1. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-1 PART 2 THE PRICE MECHANISM Chapter 3 Demand, supply and equilibrium SupplyDemand

2. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-2 Lecture Plan Demand curve The law of demand The law of supply Supply curve Equilibrium Disequilibrium Conditions of demand Conditions of supply

3. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-3 Demand A market consists of: – Buyers (demand) – Sellers (supply) – Exchange Effective demand = the quantity of a commodity which consumers will purchase at a given price per time period

4. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-4 The Demand Schedule A table showing the quantity demanded of a product at various prices Example: Demand schedule for Big Macs PriceQty demanded $1500 $2400 $3300 $4200 $5100

5. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-5 The Demand Curve Graphical representation of demand schedule Example: Demand curve for Big Macs Quantity Price $ 5 2 1 3 4 100200300400500

6. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-6 The Law of Demand As price increases the quantity demanded decreases Conversely: As price decreases the quantity demanded increases (cont.)

7. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-7 The Law of Demand (cont.) Reflects an inverse relationship, i.e. as price, quantity demanded The law of demand is caused by: – The income effect – The substitution effect

8. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-8 The Income Effect As prices increase, consumers will purchase fewer goods and services. Their purchasing power (or real income) decreases Quantity demanded decreases As prices decrease, the purchasing power of consumers increases Quantity demanded increases

9. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-9 The Substitution Effect As prices increase, consumers generally purchase more of a substitute product whose price is lower A substitute product is a product that performs a similar function and satisfies the same consumer need/want e.g.: – Tea/coffee – Butter/margarine If the price of butter increases, the quantity demanded will fall as consumers will substitute butter with margarine

10. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-10 Supply Definition: the quantity of a product which producers offer to the market at a certain price per unit of time

11. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-11 The Law of Supply As price increases the quantity supplied increases conversely as price decreases the quantity supplied decreases The law of supply is a direct relationship between price and quantity supplied As price, quantity supplied The logic of the law of supply: –Producers will seek to maximise their profits i.e.: supplying more at higher prices and less at lower prices

12. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-12 The Supply Schedule A table showing the quantity supplied at various prices Example: Supply schedule for Big Macs Price Qty supplied $1200 $2300 $3400 $4500 $5600

13. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-13 The Supply Curve A graphic representation of the supply schedule Example: Supply curve for Big Macs Price Quantity $ Supply curve 1 2 3 4 5 200300400500600

14. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-14 Market Equilibrium Supply and demand can now be brought together to form the price mechanism P Q S D Equilibrium point (P e ) PePe QeQe (cont.)

15. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-15 Market Equilibrium (cont.) Market equilibrium (E) is where: Quantity demanded = quantity supplied (intersection of demand and supply curves) The market is cleared (no shortages or surpluses) Price (P e ) is stable

16. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-16 Market Disequilibrium = where quantity demanded is NOT EQUAL to quantity supplied Types: 1. Market shortage: where quantity demanded > quantity supplied 2. Market surplus (oversupply): where quantity supplied > quantity demanded

17. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-17 Market Shortage Caused by setting price BELOW the equilibrium P Q S D PePe QsQs QdQd Shortage

18. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-18 Market Surplus Caused by setting price ABOVE the equilibrium P Q S D QdQd QsQs Surplus

19. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-19 Changes in Demand Certain factors (other than price changes) affect the absolute level of demand These factors are called conditions of demand Changes to the conditions of demand cause changes in demand and this results in shifts of the demand curve

20. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-20 An Increase in Demand The entire demand curve shifts to the right Q P D D1D1 S E E1E1 PePe Pe1Pe1 EQEQ 1

21. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-21 A Decrease in Demand The entire demand curve shifts to the left Caused by a factor other than price Q S D D1D1 E E1E1 Qe1Qe1 QeQe P PePe Pe1Pe1

22. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-22 Conditions of Demand Change in tastes Improvements in technology Real income Change in population Change in the price of substitutes Change in the price of other goods Expectations of the future Advertising

23. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-23 Changes in Supply Certain factors (other than price changes) affect the absolute level of supply These factors are called conditions of supply and they result in shifts of the supply curve (not movements along it)

24. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-24 An Increase in Supply Supply curve shifts to the right P Q S D S1S1 E E1E1 PePe Pe1Pe1 QeQe Qe1Qe1

25. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-25 A Decrease in Supply Supply curve shifts to the left P Q S D S1S1 E E1E1 Pe1Pe1 PePe Qe1Qe1 QeQe

26. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 3-26 Conditions of Supply Improvements in technology A change in production costs A change in the price of alternative products Weather and seasons