0
Quantity

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Example: Identifying demand by a shift in
supply
Price

New Supply

Old Supply
P2

P1
Market Demand

0 Q2 Q1
Quantity

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This technique only works if the curve we want to
estimate stays constant.

Example: Shift in Supply Curve

We require that the demand curve does not shift

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Price

Supply

Demand

0
Quantity
22
Price

New Supply

Old Supply

Old Demand

New Demand

0
Quantity
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 Price

New Supply

P2 Old Supply

P1
Old Demand

New Demand

0 Q2 = Q1
Quantity
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1. Example of a simple micro model of supply and
demand (two equations and an equilibrium
condition)

2. Elasticity as a way of characterizing demand and

supply

3. Factors that determined elasticity

4. Estimating demand and supply

a. From own price elasticity and equilibrium price
and quantity
b. From information on past shifts, assuming that
only a single curve shifts at a time. 25