Introduction
Lecture 2
•The circular flow model
Agent:
Demand
Households
Supply
Market:
Market:
Goods/Services
Supply
Inputs
Agent:
Demand
Firms
Economics 1 (EC107)
2013-14: Micro (Term 1)
Robin Naylor, Department of
Economics, Warwick
1
Introduction
Lecture 2
•Demand
•Consider a Demand Relation:
•What are the influences on Demand for a good . . . ?
px
po
How does a change in
some other influence
affect the demand
curve?
a
b
What does the slope of
the demand curve tell
us?
D
Xo
Robin Naylor, Department of
Economics, Warwick
X
2
Introduction
Lecture 2
We can write the demand relation as:
X d  X d ( p | p , p , M ,...)
x y z
Note the crucial difference between
(i) A movement along the demand curve
(ii) A shift in the demand curve
Robin Naylor, Department of
Economics, Warwick
3
Introduction
Lecture 2
We can also write the (inverse) demand relation as:
p  p ( X d | p , p , M ,...)
x
x
y z
This is best thought of as the equation that
determines the price the firm can charge for
particular levels of output.
Robin Naylor, Department of
Economics, Warwick
4
Introduction
Lecture 2
As a particular example of an inverse demand curve,
consider:
p  a  bX d .
How would you interpret the parameters 'a' and 'b'?
How would you draw this demand curve?
Robin Naylor, Department of
Economics, Warwick
5
Introduction
Lecture 2
Supply
•Consider a Supply Relation:
•What are the influences on Supply a good . . . ?
How does a change in
some other influence
affect the Supply curve?
px
S
a
po
What does the slope of
the Supply curve tell us?
b
Xo
Robin Naylor, Department of
Economics, Warwick
X
6
Introduction
Lecture 2
We can write the (inverse) supply relation as:
p  p ( X s | p ,...).
x
x
y
This is best thought of as the equation that
determines the price the firm requires in order
to induce it to supply particular levels of output.
Example:
p  c  dX s.
Robin Naylor, Department of
Economics, Warwick
7
Introduction
Lecture 2
Putting together Supply and Demand:
What is meant by the
‘market equilibrium’?
px
S
What are the possible
properties of a market
equilibrium?
pe
D
Xe
Robin Naylor, Department of
Economics, Warwick
X
8
Introduction
Lecture 2
Comparative Statics:
What is the effect on
market equilibrium of a
shift in demand?
px
S
pe
D
Xe
Robin Naylor, Department of
Economics, Warwick
X
9
Introduction
Lecture 2
Comparative Statics:
What is the effect on
market equilibrium of a
shift in supply?
px
S
pe
D
Xe
Robin Naylor, Department of
Economics, Warwick
X
10
Introduction
Lecture 2
Putting together supply and demand:
(1) p  a  bX d ,
(2) p  c  dX s.
How many equations do we have?
And how many unknowns?
Robin Naylor, Department of
Economics, Warwick
11
Introduction
Lecture 2
There is a 3rd equation:
(3) X d  X s.
What is this equation, in terms of its Economic meaning?
We can now solve:
Robin Naylor, Department of
Economics, Warwick
12
Introduction
Lecture 2
It is straightforward to show that:
X
a c
b d
and
ad bc
p
.
b d
In other words, . . .
Robin Naylor, Department of
Economics, Warwick
13
Introduction
Lecture 2
Knowing the values of the parameters gives
us the values of price and quantity traded in equilibrium.
We can also carry out the comparative static exercises
in order to see the effects of changes in the parameters
on the equilibrium values of price and quantities.
How would you do this?
Robin Naylor, Department of
Economics, Warwick
14
Introduction
Lecture 2
Now read B&B 4th Ed., pp. 26-43.
Robin Naylor, Department of
Economics, Warwick
15