Chapter 3

Demand and Supply Analysis
Demand







Need to satisfy human wants
Willingness to buy a particular commodity
backed by purchasing power.
Amount...
Basics





Want: having a strong desire for something
Need: lack of means of subsistence
Desire: an aspiration to acq...
Determinants of Demand


Price of the product
 Negative effect on demand



Income of the consumer
 Normal goods: dema...
More…


Price of related goods
 Substitutes






Goods that can be used as replacement of one another
and satisfy a ...
Demand Function








Functional form
Interdependence between individual demand and
its determinants
Dx = f(Px, T,...
Demand Schedule and Individual Demand
Curve
Demand Schedule

a
b
c
d
e
f

Price [Rs per unit]

Quantity demanded of X
[kg....
Market Demand and Market Demand Curve




Market: interaction between sellers and buyers of a
good (or service) at a mut...
Price of X

Individual and Market Demand Curves
3.00
2.00
1.00

2

4

6

8

Quantity of X

Consumer I

Price of X

3.00
2....
Market Demand Schedule
Reference Letter

Price [Rs per kg]

Quantity demanded
[kg per month]

U

0.50

110.0

V

1.00

90....
Market Demand Curve
3.50

Price of X [Rs per kg]

D
Z

3.00

Y

2.50

X

2.00

W
1.50
V

1.00

U
0.50

20

40

60

80

100...
Law of Demand




Other things remaining constant, when the price of
a commodity rises, the demand for that commodity
fa...
Exceptions to the Law of Demand









Giffen Goods
Snob appeal
Demonstration effect
Consumer Bias
Fashion
Futur...
Change in Quantity Demanded

Price

D0

P0
P1

0

Q0

Q1

Quantity
Change in Demand
D1

Price

D2

D0

0

Quantity
•

Shift in demand curve from D0 to D1
•

•

Increase in demand caused by:
•
•
•
•
•

•

more is demanded at each price.

...
Market Supply Schedule
Reference Letter

Price [Rs per kg]

Quantity demanded
[kg per month]

u

0.50

5.0

v

1.00

46.0
...
Supply Curve For X

3.50

S
Z

Price of X [Rs per kg]

3.00
Y

2.50
X

2.00
W
1.50
V
1.00
U
0.50

20

40

60

80

100

120...
Changes in Quantity Supplied

Price

S0

Quantity
Shifts in the Supply Curve
S2

S0

Price

S1

Quantity
•

Shift in the supply curve from S0 to S1
•

•

Increase in supply caused by:
•
•

•

Improvements in the technology of p...
Demand and Supply Schedules for X and Equilibrium Price
Price
[Rs per kg]

Quantity
demanded
[kg
per month]

Quantity supp...
•

•
•

•

•

Equilibrium occurs where the quantity demanded and
the quantity supplied are equal.
In the table the equilib...
Determination of Equilibrium Price of X
3.50
D
Z

Price of X [Rs per kg]

3.00

Y

2.50

X

2.00
1.50

W
V

1.00
U
0.50

2...
Determination of the Equilibrium Price of X
3.50

S

Price of X [Rs per kg]

D
Z

3.00

Z
Y

Y

2.50

X

2.00
1.50

W

X

...
Equilibrium Price of X

•

•

•

Equilibrium price is where the demand and supply curves
intersect, point E in the figure....
S0

Changes in Demand and Supply

S1

Price

D

E0
p0
D1

S

p1

Price

D0

E1

q0

E1
p1

q1

Quantity

[ii]. The effects...
Shifts in Demand
•

The original curves are D0 and S, which intersect to produce
equilibrium at E0.

•

Price is p0, and q...
Shifts in Supply
•

The original demand and supply curves are D and S0,
which intersect to produce an equilibrium at E0, p...
Changes in Both Demand and Supply
S0
D1

S1

Price

D0

p0

E0

E1

p1

q0

q1

Quantity
Let Us Have a RECAP!!
Demand
 An individual consumer’s demand curve shows the relation
between the price of a product and the quantity of that ...


A movement along a demand curve indicates a change in
quantity demanded in response to a change in the product’s
own pr...
Determination of Price
 At the equilibrium price the quantity demanded equals the
quantity supplied.
 Graphically, equil...
Demand and supply
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Demand and supply

  1. 1. Chapter 3 Demand and Supply Analysis
  2. 2. Demand     Need to satisfy human wants Willingness to buy a particular commodity backed by purchasing power. Amount of the commodity which will consumers are willing to buy per unit of time, at that price, factors other than price remaining constant. 3 things necessary for demand:    Time Price of the commodity Amount (or quantity) of the commodity consumers are willing to purchase
  3. 3. Basics     Want: having a strong desire for something Need: lack of means of subsistence Desire: an aspiration to acquire something Demand: effective desire, as it is backed by willingness to pay and ability to pay
  4. 4. Determinants of Demand  Price of the product  Negative effect on demand  Income of the consumer  Normal goods: demand increases with increase in consumer’s income  Inferior goods: demand falls as income rises Tastes and preferences Expectation of future price changes Population     Advertising
  5. 5. More…  Price of related goods  Substitutes    Goods that can be used as replacement of one another and satisfy a similar need If the price of a commodity increases, quantity demanded of its substitute rises. Complements   Goods that are consumed together. If the price of a commodity increases, quantity demanded of its complement falls.
  6. 6. Demand Function       Functional form Interdependence between individual demand and its determinants Dx = f(Px, T, Py, Y, Pe, N, A) Px, T, Py, Y, Pe: independent variables, Dx: dependent variable If all the variables except the own price of the commodity remain unchanged (ceteris paribus), demand function: Dx = f(Px) Ceteris paribus is a Latin phrase, literally translated in English as “with other things (being) the same” or “all other things being equal”.
  7. 7. Demand Schedule and Individual Demand Curve Demand Schedule a b c d e f Price [Rs per unit] Quantity demanded of X [kg. per month] 0.50 1.00 1.50 2.00 2.50 3.00 7.0 5.0 3.5 2.5 1.5 1.0 3.00 f e 2.50 d Price of X Point Demand Curve 2.00 c 1.50 b 1.00 a 0.50 1 2 3 4 5 6 7 Quantity of X
  8. 8. Market Demand and Market Demand Curve   Market: interaction between sellers and buyers of a good (or service) at a mutually agreed upon price. Market demand    Aggregate of individual demands for a commodity at a particular price per unit of time. Sum total of the quantities of a commodity that all buyers in the market are willing to buy at a given price and at a particular point of time (ceteris paribus) Market demand curve: horizontal summation of individual demand curves
  9. 9. Price of X Individual and Market Demand Curves 3.00 2.00 1.00 2 4 6 8 Quantity of X Consumer I Price of X 3.00 2.00 Price of X 1.00 3.00 2 2.00 4 6 8 10 12 14 Quantity of X 1.00 Total Demand: Consumer I+II 2 Consumer II 4 6 8 Quantity of X
  10. 10. Market Demand Schedule Reference Letter Price [Rs per kg] Quantity demanded [kg per month] U 0.50 110.0 V 1.00 90.0 W 1.50 77.5 X 2.00 67.5 Y 2.50 62.5 Z 3.00 60.0
  11. 11. Market Demand Curve 3.50 Price of X [Rs per kg] D Z 3.00 Y 2.50 X 2.00 W 1.50 V 1.00 U 0.50 20 40 60 80 100 120 140 Quantity of X
  12. 12. Law of Demand   Other things remaining constant, when the price of a commodity rises, the demand for that commodity falls or when the price of a commodity falls, the demand for that commodity rises. Reasons:    Substitution Effect Income Effect Law of Diminishing Marginal Utility
  13. 13. Exceptions to the Law of Demand         Giffen Goods Snob appeal Demonstration effect Consumer Bias Fashion Future expectation of prices Insignificant portion of income spent Goods without any substitutes
  14. 14. Change in Quantity Demanded Price D0 P0 P1 0 Q0 Q1 Quantity
  15. 15. Change in Demand D1 Price D2 D0 0 Quantity
  16. 16. • Shift in demand curve from D0 to D1 • • Increase in demand caused by: • • • • • • more is demanded at each price. A rise in the price of a substitute A fall in the price of a complement A rise in income A redistribution of income towards those who favour the commodity A change in tastes that favours the commodity Shift in demand curve from from D0 to D2 • less is demanded at each price.
  17. 17. Market Supply Schedule Reference Letter Price [Rs per kg] Quantity demanded [kg per month] u 0.50 5.0 v 1.00 46.0 w 1.50 77.5 x 2.00 100.0 y 2.50 115.0 z 3.00 122.5
  18. 18. Supply Curve For X 3.50 S Z Price of X [Rs per kg] 3.00 Y 2.50 X 2.00 W 1.50 V 1.00 U 0.50 20 40 60 80 100 120 140 Quantity of X
  19. 19. Changes in Quantity Supplied Price S0 Quantity
  20. 20. Shifts in the Supply Curve S2 S0 Price S1 Quantity
  21. 21. • Shift in the supply curve from S0 to S1 • • Increase in supply caused by: • • • Improvements in the technology of producing the commodity A fall in the price of inputs that are important in producing the commodity Shift in the supply curve from S0 to S2 • • more is supplied at each price. less is supplied at each price. Decrease in supply caused by: • • A rise in the price of inputs that are important in producing the commodity Changes in technology that increase the costs of producing the commodity (rare)
  22. 22. Demand and Supply Schedules for X and Equilibrium Price Price [Rs per kg] Quantity demanded [kg per month] Quantity supplied [kg per month] Excess Demand [quantity demanded minus quantity supplied] [kg per month] 0.50 110.0 5.0 105.0 1.00 90.0 46.0 44.0 1.50 77.5 77.5 0.0 2.00 67.5 100.0 -32.5 2.50 62.5 115.0 -52.5 3.00 60.0 122.5 -62.5
  23. 23. • • • • • Equilibrium occurs where the quantity demanded and the quantity supplied are equal. In the table the equilibrium price is Rs.1.50 The equilibrium quantity bought and sold is 77.5 kg per month. For prices below the equilibrium, such as Re. 0.50, quantity demanded (110) exceeds quantity supplied (5) For prices above the equilibrium, such as Rs 3.00, quantity demanded (60) is less than quantity supplied (122.5)
  24. 24. Determination of Equilibrium Price of X 3.50 D Z Price of X [Rs per kg] 3.00 Y 2.50 X 2.00 1.50 W V 1.00 U 0.50 20 40 60 80 100 120 Quantity of X 140
  25. 25. Determination of the Equilibrium Price of X 3.50 S Price of X [Rs per kg] D Z 3.00 Z Y Y 2.50 X 2.00 1.50 W X W V E V 1.00 U U 0.50 20 40 60 80 100 120 Quantity of X 140
  26. 26. Equilibrium Price of X • • • Equilibrium price is where the demand and supply curves intersect, point E in the figure. At all prices above equilibrium there is excess supply and downward pressure on price. At all prices below equilibrium there is excess demand and upward pressure on price
  27. 27. S0 Changes in Demand and Supply S1 Price D E0 p0 D1 S p1 Price D0 E1 q0 E1 p1 q1 Quantity [ii]. The effects of shifts in the supply curve p0 E0 q0 q1 Quantity [i]. The effects of shifts in the demand curve
  28. 28. Shifts in Demand • The original curves are D0 and S, which intersect to produce equilibrium at E0. • Price is p0, and quantity q0. • An increase in demand shifts the demand curve to D1 . • Price rises to p1 and quantity rises to q1 taking the new equilibrium to E1 . • A decrease in demand now shifts the demand curve to D0. • Price falls to p0 and quantity falls to q0 taking the new equilibrium to E0. • Thus, an increase in demand raises both price and quantity while a decrease in demand lowers both price and quantity
  29. 29. Shifts in Supply • The original demand and supply curves are D and S0, which intersect to produce an equilibrium at E0, price p0 and quantity q0. • An increase in supply shifts the supply curve to S1. Price falls to p1 and quantity rises to q1, taking the new equilibrium to E1 . • A decrease in supply shifts the supply curve back to S0. Price rises to p0 and quantity falls to q0 taking the new equilibrium to E0. • Thus an increase in supply raises quantity but lowers prices while a decrease in supply lowers quantity but raises price.
  30. 30. Changes in Both Demand and Supply S0 D1 S1 Price D0 p0 E0 E1 p1 q0 q1 Quantity
  31. 31. Let Us Have a RECAP!!
  32. 32. Demand  An individual consumer’s demand curve shows the relation between the price of a product and the quantity of that product the customer wishes to purchase per period of time.  It is drawn on the assumption that all other prices, income, and tastes remain constant.  Its negative slope indicates that the lower the price of the product, the more the consumer wishes to purchase.  The market demand curve is the horizontal sum of all the individual consumers.  The demand curve for a normal good shifts to the right when the price of a substitute rises, when the price of a complement falls, when total income rises, when the distribution of income changes in favour of those with large demands for the product, and when tastes change in favour of the product.  It shifts to the left with the opposite changes.
  33. 33.  A movement along a demand curve indicates a change in quantity demanded in response to a change in the product’s own price; a shift in a demand curve indicates a change in the quantity demanded at each price in response to a change in one of the conditions held constant along a demand curve. Supply  The supply curve for a product shows the relationship between its price and the quantity that producers wish to produce and offer for sale per period of time.  It is drawn on the assumption that all other forces that influence quantity supplied remain constant, and its positive slope indicates that the higher price, the more producers wish to sell.
  34. 34. Determination of Price  At the equilibrium price the quantity demanded equals the quantity supplied.  Graphically, equilibrium occurs where the demand and supply curves intersect.  At any price below equilibrium there will be excess demand and price will tend to rise; at any price above equilibrium there will be excess supply and price will tend to fall.  A rise in demand raises both equilibrium price and quantity; a fall in demand lowers both.  A rise in supply raises equilibrium quantity but lowers equilibrium price; a fall in supply lowers equilibrium quantity but raises equilibrium price.  These are those so-called ‘laws’ of supply and demand.
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