Chapter 2 DEMAND & SUPPLY PDF

 LEARNING MATERIAL BA 103- BASIC MICROECONOMICS Name of Faculty : CLEOFE DIANNE N. AYCOCHO Topic : Economics: Theory of Demand and Supply Objectives : At the end of this lesson, studen...

 LEARNING MATERIAL BA 103- BASIC MICROECONOMICS Name of Faculty : CLEOFE DIANNE N. AYCOCHO Topic : Economics: Theory of Demand and Supply Objectives : At the end of this lesson, students should be able to: 1. Explain what is Demand and Supply. 2. Explain the determinants or shifters of demand and supply. 3. Discuss the Law of Demand and Supply. 4. Draw the demand and supply curve graph that show the relationship of price and quantities. Topic: Economics: Theory of Demand and Supply The Origin of Law of Demand and Supply We know that all of the theories that we learned and currently studying in present time has an origin just like the law of demand and supply. The early thinkers that credited in discussing the Law of Supply and demand are John Locke, Sir James Stuart, Adam Smith, Alfred Marshall and Ibn Taymiyyah. John Locke was a philosopher that is credited with one of the earliest written descriptions of the economic principle in his 1691 publication, “Some consideration of the consequences of the lowering of interest and the raising of the value of money”. The concept of supply and demand was addressed by John Locke as part of discussion about interest rate in 17 th-century England. John Locke wrote: “The price of any commodity rises or falls by the proportion of the number of buyers and sellers.” The word Supply and Demand was not actually use by John Locke. 1 Sir James Steuart’s was first use the term “Demand and Supply” in his printed Inquiry into the principles of political economy, publish in 1796. One of the concerns of Steuart’s was the impact of demand and supply on laborers. Adams Smith was the Father of Economics and 1776 epic economic work, the wealth of Nation. The concept of Demand and Supply was explained by Adam Smith as an “Invisible Hand” that neutrally guides the economy and according to Adam Smith the Invisible Hands is the automatic pricing and distribution mechanism in the economy. In 1890 Alfred Marshall’s Principles of Economics developed a demand and supply curve which is still used to demonstrate the point at which the market is in equilibrium. In theory if the price of particular product increases people will buy less, but Marshall noted that in real life, this behavior was not always true. Ibn Taymiyyah was an Islamic scholar died 300 years before Locke aforementioned publication. Taymiyyah discussed how prices are determined by demand and supply and not by the unjust actions of people involved in the transaction. 2  Chapter Demand 1 Demand and Supply have been called the Bread and Butter of economics. In this e-learning material i will discuss first the demand and supply separately and then together. Learning Objectives Understand what Demand is. Explain the Law of Demand and how it works. Differentiate between change in demand and change in quantity demanded. Understand the determinants or Shifters of Demand. What is Demand? When we search the definition of demand it defines as “a forceful statement in which you say that something must be done or given to you”. But in economics the word demand has a precise meaning and it is refers to: 1. The willingness and ability of buyers to purchase different quantities of a good. 2. At different prices, 3. During a specific of time period (per day, weeks, etc.) For Example: Juan demand for Freindy’s Taro Chips, Let say that Juan is willing and able to buy 10 Dozen of chips a month at 60 pesos per Dozen of 3 chips and Juan is willing and able to buy 15 Dozen of chips a month at 50 pesos per Dozen of chips. Note: That there are important points about demand to have an effective demand. To have an effective demand there are three things need to consider the desire, the resources or money, and the willingness. Example: Juan has a great job with a good salary and Juan dream of buying a luxury car. Now let’s analyze. Is Juan has a desire? Is Juan has the resources/money? Is Juan has a willingness? We can say that Juan is an Effective demand. Always remember to have an effective demand we need to consider three things; 1. Desire 2. Resources/money 3. Willingness Demand = Desire + Willingness to Pay + Ability to Pay/Availability 4 What is the Law of Demand? ❖ Law of demand is an Inverse Relationship between price and quantity demanded. As the price of a good rises, the quantity demanded of the good falls, and as the price of a good falls, the quantity demanded of the good rises, this law states that price and quantity demanded are inversely related, ceteris paribus. Price 𝑃2 Demand 𝑃1 Quantity 𝑄2 𝑄1 Demanded As you can see in the Chart it represents the law of demand when the price of good falls which is the (P1) the Quantity demanded rises which is the (Q1). But when the price of good rises which is the (P2) the quantity demanded of good falls which is the (Q2). Assumptions in Law of Demand ❖ No change in price of related goods ❖ No change in income of the consumer ❖ No change in taste and preferences of the consumer 5  ❖ No change in climate and season ❖ No change in size and composition of population ❖ No change in expectations regarding future prices Three Reason in the Law of demand ❖ Substitution Effect ❖ Income Effect ❖ Law of Diminishing Marginal utility Substitution Effect Many goods serve the same purpose just like to satisfy hunger or craving. For example, both banana chips and taro chips satisfy hunger or craving. Let say that on Monday, the price of banana chips same to the price of taro chips, but on Tuesday the price of banana chips rises. As a result, consumer will choose to buy taro chips. In other word the rise in price in banana chips leads to a decrease in the quantity demanded of it. Price of banana Price of banana chips rises, quantity chips falls, quantity Price demanded falls. demanded rises. Price 10 Demand Demand P P 5 5 Q Quantity Q 10 Demanded Quantity Demanded 6 Income Effect Example, When the price of banana chips increase people will buy less banana chips because they have less purchasing power to buy less banana chips, and when the price for banana chips decrease people can buy more banana chips. Law of Diminishing Utility As the people consume more banana chips they get less more satisfaction or happiness from banana chips that’s why the price for banana chips need to fall to increase the quantity demanded of the people going to buy. That shows the inverse relationship between price and quantity of the law of demand. Four ways to represent the Law of Demand ❖ In words. we can represent the law of demand in words: “When the price of a good rises, quantity demand falls, and as price falls, quantity demanded rises, ceteris paribus” ❖ In Symbols. In symbols the law of demand is: P 𝑄𝑑 P 𝑄𝑑 ❖ In a Demand Schedule. A demand Schedule is the tabular/numerical representation of different combinations of price and quantity demanded displaying inverse relationship of the law of demand. Example of Demand Schedule As you can see the demand schedule show the inverse relationship of price and quantity demanded of a good. At the price of 25 peso per 7  unit, the consumer demand 2 units of good and if the price decrease to 5 peso, consumer would purchase 10 units of good. Demand schedule for Banana chips Price (in Peso) Quantity Demanded Point in part (b) 25 2 A 20 4 B 15 6 C 10 8 D 5 10 E A ❖ As a Demand Curve. A (downward-sloping) demand curve is the graphical representation of the inverse relationship between price and quantity demanded specified by the law of demand. In short, a demand curve is a picture of the law of demand. Example of Demand Curve 30 A 25 Demand Curve Price for Banna chips B 20 C 15 D 10 E 5 0 0 2 4 6 8 10 Quantity Demanded for Banana Chips B 8 Demand Function What is Demand Function? The Demand Function is mathematical its function is a symbolic representation of the relationship between dependent variable (Demand for a commodity) and independent variables (Various determinants of demand). The Demand Function can be express as. 𝑄𝑥 = 𝑓(𝑃𝑥 , 𝑃𝑦 , 𝑌, 𝑇, 𝑃, 𝐴, … ) Where: 𝑄𝑥 = Demand for commodity X 𝑃𝑥 = Price of commodity X 𝑃𝑦 = Price of Related Goods Y = Income T = Taste and Preference P = Population A = Advertisement f = Functional relation However among this various determinant or shifters of demand the most influential is the price of commodity. So we can express the demand function for simplicity as (Demand is an inverse function of its price). 𝑄𝑥 = 𝑓(𝑃𝑥 ) Demand Function Types The demand Function has two types those are linear demand function and non-linear demand function. 9 Linear demand function is happen when the slope of the demand curve is remains constant throughout it length for simplicity the demand curve is linear when the price and quantity demanded change at constant rate. The linear demand function can be express as 𝑄𝑥 = 𝑎 − 𝑏𝑃𝑥 𝑄𝑥 = Demand for Commodity a = Autonomous Demand b = Slope of Demand Curve or coefficient of 𝑃𝑥 𝑄𝑥 = 𝑎 − 𝑏𝑃𝑥 Price Demand Non-linear demand function is happen when the slope of demand curve changes all along its length or at different points on a given demand curve for simplicity if the both price and quantity demanded change at different rate. The non-linear demand function can be express as 𝑄𝑥 = 𝑎𝑃𝑥−𝑏 𝑄𝑥 = Demand for Commodity a = Autonomous Demand b = Slope of Demand Function 𝑃𝑥 = Price of Good X 𝑄𝑥 = 𝑎𝑃𝑥−𝑏 Price Demand 10 A Change in Quantity Demanded Versus a Change in Demand ❖ A change in quantity demanded is a movement along the demand curve. ❖ A change in demand is a shift in the demand curve Change in Quantity Demanded A change in Quantity demanded (a movement along the demand curve, D1 Price B A D1 Quantity Demanded Change in Quantity demand may be of two types; ❖ Expansion in Demand Rightward/downward movement ❖ Contraction in Demand Leftward/Upward movement Expansion in Demand The Expansion in Demand is when the quantity demanded for a goods X rises just because the price of the product decreases (Other things remaining the same) or just what we call “Inversely related” when the price decrease the demand increase. 11 For example, the demand of Juan, Let say that the demand of Juan for gasoline is 3 liters per day at the price of 80 pesos per liter, but when the price of gasoline falls at 50 per liters the demand of Juan per day increase at 5 liters per day. That’s what we call Expansion of demand. Contraction in Demand The Contraction in Demand is when the quantity demanded for a good X falls just because the price of the product increases (Other things remaining the same). For example, The demand of Juan for Freindy’s Taro chips, Let say that the demand of Juan for Freindy’s Taro Chips is 10 dozen per day at the price of 55 pesos per dozen, but when the price of Freindy’s Taro Chips increases at 65 pesos per dozen the demand of Juan for the Chips decreases at 5 dozen per day. Change in Demand Price D1 D2 A change in demand (a shift in the demand curve from D1 to D2) Quantity Demanded Change in Demand Change in demand is related to a change of determinants or shifter of demand other than the price of the product. An increase or decrease in 12 demand due to a change in in determinants except the price may be represented by two types; ❖ Increase in Demand or Rightward/outward shift ❖ The Decrease in Demand or Leftward/inward shift Increase in Demand Increase in demand happen without changes in price is due to the change in determinants or factors of demand just like change in income, taste and preferences, price of related goods, population etc. For example, Juan can buy 6 pieces of chicken per week with his salary, but when the salary of Juan increase the demand of Juan for the chicken increase at 8 pieces per week. Decrease in Demand Decrease in demand happen without changes in price is due to the change in determinants or factors of demand just like change in income, taste and preferences, price of related goods, population etc. For example, Juan can buy 6 pieces of chicken per week with his salary, but when the salary of Juan decrease the demand of Juan for the chicken increase at 3 pieces per week. What are the Determinants or Shifters of Demand? ❖ Preferences ❖ Number of Buyers ❖ Price of Related Goods ❖ Income ❖ Expectation of Future Price 13  ❖ Preferences Preferences of consumer affect the amount of a good they are willing to buy at a particular price. Change in preferences can change the demand curve rightward or leftward. For example, People begin to favor Banana chips to a greater satisfaction the demand of banana chips increases, and the demand curve shift rightward. Price D1 D2 A change in preferences in favor of a good shifts the demand curve rightward. Demand Quantity Demanded Price D1 A change in preferences away from the good shifts the D2 demand curve leftward. Demand Quantity Demanded 14  ❖ Number of Buyers The demand of a good in a market is related to the number of buyers in the area. The more the number of buyers, the higher the demand of good that shifts the demand curve rightward. Fewer numbers of buyers, lower the demand of good that shifts the demand curve leftward. There are some reasons in increasing the number of buyers increased migration, heightened birthrate, and so on. Also the number of buyer decrease in some reason increase death rate, war, and migration of people. ❖ Price of Related Goods There are two types of related goods: substitutes and complements. Two goods are substitute if they satisfy similar need or desires. If two goods are substitutes, as the price of one rises, the demand for the other rises, and if the price of good falls, the price of other falls. For example Banana and Sweet potato, if the price of Banana rises (falls), the demand for Sweet potato rises (falls). Good X is Banana and Good Y is Sweet potato. If 𝑃𝑋 increase then 𝐷𝑌 increase If 𝑃𝑋 decrease then 𝐷𝑌 decrease ❖ Income Income shifts the demand curve depends to the type of product when it is a normal good or inferior good. The income of the people changes (increase or decreases). For normal good the demand of good rises as the income rises, and the demand of good falls as income falls. X is a normal good: If the income increases the 𝐷𝑋 increase If the income decreases the 𝐷𝑋 decrease 15 For inferior good the demand of good falls as income rises, and the demand of good rises as income falls. Y is an inferior good: If the income increases the 𝐷𝑌 decrease If the income decreases the 𝐷𝑌 increase ❖ Expectation of Future Price Buyers of a good who expect that the price of a good to be increase next month the buyer may buy it now, it increasing the current (or present) demand for the good. Buyers of a good who expect that the price of a good to be lower next month may wait next month to buy it, it decreasing the current (or present) demand for the good. For Example: Juan planning to buy a motorcycle. One day, Juan hears that the prices of motorcycle are expected to go down next month because of promo. Consequently, Juan decides to delay purchasing motorcycle for a while. Alternatively, if Juan hear that the price of motorcycle are expected to rise next month, Juan might go ahead to purchase motorcycle now. Determinants/Shift Rightward Shift Leftward Shift factor Preferences Favorable or positive Unfavorable or negative change in taste and change in taste and preferences preferences Number of Buyers Increase in Number of Decrease in Number of Buyers Buyers Price of Related Goods Increase in the price Decrease in the price of of Substitute goods Substitute goods and and fall in the price of rise in the price of complementary goods complementary goods Income Increase in Income Decrease in Income Expectation of Future Expectation of a rise Expectation of a fall in Price in price soon price soon 16  Always remember in Demand, that the Determinants or shifter of demand shifts the demand curve, not the price because price move along the curve and price doesn’t shift the curve. Chapter Supply 2 Learning Objectives: Understand what Supply is. Explain the Law of Supply and how it works. Differentiate between change in Supply and change in quantity Supplied. Understand the determinants or Shifters of Demand. What is Supply? Just like the word demand that has a specific meaning in economics, so thus the word supply. Supply refers to: 1. The willingness and ability of seller to produce and offer to sell different quantities of a good 2. At different prices 3. During a specific time period (per day, week, etc.). The supply of commodity does not mean the entire stock of the commodity but only the amount that the entrepreneur is willing to bring into the market at a particular price. For simply to understand supply it show that when the 17 prices of good it will lead to increase the supplied of good/services and when the price falls the quantity supplied will decrease. Economists call this positive relationship between price and quantity supplied the Law of supply. What is the Law of Supply? The quantity supplied of a commodity is directly related to the price of commodity. As the price of good rises, the quantity supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus. Price Supply Direct relationship between price and quantity Supplied. Quantity For example: Price of face-shield, once the price of face-shield increase, the quantity supplied of face-shield will increase, and when the price of face- shield decrease, the quantity supplied of face-shield will decrease. 18  Price Supply 𝑃2 𝑃1 Quantity 𝑄1 𝑄2 Supplied As you can see in the graph it represents the law of supply when the price of face-shield increase from P1 to P2 the Quantity supplied increases from Q1 to Q2. Assumption of Law of Supply ❖ There is no change in the state of technology ❖ No change in price of inputs ❖ No change in the number of producers ❖ There is no change in the goal of the firm ❖ The price of other goods remain constant ❖ No change in government policy variables like tax, subsidies, etc. Supply Schedule The supply schedule is a table that shows the relationship of how much the seller o producer willing to supply at the particular price. The table below 19 shows the positive relationships of price of the commodity and quantity supply. Example of Supply Schedule Combinations Price of Good X Quantity Supply A 5 10 B 10 20 C 15 30 D 20 40 E 25 50 As you can see in the Supply curve once the price of the commodity increases the Quantity supplied of the commodity also increases. Supply Curve The supply curve is graphical or diagrammatical presentation of the combination/relationship between price and quantity supply. Example of Supply Curve Good X 30 E 25 D 20 C Price 15 B 10 A 5 0 10 20 30 40 50 Quantity Supplied 20 The upward sloping line represents the supply curve as you can see in the supply curve when the price of good X is at 5 pesos the seller/producer is at 10 quantity only but when the price of good X increase at 25 pesos the seller/producers are willing to supply more which is at 50 quantity of good X. Supply Function What is Supply Function? Supply Function is establish the mathematical or algebraic functional relationship between determinants or all factors affecting supply as an (independent variables) and supply of goods or services as the (dependent variable). For simplicity the supply function explains direct relationship between price and supply. The supply function can express as; 𝑄𝑥 = 𝑓(𝑃𝑥 , 𝑃𝑅 , 𝑃𝐼 , 𝑇, 𝑊, 𝑍, … ) Where 𝑄𝑥 = Supply for commodity X 𝑃𝑥 = Price of product 𝑃𝑅 = Price of Related products 𝑃𝐼 = price of inputs T = Technology W = Weather or natural factors Z = others factors affecting supply Supply Function Types The supply Function has two types which is the linear supply function and non-linear supply function. Linear supply function is happen when the slope of the supply curve is remains constant throughout it length for simplicity the supply curve is linear 21 when the price and quantity supplied change at constant rate. The linear supply function can be express as; 𝑄𝑥 = 𝑎 + 𝑏𝑃𝑥 𝑄𝑥 = Quantity supplied to Commodity 𝑄𝑥 = 𝑎 + 𝑏𝑃𝑥 a = Autonomous supply b = Slope of supply Curve 𝑃𝑥 = Price of Commodity Price Quantity Supplied Non-linear supply function is happen when the slope of supply curve changes at different points on a given supply curve. For simplicity if the both price and quantity demanded change at different rate it’s called non-linear supply function. The non-linear supply function can be express as; 𝑄𝑥 = 𝑎𝑃𝑥𝑏 𝑄𝑥 = Supplied of Commodity a = Autonomous supply 𝑄𝑥 = 𝑎𝑃𝑥𝑏 Price b = Slope of supply Function 𝑃𝑥 = Price of commodity X Quantity Supplied What are the Determinants or Shifters of Supply? ❖ Price of resources Decrease in Supply ❖ Technology Supply ❖ Government involvement Price ❖ Number of sellers Increase 22 in Supply  ❖ Expectation of Future Price Quantity ❖ Price of Resources Resources are needed to produce goods. For example Banana is needed to produce Banana chips. When the price of inputs in producing banana chips increase the supply of banana chips will decrease, and when the price of inputs needed in producing banana chips decrease the supply of banana chips will increase. The supply curve will shift rightward when the price of input in producing goods decrease. Price Supply S1 S2 Quantity Supplied The supply curve will shift leftward when the price of input in producing goods increase. 23  Price Supply S2 S1 Quantity Supplied ❖ Technology Technology was defined as the body of skills and knowledge concerning the use of resources in production. Advance technology make the production cost lower and faster. For example: producing Banana chips if you are producing banana chips manually without using any technology/machine it takes more time and increases in production cost, buy when you are using advance technology in producing banana chips it lower the production cost and increase the supply of banana chips. In result, technology can shift the supplied curve rightward or leftward. ❖ Government Involvement Government involvement just like subsidy, taxes, restriction and etc. can shift the supply curve rightward or leftward. Taxes can shift the supply curve to the left because of imposing taxes to a good that produce of the producers. Subsides can shift the supply curve to the right because once the government provide subsidy just like give money seller can supply more. And restriction can decrease the supply of goods which result to shift supply curve to the left. 24  ❖ Number of Sellers The number of seller can shift the demand curve rightward or leftward. If more sellers begin producing a good, the supply curve will shift rightward. If some sellers stop producing a good, the supply curve will shift leftward. ❖ Expectation of Future Price If the price of good is expected to increase in the future, producer or supplier may hold back some of the product today. So they will have more good to sell at the higher future price. In result, the current supply curve will shift leftward. For example: Producers of oil, If the producer of oil expect that the price oil will increase next month, some of oil producer will hold oil off the market this month to be able to sell it next month. And if they expect that the price of oil will decrease next month they will pump more oil this month than previously planned. Determinants/Shift Rightward Shift Leftward Shift factor Price of Resources Decrease in the price Increase in the price of of inputs needed in inputs needed in production production Technology Improvement in Use of less efficient production technology technology Government Increase in the price Decrease in the price of Involvement of Substitute goods Substitute goods and and fall in the price of rise in the price of complementary goods complementary goods Number of Sellers Increase number of Decrease in the number sellers of sellers Expectation of Future Expectation of a fall in Expectation of a rise in Price price soon price soon Shifters play a significant role in forming our economy. Getting what every shifter does and how assuming influences market interest, can assist us with better agreement and foresee the economy. Realizing this data benefits both the producer and consumer by telling them what could occur sooner rather than later. It helps shape their choices and decision on what to produce and buy or sell and purchase.25 A Change in Supply versus a Change in Quantity Supply ❖ A change in supply is a shift in the supply curve. ❖ A change in quantity supplied is a movement along the supply curve. Change in Supply Price S1 S2 Supply A change in supply (a shift in supply curve from S1 to S2) Quantity Supplied The change of supply is a change in supply curve of commodity due to change in determinants except the price of the commodity. Shift in supply curve may be represented of two types; ❖ Increase in Supply or Rightward/Outward Shift ❖ The decrease in Supply or Leftward/Inward Shift Increase in Supply Increase in supply is happening when the supply of commodity is more due to positive changes in determinants of supply while the price is constant. For Example, when the costs in production decrease, increase in subsidies, decrease in price of related goods, etc. that’s why it cause the supply curve to shift rightward. 26 Increase in supply means that the entire supply curve will shift to the right. Decrease in Supply Decrease in supply is happening when the supply of commodity is less due to negative/ unfavorable changes in determinants other than price. For Example, when the costs in production increase, decrease in subsidies, increase in price of related goods, increase in tax, etc. that’s why it cause the supply curve to shift leftward. Decrease in supply means that the entire supply curve will shift to the left. Change in Quantity Supplied Price S1 Supply B A change in quantity A supplied (a movement along the supply curve, S1) Quantity Supplied Change in quantity supply (Movement along a supply curve) is happening when there is a change in quantity supply of goods/product (increase/decrease) due to the changes of price while the determinant/shifters of supply remain constant. The change in quantity supply may be represented by two types; 27  ❖ Expansion in Supply Rightward/upward movement ❖ Contraction in Supply Leftward/downward movement Expansion supply Expansion Supply from the word expand it is happening when the quantity supplied of a good rises/increases due to rises in its price, while the other things remain constant. Contraction in Supply Contraction Supply is happening when the price of good falls which result to contract or decrease the quantity supply of the commodity while the other things remain constant. 28  Chapter Putting Demand and Supply Together 3 Learning Objectives: Define the Equilibrium. Understand how the Demand and Supply work. Understand why there’s a surplus and shortage. Learn the basic changes in supply and demand, changes in both supply and demand. In this Chapter we are going to put demand and supply together and discuss the market. The purpose of this chapter is to give and gain more knowledge and understanding about how price are determined. Demand and Supply at work For example of how the demand and supply work. Let say that the Freindy’s Nutri Chips produce 1000 pieces of their product Taro nutri chips for only one buyer that’s why they do an auction and let say that the supply curve is vertical. ❖ Let say that at the price of 9 pesos per piece of Taro nutri chips the buyers are willing to buy 250 pieces of chips which is lower than the quantity supplied that’s why Freindy’s Nutri Chips drop the price at 8 pesos. ❖ At price of 8 pesos the quantity demanded increase to 500 pieces but still the quantity supplied of the chips is greater than quantity demanded. 29  ❖ At the price of 7 pesos the quantity demanded increases to 750 pieces but the quantity supplied is greater than quantity demanded and the Freindy’s Nutri Chips decide to drop the price at 4 pesos. ❖ At 4 pesos at this 10 D S 9 𝑄𝑠 > 𝑄𝑑 time the quantity 8 𝑄𝑠 > 𝑄𝑑 demanded for the 7 𝑄𝑠 > 𝑄𝑑 product increase to 6 𝑄𝑑 = 𝑄𝑠 1500 pieces which E Price 5 S 𝑄𝑑 > 𝑄𝑠 is greater than the 𝑄𝑑 > 𝑄𝑠 4 quantity supplied of 3 the product that’s 2 why the business 1 increase the price 0 0 250 500 750 1000 1250 1500 at 5 pesos. Quantity Supplied ❖ At 5 pesos the quantity demanded drop to 1250 pieces which is still higher than the quantity supplied of the product and for one for more time the business increase the price at 6 pesos. ❖ At 6 pesos the quantity demanded is 1000 pieces of chips which is equal to the quantity supplied of chips 1000 pieces and this time the business stop the auction and the chips sold at 6 pesos per pieces. Equilibrium What is Equilibrium? Equilibrium means at “rest”. Equilibrium in a market is the price-quantity combination from which buyers or sellers do not tend to move away. Graphically equilibrium is the intersection point of the supply and demand curve. For example of Equilibrium, Let say Juan is going to the market to buy some groceries and Juan want to buy a 10kls of Taro at a price of 30 pesos per kilo 30 but Juan ask for the seller if there is any discount for only 25 pesos per kilo and the seller replied final price for 28 pesos per kilo. As you can see the price of the Taro was fix at 28 pesos where Juan and the seller agreed. That’s what we call equilibrium where the buyer and seller meet. Price Supply Equilibrium Demand Quantity Why Equilibrium important? Equilibrium is important to create both a balance market and an efficient market. If a market is at its equilibrium price and quantity, then it has no reason to move away from that point, because it’s balancing the quantity supplied and quantity demanded. The Language of supply and demand ❖ If the quantity supplied is greater than the quantity demanded, a surplus, or excess supply, exists. ❖ If the quantity demanded is greater than the quantity supplied, a shortage, or excess demand, exists. ❖ The price at which the quantity demanded equals the quantity supplied is the equilibrium price, or market clearing price. 31  ❖ The quantity that corresponds to the equilibrium price is the equilibrium quantity. ❖ Any price at which quantity demanded is not equal to quantity supplied is a disequilibrium price. ❖ A market that exhibits either a surplus or a shortage is said to be in disequilibrium. ❖ A market in which the quantity demanded is equals the quantity supplied is said to be in equilibrium. Supply 15 Surplus Price 10 E Shortage 5 Demand 50 100 150 Quantity Moving to Equilibrium As you can see on the example of how the demand and supply work it show that the equilibrium moves when there is a surplus and shortage exist. When the Surplus exist the Freindy’s Nutri Chips business lower their price, and when the shortage exist the business higher their prices. Why Does price fall when there is a surplus? The businesses lower/falls their price for the product when there is a surplus because the demand for the product is greater than the supply of the business for the product. As you can see in the chart above the supply is only 150 32 pieces at the price of 15 pesos the surplus exist when is the buyer is willing to buy a 50 pieces at the price of 15 pesos which is lower than the supplied that’s why the business lower their price to meet the equilibrium. Why does price rises when there is a shortage? The businesses increase/rise their price for the product when there is a shortage because the demand for the product is less than the supply of the business for the product. Again in the chart above the supply is 50 pieces, the business lower their price at 5 pesos the buyer willing to demand 150 pieces which is greater than the supply, that’s why the business increase their price at 10 pesos that result to the equal demanded and quantity supplied. A summary of a market (Supply and Demand) A market is composed of both supply and demand just like what is show in the graph below. Also the graph shows the factors that affect supply and demand and therefore indirectly affect the equilibrium price and quantity of a good. Market Demand Price Supply Quantity Income Number Price of Technology of Buyers resources Preferences Expectation of Government Number Future Price involvement of sellers Price of related Expectation of goods Future Price 33 The Connection between Equilibrium and Predictions Equilibrium and Disequilibrium is a real world state in the market setting. If the quantity demanded and quantity supplied is equal the market is in equilibrium and if the quantity demanded is greater or less than quantity supplied the market is in disequilibrium and that’s when the shortage and surplus exist in the market. The equilibrium and disequilibrium are mental construct as a mental contract the equilibrium represent balance/no tendency to move while the disequilibrium represent imbalance/has tendency to move. The price will move up when there is a shortage and price move down when there is a surplus. In other words the disequilibrium as a mental construct means something is going to happen that’s why equilibrium and disequilibrium use to foreshadow what is about to happen or what we call a predictions. What Can Change Equilibrium Price and Quantity? Equilibrium Price and Quantity Effects of Supply Curve Shifts and Demand Curve Shifts. The Diagram below shows the effects on equilibrium price and quantity of a change in demand, a change in supply, or change in both. ❖ A bar over a letter means constant (thus, S means that supply is constant); ❖ A downward-pointing arrow indicates a fall; ❖ An upward-pointing arrow indicates a rise. ❖ A rise (fall) in demand is the same as rightward (leftward) shift in the demand curve. A rise (fall) in supply is the same as a rightward (leftward) shift in the supply curve. 34 Four Basic Changes in Supply and Demand 𝑆1 D  𝑆̅ = P  Q  𝑃2 Price 𝑃1 Demand go up, supply remain constant = Price increase, 𝐷2 Quantity increase 𝐷1 10 15 Quantity 𝑆1 D  𝑆̅ = P  Q  Price 𝑃1 Demand go down, supply 𝑃2 remain constant = Price Decrease, Quantity Decrease 𝐷2 𝐷1 5 10 Quantity 𝑆1 𝑆2 ̅=PQ S𝐷 Price 𝑃1 𝑃2 Supply go up, Demand remain constant = Price 𝐷1 Decrease, Quantity Increase 10 15 Quantity 35  𝑆2 𝑆1 ̅=PQ S𝐷 𝑃2 Price 𝑃1 Supply Decrease, Demand remain constant = Price Increase, Quantity Decrease 𝐷1 5 10 Quantity Changes in Both Supply and Demand D  = S  = P  𝑄̅ 𝑆2 𝑆1 𝑃2 Demand Increase same Price amount that Supply Decrease, 𝑃1 = Price Increase, Quantity remain constant 𝐷2 𝐷1 10 Quantity 𝑆1 D  = S  = P  𝑄̅ 𝑃2 𝑆2 Price 𝑃1 Demand Decrease same amount that Supply Increase, 𝐷2 𝐷1 = Price Decrease, Quantity remain constant 10 Quantity 36  𝑆2 𝑆1 D>S=PQ 𝑃2 Demand Increase by a greater Price amount than Supply 𝑃1 Decrease, = Price Increase, Quantity Increase 𝐷1 𝐷2 10 15 Quantity 𝑆2 𝑆1 D