Demand and Supply The Demand Curve The Supply Curve Market Equilibrium Surplus Effects of Government Intervention—Price Controls Elasticity and revenue

1. The basics of demand and
supply

2. Topic to cover
• Demand and Supply
• The Demand Curve
• The Supply Curve
• Market Equilibrium
• Surplus
• Effects of Government Intervention—Price Controls
• Elasticity and revenue

3. Demand and Supply
• Understanding and predicting how changing world economic conditions
affect market price and production
• Evaluating the impact of government price controls, minimum wages, price
supports, and production incentives
• Determining how taxes, subsidies, tariffs, and import quotas affect
consumers and producers

4. The Demand curve
• Relationship between the quantity of a good that consumers are willing to
buy and the price of the good.
• The demand curve is thus a relationship between the quantity demanded
and the price.
• We can write this relationship as an equation:
QD = QD(P)

5. The Linear Demand curve
Price ($)
Demand
$40
0
$30
$20
20 40
$10
60 80

6. Other variables that affect Demand
The quantity that buyers are willing to buy depends not only on the price but
also on the following:
⮚Income
⮚Price of the related goods
Substitutes Two goods for which an increase in the price of one leads
to an increase in the demand of the other.
Complements Two goods for which an increase in the price of one leads
to a decrease in the demand of the other.
⮚Taste and preferences
Change in demand refers to shifts in the demand curve
Change in the quantity demanded refers to movements along the demand
curve

7. Shifting of Demand curve
Quantity of
clothing
0
$50
$40
50,000
Price of
clothing
D2
60,000
D1

8. Linear demand function
•

9. Signs of coefficients of linear demand
function
•

10. Linear demand function
•

11. Linear demand function
•

12. Inverse demand function
•

13. Graph of inverse demand function
Quantity
Price
$2,020
0 6,060

14. The Supply curve
• Relationship between the quantity of a good that producers are willing to
sell and the price of the good.
• The supply curve is thus a relationship between the quantity supplied and
the price.
• We can write this relationship as an equation:
QS = QS(P)

15. The Linear Supply curve
Quantity
Price
0
A
B
S0
P2
P1
Q1 Q2

16. Other variables that affect Supply
The quantity that producers are willing to sell depends not only on the price
they receive but also on their production costs, including wages, interest
charges, and the costs of raw materials.
Change in supply refers to shifts in the supply curve
Change in the quantity supplied refers to movements along the supply curve

17. Shifting of Supply curve
Quantity
Price
S2
Decrease
in supply
S0
S1
Increase
in supply

18. Linear supply function
•

19. Signs of coefficients of linear supply function
•

20. Linear supply function
•

21. Linear supply function
•

22. Inverse supply function
•

23. Market equilibrium
• Competitive market equilibrium
• Price of a good is determined by the interactions of the market demand and
market supply for the good.
• A price and quantity such that there is no shortage or surplus in the market.
• Forces that drive market demand and market supply are balanced, and there
is no pressure on prices or quantities to change.

24. Market equilibrium
Quantity
Price Supply
0
Demand
Surplus
Shortage

25. Market equilibrium
•

26. Market equilibrium
•

27. Stable and unstable equilibrium
• Follow the diagram below where A, B, and C are three equilibriums. Find the
stable and unstable equilibriums
S
A
B
C
D
S
D
O
Px
Qx

28. Simultaneous Shifts in Supply and Demand
• Suppose that simultaneously the following two events occur:
• worldwide demand for automobiles is projected to decrease by 30% next
year.
• war breaks out in a major oil-producing country in the Middle East.
• What is the combined impact on the international crude oil market?

29. Simultaneous Shifts in Supply and Demand
Price
(Dollars per Barrel)
Supplyoil1
$140
Pe2 = $65
Qe2 = 10 Qe1 = 120
$20
280
International Oil Market
Demandoil1
Pe1 = $80
Supplyoil2
Demandoil2
The equilibrium price increases
or decreases depending on the
magnitude of the demand
and supply changes.

30. Understanding Commodity
Supply Markets

31. • During food crisis – from early 2006 till mid of 2008 – the price of corn and soybean, soared
up along with the rise in oil price at a historical high of $ 130 per barrel.
• The concurrent swings in crude oil and agricultural commodity prices were also witnessed in
early 2009 when crude price dropped to as low as $ 30 per barrel.
• Price of agricultural commodities also spiked up till oil prices experienced a steady rise to
$110 per barrel by April 2011.
Crude oil and agricultural commodities prices co-movement

32. Reasons behind co-movement
• Traditional - Increases in energy prices raise the cost of fertilizer, pesticide, farm
mechanization, and transportation which in turn raise the prices of agricultural
commodity.
• Oil- food nexus - Upswing in soybean and corn prices was due to rising prices of
crude and its derivatives, which have increased the demand for biofuel.
• Neutrality hypothesis – delinks feedstock price movements with crude and attribute
to demand growth, monetary expansion, and exchange rate fluctuations.

33. Equilibrium analysis
Fig.1. Determination of the price of corn
Demand for corn is assumed to rise as the price of crude oil rises because an
increase in oil prices is expected to increase the demand for alternative
energy sources, such as biofuel, which in turn would raise the derived demand
for ethanol and its agricultural feedstock – corn or soybean.

34. Equilibrium analysis
•

35. Consumer surplus
• Total consumer value is the sum of the maximum amount a consumer is
willing to pay at different quantities.
• Total expenditure is the per-unit market price times the number of units
consumed.
• Consumer surplus is the extra value that consumers derive from a good but
do not pay for. Alternatively, the difference between the reservation price
and the price consumers actually pay is consumer surplus.

36. Consumer surplus
Quantity
in liters
Price per
liter
Demand
$5
0
$3
$2
1 2
$1
4 5
Total Consumer Value:
0.5($5 - $3)x2+(3-0)(2-0) = $8
Expenditures:
$(3-0) x (2-0) = $6
Consumer Surplus:
0.5($5 - $3)x(2-0) = $2
$4
3

37. Producer surplus
• The amount producers receive in excess of the amount necessary to induce them
to produce the good.

38. Producer surplus
Quantity
Price Supply
$400
0 800
Producer surplus

39. Price controls
• In a competitive market equilibrium, price and quantity freely adjust to the forces
of demand and supply.
• Sometimes the government controls how much prices are permitted to fall or rise.
• Price floor
• Price ceiling

40. Price floor
Quantity
Price Supply
0
Demand
Surplus
Pricefloor
Cost of
purchasing
excess supply

41. Price floor
•

42. Price floor
•

43. Price ceiling
Quantity
Price Supply
0
Demand
Shortage
Priceceiling

44. Price ceiling
•

45. Price ceiling
•

46. Dead weight loss

47. Elasticity
•

48. Own price elasticity
•

49. Elastic Demand Curve
Quantity
Price
elastic

50. Inelastic Demand Curve
Quantity
Price
Inelastic

51. Extreme Elasticities
Quantity
Demand
Price
Perfectly Inelastic
Demand
Perfectly
elastic

52. Elasticities of Demand & Supply
•
Determine the market-clearing price of wheat.
Determine price elasticities of demand and supply.

53. •
Elasticities of Demand & Supply

54. Point vs Arc Elasticities
•
Price of tea (INR) Quantity demanded (Kg.)
20 100
22 85

55. Short Run Vs Long Run Demand Curves
Diagrammatically explain the following
• The demand for gasoline in the short run and long run.
• The demand for automobile in the short run and long run.

56. Gasoline: Short-Run and Long-Run Demand Curves

57. Automobile: Short-Run and Long-Run Demand
Curves

58. Income elasticity
•

59. Income elasticity
• Suppose that the income elasticity of demand for transportation is estimated to
be 1.80. If income is projected to decrease by 15 %, what is the impact on the
demand for transportation?
• Is transportation a normal or inferior good?

60. Income elasticity
•

61. Cross-price elasticity
•

62. Cross-price elasticity
Commodity
Before After
Price ($) Quantity Price ($) Quantity
Mustard (Jar)
Hotdog
10
20
20
40
20
20
15
35
(a)What is the cross price elasticity of demand between Hotdog and Mustard?
(b)Are Hotdog and Mustard substitute or complements?

63. Elasticities of Linear Demand Function
•

64. Elasticities of Linear Demand Function
•

65. Elasticities of Linear Demand Function
•

66. Elasticities and Revenue
• Calculate price elasticity of demand from the following demand schedules:
Price Quantity
Demanded
Revenue
20 100 ?
22 85 ?
Price Quantity
Demanded
Revenue
100 100 ?
110 95 ?

67. Elasticities and Revenue
•
Revenue
20 100 2000
22 85 1870
Revenue
100 100 10000
110 95 10450

68. Elasticities and Revenue
Elasticity Price Revenue/consumer
expenditure
Increase Decrease
Decrease Increase
Increase Increase
Decrease Decrease
Increase Unchanged
Decrease Unchanged

69. Elasticities and Revenue
Which of the following statements correctly describes own-
price elasticity of demand, for this particular demand curve?
I. Demand is unit elastic at a price of $30, and elastic at all
prices greater than $30.
II. Demand is unit elastic at a price of $30, and inelastic at all
prices less than $30.
III. Demand is unit elastic for all prices.
a) I and II only.
b) I only.
c) I, II and III.
d) III only.

70. References
Baye, M. R. and Jeffrey T. Prince, J. T. (2014) Managerial Economics and Business
Strategy. 8th Edition, McGrawHill Education (India) Private Limited, New Delhi
Pindyck, R.S. and Rubinfeld, D.L. (2017) Microeconomics, 8th Edition, Pearson
Education, New Delhi