Demand & Supply

The Concept of Market Division of individual economic units  Buyers and Sellers Buyers  consumers, firms. Sellers  producers of goods and services Market  an institution/mechanism bringing that brings together buyers and sellers Not limited to geographical boundaries, exists in many forms Interaction of buyers and sellers  Market Price of a good or collection of goods

The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy.

The Circular Flow of Economic Activity The circular flow of economic activity shows the connections between firms and households in input and output markets.

Input Markets and Output Markets Output, or product, markets are the markets in which goods and services are exchanged. Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged. Payments flow in the opposite direction as the physical flow of resources, goods, and services (counterclockwise).

Input Markets Input markets include: The labor market, in which households supply work for wages to firms that demand labor. The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. The land market, in which households supply land or other real property in exchange for rent.

Determinants of Household Demand A household’s decision about the quantity of a particular output to demand depends on: The price of the product in question. The income available to the household. The household’s amount of accumulated wealth. The prices of related products available to the household. The household’s tastes and preferences. The household’s expectations about future income, wealth, and prices.

Goods and Services Material goods and non material goods Free goods and economic goods consumers’ goods and producers’ goods Private goods and public goods Transferable goods and non transferable goods

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

“Demand is the representation of the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specific period of time”

Meaning Desire for things Desire for things is backed by willingness and ability to pay for it, it becomes demand. Desire for commodity Willingness to pay Ability to pay Speak of demand without reference to price is meaningless. Similarly, the demand is always per unit of time-per day, per week, per month, per year etc.

"If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down." 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.

Determinants of Demand Price Income Tastes and preference Price of related commodities Size of the population Expectation about future price Income distribution Dx=F (Px, y T, Py)

Factors influencing demand Income of the people Price of related goods Tastes of consumers

What is 'Consumer Surplus' Consumer surplus is an economic measure of consumer benefit, which is calculated by analyzing the difference between what consumers are willing and able to pay for a good or service relative to its market price, or what they actually do spend on the good or service. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price.

What is 'Producer Surplus' Producer surplus is an economic measure of the difference between the amount that a producer of a good receives and the minimum amount that he or she would be willing to accept for the good. The difference, or surplus amount, is the benefit that the producer receives for selling the good in the market.

The Law of Demand The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good.

Other things being equal, more will be demanded at lower prices than at a higher price Higher the price, lower is the demand Lower the price, higher is the demand According to law of demand, there is an inverse relationship between price of a commodity and its demand. Demand curve slops down from left to right or demand curve is negatively sloped.

Demand Schedule Price Quantity Demannded Rs. 5 100 units Rs. 4

Substitution effect An effect caused by a rise in price that induces a consumer (whose income has remained the same) to buy more of a relatively lower-priced good and less of a higher-priced. Substitution effect is always negative for the seller: consumers always switch from spending on higher-priced goods to lower-priced ones as they attempt to maintain their living standard in face of rising prices. Substitution effect is not confined only to consumer goods, but manifests in other areas as well such as demand for labor and capital. If the price of an oranges falls and that of apple remain same, the consumers will substitute more of oranges for apple. i.e. with a fall in the price of oranges, its demand increases. This is known as the substitution effect.

Income Effect A change in the demand of a good or service, induced by a change in the consumers' discretionary income. Any increase or decrease in price correspondingly decreases or increases consumers' discretionary income which, in turn, causes a lower or higher demand for the same or some other good or service. For example, if a consumer spends one-half of his or her income on bread alone, a fifty-percent decrease in the price of bread will increase the free money available to him or her by the same amount which he or she can spend in buying more bread or something else.

A fall in price of a commodity means that a consumers can purchase the same quantity of the commodity by spending a less amount of money or more quantity by the same amount. In either case he is better off.

Income Effect If the price of oranges falls from Rs. 10 for a dozen to Rs. 8 per dozen, there is an increases in the real income of the consumers to the extent of Rs. 2, because formerly he was spending Rs. 10 for a dozen of oranges but now he has to spend only Rs. 8. He therefore, becomes better off by two rupees or we can say that his real income has increased by two rupees and as such he can afford to buy more oranges.

Assumptions of Law of Demand Consumers’ income must remain constant Consumers’ tastes and preferences must remain constant The number of consumers must remain constant The price of related goods must remain constant There must be no expectation about further change in price in the same direction.

What is 'Price Elasticity Of Demand' Price elasticity of demand is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. Price elasticity of demand is a term in economics often used when discussing price sensitivity. The formula for calculating price elasticity of demand is: Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

For example, if the quantity demanded for a good increases 15% in response to a 10% decrease in price, the price elasticity of demand would be 15% / 10% = 1.5. The degree to which the quantity demanded for a good changes in response to a change in price can be influenced by a number of factors. Factors include the number of close substitutes (demand is more elastic if there are close substitutes) and whether the good is a necessity or luxury (necessities tend to have inelastic demand while luxuries are more elastic).

Perfectly Elastic Demand When an insignificant or extremely small change in price causes extra ordinarily large change in demand. We have the case of perfectly elastic demand.

Perfectly Inelastic Demand When demand for a commodity remains constant irrespective of the change in its price, we have a case of perfectly inelastic demand.

Unitary Elastic Demand When a given % change in price of commodity brings about the same % change in demand, demand is unitary elastic. The proportionate changes in price and the quantity demanded will be equal and opposite. A 5% fall in price will be accompanied by 5% rise in demand.

Elastic Demand When a given % change in price of a commodity causes more than proportionate changes in demand, we have a case of elastic demand. Price fall by 2% but demand rise by 10%.

Inelastic Demand When a given % change in the price of a commodity brings about less than proportionate changes in demand for it. 10% fall in price of X might rise its demand by 2% only.

What is the 'Income Elasticity Of Demand' Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a change in real income of consumers who buy this good, keeping all other things constant. The formula for calculating income elasticity of demand is the percent change in quantity demanded divided by the percent change in income. With income elasticity of demand, you can tell if a particular good represents a necessity or a luxury.

Income elasticity of demand It is measure of change in demand in response to a given change in the income of the buyers, other factors including price remaining constant. It express relationship between percentage change in income and percentage changes in demand for the commodity.

Calculation of Income Elasticity of Demand Consider a local car dealership that gathers data on changes in demand and consumer income for its cars for a particular year. When the average real income of its customers fell from $50,000 to $40,000, the demand for its cars plummeted from 10,000 to 5,000 units sold, all other things unchanged. The income elasticity of demand is calculated by taking a negative 50% change in demand, a drop of 5,000 divided by the initial demand of 10,000 cars, and dividing it by a 20% change in real income, the $10,000 change in income divided by the initial value of $50,000. This produces an elasticity of 2.5, which indicates local customers are particularly sensitive to changes in their income when it comes to buying cars.

What is 'Cross Elasticity Of Demand' Cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demand of one good when a change in price takes place in another good. Also called cross price elasticity of demand, this measurement is calculated by taking the percentage change in the quantity demanded of one good and dividing it by the percentage change in price of the other good.

Definition of Supply Quantity of output brought for sale in the market at a certain price The amount of a good producers would want to produce and sell at a specific price

“ The amounts of a product that producers are willing and able to make available for sale at each of a series of prices during a specific period”

Supply and quantity supplied Refers to how much is produced at every price. Relationship bet. Quantity supplied and the price of that good QUANTITY SUPPLIED The amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period.

SUPPLY: The LAW OF supply The positive relationship between price and quantity of a good supplied: An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied. SUPPLY CURVE A graph illustrating how much of a product a firm will sell at different prices. SUPPLY SCHEDULE A table showing how much of a product firms will sell at different prices.

supply QTY SUPPLIED PRICE QTY DEMAND PRICE

The Difference Between Supply and Stock Stock is the quantity of output which a seller has with him and has not yet brought for sale; whereas supply is the quantity of output brought from existing stock for sale at a certain price in the market

Supply Schedule and Supply Curve - A list showing the amount of a product that producers would produce and sell at a series of varying prices, during a certain time, with all the other factors held constant Supply Curve: -The graphical representation of the relation between the quantity supplied of a good that producers are willing and able to sell and the price of the good

The Law of Supply Explains the fundamental characteristic of supply “All else equal, as price rises, the quantity supplied rises, as price fall the quantity supplied falls” Positive or direct relationship between the quantity supplied and the price Law of Supply

Assumptions of the Law Constant cost of production Constant price of capital goods Constant technology

Determinants of Supply Price of the good Resource Prices Technology Taxes and subsidies Price of Other Goods Expectations Number of Sellers

Points to remember A demand curve shows how much of a product a household would buy if it could buy all it wanted at the given price. A supply curve shows how much of a product a firm would supply if it could sell all it wanted at the given price. Quantity demanded and quantity supplied are always per time period—that is, per day, per month, or per year. The demand for a good is determined by price, household income and wealth, prices of other goods and services, tastes and preferences, and expectations.

Points to remember The supply of a good is determined by price, costs of production, and prices of related products. Costs of production are determined by available technologies of production and input prices. Be careful to distinguish between movements along supply and demand curves and shifts of these curves. When the price of a good changes, the quantity of that good demanded or supplied changes—that is, a movement occurs along the curve. When any other factor changes, the curve shifts, or changes position. Market equilibrium exists only when quantity supplied equals quantity demanded at the current price.