Analysis of Demand & Supply & Market Equilibrium
Concept of Market A market is a mechanism by which buyers and sellers interact to determine the price and quantity of a good or service Demand side of the market for a product refers to all its consumers and the price they are willing to pay for buying a certain quantity of a product during a period of time.
What is Demand??? Demand is the desire or want backed up by money Always related to price and time
Statement of Law of Demand“All other things remaining constant, higher the price of a commodity, smaller is the quantity demanded and lower the price, larger the quantity demanded” Dx = f (Px)
Reasons for Inverse Relationship Income effect- the decline in the price of a commodity leads to an equivalent increase in the income of a consumer because he has to spend less to buy the same quantity of goods. The part of the money left can be used for buying some more units of commodity. For e.g.- suppose the price of mangoes falls from Rs.100/- per dozen to 50/- per dozen. Then with the same amount of 100/- you can buy one more dozen, i.e.,2 dozens at Rs. 50/- Substitution effect- When the price of a commodity falls, the consumer tends to substitute that commodity for other commodity which is relatively expensive. For e.g. – Suppose the price of the Urad falls, it will be used by some people in place of other pulses. Thus the demand will increase.
Assumptions Underlying the Law No change in Consumer’s Income No change in Consumer’s Preferences No change in Fashion No change in Price of related goods No Expectation of future price changes or shortages
Individual Demand ScheduleTabular representation of Quantity of acommodity that an individual is willingand able to purchase over a given period oftime at each price of the commodity, whileholding constant all other relevanteconomic variables on which demanddepends.
Individual Demand SchedulePrice of Com X Quantity demanded(Rs per kg) of Com X (Qty in kg) 80 2 70 4 60 6 50 10
Market demand ScheduleTabular representation of Quantity of acommodity that all individuals are willingand able to purchase over a given period oftime at each price of the commodity, whileholding constant all other relevanteconomic variables on which demanddepends.
Market Demand SchedulePrice in (Rs) Units of Commodity X Market demanded per day Demand by Individuals or Total A B C 4 1 1 3 5 3 2 3 5 10 2 3 5 7 15 1 5 9 10 24
Determinants of Market Demand Price of Product Distribution of Income & wealth Community’s Common Habits and Scale of Preferences Spending Habits of People Growth of Population Age Structure and Sex ratio of Population Future Expectations Level of Taxation Fashions Climate Conditions Customs Advertisement
Multivariate Demand Function Dx = D (Px, Py, Pz, B, W, A, E, T, U) Here Dx, stands for demand for item x (say, a car) Px, its own price (of the car) Py, the price of its substitutes (other brands/models) Pz, the price of its complements (like petrol) B, the income (budget) of the purchaser (user/consumer) W, the wealth of the purchaser A, the advertisement for the product (car) E, the price expectation of the user T, taste or preferences of user U, all other factors.
Demand equation D= a – bP Where ‘a’ is constant parameter signifying initial demand irrespective of price ‘b’ represents slope of demand curve functional relationship between price and demand, having minus sign denotes negative function
Exceptions to Law of Demand Conspicuous consumption – The goods which are purchased for ‘Snob appeal’ are called as the conspicuous consumption. For e.g.- diamonds. They are the prestige goods. They would like to hold it only when they are costly and rare. Speculative market: in this case the higher the price the higher will be the demand. It happens because of the expectation to increase the price in the future. For e.g. shares, lotteries
Contd… Giffens goods: It is a special type of inferior goods where the fall in the price results into the decrease In the quantity demanded. This happens because of people’s preference for superior commodity Consumer’s Psychological bias: Many a times consumer judges the quality of a good from its price. Such consumers may purchase high price goods because of the feeling of possessing a better quality. The exceptional demand curve shows a positive relation between the price and the quantity demanded.
Shifts in Demand Curve Extension and Contraction of Demand occurs due to changes in price, other factors remaining constant When more of a commodity is purchased with a fall in price then it is known as extension of Demand and vice versa Refer to movement along same demand curve Increase and Decrease in Demand refers to changes in demand due to factors other than price An increase in demand signifies that more will be purchased at a given price than before . Refer to movement from one demand curve to another
Reasons for shifts (increase or decrease in Demand) Changes in Income Changes in Taste, habits and Preferences Change in Fashions and Customs Change in Distribution of Wealth Change in Substitutes Change in demand for Complementary goods Advertisement and Publicity Persuasion Change in level of taxation
Nature of Demand Demand for Consumer’s goods & Producers goods Autonomous & Derived Demand Demand for Durables and Non- Durables (Perishables) Joint Demand and Composite Demand
Supply Analysis Supply during a given period of time means the quantities of goods which are offered for sale at particular prices Supply is what seller is able and willing to offer for sale Supply and Stock are related but distinct terms-Supply comes out of Stock Stock determines potential supply Stock is outcome of production
Determinants of Supply Cost of factors of production State of Technology Factors outside Economic Sphere such as weather conditions, natural calamities, etc Tax and Subsidy
Law of Supply“Other things remaining same ,supply of a commodity rises with arise in price and falls with a fall inprice”
Assumptions : Cost of production is unchanged Technology is constant Govt policies are unchanged No change in Transport costs No speculation Prices of other goods constant
Positions: Supply Curve Extension and Contraction : refer to change in supply due to price, other things remaining same. Movement along the supply curve Increase and Decrease in Supply: refer to change in supply due to determinants other than price Shifts in Supply Curve
Causes for change in Supply Change in Cost of Production Supply also depends on Natural Factors Change in Technique of Production Policies of Government Business Combines
When market is in Equilibrium? Equilibrium price of a commodity is price at which quantity demanded of commodity equals quantity supplied and market clears Equilibrium is condition which once achieved tends to persist in time.
Equilibrium of Supply and Demand Price S Excess Supply E Excess D Demand D&S
Effect of Shift in Supply or Demand Demand & Effect on price Supply shifts and quantityIf demand Demand curve Both P & Qrises shifts to right increasesIf demand falls Demand curve Both P & Q shifts to left fallsIf supply rises Supply curve P falls but Q shifts to right increasesIf supply falls Supply curve P increases & shifts to left Q decreases
Simultaneous shifts of Supply and Demand New equilibrium price and quantity may be greater than, equal or even less than initial equilibrium levels depending on the magnitude and direction of two curves If both D & S shift to right by same amount , the equilibrium point shifts to right by same amount and hence equilibrium price remains same.
Impact of Excise tax on Price and Quantity An excise is a tax on each unit of commodity If collected from sellers tax causes supply curve to shift upward by the amount of tax Result is that consumers purchase a smaller quantity at a higher price while sellers receive a smaller net price after payment of tax
Impact of Excise tax on Price and Quantity S1 S0 T E1 Tax P1 Po E0 D Q1 Q0
Impact of Rent Control on Housing Markets Rent control is a type of price ceiling or maximum rent set below equilibrium price that government use for making rented housing affordable, however the effect has been opposite ie shortage of apartments
Rent Control create shortages S$1400MonthlyRent E$1000$600 Shortage D 1.2 1.6 2 Millions of Apartments