4032006 demand and supply notes

8/2/2019 4032006 Demand and Supply Notes

1/68

Price: The Role of Demand andSupply

Topic 2


2/68

Law of Demand

2

The quantity purchased of a good or

service is inversely related to the

price, all other things being equal(ceteris paribus)


3/68

The Law of Demand

Price changes leadto qty demandedchanging.......

Represented bymovements alongdemand curve.

Inverse relationship

between price andquantity demandedgives rise to adownward- sloping

demand curve.3

DD

Price

Quantity/wk

A

B3

2

5 15

negative slope


4/68

Quantity Demanded versusDemand

4

Quantity demanded The quantities of a good or service that

people will purchase at aspecific priceover a given period of time

Demand

A schedule of the total quantities of agood or service that purchasers will buy

at different prices at a given time


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Demand

5

Individual demand The quantity of a good or service that an

individual or firm stands ready to buy atvarious prices at a given time

Market demand

The sum of the individual demands inthe marketplace


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Demand Schedule and DemandCurve

6

Demand schedule A table showing the various quantities

of a good or service that will bedemanded at various prices

Demand curve

A curve that indicates the number ofunits of a good or service thatconsumers will buy at various prices ata given time


7/68

Demand Curve for Internet Time

7

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Quantity (millions of hours)

PriceperHour

D

Table 4-1 provides the detail for

the demand curve presented here


8/68

Changes in Quantity Demanded and inDemand

8

Change in quantity demanded Movement along the demand curve

that occurs because the price of theproduct has changed

Change in demand

A change in the amounts of the productthat would be purchased at the samegiven prices; a shift of the entiredemand curve


9/68

Demand Curves for Internet Time

9 Quantity (millions of hours)

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

PriceperH

our

D

D2

D1

A shift fromD toD1 is an increase in

demand more will be purchased at

each price

A shift fromD toD2 is adecrease in demand less

will be purchased at each

price


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Determinants of Demand

10

Changes in incomeHigher incomes increase in demand

Lower incomes decrease in demand

Changes in tastes and preferences

Change in consumer expectations


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Determinants of Demand

11

Changes in the prices of other goods Substitutes Increase in the price

of substitutes increase in

demand Complements Increase in the

price of complements decrease

in demand


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Supply

12

Supply The total quantities of a good or service that sellers

stand ready to sell at different prices at a given time

Individual supply Quantities offered for sale at various prices at a given

time by an individual seller

Market supply

Sum of the individual supply schedules in themarketplace


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Supply

13

Supply schedule A table showing the various quantities

of a good or service that sellers willoffer at various prices at a given time

Supply curve

A line showing the number of units ofa good or service that will be offeredfor sale at different prices at a giventime


14/68

Law of Supply

14

The quantity offered by sellers of a good or service isdirectly relatedto price, all things being equal

Why?

Producers are more willing to sell greater amounts of agood at a higher price , because this good has becomerelatively more profitable to produce, compared to othergds


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Changes in Quantity Supplied andin Supply

15

Change in the quantity supplied

Movement along the supply curve that occurs

because the price of the product has changed

Change in supply

A change in the amount of the product that would be

offered for sale at the same given price; a shift of the

entire supply curve


16/68

Supply Curves for Internet Time


$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

PriceperHour

SS2 S1

A shift from Sto S2

is a decrease in

demand a smaller

amount offered for

sale at each price A shift from Sto S1 isan increase in demand

a larger amount

offered for sale at each

price


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Determinants of Supply

17

Changes in the cost of resources

Increase in the cost of resources decrease in

supply Technology

Improvements increase in supply

Expectations of future prices(Shift to the right)

Prices of related products


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Expectations of Future Prices

18

If sellers expect price of the good to

fall in the future,

they will sell more nowbefore the

price actually falls!!

Supply increases today.....rightward shift


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Price of related goods

19

Related goods

(Supply side of the market)

Substitutes in production

Require the same resources

to produce

Complements in production

Jointly produced with

the same pool of resources

Example

Rubber bands

Rubber erasers

Example

Beef

Leather


20/68

Price of related goods(substitutes in production)

20

Assume that the price of Rubber Erasers (RE) has increased.

What impact does this have on the supply of Rubber Bands

(RB) ?

Price

Quantity

SS

Supply of RE

Price

Quantity

Supply of RB

SS

SS


21/68

Price of related goods(complements in production)

21

Assume that the price of beef has increased.

What impact does this have on the supply of leather ?

Price

QuantitySupply of Leather

SS

SS

Supply of Beef

Price

Quantity

SS


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Equilibrium Price

22

The price at which the quantity

demanded equals the quantity supplied

Market Equilibrium

A state whereby the forces ofmarket

demand and market supply exactly

balance each other and there is no

tendency for change

D d S l d M k t P i


23/68

Demand, Supply, and Market Pricefor Internet Time


$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

PriceperHour

SupplyDemand

EE

At a price of $1.21, 6 million

hours of Internet time will be

offered for sale and an equal

amount purchased

0 1 2 3 4 5 6 7 8 9 10 11 12 13


24/68

24


25/68

Surplus of Internet Time


$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

PriceperHo

ur

SupplyDemand

E

Surplus

At a price of $1.30, 7.8

million hours will be

offered for sale but

consumers are only

willing to purchase 4.2

million hoursQs > Qd surplus of Internet

hoursRather than hold on to these

hours, sellers will offer to sell at

lower prices with the result that

more consumers enter themarket price moves toward

$1.20


26/68

26

Shortage of Internet Time

Quantity (millions of hours)

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

PriceperHour

SupplyDemand

E

Shortage

At a price of $1.10, buyers

want to buy 8.5 million hours

but sellers are willing to

offer only 3.6 million hours

Qd > Q shortage

Some buyers will be willing to

pay more with the result that

the price will increase and

sellers will increase theamount they offer for sale

move toward $1.20


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Changes in EquilibriumPrice & Quantity

27

Once equilibrium is attained, there is notendency for change, unless demand, supplyor both market forces change.

Demand & supply change when there is achange in determinants of demand and/orsupply.


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Increase in Demand

28

Price

Quantity

SS

DD DD

E

E

P

P

Q Q

Increase inPe & Qe


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Decrease in Demand

29

Price

Quantity

SS

DD DD

P

P

QQ

E

EDecrease in

Pe & Qe


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Increase in Supply

30

Price

Quantity

SS

DD

SS

P

P

Q Q

E

E

Decrease in Pe,Increase in Qe


31/68

Decrease in Supply

31

Price

Quantity

SS

DD

SS

P

P

Q Q

E

E Increase in Pe,Decrease in Qe


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Change In Both Demand & Supply

At The Same Time

32

the effect on only eitherP or Q can bedetermined straight away

the impact on the other variable cannot bedetermined ,

unless given more information

on the size of the relative shifts


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What happens when:

33

Demand and supply increase simultaneously?

The equilibrium qty will definitely increase,

but whether the equilibrium price

will increase or decrease depends onhow much demand shifts relative to supply


34/68

Three Possible Situations:Three Possible Situations:

34

Price

Quantity

DD

DD SS

SS

P

P

Q Q

Demand increases more than supply does

E

E

Increase in Pe,Increase in Qe


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35

Price

Quantity

DD

DDSS

SS

P

P

Q Q

Supply increases more than demand does

EE

Decrease in Pe,

Increase in Qe


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36

Price

Quantity

DD

DD SS

SS

P

Q Q

Demand increases by the same amount

as supply

E ENo change in Pe,

Increase in Qe


37/68

General Guidelines

37

An increase in demand relative tosupply higher price

A decrease in demand relative tosupply lower price

An increase in supply relative to

demand lower price A decrease in supply relative to

demand higher price


38/68

Disequilibrium Due To

Government Intervention

The government maystep in to restrict the freeoperation of the marketand create disequilibrium

prices by imposing aPRICE CEILING orPRICE FLOOR

38


39/68

Price Ceiling

39

A government-mandated maximum

price that can be charged for a good or a

service below the market equilibriumProducers cannot sell at a price higher

than the ceiling price


40/68

Why Imposed Price Ceiling ?Why Imposed Price Ceiling ?

Prevent consumers from being overcharged!!!! E.g. rent controlPrice control on necessities eg rice, sugar,

oil, etc..

40

The Effects of a Price Ceiling on


41/68

The Effects of a Price Ceiling onRental Housing

41

700

500

0 18,000 30,000 40,000

ShortageD

S

E

MonthlyPrice($)

Quantity (housing units)

The effect of the

price ceiling on

rental housing is to

cause a shortage andreduce housing

opportunities to

those families they

are intended to

accommodate


42/68

How Are Consumers Affected By AHow Are Consumers Affected By A

Price Ceiling?Price Ceiling?

42

Since there is little incentive to maintain the quality ofrent-controlled housing, consumers may have to put upwith the deteriorating quality of such housing .

The amount bought and sold with a price ceilingimposed is less than that at market equilibrium.The shortage caused by the price ceiling forcesconsumers to spend more time searching for analternative.

Some people are willing to pay more to get some of thegood. These people may end up relying on politicalconnections andpaying coffee money.


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Why Imposed Price Floor???Why Imposed Price Floor???

43

To ensureproducers a higher andmore stable income eg. Price floors on

agricultural products, or min wage toensure workers a min standard of

living


44/68

The Effects of a Price Floor on Wheat

44

3.00

2.00

0 75,000 100,000 115,000

Surplus

D

S

PriceperBushe

l($)

Quantity (bushels)

The impact of the price

floor is to cause a

surplus thegovernment must then

buy and store the

surplus that is created

by the price floor

PF


45/68

Effects of Price FloorsEffects of Price Floors

45

Price floors create surpluses... govt intervention is needed

to prevent downward pressure on price

Govt often steps in to buy up the surplus, as part of itssupport program towards producers


46/68

What Does The Government

Do With The Surplus?

46

Surplus may be distributed to the poor

But govt has to ensure that its actions

does not lead to falling demandAlternatively, surplus may simply

be stored up .... wasteful if quality

deteriorates over time

H A C Aff d B A


47/68

How Are Consumers Affected By A

Price Floor?

47

Consumers pay a higher price than at marketequilibrium (PF higher than Pe).

Consumers pay taxes to cover governmentsupport for producers.

The amount bought and sold with a price floorimposed is less than that at market

equilibrium.


48/68

Price Elasticity of Demand

48

A measure of the sensitivity or

responsiveness of quantity demanded

to a change in price Formula method

Total revenue method


49/68

Formula Method

49

priceinchangepercentage

demandedquantityinchangepercentageelasticityPrice =

)/2(

)/2(

21

12

21

12

PPPP

QQ

QQ

+

+

=

Demand Curve Showing Different


50/68

Demand Curve Showing DifferentElasticities

50

D2

Quantity/Time

$13

12

11

10

9

8

7

6

5

4

3

2

1

0 1,600 2,000 2,400

Price

D

DD1

D

1

Unit elastic

Elastic demand

Inelasticdemand


51/68

Unit Elastic Demand

51

Demand that exists when a percentage

change in price causes an equal

percentage change in quantitydemanded

Has an elasticity coefficient equal to

1.0 Demand curveD in Figure 4-9


52/68

Elastic Demand

52

Demand that exists when a

percentage change in price causes a

greater percentage change in quantitydemanded

Has an elasticity coefficientgreater

than 1.0Demand curveD1 in Figure 4-9


53/68

Inelastic Demand

53

Demand that exists when a percentage

change in price causes a smaller

percentage change in quantitydemanded

Has an elasticity coefficient less than

1.0Demand curveD2 in Figure 4-9


54/68

Total Revenue Method

54

If price changes but total revenue remains constant,

unit price elasticity of demand exists

If price changes but total revenue moves in the

opposite direction, demand is elastic

If price changes and total revenue moves in thesame

direction, demand is inelastic

Characteristics Affecting Price


55/68

Characteristics Affecting PriceElasticity of Demand

55

Trend Toward

Elastic Demand

Luxuries

Large expenditures

Durable goods

Substitute goods

Multiple uses

Trend Toward

Inelastic Demand

NecessitiesSmall expenditures

Perishable goods

Complementary goodsLimited uses

Three Demand Curves Showing


56/68

Three Demand Curves ShowingDifferent Elasticities

56

D1

P P P

Q/t Q/t Q/t

D2

D3

(a) (b) (c)

Perfectly

ElasticPerfectly

Inelastic

Perfectly

Unit

Elastic

Demand Curve Showing Different


57/68

Demand Curve Showing DifferentElasticities

57

Quantity/Time

$12

11

10

9

8

7

6

5

4

3

2

1

Price

Ela

stic

Dem

and

0 10 20 30 40 50 60 70 80 90 100 110 120

UnitE

lastic

Inelastic

Dem

and

Elasticity changes along the

demand curve from elastic at

the top to inelastic at the

bottom


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Other Types of Elasticity

58

Cross elasticity of demand

Income elasticity of demand

Elasticity of supply


59/68

Cross Elasticity of Demand

59

A measure of the responsiveness of the

quantity demanded of one product as a

result of a change in the price of anotherproduct

Aproductofpricein thechangepercentage

Bproductofdemandedquantityin thechangepercentagedemandofelasticityCross =


60/68


60

Substitute goods Functionally equivalent goods

Complementary goodsGoods that are used together A change in the price of one product,

if it is substitute or complementaryproduct, can affect the quantitydemanded of the other


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61

The coefficient of cross elasticity canbe positive or negative

Positive in the case of substitutes Negative in the case of complements

The larger the coefficient, the greater

the cross elasticity


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Income Elasticity of Demand

62

A measure of the responsiveness of

quantity demanded to a change in

income

incomeinchangepercentage

quantityinchangepercentagedemandofelasticityIncome =


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Income Elasticity of Demand

63

Normal goods Positive coefficient

Demand varies in the same directionas income

Inferior goods Negative coefficient Demand varies inversely with changes

in income


64/68

Elasticity of Supply

64

A measure of responsiveness of quantity

supplied to a change in price

priceinchangepercentage

suppliedquantityinchangepercentagesupplyofelasticityPrice =

Time and Elasticity of Supply


65/68

Time and Elasticity of Supply Immediate

65

P

Q Q/t

D1

S

D

P

Demand increases fromD to

D1 and because the sellers

cannot adjust the quantity

supplied on such short notice,

the only impact is an increase

in priceP1



66/68

Time and Elasticity of Supply Short Run

66

P2

P

Q Q2 Q/t

D1

S

D

P In the short run, the

seller has sufficient

time to vary some

productive resources

supply becomesmore elastic and the

quantity supplied

increases, causing the

price to fall



67/68

Time and Elasticity of Supply Long Run

67

P3

P

Q Q3 Q/t

D1

S

D

P Over the long run,

the supply curve

becomes still more

elastic because

producers canvary all productive

resources and

make use of new

technology


68/68

Effects of a Tax on Cigarettes

D

S

Price per Pack

($)

40 50

D

S

Quantity (millions of packs)

5.25

5.00

Quantity (millions of packs)

S + $1

5.75

5.00

48 50

S+ $1

e e

R R

Price per Pack

($)

Note that the same $1 tax has a much larger impact on quantity when

d d i l ti th h it i i l ti

4032006 demand and supply notes

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