Demand, Supply, and Equilibrium

T.J. Joseph

How does a market work?
 Markets are dynamic (like weather)  They are constantly evolving

 A careful study of markets reveal certain forces

underlying the movements in a market
 Need a model - demand & supply model – to forecast

the prices and outputs in individual markets
 In a competitive market SS and DD determine the

quantity of each good produced and the price at which it is sold
1 December 2012 T.J. Joseph 2

DEMAND

1 December 2012

T.J. Joseph

3

Demand Schedule
 Quantity demanded of any good/service by an

individual is the amount of the good/service that the individual is willing and able to purchase at alternative prices during a given period of time, and other things held constant
 A demand schedule or demand curve shows the

relationship between the market price of a good/service and the quantity demanded of that good/service, other things held constant
1 December 2012 T.J. Joseph 4

Demand Schedule It shows how demand varies with price. ceteris paribus Price per unit 10 12 14 16 18 Quantity per week 200 170 140 110 80 1 December 2012 T.J. Joseph 5 .

Demand Curve 20 18 16 Price per unit 14 12 10 8 6 4 2 0 80 110 140 170 200 Qty de m ande d D 1 December 2012 T. Joseph 6 .J.

Joseph 7 .J.Demand Schedule  The demand curve slopes downward (a negatively sloped demand curve)  Indicates an inverse relationship between price and quantity demanded 1 December 2012 T.

will cause an increase in the quantity demanded of the good.  An increase in the price of a good. Joseph 8 .Law of Demand  A decrease in the price of a good.J. all other things held constant (ceteris paribus). 1 December 2012 T. all other things held constant (ceteris paribus). will cause a decrease in the quantity demanded of the good.

J. Joseph 9 .Change in Quantity Demanded Price P1 An increase in price causes a decrease in quantity demanded. P0 Q1 Q0 Quantity 1 December 2012 T.

P0 P1 Q0 Q1 Quantity 1 December 2012 T.J. Joseph 10 .Change in Quantity Demanded Price A decrease in price causes an increase in quantity demanded.

market demand is the sum of all the individual demands for a particular good or service 1 December 2012 T. Joseph 11 .J. Qd = f(P)  In other words.Market Demand  A market demand schedule specifies the units of good or service all individuals in the market are willing and able to purchase at alternative prices. ceteris paribus.

Market Demand Schedule  Consider the market for cellular phone service. A market demand schedule lays out the quantity of cell phone service demanded in the market at various prices. .  We can graph these points (the different prices and respective quantities demanded) to make a demand curve for cell phone service.

6 16.5 7.Market Demand Schedule Price (monthly bill) Cell phone service price (monthly bill) Cell phone subscribers (millions) 120 $ 124 $ 92 $ 73 $ 58 $ 46 $ 41 3.0 33.7 55.2 100 80 60 Demand 40 0 10 20 30 40 50 60 70 Quantity (millions of subscribers) .3 69.

• As the price of a good rises … consumers buy less.Market Demand Schedule Price (monthly bill) 120 • Notice how the law of demand is reflected by the shape of the demand curve. 100 80 60 Demand 40 0 10 20 30 40 50 60 70 Quantity (millions of subscribers) .

Market Demand Schedule Price (monthly bill) • The height of the demand 120 curve at any quantity shows the maximum price that consumers are 100 willing to pay for that additional unit.6 (millionth) unit. • Here. • While they would be willing to pay up to $92 for the 7. 80 60 Demand 40 0 10 20 30 40 50 60 70 Quantity (millions of subscribers) . for the 16th unit … consumers are only willing to pay up to $73 for it.

Joseph 16 .J.Why an inverse relationship?  Quantity demanded tends to fall as price rises for two reasons: (1) Substitution effect: When price of a commodity falls an individual buy more of it to substitute for other similar goods whose price has not changed (2) Income effect: When price falls. the purchasing power of an individual with a given income increases. allowing him to buy more of it 1 December 2012 T.

)  Expectations  1 December 2012 T. Joseph 17 . seasons.J.Factors Behind the Demand Curve  The market demand for a commodity is influenced not only by the commodity’s price  A whole array of factors influences how much will be demanded at a given price: Average disposable income of the consumers  Prices of other related commodities  Wealth of the consumers  Tastes and preferences  Size of the market (population)  Special Influences (govt. policies. etc.

Joseph 18 . in this sense.Classification of Goods Inferior Good:  An inferior good is a good that decreases in demand when consumer income rises  Inferiority. relate to affordability rather than about the quality of the good Example: People moving from public transport to taxies 1 December 2012 T.J.

Classification of Goods Giffen Good:  A Giffen Good is a good that experiences increased demand for when the price rises and decreased demand for when the price falls  Absence of any close substitutes  Mainly a theoretical concept ‘A rise in the price of bread makes so large a drain on the resources of the poorer labouring families. that they are forced to cut their consumption of meat and the more expensive foods: and.Sir Robert Giffen 1 December 2012 T. bread being still the cheapest food which they can get and will take.J. Joseph 19 . . and not less of it’. they consume more.

Prices of Related Goods Substitutes  A substitute good is a good that can be used in place of some other good.  Assume Pepsi and Coca cola are substitutes  We want to study market demand for Pepsi  Assume price of Pepsi and Coca Cola is Rs.10 1 December 2012 T. Joseph 20 .J.

then it is called complementary good 1 December 2012 T.Complementary goods  Any relation between demand for CDs and CD Players?  If a good is jointly consumed with another good.J. Joseph 21 .

P0 Q0 Q1 Quantity 1 December 2012 T.J. Joseph 22 .Change in Demand Price An increase in demand refers to a rightward shift in the market demand curve.

J.Change in Demand Price A decrease in demand refers to a leftward shift in the market demand curve. Joseph 23 . P0 Q1 1 December 2012 Q0 Quantity T.

J. Quantity Demanded  Movement along curves versus shifts of curves i.. change in quantity demanded and change in demand are different 1 December 2012 T.e.IMPORTANT ! Demand Vs. Joseph 24 .

SUPPLY 1 December 2012 T. Joseph 25 .J.

J.Supply Schedule  Supply schedule (or supply curve) for a commodity shows the relationship between its market price and the quantity of that commodity that producers are willing to produce and sell. Joseph 26 . other things held constant Qs = f(P) 1 December 2012 T.

J. Joseph 27 .Supply Schedule Price per unit 10 12 14 16 18 Quantity supplied per week 50 70 90 110 130 1 December 2012 T.

will cause an increase in the quantity supplied of the good.Law of Supply  A decrease in the price of a good.  An increase in the price of a good. Joseph 28 . 1 December 2012 T. all other things held constant (ceteris paribus). all other things held constant (ceteris paribus). will cause a decrease in the quantity supplied of the good.J.

Joseph 29 . P0 P1 Q1 Q0 Quantity 1 December 2012 T.J.Change in Quantity Supplied Price A decrease in price causes a decrease in quantity supplied.

Q0 1 December 2012 Q1 Quantity T. Joseph 30 .J.Change in Quantity Supplied Price P1 P0 An increase in price causes an increase in quantity supplied.

Joseph 31 . natural impacts.) 1 December 2012 T.Shifts in Supply Curve  Change in Production Technology  Change in Input (factors & materials) Prices  Change in the Number of Sellers/Producers  Change in Government policies  Expectations  Special Influences (seasons. etc.J.

P0 Q0 1 December 2012 Q1 T.Change in Supply Price An increase in supply refers to a rightward shift in the market supply curve. Joseph Quantity 32 .J.

P0 Q1 1 December 2012 Q0 T.Change in Supply Price A decrease in supply refers to a leftward shift in the market supply curve. Joseph Quantity 33 .J.

J. Joseph 34 .MARKET EQUILIBRIUM 1 December 2012 T.

Market Equilibrium  Market equilibrium is determined at the intersection of the market demand curve and the market supply curve.J. 1 December 2012 T. Joseph 35 .  The equilibrium price causes quantity demanded to be equal to quantity supplied.

Market Equilibrium  Equilibrium is a position of balance  No incentive for anyone to change their behaviour  Market equilibrium exists when demand equals supply  The equilibrium price clears the market 1 December 2012 T.J. Joseph 36 .

Market Equilibrium Price per unit Quantity demanded per week Quantity supplied per week 10 12 14 Equilibrium 200 170 140 110 80 50 70 90 110 130 16 18 1 December 2012 T. Joseph 37 .J.

J. Joseph 38 .Market Equilibrium Price D S P=16 Q=110 Quantity 1 December 2012 T.

Market Equilibrium Price D0 P1 P0 D1 An increase in demand will cause the market equilibrium price and quantity to increase S0 Q 0 Q1 1 December 2012 T. Joseph Quantity 39 .J.

Market Equilibrium Price D1 P0 P1 D0 A decrease in demand will cause the market equilibrium price and quantity to decrease S0 Q1 Q0 1 December 2012 T. Joseph Quantity 40 .J.

P0 P1 Q0 Q1 Quantity 1 December 2012 T.J.Market Equilibrium Price D0 S0 S1 An increase in supply will cause the market equilibrium price to decrease and quantity to increase. Joseph 41 .

J.Market Equilibrium Price D0 S1 S0 A decrease in supply will cause the market equilibrium price to increase and quantity to decrease. P1 P0 Q1 Q0 Quantity 1 December 2012 T. Joseph 42 .

Joseph 43 .A Rise in Input Prices  An increase in wages. for example. as firms now require a higher price for their output  The equilibrium price will rise and the quantity will fall 1 December 2012 T. will increase firms’ costs  The supply curve will therefore shift upwards to the left.J.

a) There is a report that imported apples are infected with a deadly virus b) There is a drop in the consumers’ income c) The prices of apples goes up d) The prices of oranges falls due to very good harvest e) Consumers expect that the pries of apples to decrease in the near future f) The government has increased the excise duty of apples from 5% to 15% .Exercise 1 Illustrate each of the following events using a demand and supply diagram for apples.

2. ‘Textbook of Economics’. Biztantra publications. 5th edition. 6th edition. Oxford publications. ‘Principles of Microeconomics’.References 1. . Chapters 3 in William Boyes and Michael Melvin (2009). Chapter 2 in Dominic Salvatore (2009).

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