Suma Damodaran

IIM Udaipur

Microeconomics for Managers

Shifts in DD and SS:

Comparative Statics
 Suma Damodaran
IIM Udaipur

Learning Objective, Session 4

 At the end of this Session, you should be

able to:
– Incorporate demand and supply shifts into market/
business analysis in the real world
 Suma Damodaran
IIM Udaipur

Shifts in Demand/ Supply

 In the last class we studied shifts in demand

 Next, we will study shifts in Supply
 Suma Damodaran
IIM Udaipur

Supply Shifts

 And what now, could cause supply shifts?

 Suma Damodaran
IIM Udaipur

Supply shift mean?

 Suma Damodaran
IIM Udaipur

Equilibrium Analysis
For example, what has happened
over the years in the computer
industry?
DEMAND And how would it have affected the
supply?

SUPPLY
Price

Quantity
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis
Decrease in component prices
leading to supply shits
Number of producers, as well.
DEMAND Many other factors.

SUPPLY
Price

Quantity
 Suma Damodaran
IIM Udaipur

Supply Shifts

 Go back to our example of the market for wheat

 Qd = 3550- 266P ; Qs = 1944+ 207P
 Assume now that the government decides to import
200 units of wheat (a shift due to policy!) to be sold
in the domestic market.
 What is the new equilibrium price and quantity?
 {BTW, what would it mean if the govt steps in to
procure domestic wheat of 200 units?}
 Suma Damodaran
IIM Udaipur

Shifts in Equilibrium

 Demand Function for Wheat: Qd = 3550- 266P

 Supply Function for Wheat: Qs = 1944+ 207P; new
Supply Fn: Qs = 2144+ 207P
 Therefore, to discover the price at which equilibrium will
be achieved , we equate and solve for P*
 3550 – 266 P = 2144 + 207 P
 1406 = 473 P
 P* = 2.97 (old 3.4) You see
 Q* = 2759.3 (old 2647) something?
 Suma Damodaran
IIM Udaipur

The Shifted Supply Curve

Qd =3550- 266P
Qs =1944+207P

Qs =2144+207P
 Suma Damodaran
IIM Udaipur

Shifts in Supply

 Supply Shifts can happen due to changes in

– Technology
– Input Costs
– Time
– Policy
– Number of producers…..and any other!
 Suma Damodaran
IIM Udaipur

Shifts in Demand and Supply

 Next, we will study shifts in both demand and

supply
 Suma Damodaran
IIM Udaipur

Comparative Statics again!

The analysis of shifts of Demand ,and Supply

curves and both simultaneously- the resultant
new equilibrium is what we referred to earlier as
“comparative statics”
….The determination of changes in the
endogenous variables as a result of changes in
the exogenous variables/ factors/parameters.
An example……
 Suma Damodaran
IIM Udaipur

Market for Computers

 That demand for computers expanded

hugely is common knowledge. What then
ought to have happened to (equilibrium)
price?
 Price should have gone up.
 Suma Damodaran
IIM Udaipur

Market for Computers

 That demand for computers expanded hugely is

common knowledge. What then ought to have
happened to (equilibrium) price?
 However, the index of the price of computers ( 1988
equal to 100) , came down to 10 in 2008.
 What then could explain this fall in (equilibrium)
price? Show this diagrammatically.
 Suma Damodaran
IIM Udaipur

Price chart of computers

 Suma Damodaran
IIM Udaipur

Equilibrium Analysis
Decrease in component prices
NEW DEMANDleading to supply shits
No: of producers
DEMAND Technology, and any other.

SUPPLY
Price

NEW
SUPPLY

Quantity
 Suma Damodaran
IIM Udaipur

Another Example, US Corn Market

 In 2006 price was $2 a bushel. In 2008 the price had risen to $5

a bushel
 The change in the price of corn was attributed to
– An increase in demand (due to growth in market for corn-
based ethanol)
– A decrease in supply (due to heavy rains and flooding in the
US corn belt in 2008)
– The combined impact of the upward (rightward) shift of the
DD curve and the inward shift of the SS curve would depend
on (i) magnitude of the shifts (ii) shapes of DD and SS curve
 Suma Damodaran
IIM Udaipur

Corn Market (Besanko)

SUPPLY 2008
DEMAND 2008 SUPPLY
2006
DEMAND 2006
$5
Price

$2

Quantity (billions of bushels)

 EXAMPLE 2.8 THE BEHAVIOR OF COPPER PRICES

FIGURE 2.20
COPPER PRICES, 1965–2011
Copper prices are shown in both nominal (no adjustment for inflation) and real
(inflation-adjusted) terms. In real terms, copper prices declined steeply from the
early 1970s through the mid-1980s as demand fell. In 1988–1990, copper prices
rose in response to supply disruptions caused by strikes in Peru and Canada but
later fell after the strikes ended. Prices declined during the 1996–2002 period but
then increased sharply starting in 2005.
 Suma Damodaran
IIM Udaipur

Other prices(equilibrium prices)

– And how do you think a similar chart for

semiconductors/ mobile telephony look like?
– Take a look at Fig 2.8.
 Suma Damodaran
IIM Udaipur

Comparative Statics: Summary

 Increase in DD and unchanged supply = ??

 Suma Damodaran
IIM Udaipur

Comparative Statics: Summary

 Increase in DD and unchanged supply = higher

equilibrium price and eq quantity
 Decrease in DD and unchanged supply = ??
 Suma Damodaran
IIM Udaipur

Comparative Statics: Summary

 Increase in DD and unchanged supply = higher

equilibrium price and eq quantity
 Decrease in DD and unchanged supply = lower
equilibrium price and lesser eq quantity
 Unchanged DD and increase in supply = ??
 Suma Damodaran
IIM Udaipur

Comparative Statics: Summary

 Increase in DD and unchanged supply = higher

equilibrium price and eq quantity
 Decrease in DD and unchanged supply = lower
equilibrium price and lesser eq quantity
 Unchanged DD and increase in supply = lower
equilibrium price and larger eq quantity
 Unchanged DD and decrease in supply = ??
 Suma Damodaran
IIM Udaipur

Comparative Statics: Summary

 Increase in DD and unchanged supply = higher

equilibrium price and eq quantity
 Decrease in DD and unchanged supply = lower
equilibrium price and lesser eq quantity
 Unchanged DD and increase in supply = lower
equilibrium price and larger eq quantity
 Unchanged DD and decrease in supply = higher
equilibrium price and smaller eq quantity
 ??
 Suma Damodaran
IIM Udaipur

Comparative Statics: Summary

 Increase in DD and unchanged supply = higher

equilibrium price and eq quantity
 Decrease in DD and unchanged supply = lower
equilibrium price and lesser eq quantity
 Unchanged DD and increase in supply = lower
equilibrium price and larger eq quantity
 Unchanged DD and decrease in supply = higher
equilibrium price and smaller eq quantity
 Shifts in DD and SS result unclear……..
 Suma Damodaran
IIM Udaipur

Comparative statics

 If the SS increases and Demand increases, then

the resultant change in the equilibrium price will tell
you there was a net increase in demand or a net
increase in SS.
 if Demand increases and SS decreases, then you
can be sure that the equilibrium price will only go
up….or
……any other??
 Suma Damodaran
IIM Udaipur

Focus on demand:Thus we have

moved…..

 From Demand being a function of only its

own price( ceteris paribus)
……..TO
…………
Demand being a function of a number of
variables: D = f(P, I, Pr, Tastes,……)
 Suma Damodaran
IIM Udaipur

Numerical Example for

demonstration purpose

 Demand function: Q = 300 – 2P +4I; I is in ‘000s of $

 Supply function: Q = 3P – 50
– If I = 25, find market clearing/ equilibrium P* and
Q*
 Suma Damodaran
IIM Udaipur

Numerical Example

 Demand function: Q = 300 – 2P +4I; I is in ‘000s of $

 Supply function: Q = 3P – 50
– If I = 25, find market clearing/ equilibrium P* and
Q*
300 – 2P + 100 = 3P -50
5P =450
P* = 90, Q* = 220
– If I increases to 50, find new P*, Q*
 Suma Damodaran
IIM Udaipur

Numerical Example

 Demand function: Q = 300 – 2P +4I; I is in ‘000s of $

 Supply function: Q = 3P – 50
– If I = 25, find market clearing/ equilibrium P* and Q*; P* =
90. Q* = 220
– If I increases to 50, find new P*, Q*

300 – 2P + 200 = 3P -50

5P =550
P* = 110, Q* = 280
– Find the choke price for demand; and for supply at both
levels of I
 Suma Damodaran
IIM Udaipur

Numerical Example

 Demand function: Q = 300 – 2P +4I; I is in ‘000s of $

 Supply function: Q = 3P – 50
– If I = 25, find market clearing/ equilibrium P* and Q*; P*
= 90. Q* = 220
– If I increases to 50, find new P*, Q* P* = 110. Q* = 280
– Find the choke price for demand; and for supply

Demand Choke Price: I = 25, Pdch = 200; I = 50, Pdch = 250

Supply Choke Price: I = 25, Psch = 16.67; I = 50, Psch =
16.67
 Suma Damodaran
IIM Udaipur

Problem set 1

1. P = 10 – q P = 1+ q/2
OR
q = 10- P q = 2P-2
10 – P = 2P – 2
…..P* = 4 q* = 6
 Suma Damodaran
IIM Udaipur

Problem set 1

4. Q = 15 – 2P ; Q = 5P – 6
Equilibrium price = 3; equil: Qty = 9
b. New demand fn : 18.5-2P
So new equil Price = 3.5 ; equil Qty= 11.5
Pvt consumption has gone down by 3.5.
Pvt consumption is now 11.5 – 3.5= 8 m
tonnes.