UNIT 2

Demand and supply

Prof Pallabi
Mukherjee

PALLABI MUKHERJEE
PALLABI MUKHERJEE
 Demand
 A relation between the price of a good and the
quantity that consumers are willing and able
to buy during a given period, other things
constant.

Willing: you want to buy the product

Able: you can afford the buy the product

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 Market Demand Curve
 Shows the amount of a good that will be
purchased at alternative prices.
 Law of Demand
• The demand curve is downward sloping.

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 Demand Schedule and Curve
 Demand curve:
• a curve showing the
relation between the price
of a good and quantity
demanded during a given
period, other things
remaining constant.
CETERUS PARIBUS

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 Exceptions to Law of Demand
 Veblen effect  Giffen Goods
 Changes in peoples  Different/same brand
expectations names having
 Seasonal identical products
Fluctuations. with different prices

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Determinants of Demand
 Income
 Prices of substitutes
 Prices of complements
 Advertising
 Population
 Consumer expectations

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The Demand Function
An equation representing the demand curve
Qxd = f(Px , PY , M, T,A,)

 Qxd = quantity demand of good X.

 Px = price of good X.
 PY = price of a related goods good Y.
 M = income.
 T = Tastes and preferences of individuals
 A=Advertising expenditure

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Change in Quantity Demanded
Price
A to B: Increase in quantity
demanded
A
10

B
6

D0

4 7 Quantity

PALLABI MUKHERJEE
Determinants of demand

Tastes and preferences

Different people have
different tastes and
preferences. Demand
mostly depends on them

Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999
Causes of Increase in Demand
Increase in consumer
income
 Causes consumers to
buy more of the product
at each and every price.
 Normal goods
 Inferior goods
Change in consumer income
Normal goods
 A good for which demand
increases as consumer
income rise

Inferior goods
 A good which demand
increases as consumer
income falls
Changes in Price of Related Goods
Substitutes
 Goods that are not
consumed jointly
 Goods that are related in
such a way that an increase
in the price of one shifts the
demand curve for the other
rightward.
 Increase in price of Coke
leads to increase in
demand for Pepsi
Changes in the price of related goods
Complements
 Goods that are
related in a such a
way that an increase
in the price of one
shifts the demand of
the other leftward
 Two goods that are
consumed jointly.
 An decrease in the
price of one will
increase demand
for the other
Changes in Consumer Expectations
Such as expectations in
 Prices and income
 Affect how consumers spend
their money and their
demand
 If product cheaper today
than tomorrow, then
increase in demand
• Demand: A Summary
Supply
Producer’s side
A relation between the price of a good and the
quantity that the producers are willing and able to
offer for sale during a given period, other things
constant.
Law of Supply
The quantity of a good supplied during a given period
is usually directly related to the price of the good
Increase in price leads to increase in quantity supplied
Decrease in price leads to decrease in quantity
supplied.
Creates upward sloping supply curve
Law of Supply
The quantity of a good supplied during a given period
is usually directly related to the price of the good
Increase in price leads to increase in quantity supplied
Decrease in price leads to decrease in quantity
supplied.
Creates upward sloping supply curve
Supply Shifters
Input prices
Technology or
government
regulations
Number of firms
Substitutes in
production
Taxes
Producer expectations

PALLABI MUKHERJEE
PALLABI MUKHERJEE
The Supply Function
An equation representing the supply curve:
QxS = f(Px , PR ,W, H,)

 QxS = quantity supplied of good X.

 Px = price of good X.
 PR = price of a related good
 W = price of inputs (e.g., wages)
 H = other variable affecting supply

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Change in Quantity Supplied
Price A to B: Increase in quantity supplied

S0
B
20

A
10

5 10 Quantity
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Causes of increase in Supply
• Improvements in Technology
• Changes in relevant resources
▫ Decrease in the price of resources
▫ Lowers costs
• Changes in price of alternative goods
▫ If price of alternative good increases, supply of the
good increases
• Changes in producers expectations
Changes in technology
• Technology is the economy’s stock of knowledge
about how to combine resources efficiently
Changes in Relevant Resources
Decrease in resource
prices
 Increases the supply S1
S2
of the good at each
$6
and every price.

300 400
Changes in prices of Alternative Goods
Alternative goods
 Other goods that use
Price
some or all of the same S1
resources as the good in S2
question $6

 Beef and leather.

 If the price of beef
increases, producers will Q Leather
supply more beef thus 300 400
increasing the supply of
leather. Above is the market for the
supply of leather
Changes in Producers Expectations
Expectation of future prices of resources or their own
product can cause producers to change what they offer
at each individual price
Changes in the Number of Producers
As the number of producers
change so does the supply of
the product
A decrease in the number of
producers will lead to a
decrease in supply
Causes of Decrease in Supply
Backward movement in Technology
Changes in relevant resources
 Increase in the price of resources
 Raises costs
Changes in price of alternative goods
 If price of alternative good decreases, supply of the good
decreases
Changes in producers expectations
Changes in Relevant Resources
Are those employed in
the production of the
good in question
$9 Increase in price of
resources
S1  Results in decrease in
S2
supply
500 600  Less of the good is
available at all prices
Changes in prices of Alternative Goods
Alternative goods
 Other goods that use
Price
some or all of the same
S1
resources as the good in
question $6

 Beef and leather.

 If the price of beef
decreases, producers will Q Leather
supply less beef thus 300 400
decreasing the supply of
leather. Above is the market for the
supply of leather
Market Equilibrium
Market
 Includes all the
arrangements used to buy
and sell
 Reduce transaction costs
 The place where buyers
and sellers meet to
determine price and
quantity
Equilibrium
At specific price where:
Quantity demanded = Quantity supplied
Equilibrium price –
 market clearing price
Equilibrium quantity –
D = S
Market Equilibrium
Balancing supply and
demand
QxS = Qxd
Steady-state

Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999
Equilibrium
P
At specific price
where: S
Quantity
demanded
$5
Equals Equilibrium

Quantity Supplied
D

Q
150
 Reaching Equilibrium

P If market price is ABOVE

Surplus

S
equilibrium
Qs > QD
$6
Economy is at a
$5 SURPLUS
Market price will fall

Q
100 150 200
Reaching Equilibrium
If the market P
price is BELOW S
the equilibrium
price
QD > Qs $5

Shortage exists $4

Market price rises

D
to equilibrium Shortage
Q
100 150 200
 Simultaneous Changes
Change in Change in Effect on Effect on
Supply Demand Equilibrium Equilibrium
Price Quantity
Increase Decrease Decrease Indeterminate
Decrease Increase Increase Indeterminate
Increase Increase Indeterminate Increase
Decrease Decrease Indeterminate Decrease