Chapter 2 Chapter 2 Demand Supply & 20152015 Market Equilibrium

Prof. Dr. Mohamed I. Migdad

Professor of Economics

Chapter 2 contentChapter 2 content::2.1 Introduction2.2 What Is the Market? 2.3 Consumer Demand2.4 Firms Supply2.5 Equilibrium between Supply and

Demand2.6 Price of Goods and Price Theory2.7 Role of Governments in Economics2.8 Effects of Supply and Demand

Change on Market Equilibrium

What is the cynicWhat is the cynic??

A man who knows the price of everything and the value of nothing

Oscar Wilde

3

MarketMarket Market is the word we use daily, and

simply is the place we go to purchase different goods and services.

It contains system, institutions, procedures, social relation, infrastructure, where parties engage in exchange.

It could be said that market is the process in which the prices of goods and services are established.

4

NotesNotes

1. It is not necessary for a market to be connected with a fiscal place. It economically could mean purchasing or selling over tel. or online.2. There is no specific market for all goods and services, each product is demanded and supplied in its special market.

5

Market definitionMarket definitionA market is the institution

through which buyers and sellers interact and engage in exchange.

A market economy has at its heart the actions of buyers and sellers who exchange goods and services with one another.

6

DefinitionDefinition A market at its economic terms is

a group of sellers and buyers desiring exchange of goods or services.

7

How markets workHow markets work

Buyers and sellers receive signals from one another in the form of prices.

If buyers want to buy more of a good, prices rise and sellers respond by supplying more to the marketplace.

8

MarketsMarkets If buyers want to buy less of a

good, prices fall and sellers respond by supplying less to the marketplace.

9

MarketsMarkets Market equilibrium occurs when the

price is such that the quantity that buyers are interested in purchasing is equal to the quantity that sellers are interested in supplying to the market.

10

MarketsMarketsThe market mechanism allows

an economy to simultaneously solve the three economic problems of what, how, and for whom.

11

Who control the marketWho control the market??

There is no higher authority that directs the behavior of these economic agents; rather, it is the invisible hand of the marketplace that allocates final goods and services, as well as factors of production.

12

Economic problemEconomic problem

The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?

To answer the three basic questions we need to study the economic systems.

13

14

Economic SystemsEconomic Systems

Economic systems are the basic arrangements made by societies to solve the economic problem.

They includes four systems:

15

SystemsSystems

1. Islamic economy2. Laissez-faire economies3. Command economies4. Mixed systems

16

Islamic EconomyIslamic EconomySome people think that Islam has

no economic system of its own Islamic Economics is as Old as

Islam Itself

17

Islamic EconomyIslamic EconomyIslamic economics is accordance

with Islamic law. Islamic economics can refer to

the application of Islamic law to economic activity either where Islamic rule is in force or where it is not;

18

I.EI.Ei.e. it can refer to the creation of

an Islamic economic system, or to simply following Islamic law in regards to spending, saving, investing, giving, etc. where the state does not follow Islamic law.

19

Definition of Islamic Definition of Islamic economicseconomicsThe Islamic economics is both a

science and an art which deals with the daily routine of a Muslim's economic life.

i.e. how he earns his income and how he spends it. It is a science in the sense that it involves many scientific methods in the production of material goods, their distribution and consumption.

20

PrinciplesPrinciples The Islamic economic system is

directly guided by Allah Almighty Himself.

all important aspects of the Islamic economic system and the applicable norms are thoroughly discussed in the Holy Quran

21

ContCont..

Allah created all needed provisions so that they may consume them and may satisfy their wants

22

Other principlesOther principles1. All wealth belongs to Allah (SWT(2. The Muslims are the custodians and

trustees of the wealth.3. Hoarding the wealth is forbidden.4. Circulating the wealth is obligatory

23

المبادئ بالعربية المبادئ بالعربية كل الثروة مملوكة وترجع إلى الله تعالى المسلمون هم الحراس واألمناء على

الثروة والمالاكتناز الثروات ممنوعتعميم وتدوير هذه الثروة واجب

24

The free market systemThe free market system

In a laissez-faire economy, individuals and firms pursue their own self-interests without any central direction or regulation.

The central institution of a laissez-faire economy is the free-market system.

A market is the institution through which buyers and sellers interact and engage in exchange.

25

Consumer sovereigntyConsumer sovereignty

Consumer sovereignty is the idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

26

Free enterpriseFree enterprise

Free enterprise: under a free market system, individual producers must figure out how to plan, organize, and coordinate the production of products and services.

27

distribution of outputdistribution of output

In a laissez-faire economy, the distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.

28

Free SystemFree System

The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.

29

Command economiesCommand economiesIn a command economy, a

central government either directly or indirectly sets output targets, incomes, and prices.

And the government determine what to produce and how much and How and for Whom to produce.

30

Mixed Systems, Markets, Mixed Systems, Markets, and Governmentsand Governments

Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to:

31

goals of government in goals of government in mixed economymixed economy

Minimize market inefficiencies Provide public goods Redistribute income Stabilize the macro economy:

◦Promote low levels of unemployment

◦Promote low levels of inflation

32

The Market System Relies on Supply and Demand to The Market System Relies on Supply and Demand to Solve the Trio of Economic ProblemsSolve the Trio of Economic Problems

Demand in Product or Demand in Product or Output MarketsOutput Markets

33

• A household’s decision about the quantity of a particular output to demand depends on:

What is demand:What is demand:Demand is the desire to own any

thing with an ability and willingness to pay.

It includes the ability and willingness to bay a commodity at a given period and price.

The effective demand is the demand which combines with the ability and willingness to bay in a particular period of time.

34

Major Groups of Expenditures in Gaza 2011, Major Groups of Expenditures in Gaza 2011, 20122012

Major Groups of Expenditure

Gaza strip

Feb. 2011Feb. 2012 %Change

Food and soft drinks153.71151.86-1.21

Alcoholic Beverages and tobacco

157.18157.290.07

Textiles, clothing and footwear

116.28107.28-7.74

Housing125.55129.132.85

Furniture, household goods

139.55131.94-5.45

Medical care99.02100.311.31

Transportation127.85127.16-0.54

Communications105.40107.031.55

Recreational, cultural goods and services

100.2198.60-1.60

Education107.59111.093.25

Restaurants and cafes156.38155.54-0.53

Miscellaneous goods and services

122.97131.516.94

All items of consumer price index

134.83133.88-0.70

The Relationship between Price and The Relationship between Price and Quantity DemandedQuantity Demanded

Price (P)Quantity demanded (Qd)

1020015180201602514030120351004080

The The demand curvedemand curve

The The demand curvedemand curve is a is a graph illustrating how graph illustrating how much of a given product a much of a given product a household would be willing household would be willing to buy at different pricesto buy at different prices..

37

Demand CurveDemand Curve

From Household Demand to From Household Demand to Market DemandMarket Demand

Demand depends onDemand depends on::

1. The price of the product in question.2. The income available to the household.3. The household’s amount of

accumulated wealth.4. The prices of other products

(substitutes and complements) available to the household.

40

Demand depends onDemand depends on::

5. The household’s tastes and preferences.

6. The household’s expectations about future income, wealth, and prices.

41

Quantity demandedQuantity demanded

Quantity demandedQuantity demanded is the is the amount (number of units) of a amount (number of units) of a product that a household would product that a household would buy in a given time period if it buy in a given time period if it could buy all it wanted at the could buy all it wanted at the current market price.current market price.

42

Changes in Changes in Quantity Quantity DemandedDemanded Versus Versus Changes in DemandChanges in Demand

The most important relationship in individual markets is that between market price and quantity demanded.

43

continuecontinue

We use the ceteris paribus or “all else equal” device, to examine the relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant.

44

continuecontinue

Changes in price affect the quantity demanded per period.

Changes in income, wealth, other prices, tastes, or expectations affect demand.

45

The The demand curvedemand curve

The The demand curvedemand curve is a is a graph illustrating how graph illustrating how much of a given product a much of a given product a household would be willing household would be willing to buy at different prices.to buy at different prices.

46

Demand TableDemand Table

47

PRICE (PER CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

Demand CurveDemand Curve

48

law of demandlaw of demandThe law of demand states that

there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

49

The Law of DemandThe Law of Demand

50

The slope of demand The slope of demand curvecurve

• This means that demand curves slope downward.

51

Other DeterminantsOther Determinantsof Household Demandof Household Demand

1.1. IncomeIncome is the sum of all is the sum of all households wages, salaries, households wages, salaries, profits, interest payments, profits, interest payments, rents, and other forms of rents, and other forms of earnings in a given period of earnings in a given period of time. It is a time. It is a flowflow measure. measure.

52

Other determinantOther determinant

2.2. WealthWealth, or , or net worthnet worth, is the , is the total value of what a household total value of what a household owns minus what it owesowns minus what it owes.. It is a It is a stockstock measure. measure.

53

Other DeterminantsOther Determinants

3.3. Price of other goodsPrice of other goodsA.A. Normal GoodsNormal Goods are goods for which are goods for which

demand goes up when income is demand goes up when income is higher and for which demand goes higher and for which demand goes down when income is lower.down when income is lower.

B.B. Inferior GoodsInferior Goods are goods for which are goods for which demand falls when income rises.demand falls when income rises.

54

Other DeterminantsOther Determinants

C.C. SubstitutesSubstitutes are goods that are goods that can serve as replacements for can serve as replacements for one another; when the price of one another; when the price of one increases, demand for the one increases, demand for the other goes up.other goes up.

D.D. Perfect substitutesPerfect substitutes are are identical products.identical products.

55

Other DeterminantsOther Determinantsof Household Demandof Household Demand

E.E. ComplementsComplements are goods that are goods that ““go togethergo together””; a decrease in the ; a decrease in the price of one results in an price of one results in an increase in demand for the increase in demand for the other, and vice versa.other, and vice versa.

56

The Difference between the Shift in Demand and the Change in Quantity Demanded

Qd

P

D

D1

D2

Right left

The effect of other factors on the demand curveCalled: Change in demand itself

Qd

p

D

p1

p2

Q1Q2

The change in price and quantityCalled: Change in quantity demanded

Shift of Demand VersusShift of Demand VersusMovement Along a Demand Movement Along a Demand CurveCurve

58

• A change in demand is not the same as a change in quantity demanded.

• A higher price causes lower quantity demanded and a move along the demand curve DA.

• Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from DA to DB.

A Change in Demand VersusA Change in Demand Versusa Change in Quantity Demandeda Change in Quantity Demanded

59

To summarize:

Change in price of a good or service leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).

The Impact of a Change in The Impact of a Change in IncomeIncome

60

• Higher income decreases the demand for an inferior good

• Higher income increases the demand for a normal good

The Impact of a ChangeThe Impact of a Changein the Price of Related Goodsin the Price of Related Goods

61

• Price of hamburger rises

• Demand for complement good (ketchup) shifts left

• Demand for substitute good (chicken) shifts right

• Quantity of hamburger demanded per month falls

From HouseholdFrom HouseholdDemand to Market DemandDemand to Market Demand

Demand for a good or Demand for a good or service can be defined for service can be defined for an an individual householdindividual household, , or for a group of households or for a group of households that make up a that make up a marketmarket..

62

Market demandMarket demandMarket demandMarket demand is the sum of is the sum of

all the quantities of a good or all the quantities of a good or service demanded per period by service demanded per period by all the households buying in the all the households buying in the market for that good or service.market for that good or service.

63

From HouseholdFrom HouseholdDemand to Market DemandDemand to Market Demand

Assuming there are only two households in Assuming there are only two households in the market, market demand is derived as the market, market demand is derived as follows:follows:

64

Supply in Product or Output Supply in Product or Output MarketsMarkets

Supply decisions depend on profit potential.

Profit is the difference between revenues and costs.

65

The Supply CurveThe Supply Curve

There are some other terms which refer to supply such as:

1)Supply Law.2)Supply Function.3)Supply Equation. 4)Supply Model.

Quantity supplied

67

• A supply schedule is a table showing how much of a product firms will supply at different prices.

• Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

Supply Schedule

Price (P)Quantity Supplied (Qs)

1080151002012025140301603518040200

The Supply Curve

A supply schedule

PRICE (PER

BUSHEL)

QUANTITY SUPPLIED

(THOUSANDS OF BUSHELS

PER YEAR)$ 2 0

1.75 102.25 203.00 304.00 455.00 45

CLARENCE BROWN'S SUPPLY SCHEDULE

FOR SOYBEANS

70

Price and Quantity Price and Quantity Supplied:Supplied:The Law of SupplyThe Law of Supply

71

• A A supply curvesupply curve is a graph is a graph illustrating how much of a illustrating how much of a product a firm will supply per product a firm will supply per period of time at different period of time at different prices.prices.

Supply CurveSupply Curve

72

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pri

ce o

f so

ybea

ns

per

bu

shel

($)

The Law of SupplyThe Law of Supply

The The law of supplylaw of supply states that states that there is a positive relationship there is a positive relationship between price and quantity of a between price and quantity of a good supplied.good supplied.

This means that supply curves This means that supply curves typically have a positive slope.typically have a positive slope.

73

The Law of SupplyThe Law of Supply

74

0

1

2

3

4

5

6

0 10 20 30 40 50Thousands of bushels of soybeans

produced per year

Pri

ce o

f so

yb

ean

s p

er

bu

sh

el ($

)

Other Determinants of Other Determinants of SupplySupply

1.1. The The priceprice of the good or service. of the good or service.2.2. The The cost cost of producing the good, of producing the good,

which in turn depends on:which in turn depends on:A.A. The The price of required inputsprice of required inputs

(labor, capital, and land),(labor, capital, and land),B.B. The The technologiestechnologies that can be that can be

used to produce the product,used to produce the product,3.3. The The prices of related products.prices of related products.

75

The Main Factors that Cause the Change in Supply and Affect the Supply Curve to Shift to the Right or to the Left

1) Technology Changes 2) Price of Factors of Production

(FoP)3) Number of Sellers 4) Sellers' Expectations5) Tax or Subsidy6) Price of Related Goods Produced

Shift of Supply VersusShift of Supply VersusMovement Along a Supply Movement Along a Supply CurveCurve

77

• A higher price causes higher quantity supplied, and a move along the demand curve.

• A change in determinants of supply other than price causes an increase in supply, or a shift of the entire supply curve, from SA to SB.

Shift of Supply VersusShift of Supply VersusMovement Along a Supply Movement Along a Supply CurveCurve

78

79

• In this example, since the factor affecting supply is not the price of soybeans but a technological change in soybean production, there is a shift of the supply curve rather than a movement along the supply curve.

• The technological advance means that more output can be supplied for at any given price level.

Shift of Supply Curve for SoybeansFollowing Development of a New Seed Strain

80

Shift of Supply Curve for SoybeansFollowing Development of a New Seed Strain

81

To summarize:

Change in price of a good or service leads to

Change in quantity supplied(Movement along the curve).

Change in costs, input prices, technology, or prices of related goods and services

leads to

Change in supply(Shift of curve).

Shift of Supply VersusMovement Along a Supply Curve

From IndividualFrom IndividualSupply to Market SupplySupply to Market Supply

The supply of a good or service can The supply of a good or service can be defined for an individual firm, or be defined for an individual firm, or for a group of firms that make up a for a group of firms that make up a market or an industry.market or an industry.

Market supplyMarket supply is the sum of all the is the sum of all the quantities of a good or service quantities of a good or service supplied per period by all the firms supplied per period by all the firms selling in the market for that good or selling in the market for that good or service.service.

82

From IndividualFrom IndividualSupply to Market SupplySupply to Market Supply

As with market demand, As with market demand, market market supplysupply is the horizontal summation is the horizontal summation of individual firmsof individual firms’’ supply curves. supply curves.

83

Market EquilibriumMarket Equilibrium

MarketMarket equilibriumequilibrium is the is the condition that exists when condition that exists when quantity supplied and quantity supplied and quantity demanded are equal.quantity demanded are equal.

At equilibrium, there is no At equilibrium, there is no tendency for the market price tendency for the market price to change.to change.

84

Market EquilibriumMarket Equilibrium

Only in equilibrium is quantity supplied equal to quantity demanded.

85

• At any price level other than P0, such as P1, quantity supplied does not equal quantity demanded.

Market EquilibriumMarket Equilibrium

86

Excess DemandExcess Demand

Excess demandExcess demand, or , or shortageshortage, is , is the condition that exists when the condition that exists when quantity demanded exceeds quantity quantity demanded exceeds quantity supplied at the current price.supplied at the current price.

87

• When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.

Excess DemandExcess Demand

88

Excess SupplyExcess Supply

Excess supplyExcess supply, or , or surplussurplus, is the , is the condition that exists when condition that exists when quantity supplied exceeds quantity supplied exceeds quantity demanded at the current quantity demanded at the current priceprice..

89

• When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

Excess SupplyExcess Supply

90

Changes in EquilibriumChanges in Equilibrium

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity. 91

Changes in EquilibriumChanges in Equilibrium

Lower demand leads to lower price and lower quantity exchanged.

Lower supply leads to higher price and lower quantity exchanged.

92

Relative Magnitudes of Relative Magnitudes of ChangeChange

93

• The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

Relative Magnitudes of Relative Magnitudes of ChangeChange

94

• When supply and demand both increase, quantity When supply and demand both increase, quantity will increase, but price may go up or down.will increase, but price may go up or down.

Price of Goods and Price Theory

A measurable value is needed in order to measure the rise and fall of supply and demand

Price theory, therefore, charts the movement of measurable quantities over time, and the relationship between price and other measurable variables.

  Role of Governments in Role of Governments in EconomicsEconomics

Governments could intervene in the market in a direct or an indirect way to achieve economic or social goals.

Government’s intervention is to protect both parties in the market: the sellers and the buyers.

2.7.12.7.1 How Can Governments How Can Governments Monitor and Hold PricesMonitor and Hold Prices

1) Using price ceiling or2) Price floor or3) Can provide subsidies or4) Impose taxes

Price CeilingPrice Ceiling

Governments impose maximum prices on some basic products that will force suppliers to sell less than or equal to the equilibrium price

The purpose of imposing a price ceiling is to make sure that the basic products are available to all customers at understandable prices.

The Price CeilingThe Price Ceiling

Effects of price ceiling

If the price ceiling is above the market equilibrium price, there would be no effect; however,

if the price ceiling is below the market equilibrium price, a "shortage" would be created because the quantity demanded will exceed the quantity supplied.

Price Floors

Price floors prohibit prices below a certain minimum amount. This causes surpluses.

When the price for a good is very low, this will affect the firms negatively.

As a result, the government will make an intervention to protect firms, to help them make some profit or to avoid losses

The Price FloorThe Price Floor

Effects of Price FloorEffects of Price Floor

A price floor can be set below the free-market equilibrium price. In this case, the price floor has no practical effect. The government has mandated a minimum price, but the market already bears a higher price

Effects of Price FloorEffects of Price Floor

By contrast, if the price floor is set above the free-market price, it will have a measurable impact on the market. It ensures prices to stay high so product can continue to be produced.

Effects of Price FloorEffects of Price Floor

A price floor which is set above the market equilibrium price has several side-effects, one of which is that consumers find that they must pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely.

For the government policy to be efficient and successful, the government must deal with the supply surplus through the following steps:

1) Buy the surplus from the market and either benefit from it by exporting or using it in producing, or even throwing the surplus in the sea as Brasilia deals with coffee.

For the government policy to be efficient and successful, the government must deal with the supply surplus through the following steps:

2) Increasing customs imposed on importing substitute goods which will increase consumption on goods produced locally.

For the government policy to be efficient and successful, the government must deal with the supply surplus through the following steps:

3) Governmental support to producers such as subsidies to farmers in the form of free transportation and providing credit facilities to encourage consumers to increase consumptions

Effects of Supply and Demand Change on Market

EquilibriumMarket equilibrium could change as a result of other factors change, either demand determinants such as number of consumers, consumer taste, and consumer expectations, or supply determinants such as number of suppliers, prices of production resources, taxes, and governmental subsidies.

The Five Basic Laws of Supply and Demand

1) If demand increases and supply remains unchanged, this leads to higher equilibrium price and quantity.

2) If demand decreases and supply remains unchanged, this leads to lower equilibrium price and quantity.

3) If supply increases and demand remains unchanged, this leads to lower equilibrium price and higher quantity.

4) If supply decreases and demand remains unchanged, this leads to higher equilibrium price and lower quantity.

5) If demand and supply change, the final effect will depend on the magnitude and the direction of the change.

The Effect on Market The Effect on Market Equilibrium when the Number Equilibrium when the Number of Consumers Fallsof Consumers Falls

D2D1

S

P1

P2

Q1 Q2Q

P

E1E2

The Effect on Market The Effect on Market Equilibrium when there is a Equilibrium when there is a

New TechnologyNew Technology  

The Effect on Market Equilibrium The Effect on Market Equilibrium when there is a New Technology when there is a New Technology and More Populationand More Population

The Effect when the Magnitude of Change in Supply is Higher than in

Demand

The Effect on Market Equilibrium The Effect on Market Equilibrium when there is a New Technology when there is a New Technology and More Populationand More Population

The Effect when the Magnitude of Change in Demand is Higher than in

Supply

THE END ofTHE END of CHAPTER 2 CHAPTER 2