Class of Business Economics Linked With Workshop 1: Amjad Naveed: Amjadn@btech - Au.dk

Class of Business Economics
Linked with Workshop 1
Amjad Naveed: amjadn@btech.au.dk

Ch2
The Basics of Supply and Demand
Topics
1. Market and Models
2. Demand
3. Supply
4. Market Equilibrium
5. Shift in Market Equilibrium
• Shift in demand
• Shift in supply
6. Elasticity (if time permits otherwise next week)

2.1: Markets and Models
• What is a Market?
– A market is characterized by a specific product or service,
being bought and sold at a particular location, and a time
point.
– A place where consumers, workers and firms interact for
transaction of goods or services and form the market.
– Collections of buyers and sellers that together determine
the price of a good, how???
Market and Models
• Market supply and market demand?
– Market Supply: The combined amount of a good that all producers in
a market are willing to sell
– Market Demand: The combined amount of a good that all consumers
in a market are willing to buy
Important to Note: Market demand/supply is the sum of individual
demands/supplies

4-Key Assumptions of Supply and Demand Model
– Single market: We restrict our focus to supply and demand in a single

market
– Homogeneous: All goods bought and sold in that market are identical
– Single price and same information: same price and everyone has the
same information
– Large number of buyers and sellers: There are many producers and
consumers in the market
How changing the model’s assumptions influences its predictions about market
outcomes

2.2: Demand
• What is demand?
– So, Demand is a concept specifying the different quantities of a good
that consumers is willing and able to buy at different prices
– All about consumer and they need to decide,
– how much of a good or services to buy on the basis of its price and
many other factors (?)
– What are those other factors????

Factors that influence Demand
• What factors influence the demand for a good or service?
1. Price: Main factor
2. Number of consumers: more people, higher quantity

desired
3. Consumer wealth/Income: richer, buy more of most
goods
4. Consumer tastes: taste varies with consumer
Taste changes, demand changes
5. Price of other goods
• Complements or substitutes
6. A- Z (weather, fashion, neighborhood effect etc….)

Demand: Substitutes and Complements
• Substitutes :
– a good that can be used in place of another good is called
substitute. (e.g. Coca-Cola vs Pepsi Cola)
– The demand of Pepsi cola will decrease, if Coca Cola is at
discount
• Complements
– a good that is purchased and used in combination with
another good is called complement. (e.g. Bread and butter)
– The demand of butter may go up, if bread is at discount

Demand curve:
• Demand curve:
– describes the relationship between quantity of a good that
consumers demand and the good’s price, holding all other
factors constant
– Demand curve is the graphic representation of the law of demand or
– Demand curve shows the quantity demanded at each possible price,
holding constant the other factors that influence purchases.
• Mathematical notation:
QD= QD(P)=f(P)
Demand Curve
(effect of price on Demand)
D1
3
Price per unit
1
Price D1: quantity demanded
D1 1 15
0 5 10 15 20 2 10
Quantity demanded 3 5

Law of demand
• Law of demand:
consumers purchase more of a good (high demand) if price is
low and purchase less (low demand) if price is high, holding
other factor constant that influence consumer consumption.
• Or it shows there is negative (inverse) relationship b/w price

and quantity demanded, holding other things constant
• Why Law? Proven in study after study and common sense and
general observation

Mathematical Representation:
Demand Curve
Any demand curve can be represented by an equation. The
demand curve on the previous slide is given as:
• QD = 1000 – 200P
– QD is the quantity of tomatoes demanded (in pounds) and
P is the price of tomatoes ($/pound)
– This equation implies that every $1 per pound increase in
price leads to a 200-pound decline in the quantity of
tomatoes demanded
Mathematical Representation:
Inverse Demand Curve
• Solving for price as a function of quantity demanded
yields the inverse demand curve: P = 5 – 0.005QD
– Demand choke price: the price at which quantity
demanded equals zero
– how to find demand choke price?
– Insert QD=0 and then P=5-0.005(0)= 5 is the price where

QD=0

Change in Quantity Demanded vs change in
Demand
• Change in quantity Demanded
– A movement along the demand curve that occurs as a result of a change
in the good’s price
• Change in Demand (or Shifts in Demand Curves)

– A shift of the entire demand curve caused by a change in a determinant
of demand other than the good’s own prices.
– Determinants:
• Number of consumers, Consumer wealth/Income, Consumer tastes, Price of other goods
(Complements or substitutes) or A- Z (weather, fashion, neighborhood effect etc….)

Change in quantity demanded vs change in
D2 demand (shift in Demand)
D1
Change / Price D1 D2
Shift in
3 demand 1 15 20
2 10 15
Price per unit
3 5 10
2
D1 to D2 shift because
1
of other factors (e.g.,
D2
higher income)
D1
0 5 10 15 20
Change in Quantity demanded
Quantity
Demanded

Shift in demand
(book page: 17)

Change in quantity demanded vs change in
demand (shift in Demand)
Why do we treat price differently?
• Price is usually the most important factor influencing
demand
• Prices in most markets can change easily and often
• Price is the only factor that also exerts a large, direct
influence on the other side of the market – on the quantity of
the good that producers are willing to supply.
Price therefore ties together the two sides of the model

Supply: The Supply Curve
• What is supply?
– the amount of a good that firms want to sell at a given price, holding constant
other factors that influence firms’ supply decisions, such as costs and
government actions.
• Supply curve
– the quantity supplied at each possible price, holding constant the other factors
that influence firms’ supply decisions.
• Law of supply
– There is a positive (direct) relationship b/w price of a good and its quantity
supplied
– suppliers will normally offer more for sale at high prices and
Amjadless
Naveed:
at amjadn@btech.au.dk
lower prices.
Supply: The Supply Curve
• What factors influence the supply of a good or service?

– Price
– Production costs (related to production technology)

• Production Technology: the processes used to make, distribute, and
sell a good
– Number of sellers
– Sellers’ outside options,

• Price of good in other markets and prices of other, related goods

Supply Curve
Supply Curve graphic
S1 representation of law of supply
3 curve or how much quantity of a
Price per unit
good producers are willing to sell at

2 given prices.
QS= QS(P)=f(P)
1 Price S1
S1 1 5
2 10
0 5 10 15
3 15
Quantity supplied

Supply Curve
(book page: 18)

Mathematical representation: Supply Curve
(book page: 19)
• Supply equation (similar to demand)
QS = 200P – 200
– 200P: it implies that for every dollar increase in price, the quantity
supplied of tomatoes increases by 200 pounds
• The inverse supply curve is,

P = 1 + 0.005QS
– Supply choke price: the price at which quantity supplied equals zero
– How to find: set Qs=0 in inverse supply equation then P=1 is the
supply choke price

Change in QS vs Shift in Supply
• Change in quantity supplied

 a movement along the supply curve in response to a price
change, with everything else held constant
• Change in supply (shift in supply)

 a shift of the entire supply curve caused by a change in non-
price factor.

Supply shift
• From book
Page 19

Change vs shift in Supply
Shift in Price S1 S2
Supply
S1 1 5 10
S2
3 2 10 15
Price per unit
3 15 20
2
Change in quantity supplied:

1 Change in the price of the good and
movement along the original supply
S1 curve
S2 Shift in Supply:
Change in a factors other than price of
0 5 10 15 20 a good (e.g. change in raw material or
cost of production)
Quantity supplied
Change
in QS

Shift Factors of Supply
• Other factors besides price affect how much will be

supplied:
– Cost of production: Prices of inputs used in the production
of a good.
– Technology.
– Suppliers’ expectations.
– Taxes and subsidies.

2.4: Market equilibrium
• Equilibrium - a situation in which no one wants

to change his or her behavior.
– equilibrium price is the price at which consumers
can buy as much as they want and sellers can sell as
much as they want.
– equilibrium quantity is the quantity bought and sold
at the equilibrium price.
2.4: Market equilibrium
Book , page: 21
Numbers in the
figures are different

The Market Mechanism: Equilibrium
Price D S
S1 1 15 5
3
rium 2 10 10
Price per unit
Eq uilib
E 3 5 15
2
1
• Market clears at
S1 • price P=2 and quantity Q=10
0 5 10 15
Quantity

Market equilibrium
Mathematical equilibrium
• For the tomato example:
QD =1,000–200P , QS =200P–200
Step 1:
To solve for the equilibrium price, we equate quantity supplied with quantity
demanded: QD = QS
1,000 – 200P = 200P – 200
P = $3

Market equilibrium
• Step 2.
To solve for equilibrium quantity, we plug the equilibrium price in to

either the supply or demand equation:
QD = 1,000 – 200P = 1,000 – 200(3) = 1,000 – 600 = 400
QS = 200P – 200 = 200(3) – 200 = 600 – 200 = 400.

Why markets move towards equilibrium?
Excess Supply: When price is too high
First, if P > Pe, quantity supplied will

exceed quantity demanded, resulting
in Excess Supply:
QS > QD (point W and X)
• Excess supply is also referred to

as a surplus.
• To sell their products, producers
must lower prices.
‒ As prices fall, quantity
demanded increases and
quantity supplied decreases
until the market reaches an
equilibrium at a lower price.
Why markets move towards equilibrium?
Excess Demand: When price is too low
Likewise, if P < Pe, quantity

demanded will exceed quantity
supplied, resulting in Excess
Demand: QD > QS (point Y and Z)
• Excess demand is also referred
to as a shortage.
• The shortage will induce buyers
to bid up the price.
‒ As prices rise, quantity
demanded will fall and
quantity supplied will rise
until the market reaches
equilibrium at a higher price.
Market equilibrium
• Solve example on page 23:

Figure it out 2.1
QD=50-0.5P
QS=-25+P

Market Equilibrium
What happens to the market equilibrium when there is a
shift in demand or supply?
Remember the factors that can shift the demand curve:

• Number of consumers
• Wealth or income
• Consumer tastes
• Prices of related goods (complements or substitutes)
And those that shift the supply curve:
• Number of producers
• Costs of production
• Producer outside options
MICROECONOMICS GoolsbeeAmjad Naveed:

| Levitt amjadn@btech.au.dk
| Syverson | Third Edition
The effect of Demand Shift
What happens to the market equilibrium when there is a shift
in demand or supply?
• Example: A new story reports that tomatoes are suspected of
being the source of a salmonella outbreak by Food and Drug
Administration (FDA) in January 2012. (Demand for tomatoes
falls)
• It causes to demand curve to shift ( because of the change in
other than price)

Market Equilibrium
What happens to market equilibrium if there is a salmonella
outbreak?
After a salmonella outbreak, the demand

Figure 2.7 Effects of a Fall in the
for tomatoes decreases, causing a
Demand for Tomatoes leftward shift of the demand curve from
D1 to D2.
This fall in demand results in a new
equilibrium point E2, which is lower than
the initial equilibrium point E1.
The equilibrium quantity falls from Q1 (400

pounds) to Q2 (150 pounds), and the
equilibrium price falls from P1 ($3) to P2
($1.75).

Market equilibrium
Mathematical Example from book page: 25
QD=1000-200P (OLD)
QD=500-200P (new)
QS=200P-200
Fine new price and new quantity?
P=1.75
Q=150

Market Equilibrium
What happens to market equilibrium if fertilizer become
cheaper?
Figure 2.8 Effects of an Increase

With cheaper fertilizer, farmers supply
in the Supply of Tomatoes more tomatoes at every given price and
the supply curve shifts outward from S1
to S2.
The equilibrium quantity increases from
Q1 (400 pounds) at E1 to Q2 (600 pounds)
at E2.
The equilibrium price falls from P1

($3/pound) to P2 ($2/pound).

The Effects of Supply Shifts
Market equilibrium
• Solve example on page 25:

Figure it out 2.2
Effect of shift in Supply (e.g., seed prices fell, cast of

production declines, that increases the supply)
QS=200P-200 (OLD)
QS=200P+200 (new)
QD=1000-200P (same)
P=2, Q=600
Market equilibrium
• Read page 26-30 and Solve example on page 28:

Figure it out 2.3
Effect of shift in supply

Market Equilibrium
Summary of the effect of a shift in supply or demand on
market equilibrium
Table 2.2 Effect of Shifts in Demand and Supply Curves in Isolation

Impact on
Curve that Impact on
Direction of Shift Equilibrium:
Shifts Equilibrium: Quantity
Price
Demand Out (increase in D) ↑ ↑
Curve
In (decrease in D) ↓ ↓
Supply Curve Out (increase in S) ↓ ↑
In (decrease in S) ↑ ↓

Market equilibrium
• What determines the magnitude of the change in

equilibrium price and quantity?
• Two important parameters:
Size of the shift
 The larger the shift, the larger the change in equilibrium price
or quantity
Slope of the curve

 If one curve (e.g. supply curve) shifts, the slope of the other
curve (e.g. demand curve) determines size of changes to
equilibrium price and quantity.

Application page 36-38
• Application: The supply curve of housing and

housing prices: A tale of two cities
• New York City (unit cost of production is high)
– Supply curve of housing in New York is steep – the Qs is not very
responsive to changes in price
• Houston, Texas (unit cost of production is low)

– Supply curve of housing in Houston is flat – the Qs is very responsive to
changes in price

Market equilibrium (read page:37)
• Consider
an
outward
shift in
supply
(increas
e)

EXAMPLE THE MARKET FOR WHEAT
During recent decades, changes in the wheat

market had major implications for both American
farmers and U.S. agricultural policy.
To understand what happened, let’s examine the
behavior of supply and demand beginning in 1981.
Supply: QS = 1800 + 240P
Demand: QD = 3550 − 266P
Find equilibrium quantity and price

Thank you
 Reading for next week lecture:
 Ch.2 ‘2.5-Elasticity’ Pages: 38-50
 Ch3 ‘ Using supply and demand to analyze markets’
 Producer surplus – (PS), Consumer surplus (CS)
 Price and quantity regulations and the market effect
 Please regularly check blackboard for announcements,

materials etc.
Until then, have a great week!


Class of Business Economics Linked With Workshop 1: Amjad Naveed: Amjadn@btech - Au.dk

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Class of Business Economics Linked With Workshop 1: Amjad Naveed: Amjadn@btech - Au.dk

Uploaded by

Copyright:

Available Formats

Class of Business Economics

Linked with Workshop 1

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

– Single market: We restrict our focus to supply and demand in a single

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

2. Number of consumers: more people, higher quantity

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

consumers demand and the good’s price, holding all other

– Demand curve is the graphic representation of the law of demand or

– Demand curve shows the quantity demanded at each possible price,

holding constant the other factors that influence purchases.

Amjad Naveed: amjadn@btech.au.dk

• Or it shows there is negative (inverse) relationship b/w price

Amjad Naveed: amjadn@btech.au.dk

– Insert QD=0 and then P=5-0.005(0)= 5 is the price where

Amjad Naveed: amjadn@btech.au.dk

• Change in Demand (or Shifts in Demand Curves)

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

that influence firms’ supply decisions.

• What factors influence the supply of a good or service?

– Production costs (related to production technology)

– Sellers’ outside options,

Amjad Naveed: amjadn@btech.au.dk

good producers are willing to sell at

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

• Supply equation (similar to demand)

• The inverse supply curve is,

Amjad Naveed: amjadn@btech.au.dk

• Change in quantity supplied

• Change in supply (shift in supply)

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

Change in quantity supplied:

Amjad Naveed: amjadn@btech.au.dk

• Other factors besides price affect how much will be

Amjad Naveed: amjadn@btech.au.dk

• Equilibrium - a situation in which no one wants

Amjad Naveed: amjadn@btech.au.dk

Amjad Naveed: amjadn@btech.au.dk

1,000 – 200P = 200P – 200

Amjad Naveed: amjadn@btech.au.dk

To solve for equilibrium quantity, we plug the equilibrium price in to

QD = 1,000 – 200P = 1,000 – 200(3) = 1,000 – 600 = 400

QS = 200P – 200 = 200(3) – 200 = 600 – 200 = 400.

Amjad Naveed: amjadn@btech.au.dk

First, if P > Pe, quantity supplied will

• Excess supply is also referred to

Likewise, if P < Pe, quantity

• Solve example on page 23:

Amjad Naveed: amjadn@btech.au.dk

Remember the factors that can shift the demand curve:

MICROECONOMICS GoolsbeeAmjad Naveed:

What happens to the market equilibrium when there is a shift

• Example: A new story reports that tomatoes are suspected of