Lecture 03 Demand, Supply, Equilibrium Jan 2023 PDF

Business problem: What is the best price? Economics solution: Theory of Demand Lecture 3: Demand, Supply, Equilibrium If a firm wants to increase its profits, should it raise its prices, or should it lower them? Should it increase its output, or should it reduce it? Should it...

Business problem: What is the best price? Economics solution: Theory of Demand Lecture 3: Demand, Supply, Equilibrium If a firm wants to increase its profits, should it raise its prices, or should it lower them? Should it increase its output, or should it reduce it? Should it modify its product, or should it keep the product unchanged? Market mechanism  Learning Objectives The demand curve & its determinants The supply curve and its determinants Equilibrium price and output Causes of change in equilibrium price Graphical illustration of price changes  Law of Demand The law of demand states that keeping other things unchanged(Ceteris peribus), there is an inverse(opposite) relationship between price of a normal product and quantity demand of that product. Typically, when the price increases people buy less of that product and when the price declines more is demanded. The price is the key determinant of quantity (number of units) demanded (purchased).  The demand curve: the demand for potatoes (monthly)  Market demand for potatoes (monthly) E Point Price Market demand 100 (pence per kg) (tonnes 000s) A 20 700 D 80 B 40 500 Price (pence per kg) C 60 350 C D 80 200 60 E 100 100 B 40 A 20 Demand 0 0 100 200 300 400 500 600 700 800 Quantity (tonnes: 000s)  Demand Other determinants of demand (Non price determinants) Tastes and trends, preference( Taste changes) number and price of substitute goods number and price of complementary goods- cars and petrol, shoes and polish, bread and butter income expectations  Demand Movements along and shifts in the demand curve change in price  movement along D curve change in any other determinant of demand  shift in D curve increase in demand  rightward shift decrease in demand  leftward shift  An increase in demand Possible causes of a rise in demand Tastes shift towards this product Rise in price of substitute goods Fall in price of complementary goods Rise in income P Expectations of a rise in price An increase in demand is Price represented by a rightward shift in the demand curve D0 D1 O Q0 Q1 Quantity  What determines Market Demand? (Q1) What would happen to the demand for I-phones if everyone’s income increased? Price At the same price now more I- phones would be demanded Quantity of I-phones demanded  What determines Market Demand? (Q2) What would happen to the demand for I-phones if a fault was found with the product? Price At the same price now less I-phones would be demanded Quantity of I-phones demanded  What determines Market Demand? (Q3) What would happen to the demand for I-phones if Sony brought out a near identical product at half the price? Price At the same price now less I-phones would be demanded Quantity of I-phones demanded  Law of Supply The law of supply states that there is a positive relationship between price of a normal product and quantity supply of that product. Typically, when the price increases sellers tend to supply more of that product and when the price declines less is supplied. The price is the key determinant of quantity supplied.  The supply curve: the supply of potatoes (monthly)  Market supply of potatoes (monthly) 100 e Supply d P Q 80 a 20 100 Price (pence per kg) b 40 200 c c 60 350 60 d 80 530 e 100 700 b 40 a 20 0 0 100 200 300 400 500 600 700 800 Quantity (tonnes: 000s)  Supply Other determinants of supply costs of production- willingness and ability,lower profit profitability of alternative products (substitutes in supply) price rise or cost of production fall profitability of goods in joint supply crude oil nature and other ‘random shocks’ aims of producers revenue or profit maximization expectations of producers – Kandoodhoo mirus Movements along and shifts in the supply curve a change in supply a change in the quantity supplied  Shifts in the supply curve P S2 S0 S1 Decrease Increase O Q  Price and quantity Determination Equilibrium price and output- market clears response to shortages and surpluses significance of ‘equilibrium’ Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium shortage price rises equilibrium: where D = S  Equilibrium price and output: The Market Demand and Supply of Potatoes (Monthly)  The determination of market equilibrium (potatoes: monthly) E e 100 Supply D d 80 Price (pence per kg) Cc 60 Equilibrium 40 b B a A 20 Demand 0 0 100 200 300 350 400 500 600 700 800 Quantity (tonnes: 000s)  The determination of market equilibrium (potatoes: monthly) E e 100 Supply D d 80 Price (pence per kg) Cc 60 40 b SHORTAGE B (300 000) a A 20 Demand 0 0 100 200 300 400 500 600 700 800 Quantity (tonnes: 000s)  The determination of market equilibrium (potatoes: monthly) E e 100 Supply 80 D SURPLUS d Price (pence per kg) (330 000) Cc 60 b B 40 a A 20 Demand 0 0 100 200 300 400 500 600 700 800 Quantity (tonnes: 000s)  The determination of market equilibrium (potatoes: monthly) E e 100 Supply D d 80 Price (pence per kg) 60 b B 40 a A 20 Demand 0 0 100 200 300 Qe 400 500 600 700 800 Quantity (tonnes: 000s)  Change of Price In a competitive market, the price of a product will change because of changes in determinants of demand and supply. Changes in any determinants of demand or supply will then cause the respective curves to shift, demand, supply or both, thereby a change in equilibrium price of the product. See diagrams below.  Effect of a shift in the demand curve P S Consumer taste and preferences Advertising Income expectations i New equilibrium Pe2 at point i g h Pe1 D2 D1 O Qe1 Qe2 Q  Effect of a shift in the supply curve P S2 Aims of supplier Cost of production Expectations S1 k Pe3 j g Pe1 New equilibrium at point k D O Qe3 Qe1 Q  Explanation (recap) In a competitive market, the price of a product is determined by the intersection of demand and supply. Changes in determinants of demand and supply cause shifts in demand and supply curves and thereby equilibrium price. Price changes have important implications for businesses, consumers and governments all around the world. Next Lecture Elasticity & Pricing Strategy  Key Terms: Learning outcome The law of demand Determinants of demand The law of supply Determinants of supply How price of a product is determined What are the causes of price changes Illustrate change in price of a product  UBEE (BIM) Next Lecture Elasticity & Pricing Strategy