ECO 104 Lct 3 Supply and Demand: Theory Based on ch.2 of Macroecnomics, Roger A. Arnold

Market Any place people come together to trade. People = buyers and sellers Buyers demand goods And sellers supply the goods…

DEMAND AND SUPPLY DEMAND 1)The willingness and ability of buyers to purchase different quantities of goods 2)At different prices 3)During a specific period of time SUPPLY 1)The willingness and ability of sellers to produce and offer to sell different quantities of goods 2)At different prices 3)During a specific period of time

LAW OF DEMAND AND SUPPLY LAW OF DEMANDLAW OF SUPPLY

LAW OF DEMAND AND SUPPLY DEMAND 3. Demand schedule: The numerical tabulation of the quantity demanded of a good at different prices (numerical representation of the law of DD) 4. Demand curve: The graphical representation of the law of demand. (A downward sloping line or curve) Constructed using the demand schedule. SUPPLY …numerical tabulation of quantity supplied of a good at different prices …An upward sloping line or curve (indicating a direct relationship)

Explaining The Upward Sloping SS Curve -Assuming ceteris paribus, higher prices implies higher profits which acts as an incentive for the producers/sellers/firms to produce more -Costs rise when more units of a good are produced

CHANGE IN QUANTITY SUPPLIED Implies movement along the supply curve… Factor causing this movement: change in it’s own price

CHANGE IN SUPPLY Changes in supply (SS) => shift of the supple curve Factors that cause this shift - Prices of relevant resources (R) P(R) ↑, Profit ↓, SS ↓ P(R) ↓, Profit ↑, SS ↑ ceteris paribus - Technology Technological improvement → cost of production ↓ → profit ↑ and hence, SS ↑ - Prices of other goods Sellers/producers shift to goods with higher prices (more profit), hence SS of the good ↓

Number of sellers if, # of sellers ↑ then, supply (SS) ↑ Expectations (E) of future prices E (future prices) ↑, current SS ↓, future SS ↑ Taxes and subsidies Taxes result in cost ↑, profit ↓, hence SS ↓ Government restrictions Generally restricts/reduces supply (barriers to entry, compliance with certain criteria)

The Market: DD and SS Together Equilibrium Price, P(E) : The price at which the Q(D) = Q(S) Equilibrium Quantity, Q(E): The quantity that corresponds to equilibrium price Surplus: Q(S) > Q(D) …when? Disequilibrium Shortage: Q(D) > Q(S)

Moving to Equilibrium “Free-market” allows the market to adjust itself…in the long run equilibrium is always reached in the following manner. If, surplus, Q(S) > Q(D), then P falls until Equilibrium price is reached where the market clears i.e. Q(D) = Q(S) If, shortage, Q(D) > Q(S), then P rises until Equilibrium price is reached where the market clears i.e. Q(D) = Q(S)

Equilibrium and Predictions Examples… Housing market (empty flats in Uttara is an indication of surplus in the housing market. In the future we might expect house rents to decline) Education market (current situation indicates a shortage in this market. Many students can’t get admitted due to limited seats. In the future tuition fees (pvt universities) is expected to increase)

Consumer and Producer Surplus Consumer Surplus, CS: Max buying price – Price paid Producer Surplus, PS: Price received – Minimum selling price Total Surplus = CS + PS Total surplus is maximized at equilibrium