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1
The Market Forces of Supply and
Demand
Sakib Bin Amin, Ph.D.
Assistant Professor
School of Business and Economics
North South University
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Demand
Demand refers to how much (quantity) of a product or service is desired by buyers.
The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship.
Economists have a very precise definition of demand. For them demand is the relationship between the quantity of a good or service consumers will purchase and the price charged for that good.
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Demand
Demand refers to the willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period.
A relationship between price and quantity demanded in a given time period, ceteris paribus.
Ceteris paribus is a Latin phrase that means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.”
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Demand
A household’s decision about what quantity of a particular output, or product to demand depends on a number of factors including:
The Price of the product in question.
The Income available to the Household (HH).
The Household’s amount of accumulated wealth.
The prices of other products available to the HH.
The Household’s Tastes and Preferences.
The Household’s Expectations about Future Income, Wealth and Prices.
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Demand schedule
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Demand curve
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Law of Downward-Sloping Demand
When the price of a commodity is raised ( and other things are held constant), buyers tend to buy less of the commodity and vice versa.
Why does quantity demanded tend to fall as price increases?
Substitution Effect: When the price of a good rises, we will substitute other similar goods for it.
Income Effect: The depressing effect of price increases on purchases. When a price goes up, We find ourselves somewhat poorer than we were before. Example: When Gasoline prices double, we have to curb our consumptions.
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Market Demand
Market demand refers to the sum of all individual demands for a particular good or service.
Graphically, individual demand curves are summed horizontally to obtain the market demand curve.
Market demand is the horizontal summation of individual consumer demand curves.
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Market demand curve
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Two Simple Rules for Movements vs. Shifts
Rule One
When an independent variable changes and that variable does not appear on the graph, the curve on the graph will shift.
Rule Two
When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.
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Change in Quantity Demanded versus Change in
Demand
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of the product.
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Changes in Quantity Demanded
0
D1
Price of Cigarettes per Pack
Number of Cigarettes Smoked per Day
A tax that raises the price of cigarettes results in a movement along the demand curve.
A
C
20
2.00
$4.00
12
13
Change in Quantity Demanded versus Change in
Demand
Change in Demand
A shift in the demand curve, either to the left or right.
Caused by a change in a determinant other than the price.
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Shift in Demand Curve
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Determinants of Demand
Market price
Consumer income
Prices of related goods
Tastes
Expectations of Future Price and Income
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Consumer Income Normal Good
$3.00
2.50
2.00
1.50
1.00
0.50
2 1 3 4 5 6 7 8 9 10 12 11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Increase in demand
An increase in income...
D1
D2
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Consumer Income Inferior Good
$3.00
2.50
2.00
1.50
1.00
0.50
2 1 3 4 5 6 7 8 9 10 12 11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Decrease in demand
An increase in income...
D1 D2
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Prices of Related Goods
Substitutes & Complements
When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. On the other hands an increase in the price of one results in an increase in the demand for the other.
When a fall in the price of one good increases the demand for another good, the two goods are called complements. an increase in the price of one results in a decrease in the demand for the other.
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Change in the price of a substitute good
Price of coffee rises:
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Change in the price of a
complementary good
Price of DVDs rises:
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Demand and the # of buyers
An increase in the number of buyers results in an increase in demand.
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Expectations
A higher expected future price will increase current demand.
A lower expected future price will decrease current demand.
A higher expected future income will increase the demand for all normal goods.
A lower expected future income will reduce the demand for all normal goods.
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Change in Quantity Demanded
versus Change in Demand
Variables that Affect Quantity Demanded
A Change in This Variable . . .
Price Represents a movement along the demand curve
Income Shifts the demand curve
Prices of related
goods
Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of buyers
Shifts the demand curve
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Supply
the relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.
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Supply
Quantity supplied is the amount of a good that sellers are willing and able to sell.
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Supply schedule
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Law of Supply
The law of supply states that there is a direct (positive) relationship between price and quantity supplied.
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Change in Quantity Supplied
1 5
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
S
1.00 A
C $3.00 A rise in the
price of ice
cream cones
results in a
movement along
the supply
curve.
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Change in Supply Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
S1 S2
S3
Increase in Supply
Decrease in Supply
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Market Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.
Graphically, individual supply curves are summed horizontally to obtain the market supply curve.
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Determinants of Supply
Market price
Input prices
Technology
Expectations
Number of producers
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Change in Quantity Supplied
versus Change in Supply
Variables that Affect Quantity Supplied
A Change in This Variable . . .
Price Represents a movement along the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
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Price of inputs
As the price of a inputs rises, profitability declines, leading to a reduction in the quantity supplied at any price.
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Technological improvements
Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.
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Expectations and supply
An increase in the expected future price of a good or service results in a reduction in current supply.
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Increase in # of sellers
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Supply
Demand
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
Equilibrium of
Supply and Demand
2 1 3 4 5 6 7 8 9 10 12 11 0
$3.00
2.50
2.00
1.50
1.00
0.50
Equilibrium
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Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
2 1 3 4 5 6 7 8 9 10 12 11 0
$3.00
2.50
2.00
1.50
1.00
0.50
Supply
Demand
Surplus
Excess Supply
If the price exceeds the equilibrium price,
a surplus occurs:
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Excess Demand
Quantity of Ice-Cream Cones
Price of Ice-Cream
Cone
$2.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Supply
Demand
$1.50
Shortage
If the price is below the equilibrium a shortage
occurs:
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Three Steps To Analyzing
Changes in Equilibrium
Decide whether the event shifts the supply or demand curve (or both).
Decide whether the curve(s) shift(s) to the left or to the right.
Examine how the shift affects equilibrium price and quantity.
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Demand rises
42
Demand falls
43
Supply rises
44
Supply falls
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How an Increase in Demand Affects the
Equilibrium
Price of Ice-Cream
Cone
2.00
0 7 Quantity of Ice-Cream Cones
Supply
Initial equilibrium
D1
1. Hot weather increases the demand for ice cream...
D2
2. ...resulting in a higher price...
$2.50
10 3. ...and a higher quantity sold.
New equilibrium
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
46
S2
How a Decrease in Supply Affects
the Equilibrium
Price of Ice-Cream
Cone
2.00
0 1 2 3 4 7 8 9 11 12 Quantity of Ice-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reduces the supply of ice cream...
New equilibrium
2. ...resulting in a higher price...
$2.50
3. ...and a lower quantity sold.
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Price ceiling
Price ceiling - legally mandated maximum price
Purpose: keep price below the market equilibrium price
Examples:
rent controls
price controls during wartime
gas price rationing in 1970s
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Price ceiling (continued)
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Price floor
price floor - legally mandated minimum price
designed to maintain a price above the equilibrium level
examples:
agricultural price supports
minimum wage laws
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Price floor (continued)