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# Demand and supply

## on Nov 20, 2011

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## Demand and supplyPresentation Transcript

• Demand and Supply
• Demand Schedule and Demand Curve
• Supply Schedule and the Supply Curve
• Elasticity of demand and supply
• Demand - Total quantity customers are willing and able to purchase.
• A demand function is a behavior function for consumers.
• A supply function is a behavior function for producers.
• We describe market behavior using these two functions.
• Direct Demand and Derived Demand
• Direct Demand-for consumption goods
• Goods and services that satisfy consumer desires.
• Derived Demand-These are sometimes called intermediate goods.
• For example, demand for steel (an intermediate good) is derived from the demand for final goods (e.g., automobiles).
• Quantity Demanded – amount of a good that the consumer is willing to buy and able to buy at a given price over a period of time.
• Law of Demand : All other things remaining unchanged, the quantity demanded of a good increases when its price decreases and vice versa.
• This relationship can be shown by a demand schedule, a demand curve or a demand function.
• Demand Schedule
• Demand Schedule shows the different quantities of goods that a consumer is willing to buy at various prices.
• Prices and quantities normally move in opposite directions
Prices Quantity 4 28 8 15 12 5 16 1 20 0
• Demand Curve : A curve showing the relationship between the price of a good and the quantity demanded.
price quantity
• Demand Function:
• A demand function is a causal relationship between a dependent variable (i.e., quantity demanded) and various independent variables (i.e., factors which are believed to influence quantity demanded)
• Q = f(P)
• Where Q= quantity and P = price of a good.
• Example Q = 2 – 4P
• Determinants of Demand
• Own Price
• Income of the consumer
• Price of other goods- 1 . complements
• 2 . substitutes
• Tastes and preferences
• Expectations of future prices
• Distribution of income
• Types of goods
• Complementary goods are a pair of goods consumed together. As the price of one goes up the demand for the other falls.
• Example- car and petrol
• Substitute goods are alternatives to each other. As the price of one goes up the demand for the other also goes up.
• Example – pepsi and coke
• Normal goods are those goods whose demand goes up when the consumer’s income increases.
• Inferior goods are those goods whose demand falls when the consumer’s income increases.
• Example : autotravel, kerosene
• Giffen goods are those goods whose demand moves in same direction as price
• Snob or Veblen goods are those goods whose demand falls when price falls
• Shift of the Demand Curve
• A change in demand is reflected by shift of the Demand curve and is caused by a change in any of the non price determinants of demand
price qty Here, the curve shifts due to an increase in income or an increase in price of a substitute good etc
• A change in quantity demanded is however reflected in a movement along the demand curve and is called an extension or contraction in demand.
• The movement from A to B is due to the change in price of the good all other factors remaining unchanged
A B
• Supply
• The quantity supplied is the number of units that sellers want to sell over a specified period of time at a particular price.
• Law of Supply states that all other factors remaining unchanged the supply of a good increases as its price increases. This can be shown by a supply schedule, a supply curve or a supply function.
• Supply schedule
• There exists a positive relation between quantity and price
price quantity 1 2 5 10 8 15 13 25 20 35
• Supply Curve:
qty price
• Supply function shows the relation between quantity
• and price.
• It is a positive relation. Example : q= 4+3p
• Determinants Of Supply
• Price
• Cost of production
• Technological progress
• Prices of related outputs
• Govt policy
• All factors other than price cause a shift of the supply curve and is called a change in supply
• EQUILIBRIUM
• Equilibrium - perfect balance in supply and demand
• Determines market output and price
eqm p q s dem p
• Market forces drive market to equilibrium
• at prices < equilibrium level: excess demand (amount by which quantity demanded exceeds quantity supplied at the specified price)
• at price > equilibrium level: excess supply
• equilibrium price is market clearing price: no excess demand or excess supply
• Equilibrium in a Market Demand Price Supply 800 \$3,000 2,900 1,150 \$2,500 2,550 1,500 \$2,000 2,200 1,850 \$1,500 1,850 2,200 \$1,000 1,500 2,550 \$500 1,150 2,900 \$0 0
• Surplus and Shortage
• Any price above the equilibrium causes an excess supply and any price below the equilibrium causes a shortage.
• The market if uncontrolled will automatically arrive at the equilibrium price at which supply equals demand.
• Any shift in demand and supply curves will result in a new equilibrium
• Comparison of equilibrium is called comparative -statics
• Price Rationing
• A decrease in supply creates a shortage at P 0 . Quantity demanded is greater than quantity supplied. Price will begin to rise.
• The lower total supply is rationed to those who are willing and able to pay the higher price.
• Alternative Price- Control Mechanisms
• A price ceiling is a maximum price that sellers may charge for a good, usually set by government .
• Example: rent control
• A price floor is a price above equilibrium price that the buyers have to pay.
• Example : agricultural support price, minimum wages
• Elasticity
• Elasticity: A measure of the responsiveness of one variable to changes in another variable; the percentage change in one variable that arises due to a given percentage change in another variable.
• By converting each of these changes into percentages, the elasticity measure does not depend on the units in which we measure the variables.
• ELASTICITY
• Sensitivity of the quantity demanded to price is called: price elasticity of demand :
• Arc Elasticity
• To get the average elasticity between two points on a demand curve we take the average of the two end points (for both price and quantity) and use it as the initial value:
• q2-q1/(q2+q1)/2
• p2-p1/(p2+p1)/2
• Own Price Elasticity of Demand
• Own price elasticity: A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good; the percentage change in quantity demanded divided by the percentage change in the price of the good.
• Elastic demand: Demand is elastic if the absolute value of the own price elasticity is greater than 1.
• Types of elasticities
• elastic : the quantity demanded changes more than in proportion to a change in price
• inelastic : the quantity demanded changes less than in proportion to a change in price
• Elasticity and slope Price Quantity Demanded The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded.
• Slope of the Demand Curve
•  P is the change in price. (  P<0)
•  Q is the change in quantity.
• slope =  P/  Q
Price Quantity Demand Q Q +  Q  Q P P+  P  P
• Elasticity and slope
• Elastic demand : Demand is elastic if the absolute value of own price elasticity is greater than 1.
• Inelastic demand: Demand is inelastic if the absolute value of the own price elasticity is less than 1.
• Unitary elastic demand: Demand is unitary elastic if the absolute value of the own price elasticity is equal to 1.
• Perfectly elastic demand : e= infinity
• Perfectly inelastic demand : e = 0
• Linear Demand Curve:
• price
Qty E = infinity e=lower segment/upper segment E=0 E=1
• Determinants of Elasticity
• Number and closeness of substitutes – the greater the number of substitutes, the more elastic
• The proportion of income taken up by the product – the smaller the proportion the more inelastic
• Price of the product- lower the price, lower the elasticity
• Luxury or Necessity - for example, addictive drugs
• Time period – the longer the time under consideration the more elastic a good is likely to be
• Cross-Price Elasticity
• Cross-price elasticity: A measure of the responsiveness of the demand for a good to changes in the price of a related good; the percentage change in the quantity demanded of one good divided by the percentage change in the price of a related good.
• The cross-price elasticity is positive whenever goods are substitutes.
• The cross-price elasticity is negative whenever goods are complements.
• Cross-price elasticity of demand
• how quantity of one good changes as price of another good increases
• Income elasticity of demand
• Income Elasticity
• Income elasticity: A measure of the responsiveness of the demand for a good to changes in consumer income; the percentage change in quantity demanded divided by the percentage change in income.
• The income elasticity is positive whenever the good is a normal good.
• The income elasticity is negative whenever the good is an inferior good.
• Factors affecting Income elasticity :
• Nature of the good:
• inferior goods have negative income elasticity
• Normal goods have positive income elasticity
• Luxury goods have income elasticity greater than one
• Necessary goods have income elasticity less than one
• The own advertising elasticity of demand for good X defines the percentage change in the consumption of X that results from a given percentage change in advertising spent on X.
• Elasticity and Total Revenue
• If demand is elastic, an increase (decrease) in price will lead to a decrease (increase) in total revenue.
• If demand is inelastic, an increase (decrease) in price will lead to an increase (decrease) in total revenue.
• Total revenue is maximized at the point where demand is unitary elastic.
• price revenue elasticity Increases increases E< 1 increases decreases E>1 decreases decreases E<1 decreases increases E>1 Increases/ decreases constant E=1
• MARGINAL REVENUE
• TR = P.Q
• MR = P + Q dP/dQ
• = P(1 + Q/P. dP/dQ)
• = P(1- 1/e)
• = AR(1-1/e)
• Hence if e=1, MR =0
• if e =0 , MR = INFINITY
• if e = infinity, MR = AR
• MR,AR
QTY E=1 E=infinity MR E=0
• Total revenue qty E = 1 Tr is max
• Elasticity of Supply
• Price Elasticity of Supply:
• The responsiveness of supply to changes in price
• If e s is inelastic (<1)- it will be difficult for suppliers to react swiftly to changes in price
• If e s is elastic(>1) – supply can react quickly to changes in price
e s = % Δ Quantity Supplied ____________________ % Δ Price
• Paradox of the Bumper harvest
• When prices of food crops increase, the demand does not increase proportionally.
• Hence the revenue earned by farmers fall.
• The Govt announces a floor price for the farmers- agricultural price subsidy.
• This interference with prices comes at a cost to the Govt in form of storage costs of Govt granaries.
• Application of elasticity:
• Incidence of taxation:
Supply after tax supply demand tax e1 eqm pt p1 p0