Demand and Supply - PDF

Demand and Supply  Basis of Demand Goods and services have ready markets if they directly satisfy consumer wants, or help firms produce products that satisfy consumer wants.  Basis of Demand Demand Demand is the quantity of a good or service that customers are willing and able to purc...

Demand and Supply  Basis of Demand Goods and services have ready markets if they directly satisfy consumer wants, or help firms produce products that satisfy consumer wants.  Basis of Demand Demand Demand is the quantity of a good or service that customers are willing and able to purchase during a specified period under a given set of economic conditions. The time frame might be an hour, a day, a month, or a year. Conditions to be considered include the price of the good in question, prices and availability of related goods, expectations of price changes, consumer incomes, consumer tastes and preferences, advertising expenditures, and so on.  Basis of Demand Law of Demand According to the law of demand, the lower the price of a good, the larger the quantity consumers wish to purchase, all other things held constant.  Basis of Demand Two Basic Models of Individual Demand: 1. Direct Demand This model is appropriate for analyzing individual demand for goods and services that directly satisfy consumer desires. The value or worth of a good or service, its utility, is the prime determinant of direct demand. Individuals are viewed as attempting to maximize the total utility or satisfaction provided by the goods and services they acquire and consume.  Basis of Demand Two Basic Models of Individual Demand: 1. Direct Demand Product characteristics, individual preferences (tastes), and the ability to pay are all important determinants of direct demand.  Basis of Demand Two Basic Models of Individual Demand: 2. Derived Demand The demand for a product that is derived from the demand for the products they are used to provide. It is also called input demand. Key components in the determination of derived demand are the marginal benefits and marginal costs associated with using a given input or factor of production. In short, derived demand is related to the profitability of using a good or service.  Basis of Demand Two Basic Models of Individual Demand: 2. Derived Demand For example, the demands for steel, aluminum, and plastics are all derived demands, as are the demands for machine tools and labor. None of these producers' goods are demanded because of their direct value to consumers but because of the role they play in production.  Basis of Demand Two Basic Models of Individual Demand: For final consumption products (direct demand), utility maximization as described by the theory of consumer behavior explains the basis for direct demand. For inputs (derived demand) used in the production of other products, profit maximization provides the underlying rationale for derived demand. Because both demand models are based on the optimization concept, fundamental direct demand and derived demand relations are essentially the same.  Basis for Supply The profit motive determines the quantity of a good or service that producers are willing and able to sell during a given period.  Basis for Supply Supply The supply of a product in the market is the aggregate amount supplied by individual firms. The supply of products arises from their ability to enhance the firm's value maximization objective.  Basis for Supply Supply The amount of any good or service supplied will rise when the marginal benefit to producers, measured in terms of the value of output, is greater than the marginal cost of production. The amount of any good or service supplied will fall when the marginal benefit to producers is less than the marginal costs of production. “Thus, individual firms will expand or reduce the quantity supplied based on the expected impact on profits.”  Basis for Supply Factors that Influence Supply: 1. Price of the Product Higher prices increase the quantity of output producers want to bring to market. Higher prices allow firms to pay the higher production costs that are sometimes associated with expansions in output. Conversely, lower prices typically cause producers to reduce the quantity supplied. At the margin, lower prices can have the effect of making previous levels of production unprofitable.  Basis for Supply Factors that Influence Supply: 2. Prices of Related Goods and Services The substitution of one output for another can cause an inverse relation between the supply of one product and the price of a second product. Complementary production relationships result in a positive relation between supply and the price of a related product.  Basis for Supply Factors that Influence Supply: 3. Technology The current state of technology refers to the manner in which inputs are transformed into output. An improvement in the state of technology, including any product invention or process innovation that reduces production costs, increases the quantity and/or quality of products offered for sale at a given price.  Basis for Supply Factors that Influence Supply: 4. Changes in Input Prices An increase in input prices will raise costs and reduce the quantity that can be supplied profitably at a given market price. Alternatively, a decrease in input prices increases profitability and the quantity supplied at a given price.  Basis for Supply Factors that Influence Supply: 5. Weather Temperature, rainfall, and wind all influence the quantity that can be supplied. This is especially true when it comes to agricultural products.  Basis for Supply Market supply is the aggregate of individual firm supply, so it is ultimately determined by factors affecting firm supply. Managerial decision-making requires understanding both individual firm supply and market supply conditions.  Market Equilibrium When quantity demanded and quantity supplied are in perfect balance at a given price, the product market is said to be in equilibrium. Market Equilibrium Surplus is created when producers supply more of a product at a given price than buyers demand. Surplus describes a condition of excess supply. Shortage is created when buyers demand more of a product at a given price than producers are willing to supply. Shortage describes a condition of excess demand. Market Equilibrium Surplus Surplus describes an excess in the quantity supplied over the quantity demanded at a given market price. A surplus results in downward pressure on both market prices and industry output. Shortage Shortage describes an excess in the quantity demanded over the quantity supplied at a given market price. A shortage results in upward pressure on both market prices and industry output.  Market Equilibrium “Surplus and shortage describe situations of market disequilibrium because either will result in powerful market forces being exerted to change the prices and quantities offered in the market.”  Market Equilibrium Equilibrium / Market Equilibrium Neither surplus nor shortage will occur when a market is in equilibrium, because equilibrium is defined as a condition in which the quantities demanded and supplied are exactly in balance at the current market price. Market equilibrium describes a condition of perfect balance in the quantity demanded and the quantity supplied at a given price. In equilibrium, there is no tendency for change in either price or quantity. Comparative Statics Analysis Comparative Statics Analysis The role of factors influencing demand or supply is analyzed while holding all else equal.  Basis for Supply Comparative Statics: Changing Demand In comparative statics analysis, the role of factors influencing demand is often analyzed while holding supply conditions constant.  Basis for Supply Comparative Statics: Changing Demand  Basis for Supply Comparative Statics: Changing Supply The role of factors influencing supply can be analyzed by studying changes in supply while holding demand conditions constant.  Basis for Supply Comparative Statics: Changing Supply  Basis for Supply Comparative Statics: Changing Demand and Supply  Basis for Supply Comparing market equilibrium price and output levels before and after various hypothetical changes in demand and supply conditions has the potential to yield useful predictions of expected changes. A fundamental understanding of demand and supply concepts is essential to the successful operation of any economic organization. “Ask, and it will be given to you; seek, and you will find; knock, and it will be opened to you. Matthew 7:7 Thank you for Listening...