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1.1 Demand and Supply

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Ruru (Juan Ru) Hoong

on 21 October 2014

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Transcript of 1.1 Demand and Supply

1.1 Demand and Supply
Market Equilibrium
Equilibrium: state of rest, self-perpetuating in the absence of any outside disturbance
Quantity demanded = quantity supplied
No tendency for the price to change
Market clearing/ market price
Equilibrium can be changed by non-price determinants of supply and demand
Price mechanism helps allocates scarce resources via demand and supply: responses to change in price
Demand
the quantity of a product that consumers are willing and able to buy at a given price and a given period of time.
Quantitative Aspects
The Law of Demand
Negative causal/ inversely proportional relationship between price and quantity demanded
Usually convex to origin, but straight line used for simplification
'When the price of a product falls, the quantity demanded increases, ceteris paribus'
Change in price depicted by movement along curve
P1
P2
Q1
Q2
price
quantity
Demand for Good X
Why?
1. Income effect: Change in 'real income'
(reflects the amount their incomes will buy)
If price increases, real income decreases so they are less likely to buy the good
If price decreases, real income increases so they are more likely to buy the good

2. Substitution effect:
If price increases, consumers will substitute Good X with cheaper goods
If price decreases, consumers will switch from other substitute goods to Good X

The Non-Price Determinants of Demand
*Exceptions: Ostentatious consumption (Veblen), speculative demand, theoretical Giffen goods
illustrated by a shift of the demand curve (as opposed to movement along the curve).
Income
P1
Q1
Q2
price
quantity demanded
Normal Goods
P1
Q2
Q1
price
quantity demanded
Inferior Goods
As income increases, demand increases as consumers have more money to buy
As income increases, demand decreases as consumers have more money to buy better goods
Demand eventually = 0 past a certain income
The Price of Other Goods:
P1
Q1
Q2
price
quantity demanded
Substitutes Y:
P1
Q2
Q1
price
quantity demanded
As price of substitute Y increases, increase in demand for Good X as consumers buy more X
-ve relationship
Demand for Good X
Complements Z:
Demand for Good X
As price of complement Z increases, decrease in demand for Good X as consumers by less Z & X
+ve relationship
Income Distribution
Different consumer groups consume different goods
Tastes/ Preferences
Trends
Media
Marketing can alter tastes
Seasonal Changes
Population Structure
Government Policies
Mandatory goods
Taxes on incomes
Population increases, demand increases
Age/gender proportion can affect demand for particular goods
Supply
the quantity of a product that producers are willing and able to supply at a given price and a given period of time.
The Law of Supply
Positive/ directly proportional relationship between price and quantity supplied
'When the price of a product rises, the quantity supplied increases, ceteris paribus'
More potential profits, existing producers increase output and more producers join market
Change in price depicted by movement along curve
P1
P2
Q1
Q2
price
quantity supplied
Supply for Good X
Why?
1. Profit:
As price goes up, there is more profit to be made
Incentive for producer to produce more

2. Cost of factors of production:
As production increases, more factors of production needed, so the costs rise
Producers have to put up the price

The Non-Price Determinants of Supply
illustrated by a shift of the supply curve (as opposed to movement along the curve).
Cost of Factors of Production
As costs of materials/ wages increases, supply decreases
Price of Other Products Producer Can Make :
Producer decides there is more/less profit; attracted by higher profits and changes production
*minimal change in production facilities required
State of Technology
Improvements in tech: increased supply
Decrease in technology (eg. hurricanes, wars): decreased supply
Expectations
Future prices of product
If producer expects price to go up, may hold back supply for later or produce more in preparation
If market research suggests prices will fall, producers will reduce supply
Seasonal Changes
Government Intervention
Indirect taxes
Shifts supply curve upwards by amount of tax, higher price
GST: add to price
Subsidies
Shifts supply curve downwards by amount of subsidy, lower price
Payments made to firms to reduce costs
P1
Q1
Q2
price
quantity supplied
Supply for Good X
Increase in Cost
Decrease in Cost
As costs of materials/ wages decreases, supply increases
P1
Q1
Q2
price
quantity supplied
Supply for Good X
May affect availability of product (eg. mango season)
P1
Q1
Q2
price
quantity supplied
Supply for Good X
P1
Q1
price
quantity supplied
Supply for Good X
Price rises for Good Y
Price falls for Good Y
Q2
Linear Demand Functions
Qd = a - bP
a = Qd when price = 0
(i.e. x-intercept)
(affected by non-price determinants of demand)

b = slope of the curve
A change in 'a' represents a shift in the curve, parallel to original curve
The greater 'b' is, the flatter it is
More responsive to change in price
price
quantity demanded
Linear Supply Functions
Qs = c + dP
c = Qs when price = 0
(i.e. x-intercept)
(affected by non-price determinants of supply)

d = slope of the curve
A change in 'c' represents a shift in the curve, parallel to original curve
The greater 'd' is, the flatter it is
More responsive to change in price
price
quantity supplied
negative slope illustrates the Law of Demand
positive slope illustrates the Law of Supply
price ($)
quantity (units)
excess supply
Demand
Supply
excess demand
equilibrium
Change in Market Forces
When there is a change in the non-price determinants of demand or supply, eg. income of consumers increase so there is an increase in demand
P1
Q1
Q2
price ($)
quantity (units)
Normal Goods
excess demand
P2
Demand curve shifts right
There is excess demand (shortage) as it is at disequilibrium
Prices rise as there is a shortage, so producers raise it to eliminate shortage
Signal to other producers that shortage has arisen and incentive to produce larger quantity and raise price to maximize profits
Signal to consumers that good is more expensive and incentive to buy less
Resources are reallocated using price mechanism/ rationing to apportion scarce resources (wants exceed the amount of available resources)
Invisible hand of the market
Fall in Qd: contraction & Rise in Qs, increase in price
D1
D2
S
Price Rationing: Used by the market mechanism to apportion resources that is freely determined by supply and demand

Invisible Hand: Organizes markets and ensures they arrive at equilibrium

Prices as signals: Ensure communication of information to decision makers.
Prices as incentives: Ensure that decision makers are motivated to respond to information.

Product Market: What will be produced.
Resource market: Factors of production (how it will be produced).
Consumer and Producer Surplus
price ($)
quantity (units)
D=MB
S=MC
equilibrium price
CS
PS
Consumer surplus is the extra benefit enjoyed by consumers in the market who pay less for a product than they were willing and able to pay for it.
Producer surplus is the extra benefit enjoyed by the producers in a market who sell their product for more than they were willing and able to sell it.
The community surplus is the sum of the consumer and producer surplus (maximized at equilibrium).
If producer sets it at price higher than equilibrium...
Consumer surplus falls
Producer surplus?
Price increases
Quantity decreases
price ($)
quantity (units)
D=MB
S=MC
equilibrium price
CS
PS
deadweight loss to society
P1
Q1
Allocative Efficiency
Allocative efficiency: one of the measures of economic efficiency referring to producing the combination of goods most wanted by society
Community surplus maximized
Competitive market equilibrium (D=S)
MB=MS (extra benefit to society = extra cost to producers)
Producing 'right quantities'
Achieved by competitive free markets
Consumer sovereignty: consumers also decide what gets made
Full transcript