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Ch03 ppt

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Ch03 ppt

  1. 1. PART 2 THE PRICE MECHANISM Chapter 3 Demand, supply and equilibrium Supply Demand
  2. 2. Lecture Plan <ul><li>Demand curve </li></ul><ul><li>The law of demand </li></ul><ul><li>The law of supply </li></ul><ul><li>Supply curve </li></ul><ul><li>Equilibrium </li></ul><ul><li>Disequilibrium </li></ul><ul><li>Conditions of demand </li></ul><ul><li>Conditions of supply </li></ul>
  3. 3. Demand <ul><li>A market consists of: </li></ul><ul><ul><li>Buyers (demand) </li></ul></ul><ul><ul><li>Sellers (supply) </li></ul></ul><ul><ul><li>Exchange </li></ul></ul><ul><li>Effective demand = the quantity of a commodity which consumers will purchase at a given price per time period </li></ul>
  4. 4. The Demand Schedule <ul><li>A table showing the quantity demanded of a product at various prices </li></ul><ul><li>Example: Demand schedule for Big Macs </li></ul><ul><li> Price Qty demanded </li></ul><ul><li>$1 500 </li></ul><ul><li>$2 400 </li></ul><ul><li> $3 300 </li></ul><ul><li> $4 200 </li></ul><ul><li> $5 100 </li></ul>
  5. 5. The Demand Curve <ul><li>Graphical representation of demand schedule </li></ul>Example: Demand curve for Big Macs Quantity Price $ 5 2 1 3 4 100 200 300 400 500
  6. 6. The Law of Demand <ul><li>As price increases the quantity demanded decreases </li></ul><ul><li>Conversely: </li></ul><ul><li>As price decreases the quantity demanded increases </li></ul>(cont.)
  7. 7. The Law of Demand (cont.) <ul><li>Reflects an inverse relationship, i.e. </li></ul><ul><li>as price , quantity demanded </li></ul><ul><li>as price , quantity demanded </li></ul><ul><li>The law of demand is caused by: </li></ul><ul><ul><li>The income effect </li></ul></ul><ul><ul><li>The substitution effect </li></ul></ul>
  8. 8. The Income Effect <ul><li>As prices increase, consumers will purchase fewer goods and services. Their purchasing power (or real income) decreases </li></ul><ul><li>Quantity demanded decreases </li></ul><ul><li>As prices decrease, the purchasing power of consumers increases </li></ul><ul><li>Quantity demanded increases </li></ul>
  9. 9. The Substitution Effect <ul><li>As prices increase, consumers generally purchase more of a substitute product whose price is lower </li></ul><ul><li>A substitute product is a product that performs a similar function and satisfies the same consumer need/want e.g.: </li></ul><ul><ul><li>Tea/coffee </li></ul></ul><ul><ul><li>Butter/margarine </li></ul></ul><ul><li>If the price of butter increases , the quantity demanded will fall as consumers will substitute butter with margarine </li></ul>
  10. 10. Supply <ul><li>Definition: the quantity of a product which producers offer to the market at a certain price per unit of time </li></ul>
  11. 11. The Law of Supply <ul><li>As price increases the quantity supplied increases conversely </li></ul><ul><li>as price decreases the quantity supplied decreases </li></ul><ul><li>The law of supply is a direct relationship between price and quantity supplied </li></ul><ul><li>As price , quantity supplied </li></ul><ul><li>As price , quantity supplied </li></ul><ul><li>The logic of the law of supply: </li></ul><ul><ul><li>Producers will seek to maximise their profits i.e.: supplying more at higher prices and less at lower prices </li></ul></ul>
  12. 12. The Supply Schedule <ul><li>A table showing the quantity supplied at various prices </li></ul><ul><li>Example: Supply schedule for Big Macs </li></ul><ul><li> Price Qty supplied </li></ul><ul><li>$1 200 </li></ul><ul><li>$2 300 </li></ul><ul><li>$3 400 </li></ul><ul><li>$4 500 </li></ul><ul><li>$5 600 </li></ul>
  13. 13. The Supply Curve <ul><li>A graphic representation of the supply schedule </li></ul><ul><li>Example: Supply curve for Big Macs </li></ul>Price Quantity $ Supply curve 1 2 3 4 5 200 300 400 500 600
  14. 14. Market Equilibrium <ul><li>Supply and demand can now be brought together to form the price mechanism </li></ul>P Q S D Equilibrium point ( P e ) P e Q e (cont.)
  15. 15. Market Equilibrium (cont.) <ul><li>Market equilibrium ( E ) is where: </li></ul><ul><li>Quantity demanded = quantity supplied (intersection of demand and supply curves) </li></ul><ul><li>The market is cleared (no shortages or surpluses) </li></ul><ul><li>Price ( P e ) is stable </li></ul>
  16. 16. Market Disequilibrium <ul><li>= where quantity demanded is NOT EQUAL to </li></ul><ul><li>quantity supplied </li></ul><ul><li>Types: </li></ul><ul><li>1. Market shortage: where </li></ul><ul><li>quantity demanded > quantity supplied </li></ul><ul><li>2. Market surplus (oversupply): where </li></ul><ul><li>quantity supplied > quantity demanded </li></ul>
  17. 17. Market Shortage <ul><li>Caused by setting price BELOW the equilibrium </li></ul>P Q S D P e Q s Q d Shortage
  18. 18. Market Surplus <ul><li>Caused by setting price ABOVE the equilibrium </li></ul>P Q S D Q d Q s Surplus
  19. 19. Changes in Demand <ul><li>Certain factors (other than price changes) affect the absolute level of demand </li></ul><ul><li>These factors are called conditions of demand </li></ul><ul><li>Changes to the conditions of demand cause changes in demand and this results in shifts of the demand curve </li></ul>
  20. 20. An Increase in Demand <ul><li>The entire demand curve shifts to the right </li></ul>Q P D D 1 S E E 1 P e P e 1 EQ EQ 1
  21. 21. A Decrease in Demand <ul><li>The entire demand curve shifts to the left </li></ul><ul><li>Caused by a factor other than price </li></ul>Q S D D 1 E E 1 Q e 1 Q e P P e P e 1
  22. 22. Conditions of Demand <ul><li>Change in tastes </li></ul><ul><li>Improvements in technology </li></ul><ul><li>Real income </li></ul><ul><li>Change in population </li></ul><ul><li>Change in the price of substitutes </li></ul><ul><li>Change in the price of other goods </li></ul><ul><li>Expectations of the future </li></ul><ul><li>Advertising </li></ul>
  23. 23. Changes in Supply <ul><li>Certain factors (other than price changes) affect the absolute level of supply </li></ul><ul><li>These factors are called conditions of supply and they result in shifts of the supply curve (not movements along it) </li></ul>
  24. 24. An Increase in Supply <ul><li>Supply curve shifts to the right </li></ul>P Q S D S 1 E E 1 P e P e 1 Q e Q e 1
  25. 25. A Decrease in Supply <ul><li>Supply curve shifts to the left </li></ul>P Q S D S 1 E E 1 P e 1 P e Q e 1 Q e
  26. 26. Conditions of Supply <ul><li>Improvements in technology </li></ul><ul><li>A change in production costs </li></ul><ul><li>A change in the price of alternative products </li></ul><ul><li>Weather and seasons </li></ul>

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