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23-06-2017

Demand-supply Analysis
A market consists of the buyers and
sellers of a good or service: abstraction
from any concept of specific time and
Demand and Supply location of a market.

The market demand schedule shows the


amounts of the commodity that buyers
are prepared to buy at different prices.

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.

The Demand Curve: The Relationship


Demand Schedule between Price and Quantity
Demanded
Demand Curve
The demand curve is a graph of the
relationship between the price of a good and
the quantity demanded.

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Demand Schedule and Demand Curve The downward sloping demand curve obeys

the law of demand: quantity demanded


Price of decreases as price increases.
Ice-Cream Cone
$3.00

2.50

1. A decrease
The slope is negative (but may not be
2.00
in price ...

1.50 constant) at all points of the demand curve.


1.00

0.50

It is obvious from even casual observation or


0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones introspection that demand depends on many
2. ... increases quantity
of cones demanded. things.
Copyright 2004 South-Western

In general, the quantity demanded is


expected to depend, in addition to the own A numerical example
price, on
Suppose that the demand function is
incomes Qd = 1800 20P +0.6M 50PR
Also suppose M = 20,000 and PR = 250
tastes and preferences Then Qd = 1800 20P +0.6(20,000) 50(250)
prices of related commodities = 1800 20P + 12,000 12,500
change in number of buyers Qd = 1300 20P
Any change in M or PR affects the demand
expectations, etc. curve through the intercept term shifts the
demand curve
A change in any of these other factors thus leads
to a shift in the entire curve. (ii) The sign of the coefficient of PR is negative
hence this is a complement

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Shifts in the Demand Curve


Changes in Quantity
Demanded Price of
Price of Ice- Ice-Cream
Cream A tax that raises the price of ice-
Cone
Cones cream cones results in a movement
along the demand curve.
Increase
B in demand
$2.00

Decrease
A in demand
1.00 Demand
curve, D2
Demand
curve, D1
D Demand curve, D3
0
4 8 Quantity of Ice-Cream Cones 0 Quantity of
Ice-Cream Cones
Copyright2003 Southwestern/Thomson Learning

When we draw the demand curve, we are focusing only


on the relationship between price and quantity Consumer Income
demanded. We can do this by assuming that everything Normal Good
else is being kept fixed at certain levels. Price of Ice-Cream
Cone
$3.00 An increase in
How do we expect the other things to income...
influence demand? 2.50 Increase
in demand

If I (income) increases, we expect more to 2.00

be demanded at every price the demand 1.50

curve will shift to the right. 1.00

0.50
D2
D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones

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However, there may be some inferior Consumer Income


goods whose demand falls as income
increases. Price of Ice-
Inferior Good
Cream Cone
$3.00
For example, an increase in the incomes
2.50 An increase in
of poor farmers might lead them to buy income...
more of rice and wheat and less of coarse 2.00
cereals like ragi, jowar, and bajra. 1.50
Decrease
in demand
1.00

0.50

D2 D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones

Tastes and preferences can change for many


reasons:

Demographic changes
If T (tastes and If population comes to consist of larger proportion of
older people, this will affect pattern of demand.
preferences) change such
that buyers like a New Information
Dissemination of the information on harmful side-
commodity more, again effects of drugs can lead to a fall in demand for these
the same thing will drugs.

happen.

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Prices of related goods:

If the price of a substitute rises, we expect


the demand to rise, too (as price of coffee
D1 D2 D D1
rises, the demand curve for tea shifts P1 D2
upward and to the right). P
P2 P

If the price of a complement rises, we expect Complement


QD1 QD2 Substitute
[Direct]
[Inverse]
the demand to fall (as price of sugar rises, Cereal Pop Tarts

the demand curve for tea shifts downward Milk


and to the left).

Prices of related goods contd. Prices of related goods contd.

Complements
The dramatic fall in the price of computers
Substitutes
over the past twenty years has significantly movies (in theaters) and sporting
increased the demand for printers, monitors events
and internet access. restaurants and dining at home
air travel and hotel rooms holiday in Goa versus holiday in
movies and popcorn Mussourie
bathing suits and sun tan lotion economics courses and political science
candy and dentistry courses

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Expectations

An expectation that prices will rise in


the future shifts the demand curve to
the right. D1 D2

If there is expected to be a major shortage


of some commodity, then consumers will P
stock up now or risk not getting any.

QD1 QD2

The simple thing to remember is:

a change in commoditys own price by itself


can only represent a movement along the
demand curve and not a shift in the curve; The market supply schedule shows the
amounts of the commodity that sellers
are prepared to sell at different prices.
however, a change in any of the other
things will lead to a shift of the demand
curve.

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The Supply Curve: The Relationship


Supply Schedule between Price and Quantity Supplied

Supply Curve
The supply curve is the graph of the
relationship between the price of a good and
the quantity supplied.

Supply Schedule and Supply Curve


The upward sloping supply curve that has
Price of
Ice-Cream been drawn exemplifies the law of supply:
Cone
$3.00 quantity supplied increases as price
2.50 increases.
1. An
increase
in price ... 2.00
Like demand, supply also depends on
1.50
many things.
1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
Copyright2003 Southwestern/Thomson Learning

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In general, the quantity supplied is Change in Quantity Supplied


expected to depend on Price of Ice-
Cream S
Cone

own price $3.00


C

A rise in the price


technological knowledge of ice cream
cones results in a
input prices, movement along
A the supply curve.
1.00
alternative output price changes,

expectations, etc. Quantity of


Ice-Cream
0 1 5 Cones

Shifts in the Supply Curve


Shifts in the Supply Curve
Price of
Ice-Cream Supply curve, S3
Supply
Cone
Change in Supply curve, S1
Supply
Decrease curve, S2
A shift in the supply curve, either to the left in supply
or right.
Caused by a change in a determinant other
than price.
Increase
in supply

0 Quantity of
Ice-Cream Cones
Copyright2003 Southwestern/Thomson Learning

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How do we expect the other things to


A numerical example influence supply?

Suppose that the supply function is A change in technology that allows the
Qs = 50 + 10P 8PI + 5T commodity to be produced more
If PI = 50 and T = 90, then cheaply should shift the supply curve
Qs = 50 + 10P 8(50) + 5(90) downwards and to the right.
= 50 + 10P 400 + 450 If input prices increase, exactly the
Qs = 100 + 10P opposite should happen.

I only have Substitutes in production [INVERSE]


200 acres Broccoli Corn S2 S1 S2 S1 S2
S
P2
P Oil Prices Oil Prices
P1 P
expected expected
to decrease to increase
QS1 QS2
Producers want to produce more of the good where price is increasing, If oil producers expect future oil prices to
Broccoli Corn S1
decline, they will (increase/decrease)
current production.
S
P1 S2
P
P2
If oil producers expect future oil prices to
increase, they will (increase/decrease)
QS2 QS1
current production.
or at least, where the price is not going down.

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SUPPLY AND DEMAND


Equilibrium TOGETHER
The demand and supply curves intersect Demand Schedule Supply Schedule
to determine the market equilibrium
Equilibrium: a price-quantity pair
Find a price P* such that Qd = Qs = Q* at
that price
Then (P*, Q*) constitutes an equilibrium

At $2.00, the quantity demanded


is equal to the quantity supplied!

The Equilibrium of Supply and Demand


A numerical example
Price of
Ice-Cream
Cone Supply Equation of demand curve:
Qd = 1300 20P
Equilibrium price Equilibrium Equation of supply curve:
$2.00 Qs = 100 + 10P
At equilibrium Qd = Qs
1300 20P = 100 + 10P
Equilibrium Demand Solving, P = 40
quantity
Qd = Qs = 500
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright2003 Southwestern/Thomson Learning

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Equilibrium Equilibrium

Why call it equilibrium? Surplus


1. If the market is at (P*, Q*), there are When price > equilibrium price, then quantity
no forces to move it away from (P*, supplied > quantity demanded.
There is excess supply or a surplus.
Q*)
Suppliers will lower the price to increase sales,
2. If the market is not at equilibrium, it thereby moving toward equilibrium.
tends to come back to equilibrium

P
S Equilibrium
D
Excess supply/Surplus

P Shortage
When price < equilibrium price, then quantity
P* 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.

S D

0 Q* Q

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D
S Shifts in equilibrium

More interesting is the case where there


are shifts in supply and/or demand
P* curves
As a result, the equilibrium shifts
P
Sometimes, it is useful to predict the
Excess demand/Sortage
direction of shift
S D

0 Q* Q

A war in the Middle East disrupts the supply of oil to


Three Steps to Analyzing Changes in India.
Equilibrium
Decide whether the event shifts the At the same time, the minimum age for driving is
supply or demand curve (or both). lowered to 16 years.
Decide whether the curve(s) shift(s) to
the left or to the right. We would expect that

Use the supply-and-demand diagram to (a) both the price of petrol and the quantity
see how the shift affects equilibrium purchased would definitely rise.
price and quantity. (b) both the price and the quantity purchased of
petrol would definitely fall.
(c) the price of petrol might rise or fall, but the
quantity purchased would definitely fall.
(d) the quantity purchased of petrol might rise or fall,
but the price of petrol must rise.

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P
Government interventions
D2 S2
Sometimes Governments try to correct
D1 S1 the the existing pattern of income
P2 distribution.
They often try to achieve the results
indirectly, by interfering with the market
processes.
P1
D2

S2 Examples are rent control laws and


S1
D1 minimum wage legislation.
0 Q1 Q2
Q

Rent Control Laws r

S
D

Governments sometimes try to set a


ceiling on rents in the belief that rents in
free market equilibrium would be too r*

high for most people to afford renting


flats/apartments. r
Thus in the market for housing, the Excess demand

maximum rent allowed is r which is less S


than the equilibrium level r* D

0 H

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Rent Control Laws Rent Control Laws


But the unsatisfied demand shows up in
At r, there will be excess demand for various ways.
housing. - First, landlords charge high deposits and
pugrees.
Who gains from this arrangement?
- Secondly, illegal transactions take place
The people who are able to get housing in the form of charging high rents
at the low rents. without issuing corresponding receipts.
- Landlords also might use their discretion
to screen applicants, e.g., some
landlords might rent out flats only to
vegetarians.

Rent Control Laws r S

More importantly, in the long run, the D


S

smaller value from housing as an asset


might discourage landlords from
providing adequate maintenance
services.
r*
Over time, funds are switched to other
types of investment and less funds are r

deployed in the housing industry, thus


shifting the supply curve to the left,
S
S
(from SS to S'S') and aggravating the D

initial condition of excess demand. 0 H

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Minimum Wage Legislation w

S
D

Minimum wage legislation is undertaken Excess supply

to ensure that wages paid to workers do


w

not fall below a certain minimum. w*

Hence, in the labor market, a floor is set


on wages, i.e., wages are not allowed to
fall below a certain level.
S
D

0 L

Minimum Wage Legislation Minimum Wage Legislation


At wage rate w*, there is excess supply
of labor. - In the longer run, employers might
- Since some workers would have been switch to more machine-intensive
willing to work for lower wages, a processes to economize on labor costs.
contract system of wages tends to
develop. - This shifts the demand curve for labor to
- Workers are employed for smaller periods the left and aggravates the initial
or in smaller numbers, so that the condition of excess supply.
minimum wage provision does not apply,
or they are not paid other benefits like
medical benefits, PF, gratuity, etc.

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Conclusion
Are interventions in the forms of price
ceilings or price floors always
undesirable?
There is some gain from each of these
actions and there are some losses, and
these must be balanced by society
against each other.
But when markets are not allowed to
operate freely, forces build up that tend
to bypass regulations, with unintended
and undesirable outcomes.

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