the market forces of supply and demandsakibamin.com/.../06/...demand-supply_summer-2019.pdf3 demand...

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The Market Forces of Supply and

Demand

Sakib Bin Amin, Ph.D.

Assistant Professor

School of Business and Economics

North South University

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Demand

Demand refers to how much (quantity) of a product or service is desired by buyers.

The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship.

Economists have a very precise definition of demand. For them demand is the relationship between the quantity of a good or service consumers will purchase and the price charged for that good.

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Demand

Demand refers to the willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period.

A relationship between price and quantity demanded in a given time period, ceteris paribus.

Ceteris paribus is a Latin phrase that means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.”

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Demand

A household’s decision about what quantity of a particular output, or product to demand depends on a number of factors including:

The Price of the product in question.

The Income available to the Household (HH).

The Household’s amount of accumulated wealth.

The prices of other products available to the HH.

The Household’s Tastes and Preferences.

The Household’s Expectations about Future Income, Wealth and Prices.

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Demand schedule

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Demand curve

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Law of Downward-Sloping Demand

When the price of a commodity is raised ( and other things are held constant), buyers tend to buy less of the commodity and vice versa.

Why does quantity demanded tend to fall as price increases?

Substitution Effect: When the price of a good rises, we will substitute other similar goods for it.

Income Effect: The depressing effect of price increases on purchases. When a price goes up, We find ourselves somewhat poorer than we were before. Example: When Gasoline prices double, we have to curb our consumptions.

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Market Demand

Market demand refers to the sum of all individual demands for a particular good or service.

Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

Market demand is the horizontal summation of individual consumer demand curves.

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Market demand curve

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Two Simple Rules for Movements vs. Shifts

Rule One

When an independent variable changes and that variable does not appear on the graph, the curve on the graph will shift.

Rule Two

When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.

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Change in Quantity Demanded versus Change in

Demand

Change in Quantity Demanded

Movement along the demand curve.

Caused by a change in the price of the product.

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Changes in Quantity Demanded

0

D1

Price of Cigarettes per Pack

Number of Cigarettes Smoked per Day

A tax that raises the price of cigarettes results in a movement along the demand curve.

A

C

20

2.00

$4.00

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Change in Quantity Demanded versus Change in

Demand

Change in Demand

A shift in the demand curve, either to the left or right.

Caused by a change in a determinant other than the price.

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Shift in Demand Curve

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Determinants of Demand

Market price

Consumer income

Prices of related goods

Tastes

Expectations of Future Price and Income

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Consumer Income Normal Good

$3.00

2.50

2.00

1.50

1.00

0.50

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

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

Increase in demand

An increase in income...

D1

D2

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Consumer Income Inferior Good

$3.00

2.50

2.00

1.50

1.00

0.50

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

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

Decrease in demand

An increase in income...

D1 D2

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Prices of Related Goods

Substitutes & Complements

When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. On the other hands an increase in the price of one results in an increase in the demand for the other.

When a fall in the price of one good increases the demand for another good, the two goods are called complements. an increase in the price of one results in a decrease in the demand for the other.

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Change in the price of a substitute good

Price of coffee rises:

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Change in the price of a

complementary good

Price of DVDs rises:

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Demand and the # of buyers

An increase in the number of buyers results in an increase in demand.

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Expectations

A higher expected future price will increase current demand.

A lower expected future price will decrease current demand.

A higher expected future income will increase the demand for all normal goods.

A lower expected future income will reduce the demand for all normal goods.

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Change in Quantity Demanded

versus Change in Demand

Variables that Affect Quantity Demanded

A Change in This Variable . . .

Price Represents a movement along the demand curve

Income Shifts the demand curve

Prices of related

goods

Shifts the demand curve

Tastes Shifts the demand curve

Expectations Shifts the demand curve

Number of buyers

Shifts the demand curve

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Supply

the relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.

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Supply

Quantity supplied is the amount of a good that sellers are willing and able to sell.

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Supply schedule

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Law of Supply

The law of supply states that there is a direct (positive) relationship between price and quantity supplied.

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Change in Quantity Supplied

1 5

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

S

1.00 A

C $3.00 A rise in the

price of ice

cream cones

results in a

movement along

the supply

curve.

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Change in Supply Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

S1 S2

S3

Increase in Supply

Decrease in Supply

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Market Supply

Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.

Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

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Determinants of Supply

Market price

Input prices

Technology

Expectations

Number of producers

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Change in Quantity Supplied

versus Change in Supply

Variables that Affect Quantity Supplied

A Change in This Variable . . .

Price Represents a movement along the supply curve

Input prices Shifts the supply curve

Technology Shifts the supply curve

Expectations Shifts the supply curve

Number of sellers Shifts the supply curve

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Price of inputs

As the price of a inputs rises, profitability declines, leading to a reduction in the quantity supplied at any price.

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Technological improvements

Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.

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Expectations and supply

An increase in the expected future price of a good or service results in a reduction in current supply.

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Increase in # of sellers

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Supply

Demand

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

Equilibrium of

Supply and Demand

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

$3.00

2.50

2.00

1.50

1.00

0.50

Equilibrium

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Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

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

$3.00

2.50

2.00

1.50

1.00

0.50

Supply

Demand

Surplus

Excess Supply

If the price exceeds the equilibrium price,

a surplus occurs:

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Excess Demand

Quantity of Ice-Cream Cones

Price of Ice-Cream

Cone

$2.00

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

Supply

Demand

$1.50

Shortage

If the price is below the equilibrium a shortage

occurs:

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Three Steps To Analyzing

Changes in Equilibrium

Decide whether the event shifts the supply or demand curve (or both).

Decide whether the curve(s) shift(s) to the left or to the right.

Examine how the shift affects equilibrium price and quantity.

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Demand rises

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Demand falls

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Supply rises

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Supply falls

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How an Increase in Demand Affects the

Equilibrium

Price of Ice-Cream

Cone

2.00

0 7 Quantity of Ice-Cream Cones

Supply

Initial equilibrium

D1

1. Hot weather increases the demand for ice cream...

D2

2. ...resulting in a higher price...

$2.50

10 3. ...and a higher quantity sold.

New equilibrium

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

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S2

How a Decrease in Supply Affects

the Equilibrium

Price of Ice-Cream

Cone

2.00

0 1 2 3 4 7 8 9 11 12 Quantity of Ice-Cream Cones

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Demand

Initial equilibrium

S1

10

1. An earthquake reduces the supply of ice cream...

New equilibrium

2. ...resulting in a higher price...

$2.50

3. ...and a lower quantity sold.

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Price ceiling

Price ceiling - legally mandated maximum price

Purpose: keep price below the market equilibrium price

Examples:

rent controls

price controls during wartime

gas price rationing in 1970s

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Price ceiling (continued)

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Price floor

price floor - legally mandated minimum price

designed to maintain a price above the equilibrium level

examples:

agricultural price supports

minimum wage laws

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Price floor (continued)