Chapter 2 Theory of Demand and Supply Part 2 PDF

Chapter 2. Theory of Demand and Supply Econ – Introduction to Economics (Econ 2012) Dr Seyoum Yunkura Hameso 1 Outline Theory of supply Supply schedule, supply curve and supply function Determinants of supply Elasticity of supp...

Chapter 2. Theory of Demand and Supply Econ – Introduction to Economics (Econ 2012) Dr Seyoum Yunkura Hameso 1 Outline Theory of supply Supply schedule, supply curve and supply function Determinants of supply Elasticity of supply Market equilibrium 2 Learning outcomes After covering this chapter, you will be able to: - explain the supply side of a market and the determinants of supply; - understand how the market reaches equilibrium condition, and the possible factors that could cause a change in equilibrium; and - explain the elasticity of demand and supply. 3 Theory of supply … 4 Determinants of supply Apart from the change in price which causes a change in quantity demanded, the supply of a particular product is determined by: i) price of inputs ( cost of inputs) ii) technology iii) prices of related goods iv) sellers’ expectation of price of the product v) taxes & subsidies vi) number of sellers in the market vii) weather, etc. 5 Change in quantity supplied and change in supply A higher price causes higher quantity supplied, and a move along the SS curve. A change in determinants of SS other than price causes an increase in SS, or a shift of the entire supply curve, from SA to SB. 6  Shift of supply Versus movement along a supply curve Change in price of a good or service leads to Change in quantity supplied (Movement along the curve). Change in costs, input prices, technology, or prices of related goods and services leads to Change in supply (Shift of curve). 7 Shifts in the Supply Curve: What causes them? Price of Bread Supply curve, S3 Supply curve, S1 Supply curve, S2 Decrease in supply Increase in supply Quantity of Bread 0 8 Elasticity of supply It is the degree of responsiveness of the supply to change in price. It may be defined as the percentage change in quantity supplied divided by the percentage change in price. As the case with price elasticity of demand, we can measure the price elasticity of supply using point and arc elasticity methods. However, a simple and most commonly used method is point method. The point price elasticity of supply can be calculated as the ratio of proportionate change in quantity supplied of a commodity to a given proportionate change in its price. Thus, the formula for measuring price elasticity of supply is: 9 Elasticity of supply … 10 Market equilibrium Market equilibrium occurs when market demand equals market supply. Numerical example: Given market demand: Qd= 100-2P, and market supply: P =( Qs /2) + 10 a) Calculate the market equilibrium price and quantity b) Determine, whether there is surplus or shortage at P= 25 and P= 35. 11 Effects of shift in demand and supply on equilibrium i) when demand changes and supply remains constant Factors such as changes in income, tastes, and prices of related goods will lead to a change in demand. The figure below shows the effects of a change in demand and the resultant equilibrium price and quantity. DD is the demand curve and SS is the supply curve. Given demand and supply the equilibrium price and quantity are stable. However, when these market forces change what will happen to the equilibrium price and quantity? Changes in demand and supply bring about changes in the equilibrium price level and the equilibrium quantity. 12 Effects of shift in DD and SS on equilibrium ii. When supply changes and demand remains constant Changes in supply are brought by changes in technical knowledge and factor prices. The following graph explains the effects of changes in supply. 13 How an increase in demand affects the equilibrium Price of Ice-Cream 1. Hot weather increases the Cone demand for ice cream... Supply $2.50 New equilibrium 2.00 2.... Resulting in a higher Initial price... equilibrium D D 0 7 10 Quantity of Ice-Cream Cones 3... and a higher quantity sold 14  How an increase in demand affects the equilibrium Price of Ice-Cream 1. An increase in the price of Cone sugar reduces the supply of ice-cream... S2 S1 $2.50 New equilibrium 2.00 Initial equilibrium 2.... resulting in a higher price of ice cream... Demand 0 4 7 Quantity of 3.... and a lower Ice-Cream Cones quantity sold. 15 Thank you 16