Man eco-session 2

The Basics of Demand, Supply & Equilibrium
Prof Prema Basargekar
Session 2: Man Economics

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright © 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 2
Session outline
Demand side of the market
Determinants of demand
Supply side of market
Determinants of supply
Equilibrium quantity & price
Shift in demand & supply curves & equilibrium

An Individual Demand for a
Commodity
The Demand for a commodity arises from the
consumer’ willingness and ability to
purchase a commodity.
Demand for a comm. Is always related to time
as well as to price of that commodity.
The Law of Demand states that there is an
inverse relationship between the price of a
good and the quantity of the good demanded per
time period.

Law of Demand
A decrease in the price of a good, all other things held
constant, will cause an increase in the quantity demanded of
the good.
An increase in the price of a good, all other things held
constant, will cause a decrease in the quantity demanded of
the good.

Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
An increase in price
causes a decrease in
quantity demanded.

Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
A decrease in price
causes an increase in
quantity demanded.

Reasons behind Law of Demand
Substitution Effect: When Px falls, consumer
substitutes X for other commodity & its demand
increases.
Income Effect :When Px falls, consumer can
purchase more of the commodity with given
money income as his real income increases
Utility Maximisation Behaviour: Due to law
of Diminishing marginal utility, the consumer
would be willing to purchase more only if its
price also declines along with MU. This is
because he wants to arrive at the pt of
equilibrium where MUx=Px

Utility Functions
A Utility function is a descriptive statement that relates
satisfaction to the consumer after consumption of goods and
services.
Utility = f(Goods, Services)
• Marginal Utility can be defined as the change in the total
utility resulting from a one-unit change in the consumption
of a commodity per unit of time
• M U = Change in total utility
Change in qty consumed

Basic Assumptions of Marginal Utility Analysis
• Cardinal Measurement of Utility
• Utilities are Independent
• Constant Marginal Utility of Money
• Introspection

Law of Diminishing Marginal Utility
• The additional benefit which a person derives from a
given increase of his stock of a thing diminishes with
every increase in stock that he/she already has
-Marshall
The more we have of a thing the less we want to have
more of it

An Example
Units Total Utility Marginal
Utility
1 20 20
2 38 18
3 53 15
4 64 11
5 70 6
6 70 0
7 62 -8
8 46 -16

What do we observe from the Table?
• The extra satisfaction that the consumer gets by
consumption of each successive unit goes on decreasing
• The total utility goes on increasing until the consumption
of the 5th
unit but it increases at a diminishing rate
• The total utility of a quantity of a commodity is
maximum when the marginal utility is zero
Consumer equilibrium = MU = Price of the product

Diminishing Marginal Utility Curve
Utility
Units of Commodity MU
M1 M2M3
M4 M7 M8M6M5
Q
R S
T
W
H
A
B

Determinants of Market Demand
1. Price of the product: Inverse relationship
2. Price of the related goods:
Substitutes : Positive relationship with the price of
substitute
Complementary: negative relationship with the
price of complements.

Determinants of Market Demand cont..
3. Consumer Income: Income demand
relationship can be varied:
a. Essential consumer goods: Qd will increase
along with Y, but only up to certain level
b. Inferior goods: A commodity is deemed to be
inferior if its demand decreases with increase
in Y. – Engle curve
c. Normal goods: Demand will increase with
increase in Y.
d. Luxury & Prestige: Demand for such goods will
arise beyond certain level of Y.

Determinants of Market Demand cont..
4. Consumer Taste & Preference
5. Advertisements
6. Consumers expectations about future prices &
future income
7. Demonstration effect
8. Consumer credit facility
9. Population
10. Distribution of NY, age distribution, sex ratio,
etc.

Class activity
Identify determinants of demand for following products
1. Louis Vuitton bags vs. Office bags
2. Johnson’s Baby powder vs. Himalaya’s Baby powder
3. Adidas running shoes vs. Adidas sneakers
4. Jimmy Choos shoes vs. Shool shoes
5. Titan watch Vs. Rolex watch
6. Big Bang Theory serial Vs. Pavitra Rishtes serial
7. ‘Postpaid’ vs. ‘Prepaid’ services of mobile companies
8. Sugar vs. ‘Sugar free’ capsules

Increase in Demand
• Increase in Demand: When demand increases
without any change in its price due to some other
determinant of demand such as increase in
consumer income, price of substitute, change in
taste, fashion, etc., the original demand curve will
shift to the right.

Change in Demand
Quantity
Price
P0
Q0 Q1
An increase in demand
refers to a rightward shift
in the market demand
curve.

Decrease in Demand
• When demand of the product decreases without
any change in its price but due to changes in some
other determinants of demand such as decrease in
consumer income, decrease in price of the
substitute, increase in price of complementary,
change in fashion, etc. the demand curve shifts
inwards.

Change in Demand
Quantity
Price
P0
Q1 Q0
A decrease in demand
refers to a leftward shift
in the market demand
curve.

Class activity
Which of the following pair of goods are substitute or
complements?
A. Burger and tomato ketch-up
B. When increase in price of ‘A’ reduces the demand for ‘B’.
C. When reduction in price of ‘X’ reduces the demand for ‘Y’.
D. DVDs and TV screens
E. DVDs and movie tickets
Popeye’s income declines, and as a result he buys more spinach. Is
spinach an inferior or a normal good?

Law of Supply
A decrease in the price of a good, all other things held
constant, will cause a decrease in the quantity supplied of the
good.
An increase in the price of a good, all other things held
constant, will cause an increase in the quantity supplied of
the good.

Change in Quantity Supplied
Quantity
Price
P1
Q1
P0
Q0
A decrease in price
causes a decrease in
quantity supplied.

Change in Quantity Supplied
Quantity
Price
P0
Q0
P1
Q1
An increase in price
causes an increase in
quantity supplied.

Non Price Determinants of Supply
Nonprice determinants of supply
Costs and technology
Prices of other goods or services offered by the seller
Future expectations
Number of sellers
Weather conditions

Supply
Changes in price result in changes in the quantity supplied.
This is shown as movement along the supply curve.
Changes in non-price determinants result in changes in
supply.
This is shown as a shift in the supply curve.
Supply is said to increase (decrease) when at the
same price more (less) is offered for sale, or the
same quantity is offered at a lower (higher) price

Change in Supply
Quantity
Price
P0
Q1Q0
An increase in supply
refers to a rightward shift
in the market supply curve.

Change in Supply
Quantity
Price
P0
Q1 Q0
A decrease in supply refers
to a leftward shift in the
market supply curve.

Interaction of demand & Supply

Market Equilibrium
 Demand and Supply Balance
Equilibrium exists if perfect balance exists in the quantities demanded
and supplied.
Equilibrium reflects productive and allocative efficiency.
Surplus and Shortage
Surplus is excess supply.
A surplus occurs at a price above the equilibrium level.
Shortage is excess demand.
A shortage occurs at a price below the equilibrium level.

Market Equilibrium
Equilibrium price: The price that equates the quantity
demanded with the quantity supplied.
Equilibrium quantity: The amount that people are
willing to buy and sellers are willing to offer at the
equilibrium price level.

Market Equilibrium

Market Equilibrium
Quantity
Price
P0
Q0
D0 S0
Q1
P1
D1
An increase in demand
will cause the market
equilibrium price and
quantity to increase.

Market Equilibrium
Quantity
Price
P1
Q1
S0
Q0
P0
D0D1
A decrease in demand
will cause the market
quantity to decrease.

Market Equilibrium
Quantity
Price
P0
Q0
D0 S0
Q1
P1
An increase
in supply
will cause
the market
equilibrium
price to
decrease and
quantity to
increase.
S1

Market Equilibrium
Quantity
Price
P1
Q1
D0
Q0
P0
A decrease
in supply
will cause
the market
equilibrium
price to
increase and
quantity to
decrease.
S1 S0

Comparative Statics Analysis
The short run is the period of time in which:
Sellers already in the market respond to a change in equilibrium
price by adjusting variable inputs.
Buyers already in the market respond to changes in equilibrium
price by adjusting the quantity demanded for the good or
service.

The rationing function of price is the change in market
price to eliminate the imbalance between quantities supplied
and demanded.

• An increase in
demand causes
quantity to rise.

The long run is the period of time in which:
New sellers may enter a market
Existing sellers may exit from a market
Existing sellers may adjust fixed factors of production
Buyers may react to a change in equilibrium price by changing
their tastes and preferences or buying preferences

The guiding or allocating function of price is the
movement of resources into or out of markets in response to
a change in the equilibrium price.

• Initial change: decrease
in demand from D1 to
D2
• Result: reduction in
quantity, now P2,Q2
• Follow-on adjustment:
– movement of resources
out of the market
– leftward shift in the
supply curve to S2
– Equilibrium price and
quantity now P3,Q3

Equilibrium - Example
 QD= 75,000 - 10,000P(Demand) - plywood
 QS= -15,000 + 50,000P(Supply) - plywood
 where Q is quantity measured in thousands of board feet and
P is price in dollars.
 A. Complete the following table:
 Price QS QD Surplus or Shortage
$3.00
 2.50
 2.00
1.50
1.00

Answer
Price QS QD Surplus or shortage
$3.00 135,000 45,000 +90,000
2.50 110,000 50,000 +60,000
2.00 85,000 55,000 +30,000
1.50 60,000 60,000 0
1.00 35,000 65,000 -30,000
Or QD = QS
=75,000 – 10,000P = -15,000 + 50,000P
=90,000 = 60,000P
= P = 90,000/60,000 = 1.5
= Q= 75,000 – 10,000 (1.5) = 60,000

Class activity
Using supply and demand diagrams, show the effect of
the following events on the market for personal
computers:
A. The price of computer chips falls.
B. There is rise in consumer incomes.
C. The price of computer software rises.
D. Universities require incoming freshmen to have their
own personal computers.
E. Prices of computer accessories reduce.

Class activity
A market consists of three people: A,B & C.
A = Qd = 35 – 0.50P
B = Qd = 50 – 0.20P
C = Qd = 40 – 2.00P
The industry supply curve is Qs = 40 + 2.30P
Determine the equilibrium price and quantity
Determine the amount that will be purchased by each individual.

Class activity
Consider the market for eggs. For each event indicate the change
in demand and supply and equilibrium with the help of diagram.
A. The price of the grain that is fed to hens falls.
B. A new study is released that eating eggs is hazardous to one’s
health.
C. The number of poultries reduce.
D. During the month of ‘Shravan’ people eat less eggs.
E. Due to oil spill in Bombay port, demand for fish reduces
significantly.

Concepts learnt
Law of Demand
Law of Diminishing Marginal Utility
Law of supply
Determinants of demand & supply
Increase and decrease in demand
Increase and decrease in supply
Market equilibrium
Equilibrium Price & Equilibrium Quantity
‘Rationing’ and ‘allocating’ functions of prices

Man eco-session 2

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