Class 2a

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Class 2a

  1. 1. Demand how much of a product consumers are both willing and able to buy at a given price, at a given point in time.
  2. 2. The law of demand <ul><li>• The quantity demanded is inversely related </li></ul><ul><li>with its price, all else constant. </li></ul><ul><li>- That is, when price rises, quantity demanded falls </li></ul><ul><li>• The law of demand can be explained by the </li></ul><ul><li>substitution effect and the income effect: </li></ul><ul><li>- Observed change in demand via a price change can be decomposed into a SE and an IE. </li></ul>
  3. 3. Substitution Effect <ul><li>Substitution Effect: </li></ul><ul><li>- When the price of a good rises, consumers will substitute away to other goods </li></ul><ul><li>- Holding real purchasing power constant, an increase in the price of a good relative to others, raises the opportunity cost of consuming that good, and therefore demand strictly decreases </li></ul><ul><li>- for ALL goods then: ↑ own price, SE sees ↓ quantity demanded </li></ul>
  4. 4. Income effect <ul><li>- A normal good is a good for which demand increases as consumer income rises. </li></ul><ul><li>- An inferior good is a good for which demand decreases as consumer income rises. </li></ul>
  5. 5. Demand schedule <ul><li>The demand schedule maps the quantity demanded at each price. </li></ul><ul><li>- Assumes income, other prices, tastes and expectations are the same at each price. </li></ul><ul><li>The schedule shows the absolute maximum price consumer is willing to pay for a given quantity of the good. </li></ul>
  6. 6. Example: demand schedule for milk
  7. 7. The demand curve for milk
  8. 8. Behind the demand curve <ul><li>• Demand curve can also be interpreted as the willingness to pay curve. </li></ul><ul><li>• It tells the highest price that people are willing to pay for a given quantity of a good. </li></ul><ul><li>• The highest price someone is willing to pay for q* units is equal to the marginal benefit of the q*th unit consumed: P=MB(q*) </li></ul>
  9. 9. From individual demand to market demand
  10. 10. Changes in demand <ul><li>• Determinants of demand </li></ul><ul><li>- price </li></ul><ul><li>- consumer income </li></ul><ul><li>- the prices of related goods </li></ul><ul><li>- consumer expectations </li></ul><ul><li>- the number or composition of consumers </li></ul><ul><li>- consumer tastes </li></ul>
  11. 11. Change in quantity demanded and a change in demand <ul><li>A change in quantity demanded results from a change in price (movement along the demand curve) </li></ul>
  12. 12. An increase in the market demand for milk
  13. 13. Change in quantity demanded and a change in demand <ul><li>a shift in demand results from a change in any determinants of demand other than price. </li></ul>
  14. 14. Changes in income <ul><li>• Normal goods </li></ul><ul><li>- Fashion, tvs, cars, books, steak… </li></ul><ul><li>• Inferior goods </li></ul><ul><li>- Bus tickets, rice, Foxtel, drugs </li></ul>
  15. 15. Changes in the prices of other goods <ul><li>• Substitutes and complements </li></ul><ul><li>- Substitutes are goods that are related in such a way that an increase in the price of one good leads to an increase in demand for the other good. </li></ul><ul><li>- Goods that are used instead of. </li></ul><ul><li>Eg. hotdogs and hamburgers </li></ul><ul><li>- Complements are goods that are related in such a way that an increase in the price of one leads to a decrease in demand for the other. </li></ul><ul><li>- Goods that are used with. </li></ul><ul><li>Eg. CD players and CDs </li></ul>
  16. 16. Other changes <ul><li>Other factors causing a change in demand: </li></ul><ul><li>• Change in consumer expectations </li></ul><ul><li>• Change in number or type of consumer </li></ul><ul><li>• Change in consumer tastes </li></ul>
  17. 17. An increase in the market demand for milk
  18. 18. Supply <ul><li>how much of a product producers are willing to produce at a given price, at a given point in time. </li></ul>
  19. 19. Supply schedule <ul><li>• The supply schedule maps the quantity supplied at each price. </li></ul><ul><li>- Assumes wages, costs, other prices, technologies and expectations are the same at each price. </li></ul><ul><li>• The schedule shows the absolute minimum price producer must receive before suppling a given quantity of the good. </li></ul>
  20. 20. The supply schedule for milk
  21. 21. The supply curve for milk
  22. 22. Behind the supply curve <ul><li>• The supply curve can be interpreted as a minimum supply price curve. </li></ul><ul><li>• It tells you the minimum price firms are willing and able to accept for supplying a given quantity of the good. </li></ul><ul><li>• The minimum price a firm will accept is equal to the marginal cost of producing the last unit of output: P=MC </li></ul>
  23. 23. Change in the quantity supplied and a change in supply <ul><li>• A change in the price of a good results in a change in the quantity supplied and a movement along the supply curve. </li></ul><ul><li>• A change in one of the non-price determinants of supply results in a change in supply, shifting the entire supply curve. </li></ul><ul><li>• Changing price moves us to a different row in the supply schedule. Changing something else requires us to rewrite an entire column. </li></ul>
  24. 24. Changes in supply <ul><li>Other factors causing a change in supply: </li></ul><ul><li>• Change in technology </li></ul><ul><li>• Change in price of relevant resources </li></ul><ul><li>• Change in price of alternative goods </li></ul><ul><li>• Change in producer expectations </li></ul><ul><li>• Change in number of producers </li></ul>
  25. 25. An increase in the supply of milk
  26. 26. Demand and supply create a market <ul><li>• A market is a mechanism that coordinates the independent intentions of buyers and sellers. </li></ul><ul><li>• A market reduces the transaction costs of exchange </li></ul>
  27. 27. Market equilibrium <ul><li>• Supply and demand interact to give a market equilibrium price and equilibrium quantity </li></ul><ul><li>• Equilibrium is achieved when at a common price market demand is equal to market supply. </li></ul><ul><li>• At a price above the equilibrium price there will be excess supply (or a surplus). </li></ul><ul><li>• At a price below the equilibrium price there will be excess demand (or a shortage) </li></ul>
  28. 28. Equilibrium in the dairy milk market
  29. 29. Equilibrium in the dairy milk market
  30. 30. Changes in market equilibrium price and quantity <ul><li>• Impact of changes in demand </li></ul><ul><li>- Any change in demand, with the upward-sloping supply curve held constant, will change equilibrium price and quantity in the same direction as the change in demand. </li></ul>
  31. 31. Effects of an increase in demand
  32. 32. Changes in market equilibrium price and quantity <ul><li>• Impact of changes in supply </li></ul><ul><li>- A shift in the supply curve, with the demand curve unchanged, changes equilibrium quantity in the same direction as the change in supply, but changes equilibrium price in the opposite direction. </li></ul>
  33. 33. Effects of an increase in supply
  34. 34. Changes in market equilibrium price and quantity <ul><li>• Simultaneous changes in demand and supply </li></ul><ul><li>- When both demand and supply increase, the quantity increases and the price increases, decreases or remains constant. </li></ul><ul><li>- When both demand and supply decrease, the quantity decreases and the price increases, decreases or remains constant. </li></ul>
  35. 35. Indeterminate effect of an increase in both supply and demand (shift in demand dominates)
  36. 36. Indeterminate effect of an increase in both supply and demand (shift in supply dominates)
  37. 37. Changes in supply & demand
  38. 38. Analysing changes in equilibrium <ul><li>• Decide whether the event affects the supply or the demand curve (or both). </li></ul><ul><li>• Decide whether the impact is positive or negative. </li></ul><ul><li>• Determine how the shift affects equilibrium price and quantity. </li></ul><ul><li>• Remember: a change in price only will not shift the curve. </li></ul>

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