3 demand, supply and the market

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  • 1. Demand, Supply and the MarketMarket is any place people come together to trade. Trade or exchange may take place at a physical orvirtual location. In a market economy, the price of a good is determined by the interaction of demandand supply.DemandThe willingness and ability of buyers to purchase different quantities of a good at different prices duringa specific time period. [Ceteris paribus]Demand schedule and curveA demand schedule is the numerical representation of the law of demand. Curve represents thegraphical representation of the demand schedule and law of demand.Law of demand  An inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus.  As the price of a good rises, the quantity demanded of the good falls and as the price of a good falls, the quantity demanded of the good rises [ceteris paribus] Reasons:  substitution effect  income effectFull note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 2. Determinants of demand  Price of the product  Income  Preferences  Prices of substitute goods  Prices of complementary goods  Expectations of future pricesOther than that growth of population, number of buyers in the market, living standards, advertisements,age and sex composition in population, etc influence to market demand.Change in quantity demanded vs. change in demandIncome  Normal Good - A good the demand for which rises (falls) as income rises (falls).  Inferior Good - A good the demand for which falls (rises) as income rises (falls).  Neutral Good - A good the demand for which does not change as income rises or falls.Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 3. Substitutes  Substitute goods are two goods that satisfy similar needs or desires.  If two goods are substitutes, the demand for one rises as the price of the other rises (or the demand for one falls as the price of the other falls).Complements  Two goods that are used jointly in consumption.  If two goods are complements, the demand for one rises as the price of the other falls (or the demand for one falls as the price of the other rises).Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 4. An Increase in Demand A Decrease in DemandPrice of a substitute rises Price of a substitute fallsPrice of a complement falls Price of a complement risesExpected future price rises Expected future price fallsIncome rises (normal good) or income falls Income falls (normal good) or income rises(inferior good) (inferior good)Preferences move toward the good Preferences move away from the goodPopulation increases Population falls.Market demand is the horizontal summation of individual consumer demand curvesFull note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 5. SupplySupply refers to the willingness and ability of sellers to produce and offer to sell different quantities of agood at different prices during a specific time period.Law of supply - As the price of a good rises, the quantity supplied of the good rises, and as the price of agood falls, the quantity supplied of the good falls, ceteris paribus.  The law of supply is the result of the law of increasing cost.  As the quantity of a goods produced rises, the marginal opportunity cost rises.  Sellers will only produce and sell an additional unit of a good if the price rise above the marginal opportunity cost of producing the additional unit.Fixed SupplyDeterminants of supply  Price of relevant product [Change in the quantity supplied]  Prices of relevant resources  Technology  Number of sellers  Expectation of future prices  Taxes and subsidies  Government restrictionsThe only factor that can directly cause a change in the quantity supplied of a good is a change in theprice of the good or own price.Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 6. An Increase in Supply A Decrease in SupplyPrice of inputs fall Price of inputs riseMore efficient technology Expected future price rise (natural resources)Expected future price fall (i.e. natural resource Loss of technological knowledgeproduction) Firms decline in sizeFirms grow in size Number of firms in the industry shrinksNumber of firms in the industry growsMarket equilibriumEquilibrium in a market is the price quantity combination from which there is no tendency for buyers orsellers to move away. Graphically, equilibrium is the intersection point of the supply and demandcurves.Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 7. Consumer and Producer SurplusConsumer Surplus (the difference between the maximum price a buyer is willing and able to pay for agood or service and the price actually paid.) 𝐶𝑆 = 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑏𝑢𝑦𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 − 𝑃𝑟𝑖𝑐𝑒 𝑝𝑎𝑖𝑑Producer Surplus (the difference between the price sellers receive for a good and the minimum orlowest price for which they would have sold the good.) 𝑃𝑆 = 𝑃𝑟𝑖𝑐𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑 − 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 8. Equilibrium Price and Quantity Demand rises (Effects of Supply and Demand Curve Shifts)Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 9. Demand and Supply as EquationsWe can write Q-demanded and Q-Supplied as a equation of P (Price). And we can solve these to getsupply/demand for a specific prize and get the equilibrium price (as Qd =Qs at equilibrium)Price ControlsPrice Ceiling - A government-mandated maximum price above which legal trades cannot be made. Aprice at or below the ceiling is legal.  To protect the consumers.  Put to essential goods.Government has to establish some formal system to distribute the excess supply. Otherwise it will leadto black market.Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 10. Price Floor - A government-mandated minimum price below which legal trades cannot be made. A priceat or above the price floor is legal.Government has to buy the excess otherwise higher price prompts imports of goods and inefficiencies inallocation of resources.Elasticity When price rises, what happens to demand? Demand falls BUT! How much does demand fall? Elasticity measures the extent to which demand will changeFour basic types used:  Price elasticity of demand  Price elasticity of supply  Income elasticity of demand  Cross elasticityFull note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 11. Price Elasticity of Demand  Where % change in demand is greater than % change in price – elastic  Where % change in demand is less than % change in price - inelasticIncome and Cross Elasticity of DemandIncome Elasticity of Demand:  A positive sign denotes a normal good  A negative sign denotes an inferior goodFull note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html
  • 12. Cross Elasticity:The responsiveness of demand of one good to changes in the price of a related good – either asubstitute or a complement  Goods that are complements: Cross Elasticity will have negative sign (inverse relationship)  Goods that are substitutes: Cross Elasticity will have a positive sign (positive relationship)Importance of Elasticity  Relationship between changes in price and total revenue  Importance in determining what goods to tax (tax revenue)  Importance in analyzing time lags in production  Influences the behavior of a firmFull note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html