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STUDY UNIT: 4 CHAPTER: 7 DEMAND, SUPPLY AND PRICES 7.1 Demand and supply: an introductory overview Households own factors of production sell these factors to firms in the factors market and receive rent, wages, salaries, interest and profit. Rent -natural recourses Wages & Salaries – Labour Interest – Capital Profit – entrepreneurship. Firms combine these factors of production to produce goods and services that are sold in the goods markets to households who use the income to purchase services and stock. Demand and supply are often likened to the two blades of a pair scissors that interact to determine the equilibrium price and equilibrium quantity in the market. 7.2 Demand Is the outcome of decisions about which wants to satisfy, given the available means. If you demand something, you intend to buy it and that you have the means(purchasing power) to do so. Demand is the quantities of a good or service that the potential buyers are willing and able to buy. Wants are unlimited desires or wishes that people have for goods and services. Demand is only affective if the consumer is able and willing to pay for the goods or services. Demand is a flow concept (measured over a period) Individual demand What determines the quantity of something? The price of the product :lower price more is bought The price of related products: complements and substitutes. Substitutes are goods which can be used instead of other good Income of the consumer : higher income more can be bought The taste/preference of the consumer : don’t like product you wont buy a lot Size of the household : more people more product will be bought One thing that does not determine quantity bought is the availability or supply, the availability can only affect the actual outcome in the market. ECONOMIC THEORY IS SIMPLIFIED COMMON SENSE BUT IT IS STRUCTURED, DISCIPLINED OR LOGICAL COMMON SENSE. Demand can be expressed in words, schedules, curves and equations. Verbal concept The quantity of a good demanded by an individual in a particular period depends on the price of the good, the price related goods, income of the individual, taste, number of people in household and any other possible influence. Equation concept Qd: Quantity Px: Price Pg: Price of related goods Y: Income T: Taste N: Number of people in household LAW OF DEMAND OTHER THINGS BEING EUAL(CETERIS PARIBUS) THE HIGHER THE PRICE OF THE GOOD, THE LOWER THE QUANTITY DEMANDED. Qd=f(PX,Pg,Y,T,N) Dependent variable: Qd Independent: PX,Pg,Y,T,N The purpose of theory: understand things by reducing the details to a minimum When focusing on the relationship between Qd and Px we assume that PX,Pg,Y,T,N do not change. So we rewrite equation Qd=f(PX,Pg,Y,T,N) to Qd=f(PX) ceteris paribus Schedule concept POSSIBILITY PRICE OF GOODS 1 2 3 4 5 A B C d e QUANTITY DEMANDED 6 5 4 3 2 Curve concept WEEKLY DEMAND OF GOODS 7 6 5 4 WEEKLY DEMAND OF GOODS 3 2 1 0 1 2 3 4 5 6 Each point indicates the quantity of goods demanded at that price. By joining the points we obtain the demand curve DD, the demand curve indicates the relationship between the quantity of goods demanded and price of goods , on assumption everything else stays the same Bases of any diagram is the axes Vertical axes (independent): Horizontal axes(dependent): - Negative/ inverse relationship Recap of concepts: Using words: refers to the entire relationship, between quantity demanded and the price of the goods or service. Using numbers( schedule): demand schedule is a table which shows the quantity of a good demanded at each possible price Using graphs: demand curve is the line that which indicates the quantity demanded of a good at each price Using symbols: is a shorthand way of expressing the relationship between quantity of a good and its price Market demand The individual demand curve is one of the most important building block of microeconomic theory. In a market system all the plans of the consumers and producers of a good or service have to be taken into account. Market demand is simply the sum of all the individual demands. To obtain a market demand schedule , all the demand schedules are simply added together, the market demand curve can be obtain also but just adding all the curves together. Movements along the demand curve and shifts of the curve. Movement-slope of the curve Shift-position or intercept of the curve Movement along a demand curve (change in quantity demanded) If the price of the products changes: we obtain the change in the quantity demanded by comparing the relevant points on the fixed, given or unchanged demand curve by moving along the curve. This is how we determine the change in quantity demanded. Shift of the demand curve(change in demand) A change in any determinants of demand other than the price of the product will shift the demand curve. The price is elevated to centre stage by measuring it on the vertical axis, changes in the other determinants of the demand is reflected only as shifts of the curve itself. This is change in demand. Difference between the change in quantity demanded and change in demand A change in the price of a related good There is 2 categories: substitutes and complements o Substitutes Used to replace another good, if the rice of the substitute is increased a greater quantity of the good will be demanded. The curve will shift to the right. o Complements Used jointly to satisfy want. A fall in the price of a complementary product increases the demand for the product and this is illustrated by rightward shift of curve, an increase in the price of the complement will lead to a decrease in the demand for the product shift to the left. o Change in the income of consumers Increase will lead to a increase in the demand and the curve will shift to the right whereas a decrease in the income will lead to a decrease in the demand and curve will shift to the left. Normal goods- is when income decrease demand decrease Inferior good- when income increase demand decrease, for example a family will change bread for meat because they have more money. o Change in taste When taste change demand changes, when taste decreases the demand will decrease and curve will shift leftward. When taste increase the demand will increase and curve will shift rightward. Advertising and Fashion can play a role in this change. o Change in population The larger the population the bigger the demand, smaller population the smaller the demand. Increase in population will shift curve to the tight, ceteris paribus. o Other influences A change in expected future prices Expected price change can change in demand, if price is about to fall consumer will wait till price has fallen, current demand will fall but future demand will increase. Ceteris paribus. Distribution of income Demand may also change if a constant total income is redistributed among the different households in the economy. The demand for goods bought mostly by lowincome households will increase, while the demand DETERMINANT CHANGE EFFECT ON MARKET CORRECT DESCRIPTION DEMAND CURVE ON EFFECT Price of the good Increase Upward movement A fall in the quantity along the demand curve demanded Decrease Downward movement An increase in the along the demand curve quantity demanded Prices of related good Substitutes Increase Rightward shift of the An increase in demand demanded curve Leftward shift of the A fall in demand demand curve Complements decrease Leftward shift of the A fall in demand demand curve Rightward shift of the An increase in demand demanded curve Income (normal good) Increase decrease Taste Increased Decrease Population Expected future price of goods increase Expected to increase Price expected to fall Rightward shift of the demand curve Leftward shift of the demand curve An increase in demand Rightward shift of the demand curve Leftward shift of the demand curve rightward shift of the demand curve Leftward shift of the demand curve Increase in demand Rightward shift of the demand curve Leftward shift of the demand curve Increase in demand A fall in demand Fall in demand Increase in demand A fall in demand Fall in demand Absolute price – rand and cents Relative price – ratio between the price and the prices of other goods a fall in the price does not only mean that the absolute price falls but the relative price also, the good therefor becomes relatively and absolutely cheaper than before, all the other goods become relativity more expensive than before 7.3 Supply Defined as the quantities of a good or service that producers plan to sell at each possible price during a certain period. Supply is a flow concept which is measured over a period of time, also be expressed in words, schedules, curves or equations. Individual supply What determines supply in a period? Price of goods Higher the price the more you will produce, ceteris paribus. The prices of alternative products Always consider the prices of alternatives outputs that they can produce with the same recourses, these outputs are sometimes referred to as a substitutes in production. Prices of factors of factors of production and other inputs To make a profit he has to cover his costs of production. Expected future prices State of technology New technologies that enable producers to produce at lower cost will increase the quantity supplied at each price. Supply decisions must not be confused with demand decisions or with actual outcomes in the market. Suppliers have no guarantee that their produce will sell. Verbal concept The quantity of a good supplied by an individual producer in a aprticular period is a function of the price of the good, the prices of alternative outputs, the prices of the factors of production, the expected future prices of the good and the stat of technology. Equation concept QS =Quantity of goods supplied PX =price of goods PG =price of alternative outputs PF =prices of factors of production and other inputs PE =expected future prices of goods TY =technology Expressed as: QS=F(PX,PG,PF,PE,TY) Focus primarily on the relationship between the quantity supplied and the price of the good We therefore state: QS=F(PX,PG,PF,PE,TY)- bars indicate they are kept constant QS=F(PX) Supply concept possibility Price of goods A B C D E 1 2 3 4 5 Quantity supplied 500 1000 1500 2000 2500 Curve concept supply 6 5 4 3 2 1 0 Series 1 Summary of concepts: Using words Supply refers to the entire relationship between the quantity supplied of a commodity and the price of that commodity, other things being equal. usually positive relationship, higher price higher supply Using numbers Show the quantity supplied at each price . Graphs Indicate the quantity supplied of a good at each price. Ceteris paribus. Symbols Equation shorthand way of expressing the relationships between quantity supplied of a good and its price, ceteris paribus. Market supply To move from a individual supply to a market supply the individual supplies are counted together horizontally. The market supply curve shows the relationship between the price of the product and the quantities supplied during a particular time. QS=f(PX,PG,PF,PE,TY,N) QS = Quantity supplied PX =Price per product PG =Price of alternative outputs PF =Price of factors of production and other inputs PE =Expected future prices of the product TY =Technology N =Number of firms supplying the same product Other possible determinants include: Government policy Subsidies on particular goods or services tend to raise their supply, while taxes toe reduce supply Natural disasters Joint products and by-products Some products are produced jointly (meat and leather) with the result that a change in the supply of the major product results in a similar change in the supply of a by-product. Sometimes called complements of production. Productivity This is related to technology, a change in the productivity of factors of production will lead to a change in supply. If productivity falls, production cost increase, ceteris paribus, and supply decreases. Some of the determinants of supply are interdependent. If relative price of a production is expected to increase the number of firm supplying the market will tend to increase. MOVEMENT ALON THE SUPPLY CURVE AND SHIFTS OF THE CURVE The supply curve shows the relationship between the price of the product and the quantity supplied ,ceteris paribus. At a price of P1 the quantity supplied will be Q1, if price increases to P2 the quantity supplied will also increase to Q2. Movement – Change in the price of the product, which we measure on the vertical axis, a change in quantity supplied Shift – Changes in any factor of production, change in supply A – Fall on supply B – increase in supply Determinant Change Price of the good Increase Decrease Price of alternative products Increase Decrease Prices of joint products Increase Decrease Prices of inputs Increase Decrease Expected future prices Technology Number of firms Price is expected to increase Price is expected to fall Cost-reducing improvement Cost-increasing improvement More firms enter market Firms leave market Effect on market supply curve Upward movement along the supply curve Downward movement along the supply curve Leftward shift of the supply curve Rightward shift of the supply curve Rightward shift of the supply curve Leftward shift of the supply curve Leftward (upward) shift of the supply curve Rightward (downward) shift of the supply curve Rightward shift of the supply curve Leftward shift of the supply curve Rightward shift of the supply curve Leftward shift of the supply curve Rightward shift of the supply curve Leftward shift of the supply curve Correct description of effect An increase in quantity supplied A decrease in the quantity A decrease in supply A increase in supply An increase in supply An decrease in supply A decrease inputs An increase in supply An increase in supply An decrease in supply An increase in supply An decrease in supply An increase in supply An decrease in supply 7.4 Market equilibrium Equilibrium, excess demand and excess supply Equilibrium is a state of rest in which opposing forces are balanced and in which there is no tendency for change. Excess demand – When quantity demanded is greater than supplied. Excess supply – When quantity supplied is greater that quantity demanded Equilibrium – quantity demanded is equal to quantity supplied When there is excess demand Firms sell their products but households do not obtain the quantity of the product which they would like to buy at a particular price. To obtain a bigger quantity households bet on the products for the highest price, firms realise they can rise the price. As the price rises the quantity supplied increases along the supply curve and the demand decreases along the demand curve, this process will continue till equilibrium is reached. When there is excess supply Firms find that they cannot sell all their products. They cut their production and compete with each other to find buyers by reducing the price. The result is a fall in quantity supplied along the supply curve and a increase in demand along the demand curve. This process continues until equilibrium is reached. The function of prices on a market economy Prices cause adjustments in the quantities demanded and supplied of each good Two functions in a market economy 1. Rationing function - prices serve to ratio the scarce supplies of goods and services to those who place the highest value on them 2. Allocative function - In markets where there is a excess demand prices increase, higher prices means more profit, ceteris paribus. Excess supply results in decrease in price an a decrease in profit.