Demand and Supply Part II Lecture Presentation PDF

3 DEMAND AND SUPPLY Part II Chapter Outline (A) Markets and Prices (B) Demand (C) Supply (D) Market Equilibrium (E) Predicting Changes in Price and Quantity (B) Demand Movement Along the Demand Curve When the price of the good changes and other things remain the same, the quantity deman...

3 DEMAND AND SUPPLY Part II Chapter Outline (A) Markets and Prices (B) Demand (C) Supply (D) Market Equilibrium (E) Predicting Changes in Price and Quantity (B) Demand Movement Along the Demand Curve When the price of the good changes and other things remain the same, the quantity demanded changes and there is a movement along the demand curve. (B) Demand A Shift of the Demand Curve If the price remains the same but one of the other influences on buyers’ plans changes, demand changes and the demand curve shifts. (B) Demand Six main factors that change demand (demand shifters) are: 1- Income 2- Prices of related goods 3- Expected future price 4- Expected future income and credit 5- Population 6- Preference Now let's see the effects of change in each of those factors on demand. (B) Demand 1- Income A normal good is one for which demand increases as income increases. An inferior good is a good for which demand decreases as income increases. When income increases, the demand for normal goods increases, whereas the demand for inferior goods decreases. Examples: 1- Public Bus versus Taxi 2- High-quality beef versus fast food burgers (B) Demand 2- Prices of Related Goods A substitute is a good that can be used in place of another good. Example: Tea and coffee When the price of tea rises, the demand for coffee increases. A complement is a good that is used in conjunction with another good. Example: Sugar and Tea When the price of sugar rises, the demand for tea decreases. (B) Demand 3- Expected Future Prices If the price of a good is expected to rise in the future, current demand for the good increases and the demand curve shifts rightward. Example: demand before the holy month of Ramadan 4- Expected Future Income and Credit When income is expected to increase in the future or when credit is easy to obtain, the demand might increase now. (B) Demand 5- Population The larger the population, the greater is the demand for all goods. 6- Preferences People with the same income have different demands if they have different preferences. (B) Demand Example: Change in Demand (Shift) An increase in income increases the demand for energy bars and shifts the demand curve rightward. (C) Supply If a firm supplies a good or service, then the firm 1. Has the resources and the technology to produce it, 2. Can profit from producing it, and 3. Has made a definite plan to produce and sell it. Resources and technology determine what it is possible to produce. Supply reflects a decision about which technologically feasible items to produce. The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. (C) Supply The selling decision is affected by many factors such as: 1- Price of the good 2- The prices of factors of production 3- The prices of related goods produced 4- Expected future prices 5- The number of suppliers 6- Technology 7- State of nature But the price of the good remains the most important factor that affects the selling decision. (C) Supply The Law of Supply It states that: Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. Producers are willing to supply a good only if they can at least cover their marginal cost of production, so that to achieve profit. (C) Supply The law of supply can be illustrated by the supply curve and supply schedule. Supply Curve and Supply Schedule The term supply refers to the entire relationship between the price of the good and quantity supplied of the good. A supply curve shows the relationship between the quantity supplied of a good and its price, when all other influences on producers’ planned sales remain the same. (C) Supply Example: Supply Schedule and Supply Curve The supply curve is upward sloping since a rise in the price, other things remaining the same, brings an increase in the quantity supplied. (C) Supply The supply curve is also a minimum-supply-price curve. As the quantity produced increases, marginal cost increases, so the lowest price at which someone is willing to sell an additional unit rises. This lowest price is marginal cost. Think: What will happen if one of the influences other than the price of the good changes? Here, we should differentiate between movement along the same supply curve and shift in the supply curve. (C) Supply Movement Along the Supply Curve When the price of the good changes and other things remain the same, the quantity supplied changes and there is a movement along the supply curve. (C) Supply A Shift of the Supply Curve If the price remains the same but one of the other influences on sellers’ plans changes, supply changes and the supply curve shifts. (C) Supply Six main factors that change supply (supply shifters) are: 1- Prices of factors of production 2- Prices of related goods produced 3- Expected future prices 4- Number of suppliers 5- Technology 6- State of nature Now let's see the effects of change in each of those factors on Supply. (C) Supply 1- Prices of factors of production If the price of a factor of production rises, the minimum price that a supplier is willing to accept rises too, so supply will decrease and shift to the left. Example: A rise in wages, other things remaining the same, will decrease supply. 2- Prices of related goods produced A substitute in production for a good is another good that can be produced using the same resources. The supply of a good increases if the price of a substitute in production falls. (C) Supply Goods are complements in production if they must be produced together. The supply of a good increases if the price of a complement in production rises. 3- Expected future prices If the price of a good is expected to rise in the future, supply of the good today decreases. 4- Number of suppliers The larger the number of suppliers of a good, the greater is the supply of the good. (C) Supply 5- Technology Advances in technology create new products and lower the cost of producing existing products, and thus increases supply. 6- State of nature A natural disaster decreases supply and shifts the supply curve leftward. Example: The effect of weather on supply of agricultural products (D) Market Equilibrium Equilibrium is a situation in which opposing forces balance each other. Market equilibrium occurs when the price balances the plans of buyers and sellers. That is: Quantity Demanded = Quantity Supplied (D) Market Equilibrium Example: The market equilibrium price is the price at which quantity demanded equals quantity supplied. Price Quantity Quantity State of (dollars per Demanded Supplied the Market bar) (millions of (millions of bars) bars) 0.5 22 0 Shortage 1 15 6 Shortage 1.5 10 10 Equilibrium 2 7 13 Surplus 2.5 5 15 Surplus (D) Market Equilibrium Price as a Regulator Price regulates buying and selling plans in the market. (D) Market Equilibrium Price adjustments At prices above the equilibrium price, a surplus forces the price down (price falls). At prices below the equilibrium price, a shortage forces the price up (price rises). At the equilibrium price, the price doesn’t change until an event changes demand or supply. (E) Predicting Changes in Price and Quantity A change in market equilibrium can result from a change in demand, supply, or both at the same time. 1- Change in Demand An Increase in Demand When demand increases the demand curve shifts rightward. At the original price, there is now a shortage. The price rises, and the quantity supplied increases along demand curve. If demand decreases, the opposite will take place. (E) Predicting Changes in Price and Quantity Conclusion: When demand increases: price and quantity increase When demand decreases: price and quantity decrease 2- Change in Supply An Increase in Supply When supply increases the supply curve shifts rightward. At the original price, there is now a surplus. The price falls, and the quantity demanded increases along demand curve. If supply decreases, the opposite will take place. © 2016 Pearson Education (E) Predicting Changes in Price and Quantity Conclusion: When supply increases: price decreases and quantity increases When supply decreases: price increases and quantity decreases 3- Change in both Demand and Supply A change in both demand and supply will shift both curves. Here, the final effect on equilibrium price and quantity will depend largely on the size of the change in each of demand and supply. © 2016 Pearson Education (E) Predicting Changes in Price and Quantity Notice that: A change in both demand and supply in the same direction will result in the same change on equilibrium quantity, but the change in equilibrium price will be uncertain. A change in both demand and supply in opposite directions will result in the same change on equilibrium price, but the change in equilibrium quantity will be uncertain. © 2016 Pearson Education (E) Predicting Changes in Price and Quantity Example: Assume that market demand increased, whereas market supply decrease. How will equilibrium price and quantity change in this case? Demand increased: P Q Supply decreased: P Q Here, the change in equilibrium quantity is uncertain with possible cases: 1-Increase in Demand > Decrease in Supply: Q 2-Increase in Demand < Decrease in Supply: Q 3-Increase in Demand = Decrease in Supply: Q is unchanged © 2016 Pearson Education (E) Predicting Changes in Price and Quantity In the following graph, the change in equilibrium quantity is uncertain. © 2016 Pearson Education