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# Demand and supply

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### Demand and supply

1. 1. EC611--Managerial Economics Demand and Supply Dr. Savvas C Savvides, European University Cyprus
2. 2. Some key terms Market a set of arrangements by which buyers and sellers are in contact to exchange goods or services Demand the quantity of a good buyers wish to purchase at each conceivable price Supply the quantity of a good sellers wish to sell at each conceivable price Equilibrium price price at which quantity supplied = quantity demanded 1
3. 3. What, How and for Whom The market: determines what goods are being produced • there may be goods for which no consumer is prepared to pay a price at which firms would be willing to supply decides how much of a good should be produced • by finding the price at which the quantity demanded equals the quantity supplied tells us for whom the goods are produced • those consumers willing to pay the equilibrium price 2
4. 4. Law of Demand A decrease in the price of a good, all other things held constant, will cause an increase in the quantity demanded of the good. An increase in the price of a good, all other things held constant, will cause a decrease in the quantity demanded of the good. Quantity Demanded: The amount purchased at a particular price for a given time period 3
5. 5. Law of Demand There is an inverse relationship between the price of a good and the quantity of the good demanded per time period. Substitution Effect (If PA relative to PB DA ) Income Effect (If PA DA as purchasing power of individual’s income increases). 4
6. 6. The Demand Curve 5
7. 7. The Demand Curve Demand Curve: Shows the relationship between P and Q, ceteris paribus There is an inverse relationship between P and Qd, ceteris paribus Price An increase (decrease) in price causes a decrease (increase) in quantity demanded. Demand Schedule P Qd £2.5 50 units 2.00 75 1.50 100 1.25 150 1.00 200 0.50 250 P1 P0 Demand Curve Q1 Q0 Quantity 6
8. 8. Changes in Demand “OTHER THINGS” NON-PRICE DETERMINANTS OF DEMAND Change in Buyers’ Tastes Change in Buyers Incomes Normal Goods Inferior Goods Expectations of Future Price Changes Change in the Price of Related Goods Substitute Goods Complementary Goods Change in the Number of Buyers 7
9. 9. Change in Demand A change in any of the “other things” will affect the position of Demand Price An increase (decrease) in demand refers to a rightward (leftward)shift in the market demand curve. P0 D2 Q2 Q0 Q1 D0 D1 Quantity 8
10. 10. Two ways to Reduce the Quantity Demanded The Case of Cigarettes (1) Price A movement along the demand curve from A to B It represents consumer reaction to a price change P1 A P0 D Q1 Q0 Quantity 9
11. 11. Two ways to Reduce the Quantity Demanded Price The Case of Cigarettes (2) P1 P0 B D C A D1 D0 Q4 Q3 Q2 Q0 Quantity A movement of the demand curve from D0 to D1 leads to a decrease in demand at each price The shift of demand curve may come about due to Ministry of Health announcements, health warnings on cigarette packages, banning of ads on TV, non-smoking in restaurants, offices and public places, etc 10
12. 12. Individual Consumer’s Demand QdX = f(PX, I, PY, T) QdX = quantity demanded of commodity X by an individual per time period PX = price per unit of commodity X I ∆QdX/∆PX < 0 ∆QdX/∆I > 0 for normal good; ∆QdX/∆I < 0 inferior good = consumer’s income PY = price of related (substitute or complement) ∆QdX/∆PY > 0 if X and Y are substitutes; ∆QdX/∆PY < 0 if X and Y are complements commodity T = tastes of the consumer 11
13. 13. Market Demand Curve Market Demand Curve Horizontal Summation of Individual Demand Curves 12
14. 14. Market Demand Function QX = f(PX, N, I, PY, T) QX = quantity demanded of commodity X PX = price per unit of commodity X N = number of consumers on the market I = consumer income PY = price of related (substitute or complementary) commodity Y T = consumer tastes 13
15. 15. Market Demand Function -An Example Using OLS, the demand in Cyprus for BENZINE was estimated (for the period 1970-2000) DB = 67938 – 83.4PB + 73N + 16.5Y + 2907t If we substitute in the above equation, actual values for the explanatory vbls., we get: DB = 67938 – 83.4PB + 73(700K) + 16.5 ( 5525m) + 2907(32) DB = 303026 – 83.4PB 14
16. 16. Market Demand Function -An Example (2) By then substituting alternative prices for PB, we construct a demand schedule for the year. If PB = £550: DB = 303026 – 83.4(550) = 257156 tons If PB =£600: DB = 303026 – 83.4(600) = 252986 tons If PB = £450: DB = 303026 – 83.4(450) = 265496 tons 15
17. 17. The Market Demand Curve (3) The alternative values of P and Qd give us a demand schedule From which we can construct a demand curve Price of Benzine DB = 303026 – 83.4(PB) Demand Schedule P Qd £600 252986 tons £550 257156 tons £450 D’B = 314334 – 83.4(PB) 265496 tons Quantity Let’s now substitute values for the non-price vbls. For instance for 2002 (t=33): N=705K, Y=6000M D’B = 314334 – 83.4(PB) . This is the dotted demand curve. 16 Same slope (- 83.4), but higher intercept (314334 instead of 303026)
18. 18. Market Demand Function -An Example Using OLS, the demand for sweet potatoes was estimated as follows (for the period 1949-1979) Ds = 7609 – 1606Ps + 59N + 947Y + 479Pw- 271t If we substitute in the above equation, actual values for the explanatory vbls., we get: Ds = 7,609 – 1,606Ps + 59(150.72m.)+ 947(17,600) + 479(\$2.94) – 271(1) Ds = 19,306 – 1,606Ps 17
19. 19. Market Demand Function -An Example (2) By then substituting alternative prices for Ps, we get the final demand for the year. If Ps = \$5: Ds = 19,306 – 1,606(5) = 10,312 If Ps = \$ 7 Ds = 19,306 – 1,606(7) = 8,064 tons If Ps = \$ 4 Ds = 19,306 – 1,606(4) = 12,882 tons 18
20. 20. The Supply Curve 19
21. 21. The Market Demand Curve (3) The alternative values of P and Qd give us a demand schedule From which we can construct a demand curve Demand Schedule P Price of Potatoes Qd \$7 8,064 tons \$5 10,312 \$4 12,882 \$7 D’s = 17,598 – 1,606(Ps) \$5 \$4 Ds = 19,306 – 1,606(Ps) Quantity Let’s now substitute values for the non-price vbls. For instance for 1972 (t=24): N=208m., Y=31,900, Pw=\$2.41 D’s = 17,598 – 1,606(Ps) . This is the dotted demand curve to the left. 20 Same slope (1,606), but lower intercept (17,598 instead of 19,306)
22. 22. Law of Supply A decrease in the price of a good, all other things held constant, will cause a decrease in the quantity supplied of the good. An increase in the price of a good, all other things held constant, will cause an increase in the quantity supplied of the good. Quantity Supplied: The amount offered for in the market at a particular price at a given time. 21
23. 23. The Supply Curve An increase (decrease) in price causes an increase (decrease) in quantity supplied. Price Supply Schedule P Qd £2.5 200 units 2.00 150 1.50 100 1.25 50 1.00 Supply Curve 10 0.50 P0 0 P1 Q1 Q0 Quantity 22
24. 24. Changes in Supply What are these “other things” for Supply? NON-PRICE DETERMINANTS OF SUPPLY Change in Production Technology Change in Input Prices Change in the Number of Sellers Taxes/subsidies and legal restrictions Future Price Expectations of Sellers Weather & other “exogenous” factors A change in any of these “other things” will affect the position of the Supply Curve (but NOT its slope 23
25. 25. Change in Supply Price An increase (decrease) in supply refers to a rightward (leftward) shift in the market supply curve. S0 S2 S1 P0 Q2 Quantity Q0 Q1 24
26. 26. Market Equilibrium Equilibrium: A position of balance, from which there are no inherent forces or tendencies to move away. Market equilibrium is determined at the intersection of the market demand curve and the market supply curve. Equilibrium price: The price at which the quantity demanded is equal to the quantity supplied; there is no surplus (excess supply), nor shortage (excess demand) 25
27. 27. Market Equilibrium 26
28. 28. Market Equilibrium Price D P Qd S Market Equilibrium is at E where quantity demanded equals quantity supplied. Qs 2.50 50 200 2.00 75 150 1.50 100 100 1.25 150 50 1.00 200 10 0.50 250 0 Po E Qo This is at Po (£1.50) and Qo (100 units) Quantity 27
29. 29. Demand and Supply of Potatoes (Hypothetical Values) Price (cents per kilo) 0 Quantity Demanded 133.3 Quantity Supplied -23.5 20 106.7 0 40 80.1 23.7 60 53.5 47.3 80 26.9 70.9 100 0 94.5 28
30. 30. D & S of Potatoes: Algebraic Solution Assume, for example, that the Cyprus Potato Board has estimated the demand and supply of potatoes to be the following: Demand equation: P = 100 – 0.75 Q (where – 0.75 reflects the negative slope of D) Supply equation: P = 20 + 0.85 Q (where + 0.85 reflects the positive slope of S) where, P is in CYP (C£) and Q is in tons. Solving for Q, we have: 100 – 0.75 Q = 20 + 0.85 Q 1.4 Q = 80 Q* = 50 Substituting Q = 50 in the demand eq. gives us P* = 62.5 Therefore, the equilibrium quantity would be 50 tons of potatoes, and the equilibrium price would be C£ 62.5 per ton. 29
31. 31. Price Market Equilibrium and Disequilibrium Surplus or excess supply D • P1 E S consumers wish to purchase more than producers wish to supply • • P0 • P2 S • excess demand or shortage Q0 If price were below P0 there would be excess demand D Quantity If price were above P0 there would be excess supply producers wish to supply more than consumers wish to purchase 30
32. 32. Price A Shift in Demand (1) D1 D0 If, for instance, the price of a substitute good decreases ... S Excess Supply P0 P1 E0 The demand curve shifts from D0D0 to D1D1. E1 S D1 Q1 Q0 less will be demanded at each price. D0 Quantity If price stayed at P0 there would be excess supply. So, the market moves to a new equilibrium at E1, with lower price and quantity 31
33. 33. A Shift in Demand (2) Price D0 P1 P0 D1 S0 E1 E0 Assume consumers expect the price of oil to increase (due to the possibility of a war, say the war in Iraq. This will tend to increase their current demand . An increase in demand will cause the market equilibrium price and quantity to increase. So, the market moves to a new equilibrium point at E1 Q0 Q1 Quantity 32
34. 34. A Shift in Supply (1) Price S1 S0 D E2 P1 P0 The supply curve shifts to S1S1 E0 S1 S0 If price stayed at P0 there would be excess demand D Q1 Q0 Suppose safety at work regulations (due to EU) are tightened, leading to increasing producers’ costs So the market moves to a new equilibrium at E2 Quantity Other factors leading to the same result: Oils shortage, winter freeze, drought 33
35. 35. A Shift in Supply (2) (Technical Innovation) Price D0 S0 E0 P0 P1 E1 Q0 Q1 S1 An increase in supply will cause the market equilibrium price to decrease and quantity to increase. Quantity 34
36. 36. A Market in Disequilibrium Price (Price Controls) P1 S1 S0 Suppose a disastrous wheat E1 P0 E0 excess demand Q1 D harvest moves the supply curve from S0 to S1 The government may try to protect the poor, setting a price ceiling for bread at P0 which is below P1, the new equilibrium price level The result is excess demand (shortage) Q0 Quantity RATIONING is needed to cope with the resulting excess demand. This was the case in ex-Soviet Russia and China. 35
37. 37. Price Supports Price D Surplus S PS P0 QD Q0 QS The Cyprus gov’t supports farmers (in the context of CAP), by ensuring them a price support for their produce (milk, potatoes, cereals, meat, wine, etc) at P1 which is above P0, the equilibrium price The result is excess supply (surplus) Quantity 36
38. 38. Price and Quantity Changes In practice, we cannot plot ex ante demand curves and supply curves So,historical data and the supposition that the observed values are equilibrium ones are used Since other things are often not constant, some detective work is required this is where our theory comes in useful 37
39. 39. Demand Faced by a Firm Market Structure Monopoly Oligopoly Monopolistic Competition Perfect Competition Type of Good Durable Goods Nondurable Goods Producers’ Goods - Derived Demand 38
40. 40. Determinants of Demand for a Product QX = f (PX, AX ,OX , FX … Yc , Tc , Ec …. Strategic vbls. Controlled vbls. Consumer vbls. Uncontrolled vbls. … PY, AY ,OY , FY … G, N, FX, W…) Competitor vbls. Uncontrolled Environmental vbls. Variables 39
41. 41. Linear Demand Function QX = f(PX, N, I, PY, T) QX = a0 + a1PX + a2N + a3I + a4PY + a5T PX Intercept: a0 + a2N + a3I + a4PY + a5T Slope: ∆QX/∆PX = a1 QX 40
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