1. Price theory & applications
Demand , supply & market equilibrium

2. MARKETS
Includes the interplay among all the relevant buyers and Sellers involved in the exchange of something, good, service etc
Examples: BSE, UB cafeteria, 411
Markets are important because they represent mechanism most societies use to facilitate production, distribution & transactions of all kinds

3. Tools of Analysis
Equilibrium Analysis
Optimization

4. Overview of Equilibrium Analysis (price determination)
In a free Market economy, price of a product/service is determined by demand & supply situation in that market
Market for a product will be at equilibrium when producers bring to the market exactly what consumers want to take out of the market at that price.
Equilibrium is a market situation where there is no inherent tendency for change
The market is at equilibrium when quantity demanded is equal to quantity supplied

5. Demand Side
Demand for a good refers to the various quantities of that good per unit of time that consumers will take off the market at all possible alternative prices, ceteris paribus
Quantity that consumers will take off the market will be affected by a number of factors
These factors are referred to as determinants of demand

6. Determinants of Demand
Price of the good (P)
Consumers’ tastes & Preferences (T)
No. of consumers under consideration (Pn)
Consumers’ income (I)
Prices of related goods (Pr)
Credit Availability (Ca)
Consumers’ expectations regarding future prices of the product (E)
Past levels of demand (Qt-1)
Number of goods available to consumers (R)
Q = f(P, T, Pn, I, Pr, R, Ca, E, Qt-1)

7. Demand schedules & Curves
Demand theory singles out the relationship between possible alternative prices of the product & the quantities of it that consumers will take off the market per time period
Thus determinants 2 through 9 are held constant
It conjectures quantity to be inversely related to price (law of demand)
Some exceptions may occur in which quantity taken varies directly with price, but these must be few
Demand refers to the entire demand schedule or curve
A demand schedule lists different quantities of commodity that consumers will take opposite the various prices of the good per period
Demand curve is the demand schedule plotted on an ordinary graph, Q = f(P) or P = f(Q)

8. Demand schedule and Curve contd…
Pd = a – bQd or Qd = a/b – (1/b) Pd
Qd = 50 – Pd
The downward slope reflects the law of demand – people buy more of a product, service etc, as its price falls. Why?
Plot the Demand schedule and curve

11. Change in Demand Vs Change in quantity demanded
Price per kg
Movement along demand curve
Shift in demand curve
Initial demand curve 25
New demand curve 20 20
Quantity per week 10

12. Change in Demand vs Change in qty demanded
A movement along a given demand curve represents a change in quantity demanded from a change in price of the good itself, ceteris paribus
When any of the circumstances held constant in the definition of demand curve are changed, the demand curve itself will shift (change in demand)
Take for example an increase in wages & salaries (Income), consumers will be willing to purchase more at any given price
The same reasoning applies in the case of No. of consumers and other determinants

13. Determinants of demand
Consumers’ tastes (preferences) – a change in consumer tastes that makes the product more desirable means more of it will be bought at each price
No. of buyers – an increase in the number of buyers in the market increases product demand
Income – for most products (normal/superior goods) , a rise in income causes an increase in demand. For inferior goods, an increase in income reduces their demand

14. Determinants of demand contd
Prices of related goods – a change in the price of a related good may increase or decrease the demand for a product, depending on whether it is a substitute or compliment
Substitute good – is a good that can be used in the place of another good. An increase in the price of a substitute increases the demand for the other good.
Complimentary good – is a good that is used together with another good. An increase in the price of a complimentary good reduces demand for the other.

15. Supply side
Supply of a good is defined as the various quantities of that good that sellers will place on the market at all possible prices, ceteris paribus
Quantities of a good that suppliers will put in the market will depend on a No. of factors
Such factors include, Price of the good (P)
Set of prices of resources used in producing the good (Pf)
Range of production techniques available (K)
Taxes and subsidies (Ts)
Therefore Qs = f(P, Pf, K, Ts)

16. Supply schedule & Curve
Supply schedule lists different quantities per unit of time of the good that suppliers are willing to put in the market, ceteris paribus
Supply curve is supply schedule plotted on a graph & is usually upward sloping to the right
For the supply curve, Pf, Ts and K are held constant, I.e. Qs = f(P) or Ps = f(Qs)
Example: Qs = Ps – 10 or Ps = Qs + 10
From the equation above, derive the supply schedule and curve (Do it on the board)
The law of supply states that as price rises the quantity supplied rises; as price falls quantity supplied falls. Why?

18. Supply schedule & curve
Supply curve
Price/trip
trips per week A 10 B 15 5 C 20 D 25 E 30 F 35 G 40 H 45 I 50
price/trip
Supply curve 40 30 20 10 40 10 20 30
trips/wk

19. Change in Supply vs Change in qty supplied
A change in the price of the good will occasion a movement along the supply curve, this is change in quantity supplied S0 S1
A change in any of the factors held constant will result in a shift in the entire supply curve from S0 to S1 – change in supply
Price per trip b 20 a 15 10 5 10
trips per day

20. Change in supply
If costs of factor input increase, Quantity supplied at any given price will fall. For instance we may have Qs=Ps-15 as the new supply function (Use board)
Price per trip
Trips per week B1 15
0 (5) C2 20
5 (10) D3 25
10 (15) E4 30
15 (20) F5 35
20 (25) G6 40
25 (30) H7 45
30 (35) I8 50
35 (40)

21. Market price Determination
If the demand & supply curves of any given good are placed on a single diagram, then forces that determine its mkt price will be highlighted
Demand curve highlights what consumers are willing to do
Supply curve shows what sellers are willing to do
Consumers’ demand is assumed to be independent of the activities of suppliers
Sellers’ supply is assumed to be independent of consumers’ activities

22. Market Price Determination
Price per kg
Supply curve
Demand curve 50
Excess supply a b 35 e 30 c d 25 10
Excess demand 15 20 25
Quantity per week

23. Some explanations
At a price of P10 (intercept) or lower, the price is so low that none of the good will be supplied.
On the demand, at a price of P50 (intercept) or higher, the price is so high that none of the good will be consumed.
For every P1 increase in price, qty consumed fall by 1 kg per week (slope of demand curve)
Similarly, for every P1 increase in the price, qty supplied increases by 1 kg per week (slope of supply curve)

24. Market price determination
At price of P35, producers will bring 25 kg of beef/wk to the market
Consumers will buy only 15 kg of beef/wk
Suppliers bring to mkt more than consumers can take off the mkt, there will be surplus (25-15) of 10
Suppliers will cut prices to dispose off their surpluses
As price goes down so will be the goods brought to the market
On the other hand, as price falls qty taken off the mkt by consumers will increase
Eventually price will drop to P30/kg & consumers will be willing to take exactly the amount that sellers want to place on the market at that price – This is equilibrium price
Assume the starting point was a price of P25 and do the equilibrium analysis.

25. Changes in demand
What happens to the equilibrium price & qty exchanged of a good when its demand changes, say coz of changes in income?
Price per kg
supply e2 35 e1 b 30
Excess demand D2 D1 25 20 30
kg per wk

26. Changes in Demand contd..
Demand curve shifts from D1 to D2
At the initial price of P30, suppliers supply 20kg/wk, but consumers are willing & able to buy 30kg/wk
Consumers will bid against each other, thus pushing up the price
But as price increases, consumers will demand less & less of the beef.
On the other side producers will produce more beef as its price rises
The bidding & increase in qty supplied will continue until a new equil is reached at e2

27. Changes in Supply
What happens to the equilibrium price & qty exchanged of a good when its supply changes, say coz of increases in wage level? S2 S1
Price per kg e2 35 e1 30
Excess demand
Demand curve 10 15 20
kg per week

28. Changes in Demand & supply
An increase in demand alone leads to an increase in both equil price & qty (D : P , Q )
A decrease in demand alone leads to a decrease in both equil price & qty (D : P , Q )
An increase in supply alone leads to an increase in equil qty & fall in equil price (S : P , Q )
A decrease in supply alone leads to an increase in equil price & fall in equil qty (S : P , Q )
What happens if both supply & demand increase/decrease together?

29. Surplus & shortage
A surplus is an excess of quantity supplied over quantity demanded. When there is surplus, sellers cannot sell the quantities they desire to supply.
A shortage is an excess of quantity demanded over quantity supplied. When there is a shortage buyers cannot purchase the quantities they desire
An equilibrium is a situation in which there are no inherent forces that produce change

30. Algebra of Demand-Supply Analysis
Qd = 50 – P: demand
Qs = P – 10: supply
To find Equilibrium we equate Demand to Supply, I.e Qd = Qs
50 – P = P – 10 & solve for P
2P = 60
P* = 30
Insert P* = 30 into either Qs or Qd to get Q*
Qd=50-30 = 20 = Qs = Q*
Or Pd = Ps
50 – Qd = 10 + Qs
40 = Qd + Qs, but Qs = Qd = Q*, so
40 = 2Q*
Q* = 20
Insert Q* into either Ps or Pd to get P*
P* = Pd =50-20=Ps=30