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Demand supply analysis

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The first basic module on how economies work at the micro level.

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Demand supply analysis

  1. 1. Supply and Demand How MarketsHow Markets Work?Work?
  2. 2. Learning objectives.. Examine what determines the demandExamine what determines the demand for a good in a competitive market.for a good in a competitive market. Examine what determines the supplyExamine what determines the supply of a good in a competitive market.of a good in a competitive market. See how supply and demand togetherSee how supply and demand together set the price of a good and theset the price of a good and the quantity sold.quantity sold. Consider the key role of prices inConsider the key role of prices in allocating scarce resources.allocating scarce resources.
  3. 3. DEMAND • Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at alternative prices for a given period.
  4. 4. Determinants of Demand • What factors determine how much ice cream / or which ice cream you will buy? Product’s Own Price Consumer Income Prices of Related Goods Tastes Consumer Expectations Population Advertising
  5. 5. The Demand Function • An equation representing the demand curve Qx d = f(Px ,PY , M, H,) – Qx d = quantity demand of good X. – Px = price of good X. – PY = price of a substitute good Y. – M = income. – H = any other variable affecting demand
  6. 6. Income – As income increases, the demand for a normal good will increase. – As income increases, the demand for an inferior good will decrease.
  7. 7. Prices of Related Goods – When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. – When a fall in the price of one good increases the demand for another good, the two goods are called complements.
  8. 8. The Demand Schedule and the Demand Curve – The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. – The demand curve is a graph of the relationship between the price of a good and the quantity demanded.
  9. 9. Table 1-1: Pooja’s Demand Schedule 050 240 435 630 825 1020 1215 Quantity of cones Demanded Price of Ice- cream Cone
  10. 10. Figure 1-1: Pooja’s Demand Curve Price of Ice- Cream Cone Quantity of Ice- Cream Cones 2 4 6 8 10 120 40 35 30 25 20 15
  11. 11. Market Demand Schedule • Market demand is the sum of all individual demands at each possible price. • Graphically, individual demand curves are summed horizontally to obtain the market demand curve. • Assume the ice cream market has two buyers as follows…
  12. 12. Table 1-2: Market demand as the Sum of Individual Demands 045 1020 1215 Pooja Price of Ice- cream Cone (Rs) + 1 6 7 Tej 1 240 435 630 825 2 3 4 5 4 7 10 13 16 19 Market =
  13. 13. Exceptions to the Law of Demand • Snob effect / Veblen Effect: luxury goods give snob appeal. • Inferior goods/ Giffen goods: • Absolute necessities. • Irrational Behaviour / Addictions Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999
  14. 14. The linear Demand equation • Qd = a – bP. • Dependant variable = Qd • Independent variable = P • a, b are constants • b= slope , measures the change in demand due to a change in price. • a = x-intercept , or the quantity demanded when P=0.
  15. 15. Shifts in the Demand Curve versus Movements Along the Demand Curve
  16. 16. Figure 1-2 a): A Shifts in the Demand Curve Price of Cigarette s, per Pack. Number of Cigarettes Smoked per Day D2 A policy to discourage smoking shifts the demand curve to the left. 0 20 200 D1 A 10 B
  17. 17. Figure 1-2 b): A Movement Along the Demand Curve Price of Cigarettes, per Pack. Number of Cigarettes Smoked per Day 0 20 Rs200 D1 A A tax that raises the price of cigarettes results in a movements along the demand curve. C 12 Rs400
  18. 18. I got a great deal!= Consumer Surplus • Barbeque Nation offers a lot of bang for the buck! • The Shopper’s stop sale provides good value. • Total value greatly exceeds total amount paid. • Consumer surplus is large.
  19. 19. I got a lousy deal! • That car dealer drives a hard bargain! • I almost decided not to buy it! • They tried to squeeze the very last cent from me! • Total amount paid is close to total value. • Consumer surplus is low.
  20. 20. Consumer Surplus: The Discrete Case Price Quantity D 10 8 6 4 2 1 2 3 4 5 Consumer Surplus: The value received but not paid for
  21. 21. SUPPLY • Quantity Supplied refers to the amount (quantity) of a good that sellers are willing to make available for sale at alternative prices for a given period.
  22. 22. Determinants of Supply • What factors determine how much ice cream you are willing to offer or produce? Product’s Own Price Prices of Related goods in Production Input prices Technology Expectations Number of sellers Taxes and subsidies
  23. 23. The Supply Function • An equation representing the supply curve: Qx S = f(Px,PR,W, H,) – Qx S = quantity supplied of good X. – Px= price of good X. – PR= price of a related good – W = price of inputs (e.g., wages) – H = other variable affecting supply
  24. 24. Price Law of Supply – The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises.
  25. 25. Table 4-4: Ben’s Supply Schedule 545 440 335 230 125 020 015 Quantity of cones Supplied Price of Ice- cream Cone (Rs)
  26. 26. Supply Shifters • Input prices • Technology or government regulations • Number of firms • Substitutes in production • Taxes • Producer expectations
  27. 27. The linear supply equation • Supply might be represented by a linear supply function such as • Q(s) = a + bP • Q(s) represents the supply for a good • In-class Activity: Use the linear supply equation for haircuts in your town, • Qs=-100+20P to answer the questions that follow: • Create a schedule showing the supply of haircuts in your town at prices of Rs10, Rs20, Rs30, Rs40, and Rs50. • Calculate the price-intercept of your supply curve, then use the data from your supply schedule to plot a supply curve for haircuts.
  28. 28. Change in Quantity Supplied Price Quantity S0 20 10 B A 5 10 A to B: Increase in quantity supplied
  29. 29. Change in Supply Price Quantity S0 S1 8 5 7 S0 to S1: Increase in supply 6
  30. 30. Market Supply Schedule • Market supply is the sum of all individual supplies at each possible price. • Graphically, individual supply curves are summed horizontally to obtain the market demand curve. • Assume the ice cream market has two suppliers as follows…
  31. 31. Table 4-5: Market supply as the Sum of Individual Supplies 545 020 015 Ben Price of Ice- cream Cone (Rs) + 8 0 0 Nicholas 13 440 335 230 125 6 4 2 0 10 7 4 1 0 0 Market =
  32. 32. Table 4-6: The Determinants of Quantity Supplied
  33. 33. Figure 4-7: Shifts in the Supply Curve Price of Ice-Cream Cone Quantity of Ice-Cream Cones S3 S2 S1 Decrease in supply Increase in supply
  34. 34. Market Equilibrium • Balancing supply and demand – Qx S = Qx d • Steady-state
  35. 35. If price is too low… Price Quantity S D 5 6 12 Shortage 12 - 6 = 6 6 7
  36. 36. If price is too high… Price Quantity S D 9 14 Surplus 14 - 6 = 8 6 8 8 7
  37. 37. Market equilibrium using equations: • If we are looking at the market for cans of paint, for instance, and we know that the supply equation is as follows: • QS = -5 + 2P And the demand equation is: • QD = 10 – P • Find the equilibrium demand, supply, price.

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