1. Department of Business Administration
FALL
Demand, Supply, and Equilibrium by
Assoc. Prof. Sami Fethi

2. Demand and Supply
Economics begins and ends with the “Law” of supply and demand. The laws of supply and demand are an important beginning in the attempt to answer vital questions about the working of a market system.

3. Demand
Demand for a good or service is defined as quantities of a good or service that people are ready (willing and able) to buy at various prices within some given time period, other factors besides price held constant.

4. Supply
The supply of a good or service is defined as quantities of a good or service that people are ready to sell at various prices within some given time period, other factors besides price held constant.

5. Demand Side Every market has a demand side and a supply side.
The demand side can be represented by a market demand curve which shows the amount of commodity buyers would like to purchase at different prices.
Demand curves are drawn on the assumption that buyers’ tastes, income, the number of consumers in the market and the price of related commodities are unchanged.

6. Law of Demand
The inverse relationship between the price of the commodity and the quantity demanded per period is referred to as the law of demand.
A decrease in the price of a good, all other things held constant (ceteris paribus), will cause an increase in the quantity demanded of the good.
An increase in the price of a good, all other things held constant, will cause a decrease in the quantity demanded of the good.

7. Change in Quantity Demanded
Price
An increase in price causes a decrease in quantity demanded. P1 P0
Quantity Q1 Q0

8. Change in Quantity Demanded
Price
A decrease in price causes an increase in quantity demanded. P0 P1
Quantity Q0 Q1

9. Changes in price result in changes in the quantity demanded.
Changes in Demand
Changes in price result in changes in the quantity demanded.
This is shown as movement along the demand curve.
Changes in nonprice determinants result in changes in demand.
This is shown as a shift in the demand curve.

10. Nonprice determinants of demand
Changes in Demand
Nonprice determinants of demand
Tastes and preferences
Income
Prices of related products
Future expectations
Number of buyers

11. Changes in Demand Change in Buyers’ Tastes
-Today’ consumer purchases leaner meats compared to old generations
-due to the level of blood cholesterol and body weight
Change in Buyers’ Incomes
Normal Goods
i.e., shoes, steaks, travel, automobiles, education
Inferior Goods
i.e., potatoes, hotdogs, hamburger
Change in the Number of Buyers
Change in the Price of Related Goods
Substitute Goods
i.e., Carrots can be replaced by cabbage
Complementary Goods
i.e., cars and gasoline or electric stove and electricity.

12. Change in Demand
An increase in demand refers to a rightward shift in the market demand curve.
Price P0
Quantity Q0 Q1

13. Change in Demand
A decrease in demand refers to a leftward shift in the market demand curve.
Price P0
Quantity Q1 Q0

14. Demand, Supply and Equilibrium
Every market has a demand side and a supply side. The Supply side can be represented by a market supply curve which shows the amount of commodity sellers would offer a sale at various prices.
Supply curves are drawn on the assumption of technology and input or resources (as such labor, capital and land) and prices.

15. Law of Supply
The direct relationship between the price of the commodity and the quantity supplied per period is referred to as the law of supply.
A decrease in the price of a good, all other things held constant (ceteris paribus), will cause a decrease in the quantity supplied of the good.
An increase in the price of a good, all other things held constant, will cause an increase in the quantity supplied of the good.

16. Change in Quantity Supplied
A decrease in price causes a decrease in quantity supplied.
Price P0 P1
Quantity Q1 Q0

17. Change in Quantity Supplied
An increase in price causes an increase in quantity supplied.
Price P1 P0
Quantity Q0 Q1

18. Nonprice determinants of supply
Changes in Supply
Nonprice determinants of supply
Costs and technology
Prices of other goods or services offered by the seller
Future expectations
Number of sellers
Weather conditions

19. Changes in Supply Change in Production Technology
- An improvement in the technology and a reduction in input prices would make it possible to produce a commodity at a lower cost. This indicates that sellers would be willing to sell more the goods at each price
Change in Input Prices
-↓ in agriculture product, ↓ price of lamb meat, ↑ quantity supplied so rightward shift in the market supply curve
Change in the Number of Sellers
- ↑ in no of sellers, the market supply curve shifts to right or ↓ in no of sellers, the market supply curve shifts to left
Prices of other goods or services offered by the seller
- i.e., BMW, Mercedes, Woswagen (Subs. Goods)
- i.e., lamp meat and lamp leather (comp. Goods)

20. Change in Supply
An increase in supply refers to a rightward shift in the market supply curve.
Price P0
Quantity Q0 Q1

21. Change in Supply
A decrease in supply refers to a leftward shift in the market supply curve.
Price P0
Quantity Q1 Q0

22. Market Equilibrium
Market equilibrium is determined at the intersection of the market demand curve and the market supply curve.
Equilibrium price: The price that equates the quantity demanded with the quantity supplied.
Equilibrium quantity: The amount that people are willing to buy and sellers are willing to offer at the equilibrium price level.
The equilibrium price causes quantity demanded to be equal to quantity supplied.
An increase or decrease in the demand or supply curve, it defines a new equilibrium point.

23. Market Equilibrium Price D S P Q Quantity
If the quantity supplied of a commodity exceeds the quantity demanded, this is called excess supply or surplus between D and S over point p.
If the quantity demanded of a commodity exceeds the quantity supplied, this is called excess demand or shortage between D and S below point p.
Market Equilibrium
Price D S P Q
Quantity

24. Market Equilibrium
Shortage: A market situation in which the quantity demanded exceeds the quantity supplied.
A shortage occurs at a price below the equilibrium level.
Surplus: A market situation in which the quantity supplied exceeds the quantity demanded.
A surplus occurs at a price above the equilibrium level.

25. Market Equilibrium

26. Market Equilibrium Price D0 D1 S0
An increase in demand will cause the market equilibrium price and quantity to increase. Q1 P1 P0
Quantity Q0

27. Market Equilibrium Price D1 D0 S0
A decrease in demand will cause the market equilibrium price and quantity to decrease. Q0 P0 P1 Q1
Quantity

28. Market Equilibrium Price
An increase in supply will cause the market equilibrium price to decrease and quantity to increase. D0 S0 S1 P0 Q1 P1
Quantity Q0

29. Market Equilibrium Price
A decrease in supply will cause the market equilibrium price to increase and quantity to decrease. D0 S1 S0 P1 Q1 Q0 P0
Quantity

30. The Demand Schedule and the demand curve-Example
How can the relationship between quantity demanded and price be portrayed?
Demand schedule
Demand curve

31. Table 1: A demand schedule for carrots
Table 1 is a hypothetical demand schedule for carrots. It shows the quantity of carrots that would be demanded at various prices on the assumption that average household income is fixed at $ and all other price do not change. (i.e. if the price of carrots were $60 per ton, consumers would desire to purchase $77,500 tons of carrots per month.
Av income:$ 20000 60 Z
62.5 Y
67.5 X
77.5 W 90 V
110
U $ 20
Thousands ton per months
D (quantity demanded)
P (price per ton)

32. A demand curve for carrots
A second method of showing the relation between quantity demanded and price is to draw a graph. It is a downward slope which indicates quantity demanded increases as price falls.

33. Shifts in the demand curve-Example
A demand curve or line is drawn on the assumption that everything except the commodity’s own price is held constant. A change in any of variables previously held constant will shift the demand curve or line to a new position. (i.e. A rise in household income has shifted the demand curve or line to the right.
A demand curve can shift in mainly two ways: If more bought at each price, the demand curve shift right so that each price corresponds to a higher quantity than before. If less is bought at each price, the demand curve shifts left so that each price represents to a lower quantity than before.

34. Table 2: Two Alternative Demand Schedule for carrots
An increase in average income will rise the quantity demanded at each price. When AV income rises from $20000 to $ per year, quantity demanded at price of $60 per ton increases from tons per month to tons per month. Similar rise occurs at every other price. 78 60
120
81.3
62.5
100
87.5
67.5 80
100.8
77.5
116 90 40
140
110
$ 20
Q1 (D1)
Q (D) P
Av in: $ $ 24000

35. Table 2: Two Alternative Demand Schedule for carrots
Put differently, A rise in av household income shifts the demand curve for most commodities to right so this indicates that more will be demanded at each possible price. Ultimately, the demand schedule relating columns P and D is replaced by one relating columns P and D1 in the previous table. The graphical presentation of the two functions are seen in the following graph.

36. Shifts in the demand curve-Example78 60
120
81.3
62.5
100
87.5
67.5 80
100.8
77.5
116 90 40
140
110
$ 20
Q1(D1)
Q (D) P
160
140
120
Q1D1
100
price 80 60
Q D 40 20 60 80 90
100
120
140
Quantity

37. Other Prices
Earlier, we saw that the downward slope of a commodity’s demand curve occurs because the lower its price, the cheaper the commodity is relative to other commodities that can satisfy the same needs or desires. Those other commodities are called substitutes (i.e. Carrots can be made cheap relative to cabbage either by lowering the price of carrots or raising the price of cabbage).
A rise in the price of a substitute for a commodity shifts the demand curve for the commodity to the right.

38. Other Prices
Another class of commodities is called complements. These are the commodities that tend to be used jointly each other. Such as cars and gasoline or electric stove and electricity.
A fall in the price of a complementary commodity will shift a commodity’s demand curve to the right.
For example, a fall in the price of airplane trips to Paris will lead to a rise in the demand for Disney Land tickets at paris even though their price is unchanged.

39. Tastes
Tastes have a large effect on people’s desired purchased. A change in tastes may be long-lasting such as the shift from fontain pens to ball-point pens. In this case, a change in tastes in favor of a commodity shifts the demand curve to the right.

40. Distribution of Income
A change in the distribution of income will shift to the right the demand curves for commodities bought most by those gaining income. On the other hand, it will shift to the left the demand curves for commodities bought most by those losing income.
If, for example, the government increases the deductions for children on the income tax and compensates by raising basic taxes, income will be transferred from childness persons to the large familes. So commodity more heavily bought by families with no child decline in demand.

41. Population
Population growth does not by itself create new demand. The additional people must have purchasing power before demand is changed.
Extra people of working age, however, usually means extra output and if they produce, they will earn income.
When this happens, the demand for all the commodities purchased by the new income earners will rise. Thus a rise in population will shift the demand curves to the right.

42. Individual Demand function
The demand for a commodity arises from the consumers’ willingness and ability to purchase the commodity. Consumer demand theory postulates that the quantity demanded of a commodity is a function of / or depends on the price of the commodity, the consumers’ income, the price of related commodities, and the tastes of the consumer.

43. Functional form
Qdx= (Px, I, Py, T)
An inverse relationship is expected between the quantity demanded of a commodity and its price (law of demand). That is, when the price rises, the quantity purchased declines, and when the price falls, the quantity sold increases.

44. Qdx= (Px, I, Py, N,T) QdX/PX < 0
Functional form
Qdx= (Px, I, Py, N,T)
QdX/PX < 0
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements

45. Recall: Consumer Demand Theory
Consumer demand theory postulates that the quantity demanded of a commodity per time period increases with a reduction in its price, with an increase in the consumer’s income, with an increase in the price of substitute commodities and a reduction in the price of complementary commodities, and with an increased taste for the commodity. On the other hand, the quantity demanded of a commodity declines with the opposite changes.
Consumer demand theory postulates that the quantity demanded of a commodity is a function of / or depends on the price of the commodity, the consumers’ income, the price of related commodities, the number of consumers in the market, and the tastes of the consumer.

46. Relating Concepts
The increase in Qx when Px falls occurs because in consumption, the individual consumer substitutes commodity x for other commodities which are now relatively expensive. This is called the substitution effect.
In addition, when Px falls, a consumer can purchase more of x with a given amount of money (i.e., the consumer’s real income increases). This is called the income effect.
The movement along a given demand curve resulting from a change in the commodity price is referred to as a change in the quantity demanded, while a shift in the demand curve resulting from a change in any of the factors that affect demand, other than the commodity price, is referred to as a change in demand.

47. Individual and Market Demand Curve Example Horizontal Summation: From Individual to Market Demand

48. Individual and Market Demand Curve Example
Given the following data: Pdx=$4 and Qdx=4 and Qddx=400, while at Px=$3, Qdx=6 and Qdd=600, construct the relevant individuals and market curves

49. Price Elasticity of Demand
The price elasticity of demand (Ep) is measured by the percentage change in the quantity demanded of the commodity divided by the percentage change in commodity’s price, holding constant all other variables in the demand function.

50. Price Elasticity of Demand
Point Definition
Or Elasticity at given point
Linear Function

51. Price Elasticity of Demand
Arc Definition

52. Marginal Revenue and Price Elasticity of Demand

53. Price Elasticity of Demand- Example
Find Ep at point A, B, C and G
Ep=(ΔQ/ ΔP) (P/Q)
At point A, Ep=(0-200/ 6-5) (6/0)
Ep=-200 (6/0)= - indefinite
At point B, Ep= ( /5-4) (5/200)=-5
At point C, Ep=( /4-3) (4/400)=-2
At point G,
Ep=(-200)(0/1200)=0

54. Price Elasticity of Demand- Example
Find Ep at point A, B, C and G
Ep=(ΔQ/ ΔP) (P/Q)
At point A, Ep=(-200/ 6-5) (6/0)
Ep=-200 (6/0)= - indefinite
At point B, Ep= ( /5-4) (5/200)=-5
At point C, Ep=( /4-3) (4/400)=-2
At point G, Ep=(-200) (0/1200)=0

55. Arc Elasticity of Demand- Example
Find arc Ep between points B and C
Ep=(Q2-Q1)/(P2-P1) (P2+P1)(Q2+Q1)
Ep= ( )/(4-5) (4+5)/( )
Ep=-3
Absolute value of Ep
Greater than 1- elastic
Equals 1- unit elastic
Less than 1- inelastic

56. MR and TR based on Elasticity- Example-3
1,000
-1/5 1 -5
1,200 -1
1,600
-1/2
800 2
1,800
600 3 -2
400 4 5
200 -
$ 0
-indefinite
$ 6
(5)
(4)
(3)
(2)
(1)
MR=DTR/DQ
TR=P.Q Ep Q P

57. MR and TR based on Elasticity- Example
Find MR by using P and Ep at Px =$4 and $3
MR= P{1+(1/Ep)}
At Px =$4 MR=4{1+(1/-2)=$2
At Px =$3 MR=3{1+(1/-1)=0
Based on the previous table:
P decreases TR increases when Ep is elastic
TR max or unchanged when Ep is unitary elastic
TR decreases when Ep is inelastic

58. Graphically Showing Elasticities and MR-TR
600
1200 QX
MR=0

59. Graphically Showing Elasticities and MR-TRPX 6 QX
600
1200
MRX

60. Income Elasticity of Demand
Point Definition
Linear Function

61. Income Elasticity of Demand
Arc Definition
Inferior Good
Normal Good I E
>
Necessities Good
Luxuries Good 1 I
0 < E
< 1 I E
>

62. Cross-Price Elasticity of Demand
Point Definition
Linear Function

63. Cross-Price Elasticity of Demand
Arc Definition
Complements
Substitutes

64. Income, Cross and Arc Elasticises- Example
Find arc EI between two levels of income i.e I=$10000 and I=$ when the demand for commodity X is 400.
Ep=(Q2-Q1)/(I2-I1) (I2+I1)(Q2+Q1)
Ep= ( )/(11-10) (11+10)/( )
EI= 4.2
Thus commodity x is normal and luxury.
Find arc Exy between two levels of price y i.e Py=$ 1 and Py =$ 2 when the demand for commodity X is 400.
Ep=(Q2-Q1)/(P2-P1) (P2+P1)(Q2+Q1)
Ep= ( )/(2-1) (2+1)/( )
EI= 0.6
Thus commodity y is substitute compared to commodity X
Substitutes

65. Using Elasticises In Managerial Decision Making-Example
A firm selling coffee brand X and estimated relevant demand regression as follows:
Qx= Px+0.8 I+2.0 Py-0.6 Ps+1.2 A
Qx is sales of coffee brand X, I is disposable income, Py is price of competitive coffee brand, Ps is price of sugar and A is advertising expenditures for coffee brand X.
Suppose: Px=$2, I=$2.5, Py=$1.80, Ps=$0.50 and A=$1

66. Using Elasticities In Managerial Decision Making Example
Calculate Qx and the elasticities of sales with respect to each variable in the relevant demand function
Qx= (2)…1.2(1)=2 mn pounds coffee
Calculate the elasticities of the demand for coffee brand X
Ep=-3(2/2)=-3,Ei=0.8(2.5/2)=1, Exy=2(1.8/2)
Exs=-0.6(0.5/2)=-0.15, Ea=1.2(1/2)=0.6
RECALL the Formulae

67. Using Elasticises In Managerial Decision Making-Example
Next year, the firm would like to increase Px by 5%, A by 12%, I by 4%, and Py 7% whereas Ps fall by 8%.
Determine sales of coffee brand X in the next year.
Qxx=Qx+Qx(DPx/Px)Ep……+Qx(DA/A)Ea
Qxx=2+2(5%)(-3)…..+2(5%)(0.6)
Qxx=2.2 or 2,200,000 pounds

68. The important steps by using Elasticities
The analysis of the forces or variables that affect on demand and reliable estimates of their quantitative effect on sales (elasticities) are essential in order for firm to make best operating decisions in shor-run and to plan for its growth in the long-run.
The firms can use the elasticities of demand of the variables under their controls to find out best policies as well as to maximize their profits.
If the demand for the firm’s product is price inelastic, the firm will want to increase the product price since that would increase its total revenue and reduce its total cost.
If the elasticity of the firm’s sales wrt the variable beyod its control or If the cross-price elasticity of demand for the firm’s product is very high, the firm will need to respond quickly to a competitor’s price reduction otherwise losing a great deal of its sales.

69. The important steps by using Elasticities
The size of the price elasticity of demand is larger, the closer and the greater is the number of available substitutes for the commodity. For example, sugar is more price elastic than table salt (e.g. honey)
In general, the greater is its price elasticity of demand, the greater will be the number of substitutes
For a given price change, the quantity response is likely to be much larger in the long run than short run so the price elasticity odf demand is likely to be much greater in the long run than short run .

70. The End
Thanks