demand and supply analysis (economics) lecture notes

Demand & Supply Analysis

Organisation of Presentation Rational of studying Demand Analysis Shift in Demand Curve and Movement along

the demand curve Factors affecting Demand Law of Demand Supply of commodity Factors affecting Supply Equilibrium/Disequilibrium in the Market Issues for Discussion

Why do we study Demand Analysis?Success/ failure of a firm determined by total revenue which depends on demands of consumers.

Demand is essential for creation, survival and profitability of a firm

Mere efficient production technique and/or effective management may not ensure survival of a firm if demand for the product is not sustained.

Demand Analysis Demand Summarizes the factors affecting the buyer’s behavior

(buyer is one who can buy).

Demand for a commodity is determined by

Consumer’s Desire to Acquire it

Willingness to pay for it

Ability to purchase the commodity.

Issues for Discussion Miser’s Desire for a commodity (Car) and

Ability to Pay-Is it considered as demand?

Poor guy wants to have a luxury Car

A rich guy has desire to have some commodity which he can afford and desire to have it.

Issues for discussion A miser’s desire for and ability to pay for a

Car-Not considered as demand as s/he is not inclined to pay for it

Poor guy- desire and willingness to pay for a Motorbike-Not demand as he does not have enough purchasing power.

An individual has will and purchasing power but does not have desire to have it-Not demand.

Derived and Autonomous Demand If demand for a product is determined by the

demand for some parent product-Derived Demand

(Demand for cement depends on growth of Real Estate). Demand for Producer’s good is an example of derived demand.

Autonomous demand is not derived -where the demand is independent of all other demands-it is somewhat difficult to identify.

Derived demand…..Consumer goods used for final consumption (food, cloth) can be considered as direct demand while demand for producer’s good is considered as Derived demand.

(Distinction between consumer’s good and producer’s good is somewhat arbitrary. Steel used to make utensil-consumer goods. Steel used for making machine to be used in factory-producer’s good).

Market: any institution, mechanism, or arrangement which facilitates exchange.

A market consists of a group of buyers and sellers of a particular goods or service.– Buyers determine

demand...– Sellers determine

supply...

Market Type: A Competitive Market

A Competitive Market is a market:–with many buyers and sellers–that is not controlled by any one

person–in which a narrow “range of prices”

are established that buyers and sellers act upon

Market Type: Perfect & OthersPerfectly Competitive:

– Homogeneous Products– Buyers and Sellers are Price Takers

Monopoly:– One Seller, controls price

Oligopoly:– Few Sellers, not aggressive competition

Monopolistic Competition:– Many Sellers, differentiated products

The Concept of Demand. . .

Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at alternative prices for a given period.

P

Q

Individual Demand Schedule(Cathy’s Demand for Cone Ice Cream)

Price PerCone

(P)

DailyQuantity

(Q)

$3.00 0$2.50 2$2.00 4$1.50 6

Individual Demand Curve(Cathy’s Demand for Cone Ice Cream)

P($ Per Cone)

Q (Cone Per Day)

$2.50$2.00$1.50

2 4 6

Market Demand ScheduleMarket demand is the sum of all individual

demands at each possible price.Assume the ice cream market has two

buyers as follows:Price Per Cone Cathy Nick Market Demand $1.00 8 + 5 = 13 $1.50 6 + 4 = 10 $2.00 4 + 3 = 7

Market Demand Curve(All Buyers)

P($ Per Cone)

Q (Cone Per Day)

$2.00$1.50$1.00

7 10 13

Why demand Curve Slopes downwards? When price of X falls, the commodity becomes

cheaper as compared to other commodities (substitutes: Y), assuming price of Y remain constant. So, X can be substituted for Y- SUBSTITUTION EFFECT

A fall in price, increases REAL INCOME (purchasing power) of the consumer, ceteris paribus. It motivates them to buy more of X- Income Effect

*Income effect+ Substitution effect= Price effect

Determinants of Demand

What factors determine how much ice cream you will buy?

Determinants of Demand

Product’s Own PriceConsumer IncomePrices of Related GoodsTastesExpectationsNumber of Consumers

Determinant of Demand: Product’s Own Price

Law of Demand: There exists an

inverse relationship

between Price and Quantity Demanded.

P

Q

Determinant of Demand: Product’s Own Price

Law of Demand: There exists an

inverse relationship

between Price and Quantity

Demanded ceteris paribus.

P

Q

As PQ

Ceteris Paribus . . .

...implies that all the relevant variables (e.g. determinants of demand) are held constant, except the one(s) being studied at the time.

Determinant of Demand: Income

As income increases the demand for a normal good will increase.

Examples? Demand for motor-

bike, pucca house, jewelry, etc.

P

Q

Determinant of Demand: Income

As income increases the demand for an inferior good will decrease.

P

Q

Determinant of Demand: Prices of Related Goods

When the fall in price of one good reduces the demand for another good, the two goods are substitutes.

Examples?

Determinant of Demand: Prices of Related Goods

When the fall in price of one good increases the demand for another good, the two goods are complements.

Examples? Car & Petrol

Issues for DiscussionIs there ALWAYS an Inverse Relationship exists between Price and Quantity Demanded?

Is it applicable for LUXURY GOODS?

Is this theory applicable for Inferior Good?

Normal commodity: If demand changes in the same direction as income.Inferior Commodity: If demand of a commodity decreases when income increases, the commodity is called inferior (A. Koutsoyiannis)Ex. Demand for Bazra goes down with rise in income(Does price play an active role?)

Giffen Goods: It is special case of inferior good. It is rare in practice. In this case income effect is positive and very strong. Law of demand does not hold good as demand curve has a positive slope).

Income effect per se is positive for normal good (as income increases, more of the same commodity is demanded. But it is said that income effect is negative for normal good because we relate change in purchasing power of money income to change in price of x.

Does law of demand hold good for luxury items?

(Luxury for a poor can be a necessary item for a Rich)

Rich can afford to have luxury items even when the price is going up.Wrong perception: Higher the price better the quality.

Demand for Obsolete/out of fashion goods

Even if price falls, quantity demanded does not rise (Ex. Radio is sold at cheaper rate yet people opt for TV)

Price Expectation: Even price falls, people expect it fall further and vice-versa (Exp: Stock Market)

If consumers feel Price can go up further on account of likely shortage of commodity, then they prefer to purchase it at the prevailing higher price. In contrast, expectation of glut in future leads to fall in demand in the current period.

Change in Quantity Demanded vs. Change in Demand

Change in Quantity DemandedMovement along the demand curve. Caused by a change in the Price of the product.

Change in DemandA shift in the demand curve, either to

the left or right. Caused by changes in Non-Price Factors.

Changes in Quantity DemandedPrice

Quantity

$2.00

7


Quantity

$2.00

7

$1.00

13


Quantity

$2.00

7

$1.00

13

Caused by a changein Price

Change in DemandPrice

Quantity

$2.00

7


$2.00

7

Quantity

10


$2.00

7

Quantity

10

Caused byNon-PriceFactors:Income,Tastes...

The Concept of 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.

P

Q

Law of Supply

The law of supply says the quantity supplied and price of the commodity are positively related, ceteris paribus.

Higher quantity will be supplied at higher prices and lower quantity can be supplied at lower prices.

Individual Supply ScheduleBen’s Store: Ice Cream ConesPrice Per

Cone(P)

DailyQuantity

(Q)

$3.00 5$2.50 4$2.00 3$1.50 2

PPricePer Cone

Q # Cones Per Day

$2.50$2.00$1.50

2 3 4

Individual Supply CurveBen’s Store: Ice Cream Cones

Market Supply ScheduleMarket supply is the sum of all individual

supplies at each possible price.Assume the ice cream market has two

firms as follows:Price Per Cone Ben’s Jerry’s IceMart Market Supply $0.50 0 + 0 = 0 $1.00 1 + 0 = 1 $1.50 2 + 2 = 4 $2.00 3 + 4 = 7

PPricePer Cone

Q # Cones Per Day

$2.00$1.50$1.00

1 4 7

Market Supply CurveAll Sellers

Determinants of Supply

Product’s Own PriceInput PricesTechnologyExpectations Number of Producers

Determinant of Supply: Market Price

Law of Supply There exists a direct (positive)

relationship between Price and Quantity

Supplied.

P

Q

Change in Quantity Supplied vs. Change in Supply

Change in Quantity SuppliedMovement along the supply curve. Caused by a change in the Price of the product.

Change in SupplyA shift in the supply curve, either to the left or right. Caused by changes inNon-Price Factors

Changes in Quantity SuppliedPrice

Quantity

$2.00

3


Quantity

$2.00

3

$1.00

1


Quantity

$2.00

3

$1.00

1

Caused bya change in Price

Change in SupplyPrice

Quantity

$2.00

3


Quantity

$2.00

3 6


Quantity

$2.00

3 6

Caused byNon-PriceFactors:Technology,Input Prices

Supply and Demand Together

Equilibrium Price The price at which the supply and demand

curve intersect. Quantity Supplied and Quantity Demanded are equal.

Equilibrium Quantity The quantity at which the supply and

demand curve intersect.

Forces of Demand. . .

Price

Quantity

Forces of Demand and Supply. . .

Price

Quantity

Forces of Demand and Supply At RestMarket Equilibrium

Price

Quantity

$2.00

7

Actions of buyers and sellers that move toward equilibrium

Excess SupplyPrice is above equilibrium price, therefore

producers are unable to sell all they want at the going price.

Excess DemandPrice is below equilibrium price, therefore

consumers are unable to buy all they want at the going price.


Price

Quantity

$2.50

$2.00

4 10


Price

Quantity

$2.50

$2.00

4 10

Excess Supply = 6 cones

7


Price

Quantity

$2.00

$1.50

4 7 10


Price

Quantity

$2.00

$1.50

4 7 10

ExcessDemand=6 cones

Comparative Static: Analyzing Changes in Equilibrium

Determine if an event shifts supply curve, the demand curve, or both.

Determine if curve(s) shift to left or right.

Determine how the shift affects equilibrium price and quantity.

Example Event: Heat Wave Product: Ice Cream Cones

Heat Wave Affects Buyers (Demand)

Price

Quantity

P1

Q1

Heat Wave Will Cause:“Increase in Demand”

Price

Quantity

P1

Q1

P2

Q2

An Increase in Demand: Demand Shifts Right

Price

Quantity

P1

Q1

P2

Q2

An Increase in Demand: Demand Shifts Right

Price

Quantity

P1

Q1

P2

Q2

AsDemandP Q

Changes in EquilibriumFour Principles

An Increase in Demand will cause:Pe Qe

A Decrease in Demand will cause:Pe Qe

An Increase in Supply will cause:Pe Qe

A Decrease in Supply will cause:Pe Qe

Concluding Thoughts. . .

Market economies harness the forces of supply and demand. . .

Supply and Demand together determine the prices of the economy’s different goods and services. . .

Prices in turn are the signals that guide the allocation of resources.

Thank u

demand and supply analysis (economics) lecture notes

Education