Demand and supply

LECTURE 2: MARKET FORCES: DEMAND AND SUPPLY INVISIBLE HAND ADAM SMITH (1776) the quantity of a good or service that buyers are willing and able to buy under a given set of conditions over a given period of time The various amounts of a product that producers are willing and able to produce at various prices during some specific period The market shouldn’t be regulated by government, because competition and individual self-interest would act as an “invisible hand” and guide to their most productive uses Demand Supply Market demand is a sum of individual demands Market supply is a sum of individual supplies Is formed by Households (consumers) Is formed by firms (producers) Quantity demanded (Q(D)) - a specific quantity demanded corresponding to a specific price Quantity supplied (Q(s)) a specific quantity supplied corresponding to a specific price Law of demand: the higher the prices the lower the quantity Law of supply: the higher the price the higher the The demand curve has a negative slope, consistent with the law of demand. Price 5 Quantity demanded 10 4 20 3 30 2 40 1 50 Prices – the only price factor Of goods and services Tastes and preferences Are influenced by fashion, ads, weather and so on Price of substitutes/ complements coffeetea/toothpastetoothbrush Level of income Change in income influences demand on normal and inferior goods Factors of demand Population Number of consumers Influence the market demand Consumer expectations Will the prices of goods go up or down in the future? Change in Quantity Demanded Price A to B: Increase in quantity demanded A 10 B 6 D0 4 7 Quantity Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 Change in Demand Price D0 to D1: Increase in Demand due to changes of non-price factors 6 D1 D0 7 13 Quantity Giffen goods Inferior goods like bread, rice and so on EXCEPTIONS TO LAW OF DEMAND Veblen goods Behavior is caused by the desire for conspicuous consumption Snob appeal Goods that are beyond the reach of the common man The supply curve has a positive slope, consistent with the la Price 5 Quantity supplied 50 4 40 3 30 2 20 1 10 Taxes and subsidies Prices of goods The only price factor of supply [1] [6] Producers’ expectations Factors of supply [5] [4] Number of firms [2] Input prices [3] Technology Change in Quantity Supplied A to B: Increase in quantity supplied Price S0 B 20 A 10 5 10 Quantity Change in Supply S0 to S1: factors Increase in supply due to changes in non-price Price S S1 8 6 5 7 Quantity Surplu s Quantity demanded is less than quantity supplied Qd < Qs Quantity demanded is equal to quantity Equilibriu supplied m Q d = Qs Shortage Quantity demanded is greater than quantity supplied Qd > Qs EXAMPLE #1 HOW TO FIND SHORTAGE/SURPLUS BASED ON A GRAPH At P=4 – surplus 10 000-4 000=6 000 Q(S)-Q(D) Equilibrium Equilibrium Q=7 Equilibrium P=3 At P=2 – shortage 11 000-4 000=7 000 Q(D)-Q(S) Q(S)=140+11p Q(D)= 200-p Find an equilibrium point: Q(S)=Q(D) 1) 140+11p=200-p 2) 11p+p=200-140 3) 12p=60 4) p=5 – equilibrium price 5)Q(S)=140+11*5=195 Q(D)=200-5=195 – equilibrium quantity Q(S)=Q(D) EXAMPLE #2 HOW TO FIND EQUILIBRIUM BASED ON AN EQUATION. Part 2 Q(S)=140+11p Q(D)= 200-p What happens at P=25? Q(S)=140+11*25=415 – quantity supplied Q(D)=200-25=175 – quantity demand Q(S)>Q(D) –surplus=Q(S)-Q(D)=415-175=240 MARKET OF GAS: CASE OF SHORTAGE Shift of S due to non-price factor New Equilibrium Initial Equilibrium Dead weight loss – net reduction in social welfare form trades that are not made The price ceiling moves e1 to e3 Excess demand Deficit = Qd-Qs Price Elasticity of Demand • Measures the responsiveness of quantity demanded to a change in price • Determinants • • • • Availability of close substitutes Necessities versus luxuries Definition of the market (food vs. ice cream vs. chocolate ice cream) Time horizon Price Elasticity and Total Revenue • If demand for a good is elastic, price increases lead to lower total revenue Click to • If demand for a good is inelastic, price increases lead to higher total add text revenue Price Elasticity of Supply • Measures the responsiveness of quantity supplied to a change in price • Determinants • Availability of inputs • Time