Applied Econ (PPT 2 Rev) PDF

MARKET DEMAND, MARKET SUPPLY, AND MARKET EQUILIBRIUM - **Market** is an interaction between the buyers and sellers of trading or exchange. It is where the consumer buys, and the seller sells. - **Demand** is the willingness of a consumer to buy a commodity at a given price. - **...

MARKET DEMAND, MARKET SUPPLY, AND MARKET EQUILIBRIUM - **Market** is an interaction between the buyers and sellers of trading or exchange. It is where the consumer buys, and the seller sells. - **Demand** is the willingness of a consumer to buy a commodity at a given price. - **Supply** refers to the quantity of goods that a seller is willing to offer for sale. - **Equilibrium** is the state in which market supply and demand balance each other, and as a result, prices become stable. - Generally, an over-supply of goods or services causes prices to go down, which results in higher demand. The balancing effect of supply and demand results in a state of equilibrium. - **Market system** is a powerful tool for the allocation because the changes in price from market transactions create incentives and disincentives on buyers and sellers to address disparities between demand and supply. - The instrument of allocation is the market price determined by the interactions of the buyers and the seller in the market. - Economists use the term **demand** to refer to the amount of some good or service consumers are willing to purchase at each price. - **Demand** is based on needs and wants--- a consumer may be able to differentiate between a need and a want, but from an economist's perspective, they are the same. - What a buyer pays for a unit of the specific good or service is called price. - The total number of units purchased at that price is called the quantity demanded. - A table that shows the quantity demanded at each price is called a demand schedule. A demand curve shows the relationship between price and quantity demanded on a graph. **[THE LAW OF SUPPLY AND DEMAND]** The law of supply and demand explains the interaction between the sellers of a product and the buyers. It shows the relationship between the availability of a particular product and the demand for that product has on its price. - **Demand** - is the willingness of a consumer to buy a commodity at a given price. - A demand schedule shows the various quantities the consumer is willing to buy at different prices. - A **Demand function** shows how the quantity demanded of a good depends on its determinants, the most important of which is the price of the good, thus the equation: - **Qd = f (P).** This signifies that the quantity demanded good is dependent on the price of that good. EXAMPLE: - The quantity demanded is determined at each price with the following demand functions: Qd -- 6-P/2. - At a price of Php 10per bottle, Ana is willing to buy one bottle of vinegar for a given month. As the price goes down to Php 8, the quantity she is willing to buy goes up to two bottles. - At a price of Php 2, she will buy five bottles. There is a negative relationship between the price of a good, and the quantity demanded that good. - A lower price allows the consumer to buy more, but as price increases, the amount the consumer can afford to buy tends to go down. - The **demand curve** is a graphical illustration of the demand schedule with the price measured on the vertical axis (Y), and the quantity demanded measured on the horizontal axis (X). - The value is plotted in the graph and is represented as connected dots to derive the demand curve (Figure 1). - The demand curve slopes downward, indicating the negative relationship between the two variables: price and quantity demanded. - The **downward slope** of the curve indicates that as the price of vinegar increases, the demand for the sound decreases. The negative slope at the demand curve is due to the income and substitution effect. - The **income effect** is felt when a change in the price of a good changes consumers\' real income or purchasing power, which is the capacity to buy with a given income. - **Purchasing power** is the volume of goods and services one can buy with his/her income. - The **substitution effect** is felt when a change in the price of a good changes demands due to alternative consumption of substitute goods. For example, lower prices encourage consumption away from higher-priced substitutes on top of buying more with the budget (income effect). The higher price of a product encourages cheaper substitutes, further discouraging demand for the former already limited by less purchasing power (income effect). - **THE LAW OF DEMAND** - Using the assumption of **"ceteris paribus"**, which means all other related variables except those that are being studied at the moment and are held constant, there is an inverse relationship between the price of a good and the quantity demanded good. - "The higher the price, the lower the quantity demanded, and vice versa." - The amount of a good that buyers purchase at a higher price is fewer because as the price of goods goes up, the opportunity cost of buying the good is less. Consumers will avoid buying the product. - For example, if the price of video game drops, the demand for the games may increase as more as people want the games. The demand curve is always downward sloping due to the law of diminishing marginal utility. **FACTORS AFFECTING DEMAND OF A COMMODITY** - **Income** - The willingness of a consumer to buy a commodity is influenced by the price of the commodity & his/her taste for the commodity. - The capacity to purchase the commodity is influenced by his/her income of the consumer. - A higher level of income will give him/her higher capacity to consume while a lower-income will give him limited purchasing power. - **Price of other commodities** -Prices of other goods and services may influence the demand for goods and services. - The prices on commodities may affect the demand of a particular good; the influence of related goods is more palpable. - For example, if the other good is a substitute, the increase in the price of the substitute goods may increase the demand for the commodity at hand. - Thus, when the price of beef increases, the demand for chicken will increase. If the other goods are a complementary good, a decrease in its price will impact positively on demand for the goods being investigated. - For instance, when the price of bread decreases, the demand for butter may increase since butter and bread may be considered as complementary goods. - **Tastes or preferences** - The formation of taste is influenced by several factors like cultural values, peer pressure, or the power of advertising. - For example, on the celebration of New Year's Eve, it is customary for families to have round fruits at their fruit plate to attract good luck. This tradition increased the demand for fruits during this season. - **Consumer expectations --** The expectation or prospect of what will happen to the price can influence the demand for the commodity. - For example, if you believe that rice prices will increase tomorrow, there is a tendency for consumers to increase their consumption today. - **Market** -- The size and characteristics of the market can also be influencing the demand for a commodity. - An increasing population can contribute to the expansion of existing markets for various commodities. - A lower birth rate, coupled with an aging population, may alter the composition of demand by shifting the demand toward the needs of the elderly and away from goods and services that target the youth. - **SUPPLY** - Supply refers to the quantity of goods that the seller is willing to offer for sale. - The supply schedule shows the different quantities the seller is willing to offer for sale. - The supply schedule shows the different quantities the seller is willing to sell to different prices. - The supply function shows the dependence of supply on the various determinants that affect it. - Assuming that the supply function is given as Qs: 100 + 5Pand is used to determine the quantities supplied at the given prices. Supply can be illustrated using a table or a graph. - A supply schedule is a table, like Table 2, that shows the quantity supplied at a range of different prices. A supply curve is a graphic illustration of the relationship between price, the vertical axis (Y), and quantity supplied, shown on the horizontal axis (X). - The supply schedule and the supply curve are just two different ways of showing the same information NOTE: As shown in Table 2, the relationship between the price of fish and the quantity that Jose is willing to sell is direct. The higher the price, the higher the quantity supplied. When plotted into a graph, we obtain the supply curve. **THE LAW OF SUPPLY** - The law of supply demonstrates the quantities that will be sold at given price. The higher the price, the higher the quantity supplied and vice versa. - Producers supply more at a higher price because selling at a higher quantity at a higher price increases revenue. **FACTORS AFFECTING SUPPLYOF A COMMODITY** - **Price of production inputs** -- The production of any commodity will require two major inputs- intermediate inputs or raw materials and factor inputs. - Intermediate inputs refer to the materials, including raw materials that are still going to be processed or transformed into higher levels of outputs. - The factor inputs are the processing or transforming inputs. Some examples of factor inputs are labor, capital, land, and entrepreneurship. - These factors inputs are the ones adding value to the raw materials through the process of production. When the price of these production inputs increases, there will be an increase in the cost of production at every level of production. - With the cost of production increased at a given price level, sellers will reduce the quantity supplied at alternative prices. - **Taxes** -- Business establishments are required to pay a number of taxes to various levels of government. - It is a monetary expense on the part of the firms, the payment of taxes can be considered as a part of the cost of production, although taxes are not factor inputs nor raw materials; they are still considered as part of operating a business. - Thus, an increase in sales tax, real estate tax, and other business taxes can increase the cost of supplying a commodity. This may discourage the sellers from increasing their supply of a commodity in the market. - **Technology** -- Some firms may use labor-intensive technology if the cost of labor is relatively cheap. - On the other hand, firms may use capital-intensive technology if wages are very high. - Improvements in the technology used by some firms can lower their production costs and make their firm more competitive. - A lower-cost may encourage these firms to supply more of the commodity since they can sell it at a reduced price. - **Expectation** -- The expectation or anticipation of what will happen on the price of the commodity can also influence the amount supplied in the market. - If there is an expectation that rice prices will increase next season, this may encourage farmers to plant more rice next season. The expectation of a higher price next season can discourage the rice dealers from selling the rice currently. Some of them will hoard so they can sell in the future with higher returns. **HOW DO SUPPLY AND DEMAND CREATE AN EQUILIBRIUM PRICE?** - **Equilibrium price, or market-clearing price,** is the price at which the producer can sell all the units he wants to produce, and the buyer can buy all the units he wants. - Supply and demand are balanced or in equilibrium. The demand curve is downward sloping. This is due to the law of diminishing marginal utility. - The **supply curve** is a vertical line; over time, the supply curve slopes upward; the more supplier expects to be able to charge, the more they will be willing to produce and bring to market. - In the equilibrium point, the two slopes will intersect. The market price is sufficient to induce suppliers to bring to market that same quantity of goods that consumers will be willing to pay for at that price. **MARKET EQUILIBRIUM** - When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity demanded and the quantity supplied are equal. The corresponding price is the equilibrium price or market-clearing price; the quantity is the equilibrium quantity. - The intersection of supply and demand determines the equilibrium price and quantity. The equilibrium occurs where the quantity demanded is equal to the quantity supplied. - If the price is below the equilibrium level, then the quantity demanded will exceed the quantity supplied. - Excess demand or a shortage will exist. If the price is above the equilibrium level, then the quantity supplied will exceed the quantity demanded. - Excess supply or a surplus will exist. In either case, economic pressures will push the price toward the equilibrium level. - A change in supply, demand, or both, will necessarily change the equilibrium price, quantity, or both. It is highly unlikely that the change in supply and demand perfectly offset one another so that equilibrium remains the same. - Quantity supplied is equal to quantity demanded (Qs = Qd).