demand supply - micro economics

8/6/2019 Demand Supply - Micro Economics

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Theory of Supply and Demand Every economy must choose the

market basket of goods:

-what goods to be produced- how goods to be produced

- for whom they will be produced.

The answer of these questions arefound in the Theory of Supply anddemand.


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Theory of supply and demand The theory of supply and demand shows

how consumer preferences determineconsumer demand for commodities.

The purpose of this lecture is to show howsupply and demand operates in competitivemarkets for individual commodities. We

shall study: demand curve Supply curve

How the market price is determined?


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Demand Demand is the quantity of a good people will

plan to purchase over a given time and at aparticular price

The quantity of a good a person will plan topurchase will depend on:

- Preferences (tastes)

- Price of the good

- Prices of other goods

- Expected future prices

- Income

In the aggregate, demand will also depend on:

- Population and demographics


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The Demand Schedule This relationship

between price

and quantitybought is calledthe demandschedule, or

the demandcurve.

Price Quantitydema

-nded

A

B

C

DE

5

4

3

21

9

10

12

1520


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The demand curveA, B and C are points on thedemand curve. Each point onthe curve reflects a directcorrelation between quantitydemanded (Q) and price (P).

So, at point A, the quantitydemanded will be Q1 and theprice will be P1, and so on.The demand relationshipcurve illustrates the negativerelationship between price

and quantity demanded. Thehigher the price of a goodthe lower the quantitydemanded (A), and thelower the price, the more thegood will be in demand (C).


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Downward sloping Substitution effect: When price of

one commodity rises, people tend to

substitute other similar goods for it.For example, if the price of beefincreases, people eat more chicken.

Income effect: When prices go up,one finds himself somewhat poorerthan before.


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Demand Curves Demand curve

P = 20 - 2/3QorQ = 30 - 3/2P

P

Q


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Changes in Demand Shift in a demand curve is a Change in

Demand

Change in tastes or preferences

Change in the prices of other goods- substitutes

- complements

Changes in expected future prices

Changes in income- normal goods

- inferior goods

Changes in population/demographics


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A Decrease in Demand Price of a substitute falls

Price of a complement rises

Expected future price falls

Income falls (normal good)

or income rises (inferior good)

Preferences move away from

the good

Population decreases

A decrease in demandaleftward shift

P

QD

D


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Market Demand Schedule Market demand is the sum of all

individual demands at each possible

price. Graphically, individual demand curves

are summed horizontally to obtainthe market demand curve.

Assume the ice cream market hastwo buyers as follows


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03.00

100.50

120.00

CatherinePrice of Ice-

cream Cone ($)

Table 4-2: Market demand as the Sumof Individual Demands

+

1

6

7

Nicholas

1

22.50

42.00

61.50

81.00

2

3

4

5

4

7

10

1316

19

Market

=


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Movement along the curve and

shift of the curve Movement along the curve means that other things

(such as income) were held constant when pricechanged (Own price of a commodity) i.e. moving to adifferent point on the same demand curve after a

price change.

Shifts in Demand: When there are changes in factorsother than a goods own price which affect thequantity purchased, we call these changes shifts in

demand. Demand increases (or decreases ) when t

hequantity demanded at each price increases (or

decreases).


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Table 4-3: The Determinants ofQuantity Demanded


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Price ofCigarettes,

per Pack.

Number of Cigarettes

Smoked per Day

D2

A policy to discouragesmoking shifts the demandcurve to the left.

0 20

$2.00

D1

A

10

B

Figure 4-4 a): A Shifts in the DemandCurve


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Price ofCigarettes,

per Pack.

Number of Cigarettes

Smoked per Day0 20

$2.00

D1

A

A tax that raises the priceof cigarettes results in amovements along thedemand curve.

C

12

$4.00

Figure 4-4 b): AMovement Along theDemand Curve


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Supply Supply is the quantity of a good firms

plan to produce over a given time and

at a particular price The firm has to have the resources

and technology to produce the good

The firm has to think it can producethe good at a profit


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Supply The amount of any particular good or

service supplied by a firm will depend on:- The price of the good

- The prices of inputs needed to producethe good- The available technology- Prices of other goods- Expected future prices

In the aggregate, supply will also dependon:- The number of firms in the market


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The Law of Supply

Other things remaining the same, thehigher the price of a good, the

greater will be the quantity supplied Higher prices mean it will be

profitable to expand production

With rising marginal costs higherprices are required for firms to bewilling to increase production


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Supply schedule and supply curve

The supply schedule

(and supply curve )

for a commodity shows

the relationship between

its market price and the

amount of that commodity

that producers are willing

to produce and sell, otherthings held constant.

Price Quantity

Supplie

d

A

B

C

DE

5

4

3

21

18

16

12

70


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Supply curve A, B and C arepoints on thesupply curve.Each point on thecurve reflects a

direct correlationbetweenquantity supplied(Q) and price(P). At point B,the quantity

supplied will beQ2 and the pricewill be P2, andso on.


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Supply Curves Supply Curve

P = c + d Q

OrQ = (-c + P) 1/d

P

Q

S


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Changes in Supply

Shift in a supply curve is a Change inSupply

Change in input prices Changes in technology

Changes in expected future prices

Changes in the number of firmsentry and exit of firms


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An Increase in Supply

Price of inputs fall

More efficient technology

Expected future price fall

(i.e natural resource production)

Number of firms in the

market grows

An increase in supply

a rightward shift in the

supply curve

S

S

P

Q


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ADecrease in Supply

Price of inputs rises

Loss of technological

knowledge

Expected future price rises

Number of firms in the

market shrinks

A decrease in supply

a leftward shift in the supply

curve

S

S

P

Q


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Movements along the curve


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Shifts of t

he curve

Shift in supply for apple

If the price for an apple was $2 andthe quantity supplied decreased fromQ1 to Q2, then there would be a shiftin the supply of apple.

Like a shift in the demand curve, ashift in the supply curve implies thatthe original supply curve has changed,meaning that the quantity supplied iseffected by a factor other than price.

A shift in the supply curve wouldoccur if, for instance, a naturaldisaster caused a mass shortage ofapple, which would force to supplyless apple for the same price.


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Equilibrium When supply and demand are equal (i.e. when the

supply function and demand function intersect) theeconomy is said to be at equilibrium.

At this point, the allocation of goods is at its most

efficient because the amount of goods being suppliedis exactly the same as the amount of goods beingdemanded.

Thus, everyone (individuals, firms, or countries) issatisfied with the current economic condition. At thegiven price, suppliers are selling all the goods thatthey have produced and consumers are getting all thegoods that they are demanding.


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Equilibrium As you can see on thechart, equilibriumoccurs at theintersection of thedemand and supply

curve, which indicatesno allocativeinefficiency.

At this point, the priceof the goods will be P*

and the quantity will beQ*. These figures arereferred to asequilibrium price andquantity.


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Disequilibrium Excess SupplyIf the price is set too high,excess supply will be createdwithin the economy and therewill be allocative inefficiency.

At price P1 the quantity ofgoods that the producerswish to supply is indicated byQ2. At P1, however, thequantity that the consumerswant to consume is at Q1, aquantity much less than Q2.Because Q2 is greater thanQ1, too much is beingproduced and too little isbeing consumed. Thesuppliers are trying toproduce more goods, whichthey hope to sell to increaseprofits, but those consumingthe goods will find theproduct less attractiveand purchase less becausethe price is too high.


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Disequilibrium

Excess Demand

Excess demand is created when priceis set below the equilibrium price.Because the price is so low, toomany consumers want the goodwhile producers are not making

enough of it. In this situation, at price P1, the

quantity of goods demanded byconsumers at this price is Q2.Conversely, the quantity of goodsthat producers are willing to produceat this price is Q1. Thus, there aretoo few goods being produced tosatisfy the wants (demand) of theconsumers.

However, as consumers have tocompete with one other to buy thegood at this price, the demand willpush the price up, making supplierswant to supply more and bringingthe price closer to its equilibrium.


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Equilibrium

Demand curve P = a bQd Supply Curve P = c + dQs

Equilibrium Qd = Qs = Q*and P = P*

P* = a bQ*

P* = c + dQ*

Two equations and two unknownscan solve


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Equilibrium

Demand curve P = 800 2Qd Supply Curve P = 200 + 1Qs Solve for Q*

800 2Q* = 200 + 1Q*

600 = 3Q*

Q* = 200

Solve for P*

P* = 800 400

P* = 400


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Equilibrium Price and QuantityChanges

P

Q

S

D

D

E

E

P

P

Q Q

Rightward shift indemand leads to amovement along thesupply curve.P and Q both rise.

A change in demand with a given supplycurve


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A change in supply with a given demandcurve

P

Q

S

D

EP

P

Q Q

A rightward shift insupply leads to amovement along thedemand curve.P falls and Q rises.

S

E


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A change in supply and demand samedirections

P

Q

S

D

EP

Q Q

A rightward shift in bothdemand and supplyleads to a higher Q.P may rise, fall, or stay

the same.

S

E

D


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A change in supply and demand opposite directions

P

Q

S

D

P

A rightward shift insupply and a leftwardshift in demand leads toa lower P. Q may rise,fall, or stay the same.

.

SE

DP

Q

E

demand supply - micro economics

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