Download Theory of Demand and Supply

Theory of Demand and Supply
-
-Subhalakshmi Paul Ghosh
Chandidas Mahavidyalaya,
- Dept. of Economics
- B.A. 1st year (Pass))
Topic Discuss Under Demand
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What is Demand?
Function of Demand
Law of Demand
Causes of negatively sloped demand curve
Exceptions of law of demand
Difference between individual & market demand
curve
• Difference between change in demand & change
in quantity demanded.
What is Demand?
• Quantity demanded is the amount of a good that
buyers are willing and able to purchase
• Demand is a full description of how the quantity
demanded changes as the price of the good changes.
• Definition: “A schedule of the quantities of a good that
buyers are willing and able to purchase at each
possible price during a period of time, ceteris paribus.
[all other things held constant]”
• Demand can also be perceived as a schedule of the
maximum prices buyers are willing and able to pay for
each unit of a good.
Functions of Demand
Is the functional relationship between the price of the
good and the quantity of that good purchased in a given
time period [UT], income, other prices and preferences
being held constant.
• A change in the price of the good under consideration
will change the “quantity demanded.”
Q = f (P, M, Py, preferences )
where: M = income , Py = prices of related goods
• DP causes a change in X [DQ], this is a “change in
quantity demanded”.
Law of Demand
“provided all other factors … are unchanged”
• That’s an important phrase in the wording of the Law of Demand
• The quantity demanded of a consumer good such as ice cream
depends on
–
–
–
–
–
–
The price of ice cream
The prices of related goods
Consumers’ incomes
Consumers’ tastes
Consumers’ expectations about future prices and incomes
Number of buyers, etc
• The Law of Demand says that the quantity demanded of a good is
inversely related to its price, provided all other factors are
unchanged
Demand Schedule and Demand
Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price ...
2.00
1.50
1.00
0.50
6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
0 1 2 3 4 5
SUPPLY AND DEMAND
6
Copyright © 2004 South-Western
Causes of Negatively sloped Demand Curve
The Law of Demand—Explanations
• There are two ways to explain the Law of
Demand
– Substitution effect
– Income effect
– Marginal Rates of Diminishing Return
SUPPLY AND DEMAND
7
Substitution Effect
• When the price of a good decreases,
consumers substitute that good instead of
other competing (substitute) goods
1. When the price of Coke
decreases…
Clothes
Coke
2. Consumption of
Pepsi decreases…
Books
Movies
SUPPLY AND DEMAND
3. Consumption of
Coke increases
Pepsi
8
Income Effect
• A decrease in the price of a commodity is
essentially equivalent to an increase in
consumers’ income
SUPPLY AND DEMAND
9
Lower Prices = Higher Income
Situation A
Price of an Apple
$1.00
Price of an Orange
$2.00
Income
$10.00
If prices fall, Situation A
becomes Situation C.
If income rises, Situation A
becomes Situation B.
Situation B
Price of an Apple
$1.00
Price of an Orange
$2.00
Income
$20.00
Situation C
Price of an Apple
$0.50
Price of an Orange
$1.00
Income
$10.00
SUPPLY AND DEMAND
Q: Which change is better?
A: They are both equally
desirable. A fall in prices is
equivalent to an increase in
income.
10
Income Effect
• Consumers respond to a decrease in the price of a
commodity as they would to an increase in income
• They increase their consumption of a wide range of
goods, including the good that had a price decrease
1. When the price of Coke
decreases…
Clothes
Coke
2. Consumers
feel richer…
Books
Movies
SUPPLY AND DEMAND
3. Consumption of Coke and
other goods increases
Pepsi
11
Exception of Law of Demand
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Giffen Goods
Veblem Effects
Price Expectation
Snob Effects
Bandwagon Effects
For all of the above cases demand curve is
positively sloped rather than the negative..
Market Demand is the Sum of Individual
Demands
SUPPLY AND DEMAND
13
Shifts Versus Movements Along the Demand Curve
• Any change that varies the quantity that buyers wish to
buy at a given price shifts the demand curve
• Changes in price that varies the quantity that buyers
wish to buy is represented as a movement along the
demand curve
• To summarize: Demand curve shows what happens to
the quantity demanded of a good when its price varies,
holding constant all other determinants of quantity
demanded. When one of these determinants changes,
the demand curve shifts.
Why Might Demand Increase?
Quantity Demanded
Price Situation A
0.00
0.50
1.00
1.50
2.00
2.50
3.00
12
10
8
6
4
2
0
Situation B
20
16
12
8
6
4
2
• How can we explain the
difference in
Catherine’s behavior in
situations A and B?
• Why does she consume
more in situation B at
every possible price?
SUPPLY AND DEMAND
Price
15
Quantity Demanded
Shifts in the Market Demand Curve
• … are caused by changes in:
– Consumer income
– Prices of related goods
– Tastes
– Expectations, say, about future prices and
prospects
– Number of buyers
SUPPLY AND DEMAND
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Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand curve, D 3
0
SUPPLY AND DEMAND
Demand
curve, D 1
Demand
curve, D 2
Quantity of
Ice-Cream Cones
17
Shifts in the Demand Curve
• Consumer Income
– As income increases the demand for a normal good
will increase
– As income increases the demand for an inferior good
will decrease
• Prices of Related Goods
– When a fall in the price of one good reduces the
demand for another good, the two goods are called
substitutes
– When a fall in the price of one good increases the
demand for another good, the two goods are called
complements
SUPPLY AND DEMAND
18
Topic Discuss Under Demand
•
•
•
•
What is Supply?
Function of Supply
Law of Supply
Difference between individual & market
demand curve
• Shifts of the Supply Curve
SUPPLY
• Quantity supplied is the amount of a good
that sellers are willing and able to sell
• Supply is a full description of how the quantity
supplied of a commodity responds to changes
in its price
SUPPLY AND DEMAND
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Law of Supply
• The law of supply states that, the quantity
supplied of a good rises when the price of the
good rises, as long as all other factors that
affect suppliers’ decisions are unchanged
SUPPLY AND DEMAND
21
supply schedule and supply curve
Price of
Ice-Cream
Cones
$3.00
Price of
Ice-cream cone
Quantity of
Cones supplied
2.50
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
0 cones
0
1
2
3
4
5
2.00
1.50
1.00
Supply curve
1. An increase
in price . . .
2. . . . increases quantity
of cones supplied.
0.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
22
Market supply and individual supplies
Price of ice-cream cone
Ben
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
0
0
1
2
3
4
5
Jerry
+
0
0
0
2
4
6
8
Market
=
0
0
1
4
7
10
13
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Market supply and individual supplies
Price of
Ice
Cream
Cones
$3.00
Ben’s
supply
+
SBen
Price of
Ice
Cream
Cones
$3.00
Jerry’s
supply
=
Price of
Ice
Cream
Cones
SJerry
$3.00
2.50
2.50
2.50
2.00
2.00
2.00
1.50
1.50
1.50
1.00
1.00
1.00
0.50
0.50
0.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
0
1 2 3 4 5 6 7
Quantity of
Ice-Cream Cones
0
Market
supply
SMarket
2 4 6 8 10 12 14 16 18
Quantity of Ice-Cream Cones
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Shifts in the Supply Curve: What causes them?
Price of
Ice-Cream
Cone
Supply curve, S 3
Decrease
in supply
Supply
curve, S 1
Supply
curve, S 2
Increase
in supply
0
SUPPLY AND DEMAND
Quantity of
Ice-Cream Cones 25
EQUILIBRIUM
Interaction of demand and supply
• We have seen what demand and supply are
• We have seen why demand and supply may
shift
• Now it is time to say something about how
buyers and sellers collectively determine the
market outcome
• To do this, we assume equilibrium
SUPPLY AND DEMAND
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Equilibrium
• We assume that the price will automatically
reach a level at which the quantity demanded
equals the quantity supplied
SUPPLY AND DEMAND
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Supply and demand together
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded is
equal to the quantity supplied!
SUPPLY AND DEMAND
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Equilibrium of supply and demand
Price of
Ice-Cream
Cones
$3.00
2.50
2.00
Supply
Equilibrium
price
Equilibrium
1.50
1.00
0.50
0
Equilibrium
quantity
Demand
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
30
Equilibrium
• Can we justify the assumption of equilibrium?
31
Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Cone
Supply
Surplus
$2.50
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
SUPPLY AND DEMAND
Quantity of
Ice-Cream
Cones
32
Markets Not in Equilibrium
• Surplus
– When price exceeds equilibrium price, then
quantity supplied is greater than quantity
demanded
• There is excess supply or a surplus
• Suppliers will lower the price to increase sales, thereby
moving toward equilibrium
SUPPLY AND DEMAND
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Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Cone
Supply
$2.00
1.50
Shortage
Demand
0
4
Quantity
supplied
7
10
Quantity
demanded
SUPPLY AND DEMAND
Quantity of
Ice-Cream
Cones
34
Markets Not in Equilibrium
• Shortage
– When price is less than equilibrium price, then
quantity demanded exceeds the quantity supplied
• There is excess demand or a shortage
• Suppliers will raise the price due to too many buyers
chasing too few goods, thereby moving toward
equilibrium
SUPPLY AND DEMAND
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Equilibrium
• Law of supply and demand
– The price of any good adjusts to bring the quantity
supplied and the quantity demanded for that good into
balance
SUPPLY AND DEMAND
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Unemployment: a failure of equilibrium when the
wage is too high and stuck
Wage
Labor surplus
(unemployment)
Labor
Supply
Too-high
wage
Labor
demand
0
Quantity
demanded
Quantity
supplied
SUPPLY AND DEMAND
Quantity of
Labor
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Let’s make some predictions
• We can use our understanding of the factors
that shift the demand and supply curves to
predict the consequences of
– Alternative policy proposals, and
– Events outside our control
SUPPLY AND DEMAND
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Analyzing Changes in Equilibrium:
Application
1. Change in demand- shifts in the demand
curve
2. Change in supply- shifts in the supply
curve
3. Changes in both supply and demandChange in equilibrium quantity and price
A simple application
How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
Supply
New equilibrium
$2.50
2.00
2. . . . resulting
in a higher
price . . .
Initial
equilibrium
D
D
0
7
10
3. . . . and a higher
SUPPLY AND DEMAND
quantity sold.
Quantity of
Ice-Cream Cones
40
How a Decrease in Supply Affects the Equilibrium
Price of
Ice-Cream
Cone
S2
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S1
New
equilibrium
$2.50
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
Demand
0
4
7
3. . . . and a lower
SUPPLY AND
DEMAND
quantity
sold.
Quantity of
Ice-Cream Cones
41
A Shift in Both Supply and Demand
Event
Effect on Price
Effect on Quantity
Demand increases
Up
Up
Supply decreases
Up
Down
SUPPLY AND DEMAND
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A Shift in Both Supply and Demand
SUPPLY AND DEMAND
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Analyzing Changes in Equilibrium:
Summary
DEMAND/
SUPPLY
No change in
demand
No change
in Supply
Increase in
supply
Decrease in
supply
Increase in
demand
P same
Q same
P up
Q up
P up
Q down
P up
Q ambiguous
Decrease in
demand
P down
Q down
P down
Q up
P
ambiguous
Q up
P down
Q
ambiguous
P ambiguous
Q down