Download EC611--Managerial Economics Demand and Supply

EC611--Managerial Economics
Demand and Supply
Dr. Savvas C Savvides, European University Cyprus
Some key terms
Market
a set of arrangements by which buyers and sellers are
in contact to exchange goods or services
Demand
the quantity of a good buyers wish to purchase at each
conceivable price
Supply
the quantity of a good sellers wish to sell at each
conceivable price
Equilibrium price
price at which quantity supplied = quantity demanded
1
What, How and for Whom
The market:
determines what goods are being produced
• there may be goods for which no consumer is
prepared to pay a price at which firms would be
willing to supply
decides how much of a good should be produced
• by finding the price at which the quantity
demanded equals the quantity supplied
tells us for whom the goods are produced
• those consumers willing to pay the equilibrium
price
2
Law of Demand
A decrease in the price of a good, all other
things held constant, 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.
Quantity Demanded: The amount purchased at a
particular price for a given time period
3
Law of Demand
There is an inverse relationship between the price
of a good and the quantity of the good demanded
per time period.
Substitution Effect (If PA relative to PB Î DA )
Income Effect (If PA Î DA as purchasing power
of individual’s income increases).
4
The Demand Curve
5
The Demand Curve
Demand Curve: Shows the relationship between P and Q, ceteris paribus
There is an inverse relationship between P and Qd, ceteris paribus
Price
An increase (decrease) in
price causes a decrease
(increase) in quantity
demanded.
Demand Schedule
P
Qd
£2.5
50 units
2.00
75
1.50
100
1.25
150
1.00
200
0.50
250
P1
P0
Demand Curve
Q1
Q0
Quantity
6
Changes in Demand
“OTHER THINGS”
NON-PRICE DETERMINANTS OF DEMAND
Change in Buyers’ Tastes
Change in Buyers Incomes
Normal Goods
Inferior Goods
Expectations of Future Price Changes
Change in the Price of Related Goods
Substitute Goods
Complementary Goods
Change in the Number of Buyers
7
Change in Demand
A change in any of the “other things” will affect the position of Demand
Price
An increase (decrease) in
demand refers to a
rightward (leftward)shift
in the market demand
curve.
P0
D2
Q2
Q0
Q1
D0
D1
Quantity
8
Two ways to Reduce the Quantity
Demanded
The Case of Cigarettes (1)
Price
A movement along
the demand curve
from A to B
It represents
consumer reaction
to a price change
P1
A
P0
D
Q1
Q0
Quantity
9
Two ways to Reduce the Quantity
Demanded
Price
The Case of Cigarettes (2)
P1
P0
B
D
C
A
D1 D0
Q4 Q3 Q2 Q0
Quantity
A movement of the
demand curve from D0 to
D1 leads to a decrease in
demand at each price
The shift of demand curve
may come about due to
Ministry of Health
announcements, health
warnings on cigarette
packages, banning of ads
on TV, non-smoking in
restaurants, offices and
public places, etc
10
Individual Consumer’s Demand
QdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X by an
individual per time period
PX = price per unit of commodity X Î ∆QdX/∆PX < 0
I
= consumer’s income Î ∆QdX/∆I > 0 for normal
good; ∆QdX/∆I < 0 inferior good
PY = price of related (substitute or complement)
commodity Î ∆QdX/∆PY > 0 if X and Y are
substitutes; ∆QdX/∆PY < 0 if X and Y are complements
T
= tastes of the consumer
11
Market Demand Curve
Market Demand Curve Î Horizontal Summation of
Individual Demand Curves
12
Market Demand Function
QX = f(PX, N, I, PY, T)
QX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers on the market
I = consumer income
PY = price of related (substitute or
complementary) commodity Y
T = consumer tastes
13
Market Demand Function -An Example
Using OLS, the demand in Cyprus for BENZINE
was estimated (for the period 1970-2000)
DB = 67938 – 83.4PB + 73N + 16.5Y + 2907t
If we substitute in the above equation, actual
values for the explanatory vbls., we get:
DB = 67938 – 83.4PB + 73(700K) + 16.5 ( 5525m)
+ 2907(32)
DB = 303026 – 83.4PB
14
Market Demand Function -An Example (2)
By then substituting alternative prices for PB, we
construct a demand schedule for the year.
ÎIf PB = £550:
DB = 303026 – 83.4(550)
= 257156 tons
ÎIf PB =£600:
DB = 303026 – 83.4(600)
= 252986 tons
ÎIf PB = £450:
DB = 303026 – 83.4(450)
= 265496 tons
15
The Market Demand Curve (3)
The alternative values of P and Qd give us a demand schedule
From which we can construct a demand curve
Price of Benzine
DB = 303026 – 83.4(PB)
Demand Schedule
P
Qd
£600
252986 tons
£550
257156 tons
£450
265496 tons
D’B = 314334 – 83.4(PB)
Quantity
Let’s now substitute values for the non-price vbls. For instance
for 2002 (t=33): N=705K, Y=6000M
ÎD’B = 314334 – 83.4(PB) . This is the dotted demand curve.
16
Î Same slope (- 83.4), but higher intercept (314334 instead of 303026)
Market Demand Function -An Example
Using OLS, the demand for sweet potatoes was
estimated as follows (for the period 1949-1979)
Ds = 7609 – 1606Ps + 59N + 947Y + 479Pw- 271t
If we substitute in the above equation, actual
values for the explanatory vbls., we get:
Ds = 7,609 – 1,606Ps + 59(150.72m.)+
947(17,600) + 479($2.94) – 271(1)
Ds = 19,306 – 1,606Ps
17
Market Demand Function -An Example (2)
By then substituting alternative prices for Ps,
we get the final demand for the year. If Ps =
$5:
Ds = 19,306 – 1,606(5) = 10,312
ÎIf Ps = $ 7
Î Ds = 19,306 – 1,606(7)
= 8,064 tons
ÎIf Ps = $ 4
Î Ds = 19,306 – 1,606(4)
= 12,882 tons
18
The Supply Curve
19
The Market Demand Curve (3)
The alternative values of P and Qd give us a demand schedule
From which we can construct a demand curve
Demand Schedule
P
$7
Price of Potatoes
Qd
8,064 tons
$5
10,312
$4
12,882
$7
$5
$4
D’s = 17,598 – 1,606(Ps)
Ds = 19,306 – 1,606(Ps)
Quantity
Let’s now substitute values for the non-price vbls. For instance
for 1972 (t=24): N=208m., Y=31,900, Pw=$2.41
ÎD’s = 17,598 – 1,606(Ps) . This is the dotted demand curve to the left.
20
Î Same slope (1,606), but lower intercept (17,598 instead of 19,306)
Law of Supply
A decrease in the price of a good, all other
things held constant, 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.
Quantity Supplied: The amount offered for in the market at a
particular price at a given time.
21
The Supply Curve
An increase (decrease)
in price causes an
increase (decrease) in
quantity supplied.
Price
Supply Schedule
P
Qd
£2.5
200 units
2.00
150
1.50
100
1.25
50
1.00
10
0.50
0
P0
Supply Curve
P1
Q1
Q0
Quantity
22
Changes in Supply
What are these “other things” for Supply?
NON-PRICE DETERMINANTS OF SUPPLY
Change in Production Technology
Change in Input Prices
Change in the Number of Sellers
Taxes/subsidies and legal restrictions
Future Price Expectations of Sellers
Weather & other “exogenous” factors
Î A change in any of these “other things” will
affect the position of the Supply Curve (but
NOT its slope
23
Change in Supply
Price
An increase (decrease) in supply refers to a
rightward (leftward) shift in the market
supply curve.
S0
S2
S1
P0
Q2
Quantity
Q0
Q1
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Market Equilibrium
Equilibrium: A position of balance, from which
there are no inherent forces or tendencies to
move away.
Market equilibrium is determined at the
intersection of the market demand curve and
the market supply curve.
Equilibrium price: The price at which the
quantity demanded is equal to the quantity
supplied; there is no surplus (excess supply),
nor shortage (excess demand)
25
Market Equilibrium
26
Market Equilibrium
Price
D
P
Qd
S
Market
Equilibrium is at E
where quantity
demanded equals
quantity supplied.
Qs
2.50
50
200
2.00
75
150
1.50
100
100
1.25
150
50
1.00
200
10
0.50
250
0
Po
E
Qo
This is at Po
(£1.50) and Qo
(100 units)
Quantity
27
Demand and Supply of Potatoes
(Hypothetical Values)
Price (cents
per kilo)
0
Quantity
Demanded
133.3
Quantity
Supplied
-23.5
20
106.7
0
40
80.1
23.7
60
53.5
47.3
80
26.9
70.9
100
0
94.5
28
D & S of Potatoes: Algebraic Solution
Assume, for example, that the Cyprus Potato Board has
estimated the demand and supply of potatoes to be the following:
Demand equation: P = 100 – 0.75 Q
(where – 0.75 reflects the negative slope of D)
Supply equation: P = 20 + 0.85 Q
(where + 0.85 reflects the positive slope of S)
where, P is in CYP (C£) and Q is in tons.
Solving for Q, we have: 100 – 0.75 Q = 20 + 0.85 Q
1.4 Q = 80
Q* = 50
Substituting Q = 50 in the demand eq. gives us P* = 62.5
Therefore, the equilibrium quantity would be 50 tons of potatoes,
and the equilibrium price would be C£ 62.5 per ton.
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Price
Market Equilibrium and Disequilibrium
Surplus or
excess
supply
D
•
P1
E
S
consumers wish to
purchase more than
producers wish to supply
•
•
P0
•
P2
S
•
excess
demand
or shortage
Q0
ÎIf price were below P0
there would be excess
demand
D
Quantity
ÎIf price were above P0
there would be excess
supply
producers wish to supply
more than consumers wish
to purchase
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Price
A Shift in Demand (1)
D1
D0
If, for instance,
the price of a substitute
good decreases ...
S
Excess
Supply
P0
P1
E0
ÎThe demand curve shifts
from D0D0 to D1D1.
E1
S
D1
Q1 Q0
less will be demanded at
each price.
D0
Quantity
If price stayed at P0 there
would be excess supply.
So, the market moves to a
new equilibrium at E1,
with lower price and quantity
31
A Shift in Demand (2)
Price
D0
P1
P0
D1
S0
E1
E0
Assume consumers expect
the price of oil to increase
(due to the possibility of a
war, say the war in Iraq. This
will tend to increase their
current demand .
An increase in demand will
cause the market equilibrium
price and quantity to
increase.
ÎSo, the market moves to a
new equilibrium point at E1
Q0 Q1
Quantity
32
A Shift in Supply (1)
Price
S1
S0
D
E2
P1
P0
The supply curve
shifts to S1S1
E0
S1
S0
If price stayed at P0 there
would be excess demand
D
Q1 Q0
Suppose safety at work
regulations (due to EU) are
tightened, leading to
increasing producers’ costs
So the market moves to a
new equilibrium at E2
Quantity
Other factors leading to the same result: Oils shortage, winter freeze, drought
33
A Shift in Supply (2)
(Technical Innovation)
Price
D0
S0
E0
P0
P1
E1
Q0 Q1
S1
An increase
in supply
will cause
the market
equilibrium
price to
decrease and
quantity to
increase.
Quantity
34
A Market in Disequilibrium
Price
(Price Controls)
P1
S1
S0 Suppose a disastrous wheat
E1
P0
E0
excess
demand
Q1
D
harvest moves the supply
curve from S0 to S1
The government may try to
protect the poor, setting a price
ceiling for bread at P0 which is
below P1, the new equilibrium
price level
„The result is excess demand
(shortage)
Q0 Quantity
RATIONING is needed to cope with the resulting excess demand.
This was the case in ex-Soviet Russia and China.
35
Price Supports
Price
D
Surplus
S
PS
P0
QD
Q0
QS
The Cyprus gov’t
supports farmers (in
the context of CAP),
by ensuring them a
price support for
their produce (milk,
potatoes, cereals,
meat, wine, etc) at P1
which is above P0,
the equilibrium price
ÎThe result is excess
supply (surplus)
Quantity
36
Price and Quantity Changes
In practice, we cannot plot ex ante
demand curves and supply curves
So,historical data and the supposition
that the observed values are equilibrium
ones are used
Since other things are often not
constant, some detective work is
required this is where our theory comes
in useful
37
Demand Faced by a Firm
Market Structure
Monopoly
Oligopoly
Monopolistic Competition
Perfect Competition
Type of Good
Durable Goods
Nondurable Goods
Producers’ Goods - Derived Demand
38
Determinants of Demand for a
Product
QX = f (PX, AX ,OX , FX … Yc , Tc , Ec ….
Strategic vbls.
Controlled vbls.
Consumer vbls.
Uncontrolled vbls.
… PY, AY ,OY , FY … G, N, FX, W…)
Competitor vbls.
Uncontrolled
Environmental vbls.
Variables
39
Linear Demand Function
QX = f(PX, N, I, PY, T)
QX = a0 + a1PX + a2N + a3I + a4PY + a5T
PX
Intercept:
a0 + a2N + a3I + a4PY + a5T
Slope:
∆QX/∆PX = a1
QX
40