Lecture 7 & 8

Price Analysis
Dr. Qais Aslam
 Hand Written
To be submitted on the day of Mid Term
• Assignment 1 Elasticity of Demand & Supply and
• Assignment 2 Indifference Curve Analysis
To be submitted on day of Final Exam
• Assignment 3. Pricing of factors of Production and Cost of
Production. Costs curves
• Assignment 4. Revenue curves under Perfect Competition &
Monopoly
 Market
• Market is an Institution, where buyers (Demand) and
Sellers (Supply) come in contact with each other to
determine Price
• Demand Price = Expectations of the buyer from the
market
• Supply Price = Expectations of the seller from the market
• Market Price = Realization of the expectations of buyers
and sellers
 Market Equilibrium and Price
•• Market
  equilibrium is a point at which the supply and
demand curves intersect.
• The prices of the two curves cross and therefore this is
the Market equilibrium Price for a good or service.
• Market price is only and only determined by the
equilibrium (intersection) of the forces of market
demand and market supply

qd = qs
 Market Prices
• Market Prices reflect both the benefit of a good to the
society as well as the cost to the society of producing
that good.
• Both house holds and firms look at prices when
deciding to buy and sell (hidden hand of self interest)
• They unknowingly take into account the social
benefits and social costs of their actions , and
• therefore by trying to maximize their own welfare,
they maximize the welfare of the society through the
market price 5
Market Price and equilibrium
S

E
Price (P)

Quantity Demanded (qd) and quantity Supplied (qs)

• Market equilibrium is the sum of consumer
surplus and producers surplus as shown by the
demand and supply curves.
• Market clears itself at Market Price, because all
demand is satisfied and therefore nothing
(supplied) will be sold after market price
• Market equilibrium also shows the economic
efficiency or efficiently allocation of resources
among producers and buyers through the price
mechanism
Reallocation of Resources through the price system
• Demand for x increases, therefore
• Price of x will increase
• Supply for x should increase, but labor is fully employed to produce
x and y
• Price (wages) for labor producing x will increase more than for labor
producing y
• Labor will shft from producing y (which is demanded relatively less,
therefore less wages) to producing x where there is more demand
and therefore higher wages
• Resources will reallocate from less demanded products to products
with higher demand through trial and error in the long run
 How Prices allocate Resources
• Market Forces harness the forces of supply and
demand to efficiently allocate resources and
determination of Prices of goods and services as
well as Prices in turn signal and guide the
allocation of resources efficiently, therefore
resource (factor) prices are determined towards
production of commodities that are demanded
more away from commodities that are demanded
less in an economy
 Markets are usually efficient
• Market economy is a system through which resources are allocated and decisions are
decentralized through many firms and households as they interact in the market for goods
and services and factors of production (resources)
• Markets work through the “invisible hand of self-interest”
• Increase in Demand induces Price to rise while supply increase when prices are high.
• For increase in supply , production has to increase,
• Increase in production in turn needs higher (derived) demand of factors of production,
• thus increasing the price of factors in the market and
• forcing the movement of these factors (resources from less paid jobs to higher paid jobs)
and efficiently re-allocating resources through the Price system of the market,
• and increasing the incomes of the factors in the long run,
• which in turn also influences an increase in consumptions and saving patterns in the
economy
• Thus increasing the efficiency of the economy through the market (Price) system 10
(a) Price increases when demand increases (shifts to the right) with supply
remaining constant
Price (P)
E3
P3
E2
P2

D3

D2

Quantity Demanded (qd) and quantity Supplied (qs)

(b) price decreases when demand decreases, (demand curve shifts to the
left) with supply remaining constant
Price (P)

E2
P2

P1
E1

D1 D2

Quantity Demanded (qd) and quantity Supplied (qs)

(c ) price decreases when supply increases (supply curve shifts to the
right) , with demand remaining constant
Price (P) s2

s1
E2
P2
E1
P1

Quantity Demanded (qd) and quantity Supplied (qs)

(d) Price increases when supply decreases and price decreases when
supply increases decreases, with demand remaining constant
s3
Price (P) s2
E3
P3
E2
P2

Quantity Demanded (qd) and quantity Supplied (qs)

 Increase and decrease in market Prices
• Price increases when demand is more than supply or
supply is less than demand
because buyers bid more to attain what ever commodities
are in the market and push the price up
• Price decreases when demand is less than supply or
supply is more than demand
Because the sellers try to sell off more of their stock by
lowering their supply prices thus pushing the market
price down
• We have seen that in the market the forces of demand and
supply determine the prices of goods and services and the
quantities sold
• So far, we described the way market allocates scarce
resources without directly considering the question of
whether these market allocations are desirable
• In other words, our analysis has been positive (what is) rather
than negative (what should be)
• The question is that whether at equilibrium price quantity of
products produced and consumed too large, too small or just
right?
 Consumer surplus
• Consumer surplus = a buyers willingness to pay minus the
amount the buyer actually pays
• Consumer surplus measures the benefit to buyers of
participating in a market
• When the price falls the quantity demanded rises and the
consumer surplus rises. The increase in surplus rises,
because the existing consumer now pays less and in part
because new consumer enter the market at a lower price
and vive versa
• consumer surplus reflects economic wellbeing
 Change in Price, Willingness to Pay & Consumer
Surplus
• Each buyer’s maximum is called willingness to pay and it measures how
much that buyer values the good
• The height of the demand curve reflects the buyer’s willingness to pay
• At any price given by the demand curve shows the willingness to pay of
the marginal buyer, the buyer who would leave the market first if the
price were any higher
• Consumer Surplus is the amount a buyer is willing to pay for a good
minus the amount the buyer actually pays for it
• Consumer surplus is closely related to the demand curve
• The area below the demand curve and above the price measures the
consumer’s surplus in the market
• The difference between the willingness to pay and the market price is
each buyer’s consumer’s surplus
 If Price of Good reduces from Rs. 100 to Rs. 80 Consumer surplus is Rs. 20 & If
price reduces to Rs. 70 Consumer surplus is Rs. 40
Price Price
(P) (P)
Willingness to pay of Consumer surplus to consumer
Rs. 100 consumer 1 1 of Rs. 20 at price Rs. 80
Consumer surplus of consumer
1 Rs. 20 at price Rs. 80 and is Willingness to pay of
Rs. 30 at price Rs. 70 consumer 2 Consumer surplus to consumer 2
Rs. 80 Consumer surplus of consumer 2
is Rs. 10 at price Rs. 70
is Rs. 10 at price Rs. 70 Willingness to pay of
Rs. 70
consumer 3
Total Consumer surplus of Additional Consumer surplus to
Willingness to pay of
consumer 1 & 2 is Rs. 40 consumer 1 of Rs. 10 at price Rs. 70
consumer4
at price Rs. 70

Demand

q1 q2
Quantity Demanded (qd)
 What does Consumer Surplus Measures
• The goal in developing the concept of Consumer surplus is to make normative
judgements about desirability of market outcomes
• Consumer surplus, the amount that the buyers are willing to pay for a good
minus the amount they actually pay for it, measures the benefit that the
buyers receive from a good as the buyers themselves perceive it.
• Thus, consumer surplus is a good measure of economic wellbeing if
policymakers want to respect the preferences of the buyers
• In some markets, consumer surplus does not reflect economic wellbeing
• Economists normally presume that buyers are rational when they make
decisions and that their preferences should be respected, because consumers
are the best judge of how much benefit (utility) they receive from goods that
they buy
 Producer Surplus
• Producers surplus is the amount a seller is paid for a good
minus the sellers costs
• When price rises, the quantity supplied increases, the
producers surplus rises. The increase in producers surplus
occurs in part because the existing producers now receive
more and in parts because new producers enter the market
at a higher price levels
• producer surplus also reflects economic wellbeing of the
sellers
Change in Price, Costs & Willingness to Sell
• Producers surplus is the amount a seller is paid minus
the cost of the product that is sold
• Producer surplus measures the benefit (Profit) to the
sellers of participating in the market
• Producers surplus is closely related to the supply
curve which is derived from the costs of all the sellers
of a particular good in the market
 If Price of Good Increases from Rs. 500 to Rs. 600 Producer surplus is Rs. 100
Supply
& If Price Increases from Rs. 600 to Rs. 800 Producer surplus is Rs. 300
Price
Pric (P)
Supply
e (P) Total Producer surplus of
producer 1 & 2 Rs. 300 Additional Producer surplus to
at price increase from producer 1 is Rs. 300 at price Rs. 800
Rs. 500 to Rs. 800
Rs. 900
Cost to producer 4
Rs. 800 Cost to producer 3
Producer surplus of
Producer surplus of producer 2 producer 2 Rs. 200 at price
Rs. 200 at price increase from increase from Rs. 600 to Rs.
Rs. 600 to Rs. 800 800
Rs. 600
Cost to producer 2
Rs. 500
Cost to producer 1 Initial Producer surplus of
Producer surplus of producer 1
Rs. 100 at price increase from producer 1 Rs. 100 at price
Rs. 500 to Rs. 600 and is increase from Rs. 500 to Rs. 600
Rs. 300 at price Rs. 800
q1 q2
Quantity supplied (qs)
 What does Producer’s Surplus Measure
• The area below the Price and above the supply curve measures Producer’s
surplus
• The logic is straightforward: the height of the supply curve measures seller’s
costs and the difference between the price and the cost of production is each
seller’s producer surplus
• Thus the total area is the sum of the producer’s surplus of all the sellers
• The shaded area shows just how much the producers (seller’s) wellbeing
(Profit) for each producer rises in response to higher prices.
• The pink area shows the producer surplus of seller with the least costs of
production,
• while the blue area shows the producer surplus of the seller with the seller
who has the second least costs,
• while both the pink & blue areas show the producers surplus of both the
sellers with a rise in Price from Rs. 500 to Rs. 800
●
Entrepreneu ●
Innovation
●
Productivity
r
●
Inflation
Theory of
●
Wealth
●
Philips
Profit Curve
●
Rationality
●
Normal
●
Manageria ●
Scientific
Profits l Efficiency Method
●
Monopoly Theory of ●
Economic
●
Capital Profit Models
●
Consumer ●
Function
●
Factors of
Surplus of Profit Production
●
Elasticity ●
Production
●
sales
●
Producers Possibility
surplus
maximizati Frontier
●
Inferior on Model (PPF)
goods
●
Land ●
Microecono
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Business ●
Labor mics
versus ●
Scarcity ●
Macroecon
Economic ●
Economics omics
Profit ●
Efficiency
●
Positive
●
Risk bearing Statement
Theories of
●
Equity ●
Normative
Profit
●
Opportuni Statement
●
Frictional ty Costs ●
Law of
Theory of ●
Marginal demand
Profit Change ●
Demand
●
Monopoly ●
Market ●
Quantity
Theory of Economy demanded
Profit (dq)
●
Externality
●
Invisible ●
Excess
●
Market Hand
demand
Power
●
Market ●
Law of
●
Monopoly Failures supply
• ______________________________________________________________________
______________________________________________________________________
______________________________________________________________
• Stock
• Supply
• Quantity supplied (qs)
• Excess supply
• Market
• Equilibrium Price
• Equilibrium quantity
• Competitive market
• Market Power
• Monopoly
• Consumer loyalty