Download Demand & Supply

Topic 2 (a)
Demand & Supply
Module 2 Topic 1
Demand & Supply
1. Demand
2. Supply
3. Market Equilibrium
4. Consumer & Producer Surplus
1.1 What is demand?

No. of units of a good or service that
consumers are willing and able to
purchase during a period, under a given
set of conditions
1.2 Why is the study of demand
important for firms?



Determines a firm’s profitability
Affect long run planning and strategic
decisions
Affects short run decisions
Market Demand Schedule for Compact Discs
per year
Price
$25
$20
$15
$10
$5
Fred
Mary
Total Demanded
1 + 0 =
2
1
3
3
4
5
5
7
1
3
6
9
12
P
$20
$15
Fred’s Demand Curve
$10
$5
D1
1 2 3 4 5 6 7 8 9 Q
P
$20
$15
Mary’s Demand Curve
$10
$5
D2
1 2 3 4 5 6 7 8 9 Q
P
Market Demand Curve
$20
$15
$10
$5
D3
Q
3 4 5 6 7 8 9 101112
P
$20
$15
Fred’s Demand Curve
$10
P
$20
$15
Mary’s Demand Curve
$10
$5
1 2 3 4 5 6 7 8 9 Q
12
P
D2
$5
D1
1 2 3 4 5 6 7 8 9 Q
13
Market Demand Curve
$20
$15
$10
$5
D3
Q
3 4 5 6 7 8 9 10 11 12
14
1.3

The Law of demand:
Law of Demand:

There is an inverse relationship b/w the price of
a good and the quantity buyers are willing to
purchase in a defined time period, other things
being the same (ceteris paribus).

When the price of a good rises the quantity
demanded will fall and vice versa.
1.3

Law of demand
Reasons for inverse relationship:
Income effect:
↑P=> ↓ Real income => ↓ Purchasing power
=> ↓ Qd
 Substitution effect:
↑P => the good becomes relatively more
expensive => consumers switch to other
products => ↓ Qd

1.4 Demand curve

The demand curve illustrates the
relationship b/w the quantity
demanded and the price of a good
(assuming all other influences on the
demand are held constant).
IMPORTANT - KNOW
THE DIFFERENCE
BETWEEN A CHANGE IN
THE QUANTITY
DEMANDED AND A
CHANGE IN DEMAND
When price changes,
what happens?
The curve does not shift
- there is a change in
the quantity demanded
Change in
Quantity
Demanded
Change in
Price
P
$20
$15
$10
$5
A change in price causes a
change in the quantity demanded
A
B
D
Q
10 20 30 40 50
Decrease in
quantity
demanded
Upward
movement
along the
demand curve
Price
increases
Increase in
quantity
demanded
Downward
movement
along the
demand curve
Price
decreases
When something changes
other than price, what
happens?
The whole curve
shifts,there is a
change in demand
P
$20
$15
When the ceteris paribus assumption
is relaxed, the whole curve can shift
A
$10
B
D2
D1
$5
10 20
Q
30 40 50
Change in
demand
Change in
nonprice
determinant
What can cause a demand
curve to shift?
A change in:







Number and price of substitute goods
Number and price of complementary goods
Number of consumers in the market
Expected price changes
Incomes
Tastes, preferences, fashions, trends
Advertising
Shift in Demand Curve
A change in demand results from a change in one or more of
determinants of demand, other than the price of the goods.
Price
Decrease
Increase
A change in demand
can be represented by
a shift in the position
of the demand curve.
P
D0
0
Q2
Q0
Q1
D1
Quantity
Some definitions…




Substitute goods are good that can be used in
place of another good (eg. Coke & Pepsi)
Complementary goods are goods that are used
in conjunction with each other (eg. Bread and
butter)
Normal goods are goods whose demand varies
directly with income (also known as superior
goods)
Inferior goods are goods whose demand varies
inversely with income
1.4 Psychological (or nonfunctional) factors affecting
demand:

Bandwagon effect


Snob effect


Everyone is doing it, so will I
Not everyone can do it, so I will
Conspicuous consumption

Let everyone see how much money I
have
Bandwagon effect



A situation where the more of goods are sold in the
market, the greater the strength of demand for that
goods. “Jumping on the bandwagon”
Because some consumers possess the goods, it
causes other consumers to desire it.
This is often the case with new consumer goods
introduced onto the market eg, plasma TV, iPod
Snob effect



Demand for the good strengthens as the
availability of that good is reduced.
The scarcity of the good leads consumers to
psychologically re-appraise the qualities of the
goods.
Eg, Limited Edition Books or Prints;
Exclusive Designer Wear
Conspicuous consumption



Where the consumers valuation of the good is
influenced by the price of goods in the market.
Satisfaction is gained not only from the good itself,
but also from being seen to be able to afford it.
This may be the case with such prestige items
such as paintings, or expensive clothes and cars.
2. What is Supply ?

No. of units of a good or service firms
are willing and able to produce during
a period, under a given set of
conditions
2.2 Law of Supply
There is a direct relationship
between the price of a good and
the quantity sellers are willing to
offer for sale in a defined time
period, ceteris paribus
2.1 Supply curve
Supply curve:
 The supply curve shows the relationship
between quantity supplied & price, other
things being the same (citeris paribus)
An Individual Seller’s Supply for Compact Discs
Point
A
B
C
Price
$20
10
6
Quantity
40
30
20
P
$20
A company’s
Supply Curve for
Compact Discs
Supply Curve
A
$15
B
$10
C
$5
10
20
30
40
Q
Why do supply curves have a
positive slope?

A higher price means more
profitable to suppliers/sellers.

Therefore, they will supply more of
the good or service.
Market Supply Schedule for Compact Discs
per year
Price
$25
$20
$15
$10
$5
Super Sound
High Vibes
Total
25 + 35 =
20
30
15
25
10
20
5
15
60
50
40
30
20
P
Super Sound Supply Curve
S1
$25
$20
$15
$10
10 15 20 25
Q
P
High Vibes Supply Curve
S2
$25
$20
$15
$10
20 25 30 35
Q
P
$25
$20
$15
$10
Market Supply Curve
S total
40 45 55 60
Q
IMPORTANT - KNOW
THE DIFFERENCE
BETWEEN A CHANGE
IN THE QUANTITY
SUPPLIED AND A
CHANGE IN SUPPLY
When price changes, what
happens?
The curve does not shift
- there is a change in
the quantity supplied
P
$20
A change in price
causes a change
in the quantity
supplied
Supply Curve
A
$15
B
$10
C
$5
10
20
30
40
Q
Change in
Quantity
Supplied
Change in
Price
When something changes
other than price, what
happens?
The whole curve shifts there is a change in supply
P
$20
When the ceteris paribus
assumption is relaxed, the
whole curve can shift
S1
S2
$15
$10
$5
10
20
30
40
Q
Change in
supply
Change in
nonprice
determinant
What can cause a supply curve
to shift?
A Change in:






price of substitutable goods (on the supply side)
cost of production (eg. Price of raw materials,
labour, capital)
taxes & subsidies
technology
profit expectations
number of suppliers
Shift in Supply Curve
A change in supply results from a change in one or more of
determinants of supply, other than the price of the goods.
Price
A change in supply
can be represented
by a shift in the
position of the
supply curve.
Decrease
Increase
S2
0
S0
S1
Quantity
3. Market equilibrium


The point where quantity demanded
equals quantity supplied
Market forces keep the price at
equilibrium (how?)
Equilibrium price and output:
The Market Demand and Supply of Potatoes
(Monthly)
Price of Potatoes
Total Market Demand
Total Market Supply
($ per kg)
(Tonnes: 000s)
(Tonnes: 000s)
0.40
700 (A)
100 (a)
0.80
500 (B)
200 (b)
1.20
350 (C)
350 (c)
1.60
200 (D)
530 (d)
2.00
100 (E)
700 (e)
Copyright 2001 Pearson Education Australia
The determination of market equilibrium
(potatoes: monthly)
2
E
e
Supply
Price ($ per kg)
1.6
D
d
C
1.2
c
b
0.8
B
a
0.4
A
Demand
0
0
100
200
300
400
500
fig
Quantity (tonnes: 000s)
600
700
800
Copyright 2001 Pearson Education Australia
Markets not in equilibrium

Shortage

When market price < equilibrium price,
then quantity demanded > 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.
The determination of market equilibrium
E
2
D
1.6
Price ($ per kg)
(potatoes: monthly)
e
Supply
d
C
c
1.2
b
SHORTAGE
B
0.8
(300 000)
a
A
0.4
Demand
0
0
100
200
300
400
fig
500
Quantity (tonnes: 000s)
600
700
800
Copyright 2001 Pearson Education Australia
Markets not in equilibrium

Surplus

When market price > equilibrium price,
then quantity supplied > quantity
demanded.


There is excess supply or a surplus.
Suppliers will lower the price to increase sales,
thereby moving toward equilibrium.
The determination of market equilibrium
(potatoes: monthly)
e
Supply
2
E
SURPLUS
1.6
d
D
Price ($ per kg)
(330 000)
1.2
C
c
B
b
0.8
a
0.4
A
Demand
0
0
100
200
300
400
500
600
700
800
fig
Quantity (tonnes: 000s)
Copyright 2001 Pearson Education Australia
4. 1 Consumer Surplus



the difference between what the consumers
are willing to pay (shown on the demand curve)
and what they actually pay (the market price)
In other words, Consumer surplus is the area
between the Demand curve and the Price
line
P
Consumer surplus
P1
D
O
Q1
Q
fig
Copyright 2001 Pearson Education Australia
Consumer
surplus
P
P1
Total
consumer
expenditure
O
D
Q1
Q
fig
Copyright 2001 Pearson Education Australia
Consumer surplus
P
P1
Total
consumer
surplus
Total
consumer
expenditure
O
D
Q1
Q
fig
Copyright 2001 Pearson Education Australia
Consumer Surplus


CS is the area between the demand curve
and the market price line.
It measures how much the consumer
gains from buying goods in the market
4.2 Producer surplus


the amount producers receive (market price)
above the minimum price required to
make them supply the good (shown on the
supply curve)

Producer surplus is the area between the
Price line and the Supply curve
P
Producer surplus
S
Total Producer surplus
Market price
P
1
Producer
Surplus
O
Q1
Q
fig
Copyright 2001 Pearson Education Australia
4.3 CS and PS – Economic efficiency


CS and PS are an important tool for
measuring the performance of an
economic system
or for assessing the impact of alternative
government policies in that system.
P
CS and PS – Economic efficiency
S
CS
Pm
Producer
PS
Surplus
D
O
Qm
Q
fig
Copyright 2001 Pearson Education Australia
P
CS and PS – Economic efficiency
Deadweight loss:
area A + B
S
CS
A
Pm
B
Producer
PS
Surplus
D
O
Too little
Q
fig
Copyright 2001 Pearson Education Australia
P
CS and PS – Economic efficiency
S
CS
C
Pm
D
Negative PS &
Negative CS:
area C + D
Producer
PS
Surplus
D
O
fig
Too much
Q
Copyright 2001 Pearson Education Australia
P
CS and PS – Economic efficiency
S
CS
Pm
Producer
PS
Surplus
D
O
Efficient
Q
fig
Copyright 2001 Pearson Education Australia