the market forces of supply and demand1

8/3/2019 The Market Forces of Supply and Demand1

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THE

MARKETFORCES OF

SUPPLY ANDDEMAND


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MARKETS AND COMPETITION

The terms supply and demand refer to

the behaviour of peopleA market is a group of buyers andsellers

Buyers determine demand... Sellers determine supply


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COMPETITION: PERFECT OR OTHERWISE

Perfectly Competitive: Buyers and Sellers are Price Takers

Monopoly: One Seller, controls price


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DEMAND DEFINED

A schedule or a curve that shows the

various amounts of a product thatconsumers are willing and able topurchase at each of a series of possible

prices.


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LAW OF DEMAND

As Price Falls Quantity Demanded Rises

As Price Rises Quantity Demanded Falls

An inverse relationship exists between price and quantity demanded


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TABLE 1 : CATHERINES DEMAND SCHEDULE

03.00

22.50

42.00

61.50

81.00

100.50

120.00

Quantity of conesDemanded

Price of Ice-creamCone ($)


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FIGURE 1 : CATHERINES DEMAND CURVE Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

2 4 6 8 10 120

$3.00

2.50

2.00

1.50

1.00

0.50


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03.00

100.50

120.00

CatherinePrice of Ice-creamCone ($)

TABLE 2: MARKET DEMAND AS THE SUM OF INDIVIDUAL DEMANDS

+

1

6

7

Nicholas

1

22.50

42.00

61.50

81.00

2

3

4

5

4

7

10

13

16

19

Market

=


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Price of Ice-

Cream Cone


D3

D1 D2

Decrease indemand

Increase indemand

FIGURE 2: SHIFTS IN THE DEMAND CURVE


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DETERMINANTS OF DEMAND

IncomeNormal (Superior) & Inferior Goods

Prices of Related GoodsSubstitutes & ComplementsTastes

ExpectationsNumber of Buyers


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Price of Cigarettes,

per Pack.

Number of Cigarettes Smoked per Day

D2

A policy to discouragesmoking shifts thedemand curve to the left .

0 20

$2.00

D1

A

10

B

SHIFT VERSUS MOVEMENT ALONG DEMAND CURVEFIGURE 3-A): A SHIFTS IN THE DEMAND CURVE


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Price of

Cigarettes,per Pack.

Number of CigarettesSmoked per Day

0 20

$2.00

D1

A

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

C

12

$4.00

FIGURE 3-B): A MOVEMENT ALONG THE DEMAND CURVE


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TABLE 3: THE DETERMINANTS OFQUANTITY DEMANDED


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SUPPLY DEFINED

Supply is a schedule or a curveshowing the amounts of a productthat producers are willing and able

to make available for sale at each of a series of possible prices.


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LAW OF SUPPLY

As Price Rises

Quantity Supplied Rises

As Price Falls

Quantity Supplied Falls

A direct relationship exists between price and quantity supplied


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TABLE 4: BENS SUPPLY SCHEDULE

53.00

42.50

32.00

21.50

11.00

00.50

00.00

Quantity of conesSuppliedPrice of Ice-creamCone ($)


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Price of Ice-Cream Cone

Quantity of Ice-

Cream Cones

6 8 10 120 2

1.50

1.00

1

2.00

3 4

$3.00

2.50

5

0.50

FIGURE 4: BENS SUPPLY CURVE


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53.00

00.50

00.00

BenPrice of Ice-creamCone ($)

TABLE 5: MARKET SUPPLY AS THE SUM OFINDIVIDUAL SUPPLIES

+

8

0

0

Nicholas

13

42.50

32.00

21.50

11.00

6

4

2

0

10

7

4

1

0

0

Market

=


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Price of Ice-

Cream Cone


S3

S2 S1

Decrease insupply

Increase insupply

FIGURE 5: SHIFTS IN THE SUPPLY CURVE


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DETERMINANTS OF SUPPLY

Input Prices

TechnologyExpectations

Number of Sellers


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TABLE 6: THE DETERMINANTS OF QUANTITYSUPPLIED


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SUPPLY AND DEMAND TOGETHER

Equilibrium refers to a situation in which the price

has reached the level where quantity suppliedequals quantity demanded.


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EQUILIBRIUM

Equilibrium Price The price that balances quantity supplied and quantitydemanded.On a graph, it is the price at which the supply and demandcurves intersect.

Equilibrium Quantity The quantity supplied and the quantity demanded at theequilibrium price.On a graph it is the quantity at which the supply anddemand curves intersect.


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At $2.00, the quantity demanded is equal tothe quantity supplied!

Demand Schedule Supply Schedule

EQUILIBRIUM


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Equilibriumprice

Demand

Supply

$2.00

6 8 100

Equilibrium

Equilibriumquantity


Price of Ice-

Cream Cone

421 3 5 7 9 11

FIGURE 6: THE EQUILIBRIUM OF SUPPLY ANDDEMAND


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NOT IN EQUILIBRIUM

Surplus When price > equilibrium price, then quantity supplied > quantitydemanded.

There is excess supply or a surplus.Suppliers will lower the price to increase sales, thereby movingtoward equilibrium .

Shortage When price < equilibrium price, then quantity demanded > thequantity supplied.

There is excess demand or a shortage.Suppliers will raise the price due to too many buyers chasingtoo few goods, thereby moving toward equilibrium.


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Demand

Supply

$2.00

6 8 100 Quantity of Ice-Cream Cones


421 3 5 7 9 11

$2.50

Surplus

QuantityDemanded

QuantitySupplied

FIGURE 7-A): EXCESS SUPPLY


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Demand

Supply

$2.00

6 8 100 Quantity of Ice-Cream Cone


421 3 5 7 9 11

$1.50

Shortage

QuantitySupplied

QuantityDemanded

FIGURE 7-B): EXCESS DEMAND


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THREE STEPS TO ANALYZING CHANGES INEQUILIBRIUM

Decide whether the event shifts the supply or demand curve (orboth).Decide whether the curve(s) shift(s) to the left or to the right.Use the supply-and-demand diagram to see how the shift affectsequilibrium price and quantity .Example: A Heat Wave

FIGURE 8: HOW AN INCREASE DEMAND


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D1

Supply

$2.00

6 100 Quantity of Ice-Cream Cone


421 3 5 7 11

D2

$2.50

1. Hot weather increases thedemand for ice cream

2. resulting in ahigher price

3. and a higher quantitysold.

New equilibrium

Initialequilibrium

FIGURE 8: HOW AN INCREASE DEMANDAFFECTS THE EQUILIBRIUM

FIGURE 9: HOW A DECREASE SUPPLY


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Demand

S1

$2.00

100 Quantity of Ice-Cream Cones


421 3 7 11

S2

$2.50

1. An earthquake reduces the supplyof ice cream

2. resulting in ahigher price

3. and a lower quantitysold.

New equilibrium

Initial equilibrium

FIGURE 9: HOW A DECREASE SUPPLYAFFECTS THE EQUILIBRIUM

FIGURE 10 A) A SHIFT IN BOTH SUPPLY


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D1

S1

0 Quantity of Ice-Cream Cone

Price of Ice-

Cream Cone

Q1

D2

Large increasein demand

P 2

S2

Q 2

Newequilibrium

Small decreasein supply

Initial equilibriumP 1

FIGURE 10-A): A SHIFT IN BOTH SUPPLYAND DEMAND

FIGURE 10 B) A SHIFT IN BOTH SUPPLY


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D1

S1

0 Quantity of Ice-Cream Cone

Price of Ice-

Cream Cone

Q1

D2

Large decrease

in supply

P 2

S2

Q2

Newequilibrium

Small increasein demand

Initial equilibrium P 1

FIGURE 10-B): A SHIFT IN BOTH SUPPLYAND DEMAND


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The Concept of Elasticity

Elasticity is a measure of howmuch buyers and sellers respond tochanges in market conditions.

Elasticity allows us to analyzesupply and demand with greaterprecision.


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ELASTICITY OF DEMAND AND SUPPLY

Price Elasticity of Demand (Ep)

Calculating Percentage ChangeSignificance of Price Elasticity of Demand (Ep)Determinants of Price Elasticity of Demand (Ep)


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THE PRICE ELASTICITY OF DEMAND

It measures how much the quantity demandedresponds to a change a price.Demand for a good is elastic if the quantitydemanded responds substantially to changes inthe price.Demand is said to be inelastic if the quantitydemanded responds only slightly to changes inthe price.

COMPUTING THE PRICE ELASTICITY OF


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COMPUTING THE PRICE ELASTICITY OFDEMAND

The price elasticity of demand is the change inquantity demanded divided by the percentagechange in price.

priceinchangePercentagedemandedquantityinchangePercentage

D E


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MIDPOINT METHOD

Midpoint method is a better way to calculatepercentage changes and elasticities.

2112

21

12

2

1

2

1

PP

PP

QQ

QQ

E


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PERFECTLY INELASTIC DEMAND

We say thatdemand is perfectlyinelastic when a1% change in theprice would resultin no change inquantity demanded.

Price

Quantity

PerfectlyInelasticDemand(elasticity =0)


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PERFECTLY ELASTIC DEMAND

We say thatdemand is perfectlyelastic when a 1%change in the pricewould result in aninfinite change inquantity demanded.

Price

Quantity

Perfectly Elastic Demand

(elasticity = )


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PRICE ELASTICITY OF DEMAND

From Formula Ep = % Change in Qd% Change in Price

If Price Elasticity of Demand > 1, demand is elasticIf Price Elasticity of Demand = 1, demand is unit elasticIf Price Elasticity of Demand < 1, demand is inelastic


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SLOPE OF THE DEMAND CURVE

DP is thechange in price.(DP


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CROSS ELASTICITY OF DEMAND

A measure of the extent to which the demand for a goodchanges when the price of a substitute or complementchanges, ceteris paribus

% Change in Quantity Demanded% Change in Price of one of its

substitutes or complements


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INCOME ELASTICITY OF DEMAND

A measure of the extent to which the demand fora good changes when income changes, ceterisparibus

% Change in Quantity Demanded% Change in Income


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SIGNIFICANCE OF PRICE ELASTICITY OFDEMAND

Profit maximization requires that business set a price that willmaximize the firms profit Elasticity tells the firm how much control it has over using price toraise profitIf Ep > 1, then the % Change in Qd > % Change is Price anddemand is said to be elastic

An increase in price will reduce total revenue

A decrease in price will increase total revenue


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SIGNIFICANCE OF PRICE ELASTICITY OFDEMAND

If Ep < 1, then the % change in Qd < % change in price, anddemand is said to be inelastic

An increase in price will increase total revenue

A decrease in price will decrease total revenue

If Ep = 1, then the % change in Qd = % change in Price, anddemand is said to be unit elastic

An increase in price will have no impact on total revenueA decrease in price will have no impact on total revenue


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PRICE ELASTICITY OF SUPPLY

It measures how much the quantity suppliedresponds to changes in the price.

Supply of a good is said to be elastic if thequantity supplied responds substantially tochanges in the price.Supply is said to be inelastic if the quantitysupplied responds only slightly to changes inthe price.


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COMPUTING THE PRICE ELASTICITY OF SUPPLY

The price elasticity of supply is theproportional change in quantity demandedrelative to the proportional change in price.

priceinchangePercentagesuppliedquantityinchangePercentage

S E


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PERFECTLY INELASTIC SUPPLY

We say that supplyis perfectlyinelastic when a1% change in theprice would resultin no change inquantity supplied.

Price

Quantity

PerfectlyInelasticSupply(elasticity =0)


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PERFECTLY ELASTIC SUPPLY

We say that supplyis perfectly elasticwhen a 1% changein the price wouldresult in an infinitechange in quantitysupplied.

Price

Quantity

Perfectly Elastic Supply (elasticity =

)


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COMPUTING PRICE ELASTICITY OF SUPPLY

Percentage change in quantity suppliedPercentage change in price

If Price Elasticity of Supply > 1, Supply is elasticIf Price Elasticity of Supply = 1, Supply is unit elasticIf price elasticity of supply< 1, Supply is inelastic


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INFLUENCES OF PRICE ELASTICITY OF


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INFLUENCES OF PRICE ELASTICITY OFSUPPLY

Storage Possibilities

The better the storability, the more elastic is the priceelasticity of supply


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DETERMINANTS OF ELASTICITY

Time period The longer the time underconsideration the more elastic a good is likely to beNumber & closeness of substitutes The greaterthe number of substitutes, the more elastic.The proportion of income taken up by the product The smaller the proportion the more inelastic.

Luxury or Necessity For example, addictivedrugs.


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IMPORTANCE OF ELASTICITY

Relationship between changes in price andtotal revenueImportance in determining what goods to tax(tax revenue)

Importance in analysing time lags inproductionInfluences the behaviour of a firm


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THANK YOU

the market forces of supply and demand1

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