ECN 201 Lecture 3: Supply and Demand PDF

ECN 201 LECTURE # 3 The Market Forces Of Supply & Demand RECAP ▣ What is an Economic Agent, Utility ▣ What is Law of Diminishing Marginal Utility & Law of Diminishing Marginal Returns ▣ What are the different types of Economies? ▣ What are the different schools of thought? What are Econom...

ECN 201 LECTURE # 3 The Market Forces Of Supply & Demand RECAP ▣ What is an Economic Agent, Utility ▣ What is Law of Diminishing Marginal Utility & Law of Diminishing Marginal Returns ▣ What are the different types of Economies? ▣ What are the different schools of thought? What are Economic Models Circular flow of Income Factors of Production Production Possibility Frontier/Curve (PPC/PPF) Intro ▣ When there is flood outside Dhaka the price of Vegetables in the market rise ▣ During Summer the price of airline tickets rise. ▣ When there is War in Middle East/Ukraine, it increases the price of Oil in the world market WHAT DOES ALL THESE EVENTS HAVE IN COMMON? ▣ Supply and demand are the two words economists use most often ▣ Supply and demand are the forces that make market economies work. They determine the quantity of each good produced and the price at which it is sold. ▣ If you want to know how any event or policy will affect the economy, you must think first about how it will affect supply and demand. This chapter introduces the theory of supply and demand. It shows how supply and demand determine prices in a market economy and how prices, in turn, allocate the economy’s scarce resources. What Is a Market? ▣ A market is a group of buyers and sellers of a particular good or service. The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product. ▣ Markets take many forms. Some markets are highly organized, such as the markets for many agricultural commodities. In these markets, buyers and sellers meet at a specific time and place, where auction takes place. ▣ More often, markets are less organized. For example, consider the market for ice cream in a particular town. Buyers of ice cream do not meet together at any one time. The sellers of ice cream are in different locations and offer somewhat different products. Market and Competition Market is the transaction between two parties where goods or services are transferred from seller to buyer in exchange of money. We can classify different markets depending on the degree of competition. To determine structure of any particular market, we begin by asking 1. How many buyers and sellers are there in the market? 2. Is each seller offering a standardized product, more or less indistinguishable from that offered by other sellers -Or are there significant differences between the products of different firms? 3. Are there any barriers to entry or exit, or can outsiders easily leave this market? enter and Answers to these questions help us to classify two types of competition A) Perfectly Competitive Market A market that has perfect competition is called perfectly competitive market. B) Imperfect Market There can be three types of markets based on the degree of imperfection. Monopoly Oligopoly Monopolistic Demand The Demand Curve: The Relationship between Price & Quantity Demanded The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. Many things determine the quantity demanded of any good, but in our analysis of how markets work, one determinant plays a central role—the price of the good, from which we have the Law of Demand. Next slide shows Catherine’s Demand schedule of ice-creams. Market Demand versus Individual Demand The demand curve in previous slide shows an individual’s demand for a product. To analyze how markets work, we need to determine the market demand, the sum of all the individual demands for a particular good or service. The next slide shows the demand schedules for ice cream of the two individuals in this market—Catherine and Nicholas. Changes in Demand There can be two ways it can happen: ▣Movement along the curve If there is change in price of a product then there will be a movement along its demand curve and supply curve ▣ Shift of the curve If there is a change in any factor/variable other than price (such as: income, taste, price of other goods like substitute or complementary good etc.) then there will be a shift in the curve. For example, suppose the American Medical Association discovered that people who regularly eat ice cream live longer, healthier lives. The discovery would raise the demand for ice cream. At any given price, buyers would now want to purchase a larger quantity of ice cream, and the demand curve for ice cream would shift. There are many variables that can shift the demand curve. Here are the most important ones: ▣Income What would happen to your demand for ice cream if you lost your job one summer? Most likely, it would fall. A lower income means that you have less to spend in total, so you would have to spend less on some—and probably most—goods. ◼ If the demand for a good falls when income falls, the good is called a normal good. ◼ Not all goods are normal goods. If the demand for a good rises when income falls, the good is called an inferior good. An example of an inferior good might be bus rides. As your income falls, you are less likely to buy a car or take a cab and more likely to ride a bus. ▣ Prices of Related Goods: Suppose that the price of frozen yogurt falls. The law of demand says that you will buy more frozen yogurt. ◼ At the same time, you will probably buy less ice cream. Because ice cream and frozen yogurt are both cold, sweet, creamy desserts, they satisfy similar desires. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. ◼ Now suppose that the price of hot fudge falls. According to the law of demand, you will buy more hot fudge. Yet in this case, you will buy more ice cream as well because ice cream and hot fudge are often used together. When a fall in the price of one good raises the demand for another good, the two goods are called complements. Complements are often pairs of goods that are used together, such as gasoline and automobiles, computers and software, and peanut butter and jelly. ▣ Tastes: The most obvious determinant of your demand is your tastes. If you like ice cream, you buy more of it. Economists normally do not try to explain people’s tastes because tastes are based on historical and psychological forces that are beyond the realm of economics. Economists do, however, examine what happens when tastes change. ▣ Expectations: Your expectations about the future may affect your demand for a good or service today. If you expect to earn a higher income next month, you may choose to save less now and spend more of your current income buying ice cream. If you expect the price of ice cream to fall tomorrow, you may be less willing to buy an ice-cream cone at today’s price. Case Study: Two ways to reduce Smoking Public policymakers often want to reduce the amount that people smoke because of smoking’s adverse health effects. There are two ways that policy can attempt to achieve this goal. One way to reduce smoking is to shift the demand curve for cigarettes and other tobacco products. Public service announcements, mandatory health warnings on cigarette packages, and the prohibition of cigarette advertising on television are all policies aimed at reducing the quantity of cigarettes demanded at any given price. Alternatively, policymakers can try to raise the price of cigarettes. If the government taxes the manufacture of cigarettes, for example, cigarette companies pass much of this tax on to consumers in the form of higher prices. A higher price encourages smokers to reduce the numbers of cigarettes they smoke. In this case, the reduced amount of smoking does not represent a shift in the demand curve. Instead, it represents a movement along the same demand curve to a point with a higher price and lower quantity Supply The Supply Curve: The Relationship between Price and Quantity Supplied: The quantity supplied of any good or service is the amount that sellers are willing and able to sell. There are many determinants of quantity supplied, but once again, price plays a special role in our analysis. When the price of ice cream is high, selling ice cream is profitable, and so the quantity supplied is large. At a low price, some sellers may even choose to shut down, and their quantity supplied falls to zero. This relationship between price and quantity supplied is called the law of supply: Other things equal, when the price of a good rises, the quantity supplied of the good also rises, and when the price falls, the quantity supplied falls as well. Market Supply versus Individual Supply: Just as market demand is the sum of the demands of all buyers, market supply is the sum of the supplies of all sellers. The table in next slideshows the supply schedules for the two ice-cream producers in the market—Ben and Jerry. Changes in Supply Movement along the curve If there is change in price of a product then there will be a movement along its demand curve and supply curve Shift of the curve If there is a change in any factor/variable other than price (such as: income, taste, price of other goods like substitute or complementary good etc.) then there will be a shift in the curve. Shifts in the Supply Curve Because the market supply curve holds other things constant, the curve shifts when one of the factors changes. There are many variables that can shift the supply curve. Here are some of the most important. Input Prices: To produce their output of ice cream, sellers use various inputs: cream, sugar, flavoring, ice-cream machines, the buildings in which the ice cream is made, and the labor of workers to mix the ingredients and operate the machines. When the price of one or more of these inputs rises, producing ice cream is less profitable, and firms supply less ice cream. If input prices rise substantially, a firm might shut down and supply no ice cream at all. Thus, the supply of a good is negatively related to the price of the inputs used to make the good. ▣ Technology: The technology for turning inputs into ice cream is another determinant of supply. The invention of the mechanized ice-cream machine, for example, reduced the amount of labor necessary to make ice cream. By reducing firms’ costs, the advance in technology raised the supply of ice cream. ▣ Expectations: The amount of ice cream a firm supplies today may depend on its expectations about the future. For example, if a firm expects the price of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today. Some Concepts clarified ▣ Shifts in Curves versus Movements along Curves ◼ ◼ ◼ ◼ A shift in the supply curve is called a change in supply. A movement along a fixed supply curve is called a change in quantity supplied. A shift in the demand curve is called a change in demand. A movement along a fixed demand curve is called a change in quantity demanded. Equilibrium Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. ▣Equilibrium Price ◼ The price that balances quantity supplied and quantity demanded. ◼ On a graph, it is the price at which the supply and demand curves intersect. ▣Equilibrium Quantity ◼ The quantity supplied and the quantity demanded at the equilibrium price. ◼ On a graph it is the quantity at which the supply and demand curves intersect. Figure below shows the market supply curve and market demand curve together. Notice that there is one point at which the supply and demand curves intersect. This point is called the market’s equilibrium. The price at this intersection is called the equilibrium price, and the quantity is called the equilibrium quantity. Markets are not always in Equilibrium: Moving to Equilibrium ▣ ▣ ▣ Why does the price fall when there is a surplus? Why does the price rise when there is a shortage? Mutually beneficial exchange drives the market towards equilibrium. 31 Example: A Change in Market Equilibrium Due to a Shift in Demand Notice that when hot weather increases the demand for ice cream and drives up the price, the quantity of ice cream that firms supply rises, even though the supply curve remains the same. In this case, economists say there has been an increase in “quantity supplied” but no change in “supply.” Example: A Change in Market Equilibrium Due to a Shift in Supply Example: Shifts in Both Supply and Demand Describe the following graph 35 Exercise What would happen to Demand and/or Supply in the following scenarios? ▣You win a lottery - (Demand for Cellphones) ▣There ▣There is Economic Growth (Market for Cell Phones) are “Hartals” in the economy (Market for Vegetables) THE END