Demand and Supply Analysis “You cannot teach a parrot to be an economist simply by teaching it to say ‘supply’ and ‘demand’.” ---AnonymousFaculty of Business andEconomics (FBE), The IIPM, NewDelhi
In this chapter you will…Learn the nature of a ‘competitivemarket’.Examine what determines the demandfor a good in a competitive market.Examine what determines the supplyof a good in a competitive market.See how supply and demand togetherset the price of a good and thequantity sold.Consider the key role of prices inallocating scarce resources.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
THE MARKET FORCES OF SUPPLY AND DEMAND Supply and Demand are the two words that economists use most often. Supply and Demand are the forces that make market economies work! Modern microeconomics is about supply, demand, and market equilibrium.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
MARKETS AND COMPETITION • The terms supply and demand refer to the behaviour of people......as they interact with one another in markets. • A market is a group of buyers and sellers of a particular good or service. • Buyers determine demand... • Sellers determine supply…Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Competitive Markets A Competitive Market is a market with many buyers and sellers so that each has a negligible impact on the market price.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Competition: Perfect or Otherwise Perfectly Competitive: Homogeneous Products Buyers and Sellers are Price Takers Monopoly: One Seller, controls price Oligopoly: Few Sellers, not aggressive competition Monopolistic Competition: Many Sellers, differentiated productsFaculty of Business andEconomics (FBE), The IIPM, NewDelhi
DEMAND • Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at alternative prices for a given period.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Determinants of Demand • factors determine how What much ice cream you will buy? • What factors determine how much you will really purchase? Product’s Own Price Consumer Income Prices of Related Goods Tastes ExpectationsEconomics (FBE), The IIPM, New Consumers Number ofFaculty of Business andDelhi
Price Law of Demand – The law of demand states that, other things equal (ceteris paribus), the quantity demanded of a good falls when the price of the good rises.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Income – As income increases, the demand for a normal good will increase. – As income increases, the demand for an inferior good will decrease.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Prices of Related Goods – Prices of Related Goods – When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. – When a fall in the price of one good increases the demand for another good, the two goods are called complements.Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Others– Tastes & preferences– Expectations– Re-saleability– AdvertisingFaculty of Business andEconomics (FBE), The IIPM, NewDelhi
The Demand Schedule and the Demand Curve – The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. – The demand curve is a graph of the relationship between the price of a good and the quantity demanded. – Ceteris Paribus: “Other thing being equal”Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Table 4-1: Catherine’s Demand Schedule Price of Ice- Quantity of cream Cone ($) cones Demanded 0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00 0Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Figure 4-1: Catherine’s Demand CurvePrice of Ice-CreamCone $3.00 2.50 2.00 1.50 1.00 0.50 0 2 4 6 8 10 12 Quantity of Ice-Cream Faculty of Business and Cones Economics (FBE), The IIPM, New Delhi
Market Demand Schedule • Market demand is the sum of all individual demands at each possible price. • Graphically, individual demand curves are summed horizontally to obtain the market demand curve. • Assume the ice cream market has two buyers as follows…Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Table 4-2: Market demand as the Sum of Individual DemandsPrice of Ice- Catherine Nicholas Marketcream Cone ($) 0.00 12 + 7 = 19 0.50 10 6 16 1.00 8 5 13 1.50 6 4 10 2.00 4 3 7 2.50 2 2 4 3.00 0 1 1Faculty of Business andEconomics (FBE), The IIPM, NewDelhi
Figure 4-3: Shifts in the Demand CurvePrice ofIce-CreamCone Increas e in demand Decrease in demand D2 D1 D3 Quantity of Ice-Cream Faculty of Business and Cones Economics (FBE), The IIPM, New Delhi
The Determinants of Quantity DemandedFaculty of Business andEconomics (FBE), The IIPM, NewDelhi
Shifts in the Demand Curve versus Movements Along the Demand CurveFaculty of Business andEconomics (FBE), The IIPM, NewDelhi
Figure 4-4 a): A Shifts in the Demand Curve Price ofCigarette s, per Pack. A policy to discourage smoking shifts the demand curve to the left. B A $2.00 D1 D2 0 10 20 Number of Cigarettes Smoked Faculty of Business and per Day Economics (FBE), The IIPM, New Delhi
Figure 4-4 b): A Movement Along the Demand Curve Price ofCigarette s, per Pack. C A tax that raises the price of $4.00 cigarettes results in a movements along the demand curve. A $2.00 D1 0 12 20 Number of Cigarettes Smoked Faculty of Business and per Day Economics (FBE), The IIPM, New Delhi
• The quantity of goods or services that firms are ready and are willing to sell at a given price within a period of time , other factors being held constant .• A product made available for sale by firms.
Law of Supply• It states that if the price of a good or service goes up , the quantity supplied for such good or service will also go up ; if the price goes down , the quantity supplied also goes down , ceteris paribus .
Supply Schedule• A schedule listing the various prices of a product and the specific quantities supplied at each of these prices .• Can be used to construct a supply curve .
Supply Curve• A graphical representation showing the relationship between the price of the product or factor of production and the quantity supplied per time period .• Is consistent with the Law of Supply .
Supply Function• A form of mathematical notation that links the dependent variable , quantity supplied (Qs), with various independent variables which determine quantity supplied .• Among the factors that influence the quantity supplied are price of the product, number of sellers in the market , price of factor inputs , technology , business goals , importations , weather conditions , and government policies .• Qs = f (own price , number of sellers , price of factor inputs , technology , etc .)
Change in Quantity supplied vs . Change in Supply
Change in Quantity Supplied• A change in quantity supplied is brought about by an increase (decrease) in the product’s own price .The direction should be positive considering the Law of Supply .
Change in Supply• When the entire demand supply curve shifts rightward or leftward .• Caused by factors other than the price of the good itself such as change in technology , business goals , etc , resulting to the movement of the entire supply curve .
Optimization in the useof factors of production
What is Optimization? - refers to the process of makingsomething as fully functional or effective aspossible.
Optimization in the use of Factors of Production An optimization in the utilization ofresources will increase supply, while afailure to achieve such will result todecrease in supply.
Technological Change Introduction of cost-reducinginnovations in production technologyincreases supply on one hand. On the otherhand, this can also decrease supply bymeans of freezing the production throughthe problems that the new technology mightencounter, such as technical trouble.
Future Expectations This factor impacts sellers as much asbuyers. If sellers anticipate a rise in prices,they may choose to hold back the currentsupply to take advantage of the futureincrease in price. If sellers expect a declinein price for their products, they will increasepresent supply.
Number of Sellers The number of sellers has a directimpact on quantity supplied. Simply put, themore sellers there are in the market thegreater supply of goods and services will beavailable.
Weather Conditions Bad weather, such as typhoons,drought or other natural disasters, reducessupply of agricultural commodities whilegood weather has an opposite impact.
Government Policy Removing quotas and tariffs onimported products also affect supply. Lowertrade restrictions and lower quotas or tariffsboost imports, thereby adding more supplyof goods in the market.
Quota – are limitation on the number ofimported goods which could enter a country.Tariffs - tax imposed on imported goods andservices.
Market EquilibriumMarket Equilibrium A situation in which the supply of anitem is exactly equal to its demand. Sincethere is neither surplus nor shortage in themarket, price tends to remain stable in thissituation.
This figure showsthe equilibrium betweenquantity demanded andquantity supplied. (x-axisare the quantities and y-axis are the prices). As wecan observe in the graph,market equilibrium is thepoint of intersectionbetween the supply (S) anddemand (D) curves, that is,at P=30 and Q = 150.
What happens when there is marketdisequilibrium? When there is market disequilibrium,two conditions may happen: a surplus or ashortage.
Surplus Surplus is a condition where thequantity supplied is more than quantitydemanded. Tendency is for sellers to lowermarket prices. This means a downwardpressure to price in order to restoreequilibrium in the market.
As we can observein the graph, surplus iasituation above theequilibrium point. This isbecause quantity supplied(say as P=40, Qs=200units) is greater thanquantity demanded (atP=40, Qd=100 units)resulting to 100 units moregoods being supplied
Shortage Shortage is a condition in the market inwhich quantity demanded is higher thansupplied. When the market is experiencingshortage, there is a possibility of consumersbeing abused, while the producers areenjoying imposing higher prices for theirown interest.
As we can observein the graph, shortagehappens when quantitydemanded is greater thanquantity supplied. Forinstance at price P20quantity demanded is 200units while quantitysupplied is 100 units.
What happens if disequilibrium in themarket persists at longer period of time? The government may intervene byimposing price controls.
Price Control Price Control is the specification by thegovernment of minimum or maximum pricesfor goods and services. The price may befixed at a level below the market equilibriumprice or above it depending on the objectivein mind.
Floor Price It is the legal minimum price imposedby the government. This is undertaken if asurplus in the economy persist. This move isresorted to in order to prevent bigger losseson the part of the producers
Price Ceiling It is the legal maximum price imposedby the government. Price ceiling is utilizedby the government if there is a persistentshortage of goods. It is imposed to protectconsumers from abusive sellers who takeadvantage of the situation.