Economic Analysis for Business Session V: Market Forces of Supply and Demand-II Instructor Sandeep Basnyat

P Q Recall: Supply and Demand Together D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded

Recall: Equilibrium in Automobile market Market demand curve: Qd= 20,500,000 – 500P Market supply curve: Qs = P Equilibrium is at: Qd = Qs 20,500,000 – 500P = P 2500P = Therefore, P = $25000 Q = 20,500,000 – 500(25000) = 8,000,000

P Q D SSurplus: when quantity supplied is greater than quantity demanded Surplus Example: If P = $5, then Q D = 9 lattes and Q S = 25 lattes resulting in a surplus of 16 lattes

Disequilibrium in Automobile market- Surplus Market demand curve: Qd = 20,500,000 – 500P Market supply curve: Qs = P Suppose a car is being sold at $ How many cars will be bought and sold? Qd = 20,500,000 – 500(27000)= 7,000,000 Qs = (27000) = 12,000,000 Surplus = 5 million cars.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S when quantity demanded is greater than quantity supplied Example: If P = $1, then Q D = 21 lattes and Q S = 5 lattes resulting in a shortage of 16 lattes Shortage Shortage

Disequilibrium in Automobile market- Shortage Market demand curve: Qd = 20,500,000 – 500P Market supply curve: Qs = P Suppose a car is being sold at $ How many cars will be bought and sold? Qd = 20,500,000 – 500(23000)= 9,000,000 Qs = (23000) = 4,000,000 Shortage = 5 million cars.

Comparative Static Analysis Sensitivity analysis or “what-if” analysis. Comparison of various points of equilibrium: price and quantity The role of factors influencing demand is analyzed while holding supply conditions constant. Or, the role of factors influencing supply is analyzed by studying changes in supply while holding demand conditions constant Short and Long run analyses

P Q D S Facing a surplus, sellers try to increase sales by cutting the price. This causes Q D to rise Surplus …which reduces the surplus. and Q S to fall… Short-run market change: Rationing Mechanism of Price: Surplus case

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Facing a surplus, sellers try to increase sales by cutting the price. Falling prices cause Q D to rise and Q S to fall. Surplus Prices continue to fall until market reaches equilibrium. Short-run market change: Rationing Mechanism of Price: Surplus case

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Facing a shortage, sellers raise the price, causing Q D to fall …which reduces the shortage. and Q S to rise, Shortage Short-run market change: Rationing Mechanism of Price: Shortage case

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Facing a shortage, sellers raise the price, causing Q D to fall and Q S to rise. Shortage Prices continue to rise until market reaches equilibrium. Short-run market change: Rationing Mechanism of Price: Shortage case Rationing Mechanism: Price adjustment to balance demand and supply in market

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Rationing function: The Market for Hybrid Cars: Increase in Price of Gas P Q D1D1 S1S1 P1P1 Q1Q1 price of hybrid cars quantity of hybrid cars

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND D curve shifts to the right because increased price of gas increases demand for hybrid cars. S curve does not shift, because price of gas does not affect cost of producing hybrids. A Change in Demand A Change in Demand Assumption: Increase in price of gas. P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q2Q2 The shift causes an increase in price and quantity of hybrid cars.

Price Rationing: A Change in Demand P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q2Q2 Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.

S curve shifts because event affects cost of production. D curve does not shift, because production technology is not one of the factors that affect demand. S shifts right because event reduces cost, makes production more profitable at any given price. EXAMPLE 2: A Change in Supply P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 P2P2 Q2Q2 EVENT: New technology reduces cost of producing hybrid cars. The shift causes price to fall and quantity to rise.

Long run analysis: Guiding or Allocating Mechanism: Market for Hybrid Cars P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 D2D2 P3P3 Q3Q3 EVENTS: 1. Price of gas rises 2.New technology reduces production costs P2P2 Q2Q2 Short-run Analysis Long-run Analysis

Short-run vs Long-run Short-run or Rationing Mechanism: Period of time buyers and sellers already in market respond to change in equilibrium price by adjusting the amount of resources (variable inputs) Long run or Guiding or Allocating Mechanism: Period of time buyers and sellers, new or existing in market respond to change in equilibrium price by moving the amount of resources (variable/fixed inputs) in or out from the market.

Variations: A Change in Both Supply and Demand P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 D2D2 P2P2 Q2Q2 EVENTS: Price of gas rises AND New technology reduces production costs But supply increases more than demand. Note: P falls compared to the original price.

A C T I V E L E A R N I N G 3 : Changes in supply and demand 20 For a hypothetical market, use Short-run and Long analysis for the following cases: 1. When Demand and Supply both increases but D > S 2. When Demand increases and Supply decreases but D > S 3. When Demand increases and Supply decreases but D < S 4. When Demand decreases and Supply increases but D < S 5. When Demand decreases and Supply increases but D > S

Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve ◦ occurs when a non-price determinant of supply changes (like technology or costs) Change in the quantity supplied: a movement along a fixed S curve ◦ occurs when P changes Change in demand: a shift in the D curve ◦ occurs when a non-price determinant of demand changes (like income or No. of buyers) Change in the quantity demanded: a movement along a fixed D curve ◦ occurs when P changes

Estimated Industry Demand for New Automobiles Parameter Estimated Value Independent Variable Estimate for Variable (1) (2) (3) Average Price for New Cars (P) –500 $25,000 Average Price for New Luxury Cars(PX)210 $50,000 Disposable Income, per Household (I) 200 $45,000 Population (Pop) (millions) 20, Average Interest Rate (i) (percent) –1,000,000 8% Industry Advertising Expenditures (A)600 $5,000 million Ex 1: Automobile Market Demand and Supply Analysis Estimated Industry Supply for New Automobile Parameter Estimated Value Independent Variable Estimate for Variable (1) (2) (3) Average Price for New Cars (P) 2,000$25,000 Average Price for SUV(Psuv)-400 $35,000 Average Hourly Wage Rate (W) -100,000$85 Average Cost of Steel/Ton (S) -13, Average Cost of Energy/mcf (E) –125,000 $4 Average Interest Rate (i) in percent-1,000,000 8%

Practice 1-Market Demand-Supply Analysis Considering the Estimated demand and supply conditions of the new automobile in the previous slide, find the followings: 1.With the increased competition in the market, the automobile industry increased its advertising expenditure by $5000 million. Will the industry be able to sell more automobile or less now? By how much? Show your results using demand and supply diagram. 2.In response to part 1, the SUV sellers decreased their price of SUV by $2000. How will this affect the new automobile industry now? Is it necessary for the industry to decrease the price of new automobile? By how much? How many new cars will the industry be able to sell now? Show your results using demand and supply diagram. (Hint: Use increased advertising expenses in demand function, keep supply function constant and find equilibrium. Use similar method for case 2.)

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