Market Forces: Demand and Supply

or
Market System in Action
WEEK 3
 LEARNING OUTCOME:
Explain the laws of demand and supply, and identify factors that
cause demand and supply to shift.

 Calculate consumer surplus and producer surplus, and describe what

they mean.

Explain price determination in a competitive market, and show how

equilibrium changes in response to changes in determinants of
demand and supply.
 DEMAND
Suppose a clothing manufacturer desires information about the impact
of its pricing decisions on the demand for its jeans in a small foreign
market. To obtain this information, it might engage in market research
to determine how many pairs of jeans consumers would purchase each
year at alternative prices per unit. ( TABLE 2-1)
Law of demand As the price of a good rises (falls) and all other things
remain constant, the quantity demanded of the good falls (rises).

Market demand curve A curve indicating the total quantity of a good

all consumers are willing and able to purchase at each possible price,
holding the prices of related goods, income, advertising, and other
variables constant. ( FIGURE 2-1)
PRICE OF QUANTITY
 DEMAND SHIFTERS
Change in quantity demanded Change in demand
Changes in the price of a good Changes in variables other than
lead to a change in the quantity the price of a good, such as
demanded of that good. This income or the price of another
corresponds to a movement good, lead to a change in
along a given demand curve. demand. This corresponds to a
shift of the entire demand curve
 Income
Normal good • Inferior good
A good for which an increase A good for which an increase
(decrease) in income leads to an (decrease) in income leads to a
increase (decrease) in the demand decrease (increase) in the demand
for that good. for that good.
YOU WON PHP 400 MILLION IN
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 Price of Related Goods
Substitutes Complements
Goods for which an increase Goods for which an increase
(decrease) in the price of one (decrease) in the price of one
good leads to an increase good leads to a decrease
(decrease) in the demand for the (increase) in the demand for the
other good. other good
Advertising and Consumer Taste
- Informative Advertising
- Persuasive Advertising

Population

Consumer expectation F(P) = Q

 CONSUMER EXPECTATION &
ADVERTISING POPULATION
 DEMAND FUNCTION
Demand function A function that describes how much of a good
will be purchased at alternative prices of that good and related goods,
alternative income levels, and alternative values of other variables
affecting demand.
LINEAR DEMAND FUNCTION
- If is positive then X is a
substitute of good Y.
- If is negative then X is a
complement of good Y.
- If is negative increase in
Income leads lower
consumption of X,therefore X is
inferior good.
 EXAMPLE 1
An economic consultant for X Corp. recently provided the firm’s marketing
manager with this estimate of the demand function for the firm’s product:
Qdx = 12,000 − 3Px + 4Py − 1M + 2 Ax
where Qxd represents the amount consumed of good X, Px is the price of
good X, Py is the price of good Y, M is income, and Ax represents the
amount of advertising spent on good X. Suppose good X sells for Php200
per unit, good Y sells for Php 15 per unit, the company utilizes 2,000 units
of advertising, and consumer income is Php 10,000. How much of good X
do consumers purchase? Are goods X and Y substitutes or complements? Is
good X a normal or an inferior good? Find the inverse demand function of
Px. and graph it.
 CONSUMER SURPLUS
 The value consumers get from a good but do not have to pay for.

Assume that you have join 10k run, and you are thirsty, in this case
you are willing to pay Php 5 per liter of for the first drop of water. As
you consume more water, you are less willing to pay more.

 ASSUME THAT YOU VALUE 2 LITERS OF WATER AT Php 8. AND YOU

WANT TO BUY 2 LITERS OF WATER, WHAT WOULD BE YOUR
CONSUMER SURPLUS. ( SEE FIGURE 2-5)
FIGURE 2-5
• Since you will buy two liters of water , it will cost you Php 6.
- since you value it at Php 8 your consumer surplus would be 2.
(8-6=2)
- using figure 2 we can also find consumer surplus by finding the area
of the triangle :
 EXAMPLE 2
A typical consumer’s demand for the Happy Beverage Company’s
product looks like that in Figure 2–5. If the firm charges a price of Php 2
per liter, how much revenue will the firm earn and how much
consumer surplus will the typical consumer enjoy? What is the most a
consumer would be willing to pay for a bottle containing exactly 3 liters
of the firm’s beverage?
 SUPPLY
Market supply curve
A curve indicating the total
quantity of a good that all
producers in a competitive market
would produce at each price,
holding input prices, technology,
and other variables affecting
supply constant
 CHANGE IN QUANTITY SUPPLIED
Changes in the price of a good
lead to a change in the quantity
supplied of that good. This
corresponds to a movement along
a given supply curve.
CHANGE IN SUPPLY
Changes in variables other than
the price of a good, such as input
prices or technological advances,
lead to a change in supply. This
corresponds to a shift of the entire
supply curve.
 SUPPLY SHIFTERS
Input Prices
Technology or Government Regulations
Number of Firms
Substitutes in Production
Producer Expectations
Taxes
-excise tax
- Ad valorem tax
THE SUPPLY FUNCTION
 LINEAR SUPPLY FUNCTION
A representation of the supply
function in which the supply of a
given good is a linear function of
prices and other variables
affecting supply.
 EXAMPLE 3
Your research department estimates that the supply function for high
definition televisions (HDTVs) is given by
Qx s = 2,000 + 3 Px − 4 Pt − Pw
where Px is the price of HDTVs, Pt represents the price of a tablet, and
Pw is the price of an input used to make HDTVs. Suppose HDTVs are
sold for Php 400 per unit, tablets are sold for Php 250 per unit, and the
price of an input is Php 1,400. How many HDTVs are produced? What is
the inverse demand Curve of Px ? Graph the inverse demand curve.
 Producer Surplus
• The amount producers receive in
excess of the amount necessary
to induce them to produce the
good.
 EXAMPLE 4
• WHAT WOULD BE THE PRODUCER SURPLUS IN EXAMPLE 3?
MARKET EQUILIBRIUM
 EXAMPLE 5
According to an article in China Daily, China recently accelerated its
plan to privatize tens of thousands of state-owned firms. Imagine that
you are an aide to a senator on the Foreign Relations Committee of the
U.S. Senate, and you have been asked to help the committee determine
the price and quantity that will prevail when competitive forces are
allowed to equilibrate the market. The best estimates of the market
demand and supply for the good (in U.S. dollar equivalent prices) are
given by Qd = 10 − 2P and Qs = 2 + 2P, respectively. Determine the
competitive equilibrium price and quantity. Try to graph the demand
and supply function.
 COMPARATIVE STATICS
CHANGES IN DEMAND CHANGES IN SUPPLY
Simultaneous Shifts in Supply and Demand
 EXAMPLE 6
Suppose you are the manager of a chain of computer stores. For
obvious reasons you have been closely following developments in the
computer industry, and you have just learned that Congress has passed
a two-pronged program designed to further enhance the U.S. computer
industry’s position in the global economy. The legislation provides
increased funding for computer education in primary and secondary
schools, as well as tax breaks for firms that develop computer software.
As a result of this legislation, what do you predict will happen to the
equilibrium price and quantity of software?
 EXAMPLE 7
• Sam Robbins, owner and CEO of PC Solutions, arrived at the office and glanced at the
front page of The Wall Street Journal waiting on his desk. One of the articles contained
statements from executives of two of South Korea’s largest semiconductor
manufacturers— Samsung Electronic Company and Hynix Semiconductor—indicating
that they would suspend all their memory chip production for one week. The article
went on to say that another large semiconductor manufacturer was likely to follow suit.
Collectively, these three chip manufacturers produce about 30 percent of the world’s
basic semiconductor chips. PC Solutions is a small but growing company that assembles
PCs and sells them in the highly competitive market for “clones.” PC Solutions
experienced 100 percent growth last year and is in the process of interviewing recent
graduates in an attempt to double its workforce. After reading the article, Sam picked up
the phone and called a few of his business contacts to verify for himself the information
contained in the Journal. Satisfied that the information was correct, he called the
director of personnel, Jane Remak. What do you think Sam and Jane discussed?