micro lecture 2 theory of demand supply and market equlibrium

8/3/2019 Micro Lecture 2 Theory of Demand Supply and Market Equlibrium

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BS1163 Introductionto Microeconomics:

Lecture 2The Theory of

Demand, Supply, andMarket Equilibrium


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1.2

Economic Systems - The Process ofAllocation Can Be Handled Differently

Command economy - decisions aretaken by government and its agencies

Free market - changes in prices act assignals to consumers and firms and directresources to their allocations

Mixed economy - such as the UK,combines elements of both


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Commandeconomy

free-marketeconomy

N. Korea

Cuba Poland France

UK

USA

Early 1980s

Classifying economic systems

China Hong

Kong


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Commandeconomy

free-marketeconomy

N. Korea

N. Korea

Cuba

China

Poland

Poland France

France

UK

UKUSA

USA

Early 1980s

Early 2000s

Classifying economic systems

China Hong

Kong

CubaChina

(HongKong)


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Advantages of Markets

Prices transmit information betweenbuyers and sellers

no need for costly bureaucracy

incentives to be efficient - because of

profit and utility maximisation competitive markets are responsive to

consumers


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Disadvantages of Markets

competition may be limited: problem ofmarket power

inequality -prices distribute income the environment and other social goals

may be ignored


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Reality - A Mixed Economy

A mixed economy such as in the UKresults when society employs markets

where they workBut uses regulation and government

provision where markets dont work

Important Lesson - An economy thatallocated resources purely with themarket mechanism would beinefficient.


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Demand and Supply:

A Model of How MarketsDetermine the Prices and

Quantities of Goods Sold


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1.9

Price and Opportunity Cost

Price is the number of dollars that mustbe given up in exchange for an item this is referred to as the money price.

The ratio of one price to another isreferred to as the relative price.

Relative prices are opportunity costs.


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1.10

Price and Opportunity Cost

Relative Prices

price index

Supply and demand determines relative prices.

Price falling means the price falls relative to theaverage price of other goods and services.

Computers and Air Travel are both examples ofgoods with prices that have declined in relative termsover the past 30 years.

E.g their prices in nominal terms have risen less fastthan general price inflation, or may even have fallen


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1.11

Moores Law and the Cost/Price of

Computers In 1970 Gordon Moore predicted that the number of

transistors on a chip would double every two years.

This also means that the average cost of producing chipshas declined over time. As this cost reducing effect hasoutstripped the increase in demand for computers, prices

in both nominal and real terms for computers have fallen .e.g opportunity costs have declined. Source:

http://www.intel.com/technology/mooreslaw/index.htm


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1.12

Historically Commodity Prices have been falling given bettertechnology and new sources, but in past few years this trend hasbeen reversed as demand (fueled by Chinese and other growth)has outstripped supply: Example Canadian Commodity Prices.

Source: http://www.bankofcanada.ca/bcpi/web_annual.pdf


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1.13

This has a follow on effect in the currency markets, as The Economist ArticleThe Looney Takes Wing Sept 27th 2007, discusseshttp://www.economist.com/world/la/displaystory.cfm?story_id=9867397

This shows interrelationshipbetween markets with conditionsin one market (e.g demand andsupply of commodities, influenci

market outcomes in the currencymarkets


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The Theory of

DEMAND


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1.15

What Determines Buyingplans?

The Most Important Factor

The price of a good


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1.16

Demand Schedule - lists the quantitiesdemanded at each possible price (ceterisparibus).

a 1 9b 2 6

c 3 4

d 4 3

e 5 2

Price Quantity(dollars per Video) (millions of videos per week)


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1.17

Demand Curve - shows the relationshipbetween the quantity demanded of a good andits price (ceteris paribus).

0 2 4 6 8 10

1

2

3

4

5

6

e

d

c

b

a

Quantity (millions of videos per week)

Price(dollarpervideo)

Demand for videos


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Quantity Demanded Is the specific quantity of a good that

buyers wish to purchase at a particular

price. A specific point on the demand curve

Demand the quantity of a good buyers wish to

purchase at each conceivable price

The entire demand curve

Demand vs. Quantity Demanded


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1.19

When Prices Change, this causes achange in the Quantity Demanded

If the price of a product changes, this

causes movement along a demandcurve, and shows a change in thequantity demanded.


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The Law of Demand

D

Quantity

Price

ceteris paribus, as price

increases, the quantity

demanded of a product

decreases.

Demand Curves are

Downward Sloping

A negative relationship

between P and QD


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1.21

What Else Determines Buyingplans?

The Determinants of Demand

Prices of related goods

consumer income consumer preferences

Expected future prices

Number of Buyers


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1.22

Prices of Related Goods

Substitutes - goods used in the place ofanother good Demand increases asthe price of substitutes increases

Complements - goods used in conjunctionwith another good Demand decreasesas the price of complements increase


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1.23

Income

Normal Goods demand increases asincome increases

Inferior Goods demand decreases asincome increases


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1.24

Expected Future Prices

If the price of a good is expected to rise inthe future, people buy more of the goodnow. This increases demand today

If the price of a good is expected to fall inthe future, people buy less of the goodnow. This decreases demand today

O


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1.25

Two Other Determinants ofDemand

Number of Buyers

Size and age structure of population

Preferences

Attitudes toward goods and services


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1.26

A Change in the Quantity DemandedVersus a Change in Demand

A movement along a demand curve,

which results from a change in price,shows a change in the quantitydemanded.

If some other influence on buyers planschanges, holding price constant, thereis a change in demand.


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1.27

The Demand Function and ceteris paribus

P=- bQD+a+bIncome-cPComplements +dPSubstitutes+

ePFuture+ gBuyers+ fPreferences

When we assume that all things are equal except for price, allthe determinants of demand are constant and we can write

P = abQDWhich is the simple relationship between demand and price

shown in a demand curve

Changes in the determinants of demand therefore cause theintercept of the demand curve to change and will cause the

entire curve to move up or down.


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1.28

a

Demand

Quantity demanded (QD)

Price(P)

Intercept on

y axis is a

Slope is - b

P = a - bQD

Demand Curve

0

Any change in a

determinant of demandcauses a change in theintercept a, and movesthe Demand curve upor down

Any change in pricecauses movementalong the curve


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1.29

Example: Impact of reduction in VideoRecorders on the demand for videos

Original demand schedule New demand schedule

VCR $200 VCR $50

Price Quantity Quantity(dollars

per video)(millions of videos

per week)

a 1 9

Price(dollars

per video)

(millions of videos

per week)

b 2 6

c 3 4

d 4 3

e 5 2

a' 1 13

b' 2

c' 3

d' 4

e' 5

10

8

7

6

Increase in Demand with Lower VCR Price: The


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1.30

Increase in Demand with Lower VCR Price: TheQuantity Demanded is higher at every price sothis is an increase in demand

0 2 4 6 8 10 12 14

1

2

34

5

6


Price(dollarp

erVideo)

e

d

c

b

aDemand for videos(VCR $200)

e'

d'

c'

b'

a'

Demand for vidoes

(VCR $50)


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The Theory of

Supply

Wh t D t i S lli


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1.32

What Determines Sellingplans?

The Most Important Factor

The price of a good

Supply Schedule list the quantities


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1.33

Supply Schedule list the quantitiessupplied at each different price (ceterisparibus).

a 1 0

b 2 3

c 3 4

d 4 5

e 5 6

Price Quantity(dollars per video) (millions of vidoes per week)

Supply curve shows the relationship


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1.34

Supply curve shows the relationshipbetween the quantity supplied of a goodand its price (ceteris paribus).

0 2 4 6 8 10

1

2

34

5

6

Quantity(millions of vidoes per week)

Price(dollarp

ertape)

Supply of Videos

a

b

c

d

e


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1.35

Supply vs. Quantity Supplied

Supply the quantity of a good suppliers wish to sell

at each conceivable price

The entire supply curve

Quantity Supplied Is the specific quantity of a good that

sellers wish to sell at a particular price.

A specific point on the supply curve


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The Law of Supply

Quantity

Price

S

ceteris paribus, as

price increases, the

quantity supplied of a

product increases.

Supply Curves are

Upward Sloping

A positive relationshipbetween P and QS


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1.37

The Determinants of Supply

Prices of Inputs

The Number of Suppliers

Technology

Government Regulation

Expected Future Prices


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1.39

Example: Impact of Cost ReducingTechnology on the supply of videos

Original supply schedule New supply schedule

Old technology New technology

Price Quantity Quantity(dollars

per video)(millions of videos

per week)

a 1 0

Price(dollars

per video)

(millions of videos

per week)

b 2 3

c 3 4

d 4 5

e5 6

a' 1 3

b' 2

c' 3

d' 4

e'5

6

8

10

12


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1.40

Increase in Supply


Pri

ce(dollarperta

pe)

0 2 4 6 8 10 12 14

1

2

34

5

6

a

e

d

c

bSupply of videos

(new technology)

a'

b'

c'

d'

e'

Supply of videos(old technology)


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1.41

A Change in the Quantity SuppliedVersus a Change in Supply

Quantity

Price S0S0 S1

S2

Increase in

supplysupply

Decrease in

Increase in

quantity

supplied

Decrease in

quantity

supplied


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1.42

A Change in the Quantity SuppliedVersus a Change in Supply

A movement along a supply curve,which results from a change in price,shows a change in the quantitysupplied.

If some other influence on sellers plans

changes, holding price constant, thereis a change in supply.


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Market Equilibrium


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1.45

Market Equilibrium

Quantity Quantity Excess Demand()Price demanded supplied Excess Supply(+)(dollars

per video) (millions of videos per week)

1 9 0 -9

2 6 3 -3

3 4 4 04 3 5 +2

5 2 6 +4


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1.46

Market Equilibrium

0 2 4 6 8 10

1

2

34

5

6


Price(dollarpertape)

Supply of videos

Demand for videos

Equilibrium

ExcessDemand of 3

million at $2

a video

Excess Supply

of 2 million at$4 a video


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E S l P i Ab


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Excess Supply-Price AboveEquilibrium Price

If price were above P0 therewould be excess supply ofEB - EA

producers wish to supplymore than consumers

wish to demand In response, prices would

fall, causing Qsupplied todecreaseQdemand toincrease, moving themarket back to

equilibriumD0

D0S

S

Q0

P0 E0

Quantity

P1EA EB

E D d P i B l


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Excess Demand-Price BelowEquilibrium Price

If price were below P0 therewould be excess demand ofEB - EA

consumers wish todemand more thanproducers wish to supply

Prices would go up,causing Qsupplied toincreaseQdemand todecrease, moving themarket back toequilibrium

D0

D0S

S

Q0

P0 E0

Quantity

P1E

A E

B


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Market equilibrium

Market equilibrium is at

E0 where quantitydemanded equalsquantity supplied

with price P0 and

quantity Q0D0

D0S

S

Q0

P0 E0

Quantity


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1.51

Market Equilibrium

Price Adjustments

Excess Demand results in a shortage and

forces the price up to the equilibrium price Excess Supply results in a surplus and

forces the price down to the equilibriumprice.

I t f P i C ili A


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Impact of Price Ceilings: AMarket in Disequilibrium

Suppose a disastrousharvest moves the supplycurve to SS

government may try toprotect the poor, setting aprice ceilingat P1

which is below P0, thenew equilibrium price

RATIONINGis needed to

cope with the resultingexcess demand

Moreover, Q0-Q1 will notbe supplied because ofthe price ceiling

Quantity

P0

Q0Q1

D

S

S

P1

E

A B

P2

Minimum price: price floor


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Minimum price: price floorP

QO

Pe

minimumprice

Qd Qs

S

D

surplus


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What, How and For Whom

The market:

decides how muchof a good should be produced

by finding the price at which the quantity demanded

equals the quantity supplied

tells us for whomthe goods are produced

those consumers willing to pay the equilibrium price

determines whatgoods are being produced

there may be goods for which no consumer is prepared

to pay a price at which firms would be willing to supply


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1.57

For Review

Changes In DemandThe demand for tapes

Decreases if:

The price of a substitute falls.The price of a complement rises.

Income falls (a tape is a normal good).

The population decreases.The price of a tape is expected to fall in

the future.


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1.58

For ReviewChanges In Demand

The demand for tapes

Increases if:

The price of a substitute rises.

The price of a complement falls.

Income rises (a tape is a normal good).

The population increases.

The price of a tape is expected to rise inthe future.


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1.59

FOR REVIEW: A Change in the QuantityDemanded Versus a Change in Demand

Quantity

Price

D1

D2

Decrease in

quantity

demanded

Increase in

quantity

demanded

D0

Increase in

demand

Decrease in

demand


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1.60

Two ways in which demand may increase -(1) Change in Quantity Demanded

(1) A movementalongthe demandcurve from A to B

represents consumerreaction to a pricechange

This occurs inresponse to a

CHANGE INSUPPLY which hascaused the supplycurve to shift

A

B

P0

P1

Q0Q1 Quantity

D


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1.61

Two ways in which demand may increase(2) A Change in Demand

(2) A movementofthedemand curve from D0to D1

Caused by a change in

a Determinant ofDemand causingdemand to change atevery price

e.g. at P0

demandincreases from Q0to Q1

Causes a Change in QSupplied

A

B

P0

Q0 Q1

C

D0D1

Quantity


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1.62

For Review:

The Law of Supply

The quantity of tapes supplied

Decreases if:The price of a tape falls.

Increases if:

The price of a tape rises.


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1.63

For Review:

Changes In Supply

The supply of tapes

Decreases if:

The price of inputs used to produce tapes rises. The number of tape producers decreases.

The price of a tape is expected to rise in thefuture

Government regulation increases costs


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1.64

For Review:

Changes In Supply

The supply of tapesIncreases if:

The price of a inputs used to produce tapes falls. The number of tape producers increases

More efficient technologies for producing tapes arediscovered.

The price of a tape is expected to fall in the future.

Changes in government regulations reduce costs

M h i l NAny change in a


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Mathematical Note

c

Supply

Quantity supplied (Q )

Price(P

)

Slope is d

P = c + dQSSupply Curve

Intercept ony axis is c

0

Any change in adeterminant of supplycauses a change in theintercept c, and moves

the supply curve up ordownAny change in pricecauses movementalong the curve

micro lecture 2 theory of demand supply and market equlibrium

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