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PROFESSOR: So today what we're going to do is continue our discussion of supply and demand. This is sort of introduction week, if you will. We've kind of talked about supply and demand, and you guys, rightly, immediately were on to where do those curves come from. And that's what we'll start next week.

But what I want to do today is talk some more about what determines the shapes of supply and demand curves and just think about an overview of how we think about supply and demand interacting in a market and what determines how responsive individuals and firms are to prices.

And, once again, remember everyone should have a handout that you should have picked up in the back on your way in. So everyone should have a handout. What we talked about last time was the sort of qualitative effects, the qualitative version of the supply and demand model.

We talked about what happens when a supply curve shifts, what happens when a demand curve shifts. We talked about how either a supply shock or a demand shock could lead to the price being increased. But they could have very different effects on quantity, et cetera.

What we didn't talk about is how big these effects are. I made up some numbers. I threw them on the graphs. But I didn't talk about where the size of those effects come from. And where they come from is the shapes of the supply and demand curve.

And that's what we'll talk about today is what determines the shapes of supply and demand curves. And that will be the focus of today's lecture. I'll talk both theoretically about what determines these shapes and empirically about how economists go about figuring out the shapes of supply and demand curves.

So, to think about this, let's start with Figure 3-1, which is a standard market diagram we had last time. With an initial equilibrium at point E1, with an initial price P1 and a quantity Q1. That's the equilibrium that's stable. Because at that price P1, consumers demand Q1 units, and suppliers are willing to provide Q1 units. So that's a stable equilibrium.

Now we have some supply shift. Last time we talked about somehow a pork-specific drought. That leads the supply to shift inward. So the supply curve rises to S2.

At that new price, initially, you would have excess demand. But quickly the price increases to shut off that excess demand. And you end up with a new equilibrium with a higher price, P2, and a lower quantity Q2, and new equilibrium point E2. OK? And we talked that through last time.

What I want to talk about this time is well, what determines the size of that shift from Q1 to Q2 and that price increase from P1 to P2? What's going to determine it is the elasticity of supply and demand. The elasticity of supply and demand is how much do supply and demand respond? Do the quantities supplied and the quantities demanded respond when the price changes?

When we say, how elastic is demand, what we mean is how sensitive to price is the quantity demanded. Or, alternatively, what is the slope of that demand curve? So the slope of the demand curve will be the sensitivity of quantity demanded to the price consumers face. And that will determine the market responsiveness.

In economics, it's always true that the best way to think about things is to go to extremes. You have to remember that extremes don't exist in the real world. But it's a useful teaching device to think about extremes.

So let's think about one extreme case in Figure 3-2. Let's think about the case of perfectly inelastic demand.

But what I want to do today is talk some more about what determines the shapes of supply and demand curves and just think about an overview of how we think about supply and demand interacting in a market and what determines how responsive individuals and firms are to prices.

And, once again, remember everyone should have a handout that you should have picked up in the back on your way in. So everyone should have a handout. What we talked about last time was the sort of qualitative effects, the qualitative version of the supply and demand model.

We talked about what happens when a supply curve shifts, what happens when a demand curve shifts. We talked about how either a supply shock or a demand shock could lead to the price being increased. But they could have very different effects on quantity, et cetera.

What we didn't talk about is how big these effects are. I made up some numbers. I threw them on the graphs. But I didn't talk about where the size of those effects come from. And where they come from is the shapes of the supply and demand curve.

And that's what we'll talk about today is what determines the shapes of supply and demand curves. And that will be the focus of today's lecture. I'll talk both theoretically about what determines these shapes and empirically about how economists go about figuring out the shapes of supply and demand curves.

So, to think about this, let's start with Figure 3-1, which is a standard market diagram we had last time. With an initial equilibrium at point E1, with an initial price P1 and a quantity Q1. That's the equilibrium that's stable. Because at that price P1, consumers demand Q1 units, and suppliers are willing to provide Q1 units. So that's a stable equilibrium.

Now we have some supply shift. Last time we talked about somehow a pork-specific drought. That leads the supply to shift inward. So the supply curve rises to S2.

At that new price, initially, you would have excess demand. But quickly the price increases to shut off that excess demand. And you end up with a new equilibrium with a higher price, P2, and a lower quantity Q2, and new equilibrium point E2. OK? And we talked that through last time.

What I want to talk about this time is well, what determines the size of that shift from Q1 to Q2 and that price increase from P1 to P2? What's going to determine it is the elasticity of supply and demand. The elasticity of supply and demand is how much do supply and demand respond? Do the quantities supplied and the quantities demanded respond when the price changes?

When we say, how elastic is demand, what we mean is how sensitive to price is the quantity demanded. Or, alternatively, what is the slope of that demand curve? So the slope of the demand curve will be the sensitivity of quantity demanded to the price consumers face. And that will determine the market responsiveness.

In economics, it's always true that the best way to think about things is to go to extremes. You have to remember that extremes don't exist in the real world. But it's a useful teaching device to think about extremes.

So let's think about one extreme case in Figure 3-2. Let's think about the case of perfectly inelastic demand.

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