The Model

Playconomics, LHS

Shift in demand : numerical example

Assume :

original equation for demand is P = 88 - Qd

equation for supply is P = 0.1 Qs

At equilibrium : Qs = Qd
Therefore
88 - Qd = 0.1 Qs
Therefore
88 = 1.1Q therefore Q = 80
Substitute to find Price : P = 88 - 80 = 8

Diagram : positive consumption

externality

What is new equilibrium

Assume the product has a per unit positive externality of $5.5

New equation for demand is: P = 88-Qd + 5.5

The equation for supply is : P = 0.1Qs

What is the optimum equilibrium P and Q

At equilibrium : Qs = Qd
Therefore 93.5-Qd = 0.1 Qs
Therefore 93.5 = 1.1Q therefore Q = 85
Substitute to find Price : Pd = 93.5 85= 8.5
Substitute to find Price : Ps = 0.1 x 85 = 8.5
4

Diagram : positive consumption externality

If Government gives a Subsidy to the Consumer, what out of pocket expense will they pay ?
Answer : the price $8.5 government assistance $5.5 = $3

What is new equilibrium

Assume the product has a per unit positive externality of $5.5

GOVERNMENT GIVES THE PRODUCER A SUBSIDY of $5.5
New equation for demand is: P = 88-Qd
The equation for supply is : P = 0.1Qs -5.5 Why ?

What is the optimum equilibrium P and Q ?

At equilibrium : Qs = Qd
Therefore 88-Qd = 0.1 Qs -5.5
Therefore 93.5 = 1.1Q therefore Q = 85

Substitute to find Price : Pd = 88 85= 3

Substitute to find Price : Ps = (0.1 x 85) -5.5 = 3
6

Diagram

The Model : Shifts in Supply

Playconomics, LHS

Equilibrium Output and Price ?

Assume : equation for demand is P = 60 -0.2Qd
equation for supply is P = 0.2 Qs
At equilibrium : Qs = Qd
Therefore
60 -0.2Qd = 0.2 Qs
Therefore
60 = 0.4Q therefore Q = 150
Substitute to find Price : P = 60 0. 2 (150) = 30

Decrease in Supply : New Equilibrium

Assume a negative externality of $10

Decrease in Supply
New equation for supply is : P = 0.2 Qs + 10...why ?
Equation for demand is : P = 60 -0.2Qd

At equilibrium : Qs = Qd
Therefore 60 -0.2Qd = 0.2 Qs + 10
Therefore 50 = 0.4Q therefore Q = 125
Substitute to find Price : P = 60 0. 2 (125) = 35
10

Diagram

11

Use the information below to answer

Question below
The demand curve for paper clips is given by
the equation:
Qd = 36 -2P
What is the Output when P is 12 ?
What is the consumer surplus ?

Diagram

Use the information below to answer

Question below
The demand curve for paper clips is given by
the equation:
P = 36 -2Q
P = Qs

What is the price P and Q at equilibrium ?

3Q =36
Q = 12
P = Qs=12
P= 36-(2x12)=12

Diagram

Consumer and Producer Surplus

Consumer Surplus = (24 x12 ) = 144
Producer Surplus = (12 x 12) = 72
Total Surplus = 144 + 72 = 216

Ceiling price:
P = 36 -2Qd
P = Qs
Assume a price ceiling at $6
Draw the diagram

What is the Qd and Qs ?

6 = 36- (2x Qd ) Qd =15

Qs = P= 6

What is the new consumer surplus ?

At Qs 6 the reservation price is 36 (2x6) =24
Surplus is 6(24-6) + (12 x 6) = 144

What is the new producer surplus ?

(6 x 6) = 18

What is the dead weight loss ?

(24-6) x 6 = 54

Diagram

CS 144 + PS 18 + DWL 54 = 216

Price Elasticity of Demand

Definition:
The Price Elasticity of demand represents the
percentage change in the quantity demanded
resulting from a very small percentage change in
price. It also measures the responsiveness of the
demand to changes in price.

Playconomics, LHS

19

Price Elasticity of Demand

ElasticityA = (1/slope) x (PA/QA)
ElasticityA = (Q/QA) / (P/PA)

ElasticityA < 0 Why? P Q

P Q
(Convention:
When we report the elasticity we
always use its absolute value)

Playconomics, LHS

20

Price Elasticity
Where Q is the original quantity and P is the
original price.

Q Q
Price elasticity
P P

Price Elasticity
Example
Originally
Price (P) = $100
Quantity (Q) = 20

New
Price (P) = $105
Quantity (Q) = 15

5 20 25

5 : Elastic
5 100
5

Calculating price elasticity of demand

Figure 4.3 Calculating price elasticity of demand at A
The price elasticity of demand at point A is given by (P/Q) (1/slope) =
(8/3) (1/4) = 2/3.

slope

vertical intercept
20

4
horizontal intercept
5

8 1
8
2
x

3 4 12
3

4 1 1
D1

4 12 2
6

4 1
D2
2

4
12

Price Elasticity of Demand

Definition:
Elastic Demand: Demand is elastic when the price
elasticity of demand is greater than 1.
Unit Elastic Demand: Demand is unit elastic when
the price elasticity of demand is equal to 1.
Inelastic Demand: Demand is inelastic when the
price elasticity of demand is less than 1.
Playconomics, LHS

25

Elasticity and Expenditure

Quantity

Price

Total
Spending

Marginal
Spending

$10

$10

$10

$9

$18

$8

$8

$24

$6

$7

$28

$4

$6

$30

$2

$5

$30

$0

$4

$28

-$2

$3

$24

-$4

$2

$18

-$6

10

$1

$10

-$8

Why does elasticity change along a

straight line demand curve
Diagram

Law of Demand
if P Q
if P Q
but as price changes, elasticity of demand changes
at low ranges of quantity, demand is price elastic, but as
quantity increases, demand will become price inelastic
as demand (AR) falls, MR is falling more steeply
underneath it

Question
The absolute value of price elasticity of demand for a product is
2.0. Assume that the price for this product increases by 5 percent.
If sales before the price change were 200 units, what will sales be
after the price change, ceteris paribus?
(a) 180 units
(b) 190 units
(c) 210 units
(d) 220 units