Demand & Supply Market Equilibrium

Tk DEMAND DEFINED PQDQD A schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices.

LAW OF DEMAND As Price Falls… …Quantity Demanded Rises As Price Rises… …Quantity Demanded Falls An inverse relationship exists between price and quantity demanded

Diminishing Marginal Utility LAW OF DEMAND

Diminishing Marginal Utility LAW OF DEMAND Income Effect

Diminishing Marginal Utility LAW OF DEMAND Income Effect Substitution Effect

Diminishing Marginal Utility Income Effect Substitution Effect LAW OF DEMAND Demand Curve Individual and Market Demand

GRAPHING DEMAND P Q o PQDQD Price of Corn Quantity of Corn CORN Plot the Points

55 P Q o PQDQD Tk Price of Corn Quantity of Corn CORN Plot the Points GRAPHING DEMAND

35 P Q o PQDQD Price of Corn Quantity of Corn CORN Plot the Points GRAPHING DEMAND

P Q o PQDQD Price of Corn Quantity of Corn CORN Plot the Points GRAPHING DEMAND

P Q o PQDQD Price of Corn Quantity of Corn CORN Plot the Points GRAPHING DEMAND

P Q o PQDQD D Price of Corn Quantity of Corn CORN Connect the Points GRAPHING DEMAND

P Q o PQDQD D Price of Corn Quantity of Corn CORN What if Demand Increases? GRAPHING DEMAND

P Q o PQDQD D Price of Corn Quantity of Corn CORN D’ Increase in Demand Increase in Quantity Demanded GRAPHING DEMAND

P Q o PQDQD D Price of Corn Quantity of Corn CORN What if Demand Decreases? GRAPHING DEMAND

P Q o PQDQD D Price of Corn Quantity of Corn CORN D’ Decrease in Demand Decrease in Quantity Demanded GRAPHING DEMAND

DETERMINANTS OF DEMAND Tastes Number of Buyers Income – Normal (Superior& Inferior) Goods Prices of Related Goods – Substitutes & Complements – Unrelated Goods Expectations

Supply Quantity supplied is the amount of a good that sellers are willing and able to sell.

SUPPLY DEFINED PQSQS CORN Supply is a schedule or a curve showing the amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices

Supply schedule Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied.

Baby ice-cream’s supply schedule Price of Ice-creamQuantity of Ice-cream Supplied Tk

5 P Q o PQSQS Price of Corn Quantity of Corn CORN Plot the Points GRAPHING SUPPLY

P Q o PQSQS Price of Corn Quantity of Corn CORN Plot the Points GRAPHING SUPPLY

35 P Q o PQSQS Price of Corn Quantity of Corn CORN Plot the Points GRAPHING SUPPLY

P Q o PQSQS Price of Corn Quantity of Corn CORN Plot the Points GRAPHING SUPPLY

P Q o PQSQS Price of Corn Quantity of Corn CORN Plot the Points GRAPHING SUPPLY

S P Q o PQSQS Price of Corn Quantity of Corn CORN Connect the Points GRAPHING SUPPLY

S P Q o PQSQS Price of Corn Quantity of Corn CORN What if Supply Increases? GRAPHING SUPPLY

S P Q o Price of Corn Quantity of Corn PQSQS CORN S’ Increase in Supply Increase in Quantity Supplied GRAPHING SUPPLY

S P Q o PQSQS Price of Corn Quantity of Corn CORN What if Supply Decreases? GRAPHING SUPPLY

S P Q o PQSQS Price of Corn Quantity of Corn CORN S’ Decrease in Supply Decrease in Quantity Supplied GRAPHING SUPPLY

Another example: Supply in Output Markets A supply schedule is a table showing how much of a product firms will supply at different prices.A supply schedule is a table showing how much of a product firms will supply at different prices. Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

The Supply Curve: The Relationship between Price and Quantity Supplied Supply Curve The supply curve is the graph of the relationship between the price of a good and the quantity supplied.

Figure Baby Ice-cream’s Supply Schedule and Supply Curve Price of Ice-Cream Cone Quantity of Ice-Cream Cones Tk An increase in price increases quantity of cones supplied. Price of Ice- cream Quantity of Ice-cream Supplied Tk

The Supply Curve and the Supply Schedule A supply curve is a graph illustrating how much of a product a firm will supply at different prices.A supply curve is a graph illustrating how much of a product a firm will supply at different prices.

LAW OF SUPPLY As Price Rises… …Quantity Supplied Rises As Price Falls… …Quantity Supplied Falls A direct relationship exists between price and quantity supplied

The Law of Supply Law of Supply –The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises.

The Law of Supply The law of supply states that there is a positive relationship between price and quantity of a good supplied. This means that supply curves typically have a positive slope.

Factors or Determinants of Supply The price of the good or service. The cost of producing the good, which in turn depends on: –The price of required inputs (labor, capital, and land), –The technologies that can be used to produce the product, The prices of related products.

A Change in Supply Versus a Change in Quantity Supplied A change in supply is not the same as a change in quantity supplied.A change in supply is not the same as a change in quantity supplied. In this example, a higher price causes higher quantity supplied, and a move along the supply curve.In this example, a higher price causes higher quantity supplied, and a move along the supply curve. In this example, changes in determinants of supply, other than price, cause an increase in supply, or a shift of the entire supply curve, from S A to S B.In this example, changes in determinants of supply, other than price, cause an increase in supply, or a shift of the entire supply curve, from S A to S B.

When supply shifts to the right, supply increases. This causes quantity supplied to be greater than it was prior to the shift, for each and every price level. A Change in Supply Versus a Change in Quantity Supplied

A Change in Supply (Shift in Supply)Versus a Change in Quantity Supplied To summarize : Change in price of a good or service leads to Change in quantity supplied (Movement along the curve). Change in costs, input prices, technology, or prices of related goods and services leads to Change in supply (Shift of curve).

Individual and Market Supply Curves The market supply curve is derived by adding the individual supply curves of each supplier.

From Individual Supply to Market Supply The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry. Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service.

From Individual Supplies to a Market Supply Quantities Supplied ABCDEFGHIABCDEFGHI (1) Price (per DVD) (2) Asad's Supply (5) Market Supply (4) Chaitali's Supply (3) Bablu's Supply

From Individual Supplies to a Market Supply Price per DVD ChaitaliBablu Asad Quantity of DVDs supplied (per week) $ I H G F E D C B A Market Supply CACA

Market Supply: Another Illustration As with market demand, market supply is the horizontal summation of individual firms’ supply curves.

Market Equilibrium

The operation of the market depends on the interaction between buyers and sellers. An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change.

MARKET DEMAND & SUPPLY B U Y E R S PQDQD BUSHELS OF CORN MARKET DEMAND 2,000 4,000 7,000 11,000 16, S E L E R S 12,000 10,000 7,000 4,000 1,000 PQSQS BUSHELS OF CORN MARKET SUPPLY EQUILIBRIUM Graphically… xx

7 S P Q o $ PQDQD ,000 4,000 7,000 11,000 16, ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Market Clearing Equilibrium MARKET DEMAND & SUPPLY

Market Equilibrium Only in equilibrium is quantity supplied equal to quantity demanded. At any price level other than P 0, the wishes of buyers and sellers do not coincide.At any price level other than P 0, the wishes of buyers and sellers do not coincide.

Market Disequilibria Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price. When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.

Market Disequilibria Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price. When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

Increases in Demand and Supply Higher demand leads to higher equilibrium price and higher equilibrium quantity. Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Decreases in Demand and Supply Lower demand leads to lower price and lower quantity exchanged. Lower supply leads to higher price and lower quantity exchanged.

Relative Magnitudes of Change The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

Relative Magnitudes of Change When supply and demand both increase, quantity will increase, but price may go up or down.When supply and demand both increase, quantity will increase, but price may go up or down.

Price Ceiling A maximum price that sellers may charge for a good, usually set by government. Excess Demand (Shortage) Created by a Price Ceiling

CONCEPT OF SLOPE AND ELASTICITY

Slope and Elasticity Slope Slope is the changes in quantity demanded because of changes in any variable = ΔQ/ΔP Elasticity Elasticity is the percentage change in quantity demanded because of percentage change in any variable. Elasticity is of two types: (1) Point Elasticity and (b) Arc Elasticity.

The Concept of Elasticity Elasticity is a measure of the responsiveness of one variable to another. The greater the elasticity, the greater the responsiveness.

Price Elasticity The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.

Sign of Price Elasticity According to the law of demand, whenever the price rises, the quantity demanded falls. Thus the price elasticity of demand is always negative. Because it is always negative, economists usually state the value without the sign.

What Information Price Elasticity Provides Price elasticity of demand and supply gives the exact quantity response to a change in price.

Elasticity When (In Theory) When (in Absolute Sense) The Demand is Called ξ < -1ξ > 1 Elastic ξ = -1ξ = 1 Unitary Elastic -1 < ξ ≤ 0ξ < 1 Inelastic

Price Elasticity Price Elasticity is the percentage change in quantity demanded because of percentage change in price. = %ΔQ/%ΔP Price Elasticity can be of two types: 1.Point Price Elasticity 2.Arc Price Elasticity

Income Elasticity Income Elasticity is the percentage change in quantity demanded because of percentage change in income = %ΔQ/%ΔY

Cross Elasticity Cross Elasticity is the percentage change in quantity demanded because of percentage change in the price of another good (say z). = %ΔQ/%ΔPz

ElasticInelastic PositiveNegative Price Elasticity ExceptionalNormal Normal (negative) Income Elasticity NormalInferiorBasic Necessity Goods Cross Elasticity SubstituteComplementary

Special Cases P D D Q0 0 Q Infinite price elasticZero price elastic

Perfectly inelastic demand curve Price 0 Quantity Perfectly Inelastic Demand Curve

Perfectly elastic demand curve Perfectly Elastic Demand Curve Price 0 Quantity

Elasticity and Passage of Time DoDo D1D1 D2D2 D3D3 Qo Q’o Q1Q2 Q3 Q P O

Elasticity Along a Demand Curve Price $ Quantity Elasticity declines along demand curve as we move toward the quantity axis E d = 1 E d = 0 E d < 1 E d > 1 E d = ∞

The Price Elasticity of Demand Along a Straight-line Demand Curve

Data for Calculating Elasticity at shaded section PxPzYQx

Price Point Elasticity: (5-4)/ (6-7)*7/4 = Comment: We found negative but elastic relationship between price and quantity demanded, which is normal. Income Elasticity: (5-4) / ( )*400/4 = -2 Comment: The income elasticity is negative. It is elastic. Negative elasticity means the good concerned is an inferior goods. Cross Elasticity: (5-4) / (15-13)*13/4 = Comments: The cross elasticity is positive and elastic. It means the good concerned is a substitute.

Use of Regression to Estimate Elasticity Convert data into log (ln) Run multiple regression Discuss R2, F, t-statistics, DW etc. Comments on elasticities found. Use b-values to estimate what would happen to quantity demand if … things happen. Forecast demand.