basic analysis of demand and supply

Basic Analysis of Demand and SupplyChapter 2

MARKETBasic Analysis of Demand and Supply

Market

Where buyers and sellers meet

Where transactions take place

Where do transactions take place?

Market

Tangible Domain

Wet Market

Dry Market

Intangible Domain

Stock Market

Real Estate Market

Labor Market

DEMANDBasic Analysis of Demand and Supply

Demand

Demand

Desire to possess a

thing

Ability to pay for it

Willingness in utilizing

it

You cannot always buy them just by want/desire because you face constraints

Constraints

You have to pay

You lack funds

Opportunity cost

Opportunity Cost

• Every decision to buy one thing is a choice NOT to buy the other. The option not chosen is the opportunity cost.

LAW OF DEMANDBasic Analysis of Demand and Supply

Law of Demand

Price

Demand

*Ceteris Paribus

Ceteris Paribus

• Ceteris Paribus is a Latin term for all other things being equal or held constant.

Validity and Justification of Law of Demand

ProofsTo justify the Law of

Demand

Income Effect

If Price decreases, consumers can buy more.

Substitution Effect

If price increases, consumers will look for others with lower price

DETERMINANTS OF DEMANDBasic Analysis of Demand and Supply

Determinants of Demand

• Factors that actually influence the quantity of demand.

Determinants of Demand

Consumer’s Income

Expectation of Future

Prices

Price of Related Products

Occasional/Seasonal Products

Consumer Tastes

Population Change

C

E

PO

CT

PC

Consumers’ Income

INCOME PURCHASING POWER

C

E

PO

CT

PC

*changes demand depending on the types of goods

Types of Goods

Normal Good

Demand ↑ - Income ↑

Inferior Good

Demand ↓ - Income ↑

C

E

PO

CT

PC

Determinants of Demand

Consumer’s Income

Expectation of Future

Prices

Price of Related Products

Occasional/Seasonal Products

Consumer Tastes

Population Change

C

E

PO

CT

PC

Expectations of Future Prices

• Prices expected in future periods

C

E

PO

CT

PC

Determinants of Demand

Consumer’s Income

Expectation of Future

Prices

Price of Related Products

Occasional/Seasonal Products

Consumer Tastes

Population Change

C

E

PO

CT

PC

Prices of Related Products

• Changes in prices of related goods• The direction in which demand would

change depends on the relationships of products.

C

E

PO

CT

PC

Relationships of Products

Goods that can be used in place of other goods

Gasoline and LPG

Substitute ProductsGoods that go together/cannot be used without the other

Mini4WD and Accessories

Complementary Products

C

E

PO

CT

PC

Determinants of Demand

Consumer’s Income

Expectation of Future

Prices

Price of Related Products

Occasional/Seasonal Products

Consumer Tastes

Population Change

C

E

PO

CT

PC

Occasional/Seasonal Products• Demand increases in various events/seasons in a given year

C

E

PO

CT

PC

Determinants of Demand

Consumer’s Income

Expectation of Future

Prices

Price of Related Products

Occasional/Seasonal Products

Consumer Tastes

Population Change

C

E

PO

CT

PC

Consumer’s Tastes/Preferences

Religion

Culture

Age Tradition

etc

C

E

PO

CT

PC

Determinants of Demand

Consumer’s Income

Expectation of Future

Prices

Price of Related Products

Occasional/Seasonal Products

Consumer Tastes

Population Change

C

E

PO

CT

PC

Population Change

Population

Demand

C

E

PO

CT

PC

DEMAND FUNCTION, DEMAND SCHEDULE AND DEMAND CURVE

Basic Analysis of Demand and Supply

Demand Function• Formula for showing the relationship between demand and its

determinants

• Where:– PGS = Price of good/service

– I = Income– Ec = Consumer’s Expectations

– PRP = Price of Related Products

– Tc = Consumer’s Tastes

– Pop = Population

Demand Schedule• Table showing the relationship of price and demand

Points Price (Millions) Quantity Demanded

A 0 4000

B 1 3500

C 2 3000

D 3 2500

E 4 2000

F 5 1500

G 6 1000

H 7 500

Demand Curve• Graph of the price and demand ceteris paribus

0 500 1000 1500 2000 2500 3000 3500 4000 45000

1

2

3

4

5

6

7

8

Price

Quantity Demanded

SUPPLYBasic Analysis of Demand and Supply

Supply

Supply

Goods/services willing to sell

Services sold at given price to maximize

profitMaximum quantity of

goods producers are willing to offer

You cannot always sell them just to maximize profit because you face constraints

Constraints

Market Price

Cost of Production

Market Price

• It is the price that the sellers can charge their product in a competitive market.

Constraints

Market Price

Cost of Production

Cost of Production

• The costs of the production process and the prices of inputs that they have used to make the product

LAW OF SUPPLYBasic Analysis of Demand and Supply

Law of Supply

Price Supply

*Ceteris Paribus

Because ↑ Price = ↑Profit

DETERMINANTS OF SUPPLYBasic Analysis of Demand and Supply

Tech

nolo

gica

l Cha

nge

Co

st o

f In

pu

ts

Fu

ture

Pri

ce E

xpe

cta

tion

s

Pric

e of

Rel

ated

Pro

duct

s

Op

timiz

atio

n o

f Pro

du

ctio

n

Fa

cto

rs

Gov

’t R

egul

atio

n an

d Ta

xes

Gov

’t S

ubsi

dies

Wea

ther

Con

ditio

ns

Num

ber

of F

irms

Determinants of Supply

Technological Change

Production Cost

Supply

*because profit increases as supply increases

*Due to state-of-the-art machineries able to mass produce goods/services

Cost of Inputs Used

Cost of Production

Quantity supplied

*because profit decreases as supply decreases

Future Price Expectations

The future expectation of price is to go up

Keep goods till the price rises

Pric

e

Supply

Price of Related Products

• Changes in the supply of goods have significant effect in the supply of such goods.

Optimization of Production Factors

• The process/methodology of making something as fully perfect, functional, or effective as possible.

• Efficient use of resources

Gov’t Regulation and Taxes

Tax

Production Cost

Profit

Supply

Gov’t Subsidies

Government Subsidies (financial Aids/Assistance)

Production Cost

More Profit

Weather Conditions

Bad Weather

Good Weather

Number of Firms or Sellers in the Market

Dealers

Supplies

Profit

SUPPLY FUNCTION, SUPPLY SCHEDULE AND SUPPLY CURVE

Basic Analysis of Demand and Supply

Supply Function• Formula for showing the relationship between Supply and its determinants

• Where:– PGS = Price of good/service

– T = Technology– CI = Cost of Inputs

– PE = Expectation of Future Price

– PRP = Price of Related Products

– OFP = Optimization of Factors of Production

– TGR = Gov’t Regulations and Taxes

– SG = Gov’t Subsidies

– W = Weather Conditions– NF = Number of Firms in the Market

Supply Schedule• Table showing the relationship of Price and Supply

Points Price (Millions) Quantity Supplied

A 0 -2000

B 1 -1000

C 2 0

D 3 1000

E 4 2000

F 5 3000

G 6 4000

H 7 5000

Supply Curve• Graph of the price and Supply ceteris paribus

-3000 -2000 -1000 0 1000 2000 3000 4000 5000 60000

1

2

3

4

5

6

7

8

Series1; 0

1

2

3

4

5

6

7

Price

Quantity Supplied

Pri

ce (

mill

ion

s)

MARKET EQUILIBRIUMBasic Analysis of Demand and Supply

Market Equilibrium

Demand Supply

Equilibrium

Demand Supply

S

S

SD

D

D

Equilibrium Market Price

Equilibrium Market Price

Equilibrium Market Price

Buyer

Seller

Equilibrium using Demand and Supply Schedule

Points Price (millions)

Quantity Demanded

Quantity Supplied

State of Market

Pressure on Price

A 0 4000 -2000 Shortage-5000 Upward

B 1 3500 -1000 Shortage-4500 Upward

C 2 3000 0 Shortage-3000 Upward

D 3 2500 1000 Shortage-1500 Upward

E 4 2000 2000 Equilibrium0 Neutral

F 5 1500 3000 Surplus1500 Downward

G 6 1000 4000 Surplus3000 Downward

H 7 500 5000 Surplus4500 Downward

Equilibrium using Demand and Supply Curves

-3000 -2000 -1000 0 1000 2000 3000 4000 50000

1

2

3

4

5

6

7

8

DemandSupply

Quantity Demanded

Pri

ce (

Mill

ion

s)

Equilibrium Point

What happens when there is a market disequilibrium?

Market Disequilibrium

Shortage Surplus

Shortage

Quantity Demanded

Quantity Supplied

Shortage

-3000 -2000 -1000 0 1000 2000 3000 4000 50000

1

2

3

4

5

6

7

8

DemandSupply

Quantity Demanded

Qu

an

tity

Su

pp

lied

Shortage

Prices have the tendency to go UP to restore the equilibrium(without government intervention)

Equilibrium using Demand and Supply Schedule

Points Price (millions)

Quantity Demanded

Quantity Supplied

State of Market

Pressure on Price

A 0 4000 -2000 Shortage-5000 Upward

B 1 3500 -1000 Shortage-4500 Upward

C 2 3000 0 Shortage-3000 Upward

D 3 2500 1000 Shortage-1500 Upward

E 4 2000 2000 Equilibrium0 Neutral

F 5 1500 3000 Surplus1500 Downward

G 6 1000 4000 Surplus3000 Downward

H 7 500 5000 Surplus4500 Downward

Market Disequilibrium

Shortage Surplus

Surplus

Quantity Demanded

Quantity Supplied

Surplus

-3000 -2000 -1000 0 1000 2000 3000 4000 50000

1

2

3

4

5

6

7

8

DemandSupply

Quantity Demanded

Qu

an

tity

Su

pp

lied

Surplus

Prices have the tendency to go DOWN to restore the equilibrium(without government intervention)

Equilibrium using Demand and Supply Schedule

Points Price (millions)

Quantity Demanded

Quantity Supplied

State of Market

Pressure on Price

A 0 4000 -2000 Shortage-5000 Upward

B 1 3500 -1000 Shortage-4500 Upward

C 2 3000 0 Shortage-3000 Upward

D 3 2500 1000 Shortage-1500 Upward

E 4 2000 2000 Equilibrium0 Neutral

F 5 1500 3000 Surplus1500 Downward

G 6 1000 4000 Surplus3000 Downward

H 7 500 5000 Surplus4500 Downward

MARKET INTERFERENCEBasic Analysis of Demand and Supply

Market Interference

• utilized supply and demand models are only possible in an unregulated market

• In real world situations, governments around the world try to control prices because:–Some sectors do not benefit–Some sectors take advantage of price controls

Price Control

• Specification of MINIMUM PRICE and/or MAXIMUM PRICE of goods and services by the government.

Price Control

Price Ceiling Price Floor

Price Ceiling

• Legal maximum price imposed by the government.

• Used only by the government if there is a persistent SHORTAGE OF GOODS

Price Ceiling

-3000 -2000 -1000 0 1000 2000 3000 4000 50000

1

2

3

4

5

6

7

8

DemandSupply

Quantity Demanded

Qu

an

tity

Su

pp

lied

*to protect the consumers from the rising price of supplies

Price Control

Price Ceiling Price Floor

Price Floor

• Legal MINIMUM PRICE imposed by the government.

• Used only by the government if there is a persistent SURPLUS OF GOODS

Price Floor

-3000 -2000 -1000 0 1000 2000 3000 4000 50000

1

2

3

4

5

6

7

8

DemandSupply

Quantity Demanded

Qu

an

tity

Su

pp

lied

*to protect the producers from the falling price of supplies

Humans and animals are both selfish. They virtually don’t care about others. They say clever things, make relationships where both sides use each other, and look for a way to profit

themselves while limiting the loss for the other group.