Chapter 2a Students - Demand and Supply PDF

Topic 2(a) DEMAND, SUPPLY & MARKET EQUILIBRIUM  Topic Outline 2.1 Introduction: Market and the Circular Flow 2.2 Demand (DD) 2.3 Supply (SS) 2.4 Market Equilibrium 2.5 Change in Equilibrium (SS & DD) 2.6 SS/DD Analysis: Example 2.1 INTRODUCTION Market & the circulation flow...

Topic 2(a) DEMAND, SUPPLY & MARKET EQUILIBRIUM  Topic Outline 2.1 Introduction: Market and the Circular Flow 2.2 Demand (DD) 2.3 Supply (SS) 2.4 Market Equilibrium 2.5 Change in Equilibrium (SS & DD) 2.6 SS/DD Analysis: Example 2.1 INTRODUCTION Market & the circulation flow 3  Markets A market is a group of buyers and sellers of a particular goods and services. A market may be local, national or international in scope. This chapter concern purely competitive market with a large number of independent buyers and sellers. 4  2.2 DEMAND An economic principle that describes a consumer’s desire and willingness to pay a price for a specific good or service, other factors constant.  Law of Demand Says that quantity demanded varies inversely, or negatively, to the price, other things constant. __________ relationship between price and quantity demanded. The _____ the price, the ______ the quantity demanded. Demand Schedule & Demand Curve: The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. The demand curve is a graph of the relationship between the price of a good and the quantity demanded. Demand Schedule and Demand Curve Price of Pizza Quantity of Pizza ($/Slice) Demanded (Slices) 2.50 4 2.00 6 1.50 8 1.00 10 0.50 12 The demand schedule is a table The demand curve is a graph of the that shows the relationship between relationship between the price of a the price of the good and the good and the quantity demanded. quantity demanded.  Individual Demand & Market demand: The individual demand is the relationship between the quantity demanded by a single buyer and its price. The market demand is the relationship between the total quantity demanded by all consumers in the market and its price.  The market demand curve is the horizontal sum of the individual demand curves! When the price is $6.00, When the price is $6.00, The market demand at Mr. Lee will demand 4 Mr. Wong will demand 3 = $6.00 will be 7 slices of + slices of pizza slices of pizza. pizza Mr.Wong’s Demand Market Demand Mr. Lee’s Demand Price of Pizza ($/Slice) Price of Pizza ($/Slice) Price of Pizza ($/Slice) Example 6.00 6.00 6.00 3.00 3.00 3.00 7 13 Quantity of Pizza 4 8 Quantity of Pizza 3 5 Quantity of Pizza When the price is $3.00, The market demand at When the price is $3.00, Mr. Wong will demand 5 $3.00, will be 13 slices of Mr. Lee will demand 8 slices of pizza. pizza. slices of pizza.  Changes in Quantity Demanded (Qd)& Change in Demand (DD): Changes in quantity demanded result in movement along the demand curve due a change in price of that particular good while other factors remain constant. (upward/downward movement) Change in demand is the shift of the demand curve due a change in other factors while price remains constant. (leftward/ rightward shift) Changes in Quantity Demanded Price of pizza Price of Pizza increases and results ($/Slice) in a movement along B the demand curve. $6.00 $3.00 A D 0 2 4 Quantity of Pizza  Change in Demand (shift): A shift in the demand curve either to the left or right caused by any changes that alters the quantity demanded at every price. Such as: 1. Prices of related goods – substitutes goods or complements goods 2. Changes in consumer income – normal goods or inferior goods 3. Tastes and preferences 4. Population or number of buyers 5. Expectations about the future price  Shifts in The Demand Curve Price of Pizza ($/Slice) Increase in demand Decrease in demand Demand curve, D2 Demand curve, D1 Demand curve, D3 0 Quantity of Pizza  1. Prices of Related Goods: (i) Substitutes Goods - A product that can be used in place of another product (similar satisfaction). - A change in the price of substitute products affect the demand for the product in the same direction in which the price change. - E.g. tea vs. coffee (Pcoffee ↑ ; Qd coffee↓ ; Dtea↑ )  Prices of Related Goods (cont.) (ii) Complements Goods - A product that is used in conjunction with another product (use together). - The change in the price of a complementary product affects the demand for the product in the opposite direction to the change price. - E.g. pen and ink. ( Ppen↑ ; Qd pen ↓ ; Dink↓ )  2. Changes in Consumer Income: Goods can be classified into two broad categories:  Normal goods: the demand increases when income increases and demand decreases when income decrease.  (Income ↑; Demand↑)  Inferior goods: the demand decreases when income increases and demand increases when income decreases  (Income ↑; Demand↓)  3. Tastes & Preferences: Tastes and preferences of consumers change significantly. If a product become more fashionable, the demand for it will increase and if the same product becomes outdated, the demand for it will fall. E.g. Changes in music.  4. Population or Number of Buyers: A larger population with a high rate of growth creates greater demand for goods and services. E.g. An increase in the population of UTAR would increase the demand for houses and other goods and services.  5. Expectations about the future price: Expectation of price in the future could either increase or decrease current demand. E.g: If consumers currently expect that the price will be lower later, they will demand less now. Demand curve will shift to the left. E.g: If consumers currently expect that the price will be higher later, they will demand more now. Demand curve will shift to the right.  2.3 SUPPLY Supply indicates how much of a good producers are willing and able to offer for sale per period at each possible price, other things constant.  Law of Supply Law of supply states that the quantity supplied is usually directly related to its price, other things constant. _______ relationship between price and quantity suppled.  The lower the price, the smaller the quantity supplied  The higher the price, the greater the quantity supplied  Supply Schedule & Supply Curve The supply schedule is a table that showing how much of a product firms will set at different prices. The supply curve is a graph illustrating how much of a product a firm will set at different prices. Supply Schedule and Supply Curve Price of Pizza ($/Slice) Price of Pizza Quantity of S ($/Slice) Pizza 30 25 5 0 20 10 1 15 15 2 10 20 3 25 4 5 30 5 Quantity 0 1 2 3 4 5 of Pizza  Individual Supply & Market Supply The individual supply is the relationship between price of good and the quantity an individual producer is willing and able to sell per period, other things constant. The market supply is the sum of all that is supplied each period by all producers of a single product. Individual and Market Supply Curve  Changes in Quantity Supplied (Qs) & Change in Supply (SS) A changes in quantity supplied result in the movement along the supply curve due a change in price while other factors remain constant. Change in supply is shift of supply curve resulting from a change in one of the determinants of supply other than price of the goods. Changes in Quantity Supplied Price of Pizza S ($/Slice) B $6.00 A rise in the price of pizza results in a movement along the supply A curve. $2.00 Quantity of Pizza 0 3 8  Change in Supply A shift of the supply curve, either to the left or right. Determinants of supply other than the price of the good 1. Input prices 2. Government regulation 3. Technology 4. Prices of related products 5. Number of sellers 6. Expectations  Shifts in The Supply Curve Price of Pizza ($/Slice) Supply Curve (S2) Supply Curve (S1) Decrease Supply Curve (S3) in Supply Increase in Supply Quantity of Pizza  1. Input prices Response to the factor of production (labor, land and capital). E.g: To produce ice-cream, sellers use various inputs such as cream, sugar, flavoring, ice-cream machines. When price of one or more of these inputs rises, producing ice-cream is less profitable (higher cost). Supply curve will shift to the left. When price of one or more of these inputs falls, producing ice-cream is more profitable (lower cost). Supply curve will shift to the right.  2. Government Regulation Supply may also change because of changes in the legal and regulatory environment in which firms operate. E.g.: Taxes - will increase the firms cost and decrease the supply. Supply curve will shift to the left. Subsidies - will decrease the firms cost and increase the supply. Supply curve will shift to the right.  3. Technology Represents the economy’s knowledge about how to combine resources efficiently. If a better technology is discovered, production costs will fall. Thus, suppliers will be more willing and able to supply the good at each price. E.g: When new technology are introduced in the production of ice cream. Supply of ice cream will increase. Supply curve will shift to the right.  4. Price of Related Goods – Substitutes Goods: If there is an increase in the price of substitute goods in production, supply of a good will decrease. Example: Big Mac Hamburger (BM) and Double Cheese (DC) Burger ( PBM ↑; QSS BM↑; SSDC↓ ) – Complementary Goods An increase in the price of complementary goods will increase the supply of a good & vice versa. Example: Pen and Ink ( Ppen ↑; QSS pen↑; SSink ↑ ) 34  5. Number of Sellers Affect the supply curve in the market either to the right or left. E.g: More Sellers: If there is an increase in the number of sellers in the market, then the supply of the good increases. Supply curve will shift right. Fewer Sellers: If there is a decrease in the number of sellers in the market, then the supply of the good decreases. Supply curve will shift left. 35  6. Expectations Expectation of price in the future could either increase or decrease current supply. E.g: If producers currently expect that the price will be lower later they will supply more now. Supply curve will shift to the right. If producers currently expect that the price will be higher later they will supply less now. Supply curve will shift to the left.  Market Equilibrium The condition that exists in a market when the plans of buyers match those of sellers. So quantity demanded equals quantity supplied and the market clears. There is no tendency for price to change.  Market Equilibrium (cont.) The price that The quantity balances supplied and quantity the quantity supplied and demanded at quantity the demanded. equilibrium price.  MARKET EQUILIBRIUM Output (Product) Market DD & SS Interaction 3 set of market condition / effect: (a) The quantity demanded (b) The quantity demanded (c) The quantity supplied equal the quantity supplied exceeds the quantity supplied exceeds the quantity (Qd=Qs) at the current (Qd>Qs) at the current price. demanded (Qs>Qd) at the price. This situation called This situation called current price. This situation _______________ ________________ called _________________ Equilibrium Price of Pizza ($/Slice) Supply Equilibrium price Equilibrium $2.00 Equilibrium Demand quantity 0 1 2 3 4 5 6 7 8 9 10 11 12 13Quantity of Pizza Excess Demand (Shortage) When:  Current Price < Equilibrium Price, then  Qd > Qs - There is excess demand or a shortage. Excess Demand (Shortage) Price of Pizza ($/Slice) Supply $3.50 $2.00 Shortage Demand 0 5 8 10 Quantity of Pizza Quantity Quantity supplied demanded  Excess Supply (Surplus) When:  Current price > Equilibrium Price, then  Qs > Qd - There is excess supply or a surplus. Excess Supply (Surplus) Price of Pizza ($/Slice) Supply Surplus $3.50 $2.00 Demand 0 5 8 10 Quantity of Pizza Quantity Quantity demanded supplied  2.5 CHANGE IN EQUILIBRIUM: The market equilibrium will change when there is a shift in the demand or supply curve. We will see what happens when: (i) The demand curve shifts and supply remains constant. (ii) The supply curve shifts and demand remains constant. (iii) Both the demand and supply curves shift.  Three Steps for Analyzing Changes in Equilibrium: 1. Decide whether the events shifts the supply or demand curve (or both). 2. Decide in which direction the curve shifts. 3. Use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity.  Effect of Change in Demand Change in DD can arise from a number of factors; change in income, tastes, etc. Price of Pizza  Suppose there is an ($/Slice) S0 increase in the demand for Pizza, the demand curve E1 will shift $6.0 rightward/upward, to D1. 0 E0  The equilibrium price will $3.0 increase, and the 0 equilibrium quantity will also increase. D0 D1 0 4 8 Quantity of Pizza  Effect of Change in Supply Change in SS can arise from a number of factors; change in cost, technology, etc Price of Pizza ($/Slice) S0  Suppose there is an S1 increase in the supply for Pizza, the supply curve E0 will shift $6.00 rightward/downward, to E1 S1. $3.00  The equilibrium price will decrease, and the equilibrium quantity will increase. D0 0 4 8 Quantity of Pizza  Effect of Changes in Both Demand and Supply As long as only one curve shifts, equilibrium price and quantity will change. If both curve shift, the outcome is obvious. Changes in SS = Changes in DD Changes in SS < Changes in D Changes in SS > Changes in DD For example: (a) Supply change > demand change Price of S0 Pizza ($/Slice) S1 E0 $6.00 E1 $3.00 D0 D1 0 4 8 Quantity of Pizza  (b) Supply change < demand change Price of Pizza S0 ($/Slice) E0 S1 $6.0 0 E1 $3.0 0 D0 D1 0 6 8 Quantity of Pizza  (b) Supply change = demand change SS↑; SS curve shift right. Price of S0 DD↓; DD curve shift left. Pizza ($/Slice) As ↑SS = ↓DD; $6.00 E0 S1 Equilibrium price ↓ Equilibrium quantity remain the same E1 $3.00 D0 D1 0 6 Quantity of Pizza Q and A 53  2.6 Supply and Demand Analysis: Question (i): Proton Berhad increases the price of its car model, Proton Exora from P0 to P1. Explain the law of demand and based on it, explain what will happen to the quantity demanded for Proton Exora car. Sketch a graph to illustrate your explanation. 54 55 Question (ii): What will happen to Perodua Aruz (substitutes) when the price of Proton Exora car rise? Sketch a graph to illustrate your explanation. 56 57 Question (iii): Assume that Proton Exora cars need a specific regular maintenance service to bring out the performance of the car. Based on situation in (i), what will happen to the demand of that specific regular maintenance service? 58 59 60