Outline• Market• Market Demand• Market Supply• Market Equilibrium• Price Adjustment Process• Shifts in Market Demand (increase, decrease)• Shifts in Market Supply (increase, decrease)• Interaction of Market Forces
Markets• In a market economy, the price of a good is determined through the interaction between demand and supply side forces• Market is some institutional framework in which price of a product as well as the quantity which is going to be transacted are determined through the interaction between demand and supply , coming up from the buyers and the sellers of the product
Markets• Constituents of a market-productconsumers/buyers-creating the demand side force in the marketsuppliers/sellers/manufacturers-generating the supply side force in the market
Demand• The desire to purchase a product (either a commodity or service) at a given market price to satisfy a need/want, backed up by purchasing capacity as well as the willingness to spend for that specific purpose
Demand• Constituents of demand-desirefinancial capabilitywillingness to spend for that purpose
Law of Demand• an inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus• the higher the price the lower the quantity demanded & vice versa• Reasons: – substitution effect – income effect
Demand Schedule-a tabular presentation of Law of Demand
Demand Curve- a graphical presentation of Law of Demand
Determinants of Demand• price of the product• tastes and preferences• prices of related goods and services (complements & substitutes)• income• wealth• number of consumers/population• expectations of future prices and income• currency depreciation/appreciation• special influences
Change in Quantity Demanded vs. Change in Demand (Shift)Change in quantity demanded Change in demand
Prices of Related Goods• substitute goods – an increase in the price of one results in an increase in the demand for the other.• complementary goods – an increase in the price of one results in a decrease in the demand for the other.
Change in the price of a substitute good • Price of coffee rises:
Change in the price of a complementary good • Price of DVDs rises:
Income and Demand: normal goods• A good is a normal good if an increase in income results in an increase in the demand for the good
Income and Demand: inferior goods• A good is an inferior good if an increase in income results in a reduction in the demand for the good
Market Demand Curve• Market demand is the horizontal summation of individual consumer demand curves
Supply• The desire to supply/sell a product (either a commodity or service) at a given market price• The is something different than Stock• Constituents of supply-Desire to sellstock at disposalwillingness to sell at ongoing market price
Law of Supply• A positive relationship exists between the price of a good and the quantity supplied in a given time period, ceteris paribus. Reasons for Law of Supply• The law of supply is the result of the law of increasing cost.• As the quantity of a good produced rises, the marginal opportunity cost rises.
Reasons for Law of Supply• Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.• To produce more, the producers require hiring more factors of production at higher prices (usually), which raises cost of production if the factor supply is fixed• So, the suppliers will only supply at higher prices (usually)
The Law of Supply• The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa.• Reasons –they seek higher profits –they must cover higher marginal costs of production
Supply CurveThe supply curve has a positive slope, consistentwith the law of supply.
Determinants of Supply• price of the product• price of resources• technology and productivity• expectations of producers• number of producers/suppliers• prices of related goods and services (complements, substitutes)• goverment policy (tax, subsidy)• special influences
Change/Shift in Supply vs. Change in Quantity SuppliedChange in supply Change in quantity supplied
Price of Resources• As the price of a resource rises, profitability declines, leading to a reduction in the quantity supplied at any price.
Technological Improvements• Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.
Expectations and Supply• An increase in the expected future price of a good or service results in a reduction in current supply. Prices of Other Goods• Firms produce and sell more than one commodity.• Firms respond to the relative profitability of the different items that they sell
Prices of Other Goods• The supply decision for a particular good is affected not only by the good’s own price but also by the prices of other goods and services the firm may produce
International Effects• firms import raw materials (and often the final product) from foreign countries, the cost of these imports varies with the exchange rate.• appreciation/depreciation of currency affects the supply
Market Supply Curve• Market supply is the horizontal summation of individual producer supply curves
Equilibrium• In economics, an equilibrium is a situation in which: –there is no inherent tendency to change, –quantity demanded equals quantity supplied, and –the market just clears
Equilibrium, Surplus & DeficitsEquilibrium occurs at a price of $3 and a quantityof 30 units
Shortages and Surpluses• a shortage occurs when quantity demanded exceeds quantity supplied –a shortage implies the market price is too low• a surplus occurs when quantity supplied exceeds quantity demanded –a surplus implies the market price is too high
Price Ceilings & Floors• a price ceiling is a legal maximum that can be charged for a good – results in a shortage of a product – common examples include sugarcane price, apartment rentals in public sector• a price floor is a legal minimum that can be charged for a good – results in a surplus of a product – common examples include soybeans, milk, minimum wage
Price Ceilinga price ceiling is set at tk. 2 resulting in a shortageof 20 units
Price Floora price floor is set at tk. 4 resulting in a surplus of20 units
Shift in the Demand Curve• A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand• Factors that shift the demand curve include: – Change in consumer incomes – Population change – Consumer preferences – Prices of related goods: • Substitutes: goods consumed in place of one another • Complements: goods consumed jointly
Shift in the Demand CurveThis demand curve has shifted to the right.Quantity demanded is now higher at any givenprice.
Equilibrium After a Demand ShiftThe shift in the demand curve moves themarket equilibrium from point A to point B,resulting in a higher price and higher quantity.
Shift in the Supply CurveFor an given rental price, quantity suppliedis now lower than before.
Equilibrium After a Supply ShiftThe shift in the supply curve moves the marketequilibrium from point A to point B, resulting ina higher price and lower quantity.
Elasticity• The percentage (%) change in dependent variable (demand, supply) due to one percent (1%) change in independent variable (price, income).
Price Elasticity of Demand DemandP The percentage change in the quantity demanded A given. . . . . . a one percent change B in the price. Q
Ranges of Elasticity• Perfectly Inelastic Consumers are “completely unresponsive” to price changes.• Perfectly Elastic Consumers are “extremely responsive” to price changes.• Unit Elastic Response is “equal to” change in price.
Elasticity of Demand Perfectly InelasticP2 Even if price increases a lotP1 quantity demanded stays the same.
Elasticity of Demand A small increase in price will cause demand to drop offP1 completely. Perfectly Elastic
Computing Elasticity Coefficient Percentage Change in Price Elasticity Quantity Demanded = of Demand Percentage Change in Price• Computed as the percentage change in the quantity demanded divided by the percentage change in price.
Computing Elasticity Coefficient Demand for Ice Cream E D =2.20 (8 - 10) / 102.00 ($2.20 - $2.00) / $2.00 8 10
Elasticity and Total Revenue E > 1 then D P Q and TR
Elasticity and Total Revenue E < 1 then D P Q and TR
Income Elasticity of Demand• The percentage change in the quantity demanded given a one percent change in income.
Computing Income Elasticity Percentage Change inIncome Elasticity Demand = of Demand Percentage Change in Income• Computed as the percentage change in demand divided by the percentage change in Income.
Income Elasticity... Types YD > 0 Normal Goods YD < 0 Inferior GoodsYD = 0 Income-neutral Goods
Cross-Price Elasticity of Demand• Cross-price elasticity of demand measures percentage change in quantity demanded of one good caused by a 1% change in price of another good• While all other influences on demand remain unchanged• While the sign of the cross-price elasticity helps us distinguish substitutes (positive) and complements (negative) among related goods 57
Cross-Price Elasticity of Demand Its size tells us how closely the two goods are related A large absolute value for EXZ suggests that the two goods are close substitutes or complements While a small value suggests a weaker relationship 58
Price Elasticity of Supply Price• The percentage change in quantity supplied B resulting from a one (1) percent change in price. A Quantity
Determinants of Elasticity of Supply• Flexibility or ability of sellers to change the amount of the good they produce. – land vs manufactured goods – more elastic in the long run
Computing Elasticity Coefficient Percentage Change in Elasticity Quantity Supplied = of Supply Percentage Change in Price• Computed as the percentage change in the quantity supplied divided by the percentage change in price.