3 demand and supply


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3 demand and supply

  2. 2. Significance: The tools of demand and supply can be applied to arange of important topics such as: evaluating how global weather conditions will affectagricultural production and market prices of agriculturalcommodities; assessing the impact of government rent control on thehousing market; understanding how taxes, subsidies, and other governmentpolicies affect both consumers and producers. Demand and supply analysis deals with how prices ofproducts and resources are determined.2
  3. 3. The Concept of DEMAND: Demand - refers to the various quantities of a good orservice that consumers are willing and able topurchase at alternative prices, ceteris paribus (other thingsremaining equal). It conveys both the elements of desire for the commodityand capacity to pay (must be willing and able). It emphasizes the relationship between quantity bought andits price, although there may be other factors that determinehow much a consumer wants to purchase.3
  4. 4. The Law of Demand: Asserts that the quantity demanded of a good orservice is negatively or inversely related to itsown price – the First Law of Demand. When the price increases, less of the good or servicewill be bought When the price decreases, more of the commoditywill be purchased.WHY SO?4
  5. 5. Two Reasons for the InverseRelationship: Substitution effect When price of a good decreases, the consumersubstitutes the lower priced good for the moreexpensive ones. Income effect When price decreases, the consumer’s real income(or purchasing power) increases, so he tends to buymore of the good.P Q5
  6. 6. Presentation of the DemandRelationship:The relationship between quantity purchasedand alternative prices may be presented in 3ways: Demand schedule – in tabular form. Demand curve – in graphical form. Demand function – in equation form.6
  7. 7. Demand Schedule:Demand Schedule for ShoesPrice of a pair of shoes(in pounds) Quantity demanded/year0 850 7100 6150 5200 4250 3300 2350 1400 07
  8. 8. 8Demand Curve:QuantityPrice(inpounds)PQ0 2 4 6 8100200300400DFigure 1: Demand Curve. The negative slope of thedemand curve depicts the inverse relationship betweenprice and quantity demanded.
  9. 9. Demand Function: Quantity demanded (Q) is expressed as a mathematicalfunction of price (P). The demand function may thus bewritten as:Qd = a - bPwhere a is the horizontal intercept of the equation or the quantitydemanded when price is zero. (- b) is the slope of the function. Example: Qd = 8 - 0.02P9
  10. 10. Important Factors AffectingDemand:1. Price of the commodity.2. Consumer incomes.3. Prices of related commodities (substitutes andcomplements).4. Tastes and preferences.5. Consumer expectations.6. Number of consumers.10
  11. 11. (Cont.) Income:As income changes, demand for a commodityusually changes. Normal goods – are goods whose demand respondspositively to changes in income. Most goods are normal goods. As income increases, moreof shoes, TVs, clothes, are bought. Inferior goods – are goods whose demand respondsnegatively to changes in income. Few but existent. Examples: old cell phone models, usedcars, some food items.11
  12. 12. (Cont.) Prices of Related Commodities in Consumption: Substitutes – are goods that are substitutable with each other(not necessarily perfect). Examples are coffee and tea, Coke and Pepsi. When the price of a substitute increases (Py ), quantity bought of theother good (Qx) increases - (direct relationship) Complements – are goods that are used or consumedtogether. Examples are coffee and sugar, bread and butter, tennis rackets andtennis balls, computers and software packages. When the price of a complement increases, quantity bought of theother good decreases - (inverse relationship).12
  13. 13. (Cont.) Consumer Tastes and Preferences: When consumer tastes shift towards a particular good, greateramounts of a good are demanded at each price. Example: if consumers’ preference for drinking bottled waterincreases its demand curve will shift rightward. If consumer preferences change away from a good, itsdemand will decrease. At every possible price less of the goodis demanded than before. Example: the demand for cassette tapes decreased due to preferencefor DVDs.13
  14. 14. (Cont.) Consumer Expectations:Expectations about future prices and incomes affectcurrent demand for many goods and services. If we expect price of sugar to increase, we might stock up onthe good to avoid the expected price increase. Thus, currentdemand for sugar might increase. Those who expect to lose their jobs due to bad economicconditions, will reduce their demand for a variety of goods inthe current period.14
  15. 15. (Cont.) Number of Consumers:It affects the total demand for a good. Total demand is also known as market demand. It is thehorizontal summation of the individual demands of allconsumers. An increase in the number of consumers shifts themarket demand curve to the right. Example: demand for housing and transportation increaseswith an increase in population. On the other hand, less consumers will cause themarket demand to decrease, resulting in a shift to theleft of the entire demand curve.15
  16. 16. Change in Quantity Demanded vs.Change in Demand: Change in quantity demanded – is a movementalong the same demand curve, due solely to achange in price, i.e., all other factors heldconstant. Change in demand – is a shift in the entiredemand curve (either to the left or to the right)as a result of changes in other factors affectingdemand.16
  17. 17. Change in quantity demanded:PriceQuantityp1p2q1 q2D• A decrease in price from p1to p2 brings about anincrease in quantitydemanded from q1 to q2• It is shown as a movementalong the same demandcurve from A to B17AB
  18. 18. Change in demand:PriceQuantityp1q1• An increase in demandmeans that at the sameprice such as p1 more will bebought, due to other factorssuch as increasedincomes, increase in numberof consumers, etc.• It is shown as a shift in theentire demand curve.D0D1q2This is adecrease indemandD218
  19. 19. Change in Demand:PQDD’Increase in DemandPQDD’Decrease in Demand19
  20. 20. The Concept of SUPPLY: Supply refers to the various quantities of a good orservice that producers are willing to sell at alternativeprices, ceteris paribus. Obviously, firms are motivated to produce and sell more athigher prices. Supply emphasizes the relationship between quantity sold ofa commodity and its price. However, there are other factorsthat determine how much a producer would like to produceand sell.20
  21. 21. The Law of Supply: It states that the quantity sold of a good orservice is positively or directly related to its ownprice. When the price increases, more of the good orservice will be supplied. When the price decreases, less of the commodity willbe supplied.21
  22. 22. Presentation of the SupplyRelationship:The relationship between quantity suppliedand alternative prices may be presented in 3ways: Supply schedule –in tabular form. Supply curve – in graphical form Supply function – in equation form22
  23. 23. Supply Schedule:Supply Schedule of ShoesPrice of a pair of shoes(in pounds) Quantity supplied/year0 050 1100 2150 3200 4250 5300 6350 7400 823
  24. 24. Supply Curve:QuantityPrice(inpesos)PQ0 2 4 6 8100200300400SFigure 2: Supply Curve. The positive slope of the supplycurve depicts the direct relationship between price andquantity supplied.24
  25. 25. Supply Function: Quantity supplied (Qs) is expressed as a mathematicalfunction of price (P). The supply function may thus bewritten as:Qs = c + dPwhere c is the horizontal intercept of the equation or the quantitysupplied when price is zero d is the slope of the function. Example: Qs = 0 + 0.02P25
  26. 26. Factors Affecting Supply: There are other factors aside from price thataffect the supply schedule. Some of the mostimportant of these factors include:1. Resource prices.2. Prices of related goods in production.3. Technology.4. Expectations.5. Number of sellers.26
  27. 27. (Cont.) Resource Prices: When prices of inputs to production increase, thesupply of the firms product decreases. Decreases in resource prices, however, translateinto an increase in supply. The entire supply curveshifts to the right.27
  28. 28. (Cont.) Prices of Related Goods in Production: Resources can be employed to produce several alternativegoods and services. Examples from agriculture: a piece of farmland can be used to grow cotton, corn, orsugarcane. An increase in price of sugarcane may result indecreased supply of cotton and corn. farmers can use their land and labor to produce ornamentalflowers instead of vegetables. If vegetable prices decrease, thesupply of ornamental flowers may increase.28
  29. 29. (Cont.) Technology:A change in production techniques can lower or raiseproduction costs and affect supply. Improvements in technology shift the supply curve tothe right. A cost-saving invention will enable firms to produce andsell more goods than before at any given price. New high yielding crop varieties will increase productionon the same amount of land.29
  30. 30. (Cont.) Producer Expectations: When producers expect the price of their product toincrease in the future, they may hoard their output for latersale, thus reducing supply in the present period. Thus thesupply curve shifts to the left. If firms expect that the price of their product will fall in thenear future, supply may increase in the current period asfirms try to increase production as well as to dispose oftheir inventory.30
  31. 31. (Cont.) Number of Sellers:As the number of sellers increases, so will totalsupply. The market supply is the horizontal summation of thesupply schedules of individual producers. As more firms enter the market, more will be offered forsale at each possible price, thus shifting the supply curve tothe right. Similarly, the supply curve shifts to the left when firms exitthe market.31
  32. 32. Change in Quantity Supplied vs.Change in Supply: Change in quantity supplied – is a movementalong the same supply curve, due solely to achange in price, i.e., all other factors heldconstant. Change in supply – is a shift in the entire supplycurve (either to the left or to the right) as a resultof changes in other factors affecting supply.32
  33. 33. Change in Quantity Supplied:PriceQuantityp1p2q1 q2S• An increase in price from p1to p2 results in an increase inquantity supplied from q1 toq2• It is shown as a movementalong the same supply curvefrom A to B.33AB
  34. 34. Change in Supply:PriceQuantityp1q1• An increase in supplymeans that at the sameprice such as p1 more will besupplied, due to otherfactors such as improvementin technology, increase innumber of producers, etc.• It is shown as a shift in theentire supply curve.S0S1q2This is adecrease insupplyS234
  35. 35. (Cont.)PQSS’Increase in SupplyPQDD’Decrease in SupplySS’35
  36. 36. Market Equilibrium Market equilibrium is that state in which the quantitythat firms want to supply equals the quantity thatconsumers want to buy. The price that clears the market is called the equilibriumprice and the quantity (sold and bought) is called theequilibrium quantity. The market is said to be "at rest" since the equilibrium priceand equilibrium quantity will stay at those levels until eitherdemand or supply changes.36
  37. 37. (Cont.)Market for ShoesPrice of a Pair of Shoes(in pounds)Quantity Demanded perYearQuantity Suppliedper Year0 8 050 7 1100 6 2150 5 3200 4 4250 3 5300 2 6350 1 7400 0 8Equilibrium Quantity=4EquilibriumPrice=20037
  38. 38. (Cont.) At prices above the equilibrium price, quantity supplied isgreater than quantity demanded, resulting in a temporarysurplus. In a surplus situation, producers will try to reduce price toentice consumers to buy more shoes. Actions by bothproducers and the public will wipe out the temporary surplus. At prices below the equilibrium price, consumers desire tobuy more shoes than are available, creating a temporaryshortage. Consumers will try to outbid each other, thus pushing up theprice. As price rises, firms increase their production whilesome consumers reduce their purchases.38
  39. 39. (Cont.)QuantityPrice(inpounds)PQ0 2 4 6 8100200300400SShortageSurplus39
  40. 40. (Cont.) Algebraic solution: equate the demand and supplyequations (Qd=Qs).Qd = 8 - 0.02PQs = 0 + 0.02 P Step by step solution: 8 - 0.02P = 0 + 0.02 P 0.04P = 8 P* = 8/0.04 = 200 Qd = 8 – 0.02(200) = 8 – 4 = 4 P* =200 per unit, Q* = 4 per year40
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