4032006 demand and supply notes
TRANSCRIPT
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Price: The Role of Demand andSupply
Topic 2
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Law of Demand
2
The quantity purchased of a good or
service is inversely related to the
price, all other things being equal(ceteris paribus)
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The Law of Demand
Price changes leadto qty demandedchanging.......
Represented bymovements alongdemand curve.
Inverse relationship
between price andquantity demandedgives rise to adownward- sloping
demand curve.3
DD
Price
Quantity/wk
A
B3
2
5 15
negative slope
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Quantity Demanded versusDemand
4
Quantity demanded The quantities of a good or service that
people will purchase at aspecific priceover a given period of time
Demand
A schedule of the total quantities of agood or service that purchasers will buy
at different prices at a given time
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Demand
5
Individual demand The quantity of a good or service that an
individual or firm stands ready to buy atvarious prices at a given time
Market demand
The sum of the individual demands inthe marketplace
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Demand Schedule and DemandCurve
6
Demand schedule A table showing the various quantities
of a good or service that will bedemanded at various prices
Demand curve
A curve that indicates the number ofunits of a good or service thatconsumers will buy at various prices ata given time
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Demand Curve for Internet Time
7
$1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity (millions of hours)
PriceperHour
D
Table 4-1 provides the detail for
the demand curve presented here
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Changes in Quantity Demanded and inDemand
8
Change in quantity demanded Movement along the demand curve
that occurs because the price of theproduct has changed
Change in demand
A change in the amounts of the productthat would be purchased at the samegiven prices; a shift of the entiredemand curve
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Demand Curves for Internet Time
9 Quantity (millions of hours)
$1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
0 1 2 3 4 5 6 7 8 9 10 11 12 13
PriceperH
our
D
D2
D1
A shift fromD toD1 is an increase in
demand more will be purchased at
each price
A shift fromD toD2 is adecrease in demand less
will be purchased at each
price
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Determinants of Demand
10
Changes in incomeHigher incomes increase in demand
Lower incomes decrease in demand
Changes in tastes and preferences
Change in consumer expectations
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Determinants of Demand
11
Changes in the prices of other goods Substitutes Increase in the price
of substitutes increase in
demand Complements Increase in the
price of complements decrease
in demand
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Supply
12
Supply The total quantities of a good or service that sellers
stand ready to sell at different prices at a given time
Individual supply Quantities offered for sale at various prices at a given
time by an individual seller
Market supply
Sum of the individual supply schedules in themarketplace
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Supply
13
Supply schedule A table showing the various quantities
of a good or service that sellers willoffer at various prices at a given time
Supply curve
A line showing the number of units ofa good or service that will be offeredfor sale at different prices at a giventime
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Law of Supply
14
The quantity offered by sellers of a good or service isdirectly relatedto price, all things being equal
Why?
Producers are more willing to sell greater amounts of agood at a higher price , because this good has becomerelatively more profitable to produce, compared to othergds
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Changes in Quantity Supplied andin Supply
15
Change in the quantity supplied
Movement along the supply curve that occurs
because the price of the product has changed
Change in supply
A change in the amount of the product that would be
offered for sale at the same given price; a shift of the
entire supply curve
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Supply Curves for Internet Time
16 Quantity (millions of hours)
$1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
0 1 2 3 4 5 6 7 8 9 10 11 12 13
PriceperHour
SS2 S1
A shift from Sto S2
is a decrease in
demand a smaller
amount offered for
sale at each price A shift from Sto S1 isan increase in demand
a larger amount
offered for sale at each
price
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Determinants of Supply
17
Changes in the cost of resources
Increase in the cost of resources decrease in
supply Technology
Improvements increase in supply
Expectations of future prices(Shift to the right)
Prices of related products
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Expectations of Future Prices
18
If sellers expect price of the good to
fall in the future,
they will sell more nowbefore the
price actually falls!!
Supply increases today.....rightward shift
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Price of related goods
19
Related goods
(Supply side of the market)
Substitutes in production
Require the same resources
to produce
Complements in production
Jointly produced with
the same pool of resources
Example
Rubber bands
Rubber erasers
Example
Beef
Leather
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Price of related goods(substitutes in production)
20
Assume that the price of Rubber Erasers (RE) has increased.
What impact does this have on the supply of Rubber Bands
(RB) ?
Price
Quantity
SS
Supply of RE
Price
Quantity
Supply of RB
SS
SS
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Price of related goods(complements in production)
21
Assume that the price of beef has increased.
What impact does this have on the supply of leather ?
Price
QuantitySupply of Leather
SS
SS
Supply of Beef
Price
Quantity
SS
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Equilibrium Price
22
The price at which the quantity
demanded equals the quantity supplied
Market Equilibrium
A state whereby the forces ofmarket
demand and market supply exactly
balance each other and there is no
tendency for change
D d S l d M k t P i
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Demand, Supply, and Market Pricefor Internet Time
23 Quantity (millions of hours)
$1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
PriceperHour
SupplyDemand
EE
At a price of $1.21, 6 million
hours of Internet time will be
offered for sale and an equal
amount purchased
0 1 2 3 4 5 6 7 8 9 10 11 12 13
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24
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Surplus of Internet Time
25 Quantity (millions of hours)
$1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
0 1 2 3 4 5 6 7 8 9 10 11 12 13
PriceperHo
ur
SupplyDemand
E
Surplus
At a price of $1.30, 7.8
million hours will be
offered for sale but
consumers are only
willing to purchase 4.2
million hoursQs > Qd surplus of Internet
hoursRather than hold on to these
hours, sellers will offer to sell at
lower prices with the result that
more consumers enter themarket price moves toward
$1.20
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26
Shortage of Internet Time
Quantity (millions of hours)
$1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
0 1 2 3 4 5 6 7 8 9 10 11 12 13
PriceperHour
SupplyDemand
E
Shortage
At a price of $1.10, buyers
want to buy 8.5 million hours
but sellers are willing to
offer only 3.6 million hours
Qd > Q shortage
Some buyers will be willing to
pay more with the result that
the price will increase and
sellers will increase theamount they offer for sale
move toward $1.20
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Changes in EquilibriumPrice & Quantity
27
Once equilibrium is attained, there is notendency for change, unless demand, supplyor both market forces change.
Demand & supply change when there is achange in determinants of demand and/orsupply.
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Increase in Demand
28
Price
Quantity
SS
DD DD
E
E
P
P
Q Q
Increase inPe & Qe
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Decrease in Demand
29
Price
Quantity
SS
DD DD
P
P
QQ
E
EDecrease in
Pe & Qe
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Increase in Supply
30
Price
Quantity
SS
DD
SS
P
P
Q Q
E
E
Decrease in Pe,Increase in Qe
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Decrease in Supply
31
Price
Quantity
SS
DD
SS
P
P
Q Q
E
E Increase in Pe,Decrease in Qe
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Change In Both Demand & Supply
At The Same Time
32
the effect on only eitherP or Q can bedetermined straight away
the impact on the other variable cannot bedetermined ,
unless given more information
on the size of the relative shifts
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What happens when:
33
Demand and supply increase simultaneously?
The equilibrium qty will definitely increase,
but whether the equilibrium price
will increase or decrease depends onhow much demand shifts relative to supply
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Three Possible Situations:Three Possible Situations:
34
Price
Quantity
DD
DD SS
SS
P
P
Q Q
Demand increases more than supply does
E
E
Increase in Pe,Increase in Qe
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Three Possible Situations:Three Possible Situations:
35
Price
Quantity
DD
DDSS
SS
P
P
Q Q
Supply increases more than demand does
EE
Decrease in Pe,
Increase in Qe
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Three Possible Situations:Three Possible Situations:
36
Price
Quantity
DD
DD SS
SS
P
Q Q
Demand increases by the same amount
as supply
E ENo change in Pe,
Increase in Qe
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General Guidelines
37
An increase in demand relative tosupply higher price
A decrease in demand relative tosupply lower price
An increase in supply relative to
demand lower price A decrease in supply relative to
demand higher price
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Disequilibrium Due To
Government Intervention
The government maystep in to restrict the freeoperation of the marketand create disequilibrium
prices by imposing aPRICE CEILING orPRICE FLOOR
38
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Price Ceiling
39
A government-mandated maximum
price that can be charged for a good or a
service below the market equilibriumProducers cannot sell at a price higher
than the ceiling price
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Why Imposed Price Ceiling ?Why Imposed Price Ceiling ?
Prevent consumers from being overcharged!!!! E.g. rent controlPrice control on necessities eg rice, sugar,
oil, etc..
40
The Effects of a Price Ceiling on
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The Effects of a Price Ceiling onRental Housing
41
700
500
0 18,000 30,000 40,000
ShortageD
S
E
MonthlyPrice($)
Quantity (housing units)
The effect of the
price ceiling on
rental housing is to
cause a shortage andreduce housing
opportunities to
those families they
are intended to
accommodate
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How Are Consumers Affected By AHow Are Consumers Affected By A
Price Ceiling?Price Ceiling?
42
Since there is little incentive to maintain the quality ofrent-controlled housing, consumers may have to put upwith the deteriorating quality of such housing .
The amount bought and sold with a price ceilingimposed is less than that at market equilibrium.The shortage caused by the price ceiling forcesconsumers to spend more time searching for analternative.
Some people are willing to pay more to get some of thegood. These people may end up relying on politicalconnections andpaying coffee money.
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Why Imposed Price Floor???Why Imposed Price Floor???
43
To ensureproducers a higher andmore stable income eg. Price floors on
agricultural products, or min wage toensure workers a min standard of
living
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The Effects of a Price Floor on Wheat
44
3.00
2.00
0 75,000 100,000 115,000
Surplus
D
S
PriceperBushe
l($)
Quantity (bushels)
The impact of the price
floor is to cause a
surplus thegovernment must then
buy and store the
surplus that is created
by the price floor
PF
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Effects of Price FloorsEffects of Price Floors
45
Price floors create surpluses... govt intervention is needed
to prevent downward pressure on price
Govt often steps in to buy up the surplus, as part of itssupport program towards producers
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What Does The Government
Do With The Surplus?
46
Surplus may be distributed to the poor
But govt has to ensure that its actions
does not lead to falling demandAlternatively, surplus may simply
be stored up .... wasteful if quality
deteriorates over time
H A C Aff d B A
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How Are Consumers Affected By A
Price Floor?
47
Consumers pay a higher price than at marketequilibrium (PF higher than Pe).
Consumers pay taxes to cover governmentsupport for producers.
The amount bought and sold with a price floorimposed is less than that at market
equilibrium.
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Price Elasticity of Demand
48
A measure of the sensitivity or
responsiveness of quantity demanded
to a change in price Formula method
Total revenue method
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Formula Method
49
priceinchangepercentage
demandedquantityinchangepercentageelasticityPrice =
)/2(
)/2(
21
12
21
12
PPPP
QQ
QQ
+
+
=
Demand Curve Showing Different
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Demand Curve Showing DifferentElasticities
50
D2
Quantity/Time
$13
12
11
10
9
8
7
6
5
4
3
2
1
0 1,600 2,000 2,400
Price
D
DD1
D
1
Unit elastic
Elastic demand
Inelasticdemand
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Unit Elastic Demand
51
Demand that exists when a percentage
change in price causes an equal
percentage change in quantitydemanded
Has an elasticity coefficient equal to
1.0 Demand curveD in Figure 4-9
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Elastic Demand
52
Demand that exists when a
percentage change in price causes a
greater percentage change in quantitydemanded
Has an elasticity coefficientgreater
than 1.0Demand curveD1 in Figure 4-9
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Inelastic Demand
53
Demand that exists when a percentage
change in price causes a smaller
percentage change in quantitydemanded
Has an elasticity coefficient less than
1.0Demand curveD2 in Figure 4-9
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Total Revenue Method
54
If price changes but total revenue remains constant,
unit price elasticity of demand exists
If price changes but total revenue moves in the
opposite direction, demand is elastic
If price changes and total revenue moves in thesame
direction, demand is inelastic
Characteristics Affecting Price
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Characteristics Affecting PriceElasticity of Demand
55
Trend Toward
Elastic Demand
Luxuries
Large expenditures
Durable goods
Substitute goods
Multiple uses
Trend Toward
Inelastic Demand
NecessitiesSmall expenditures
Perishable goods
Complementary goodsLimited uses
Three Demand Curves Showing
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Three Demand Curves ShowingDifferent Elasticities
56
D1
P P P
Q/t Q/t Q/t
D2
D3
(a) (b) (c)
Perfectly
ElasticPerfectly
Inelastic
Perfectly
Unit
Elastic
Demand Curve Showing Different
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Demand Curve Showing DifferentElasticities
57
Quantity/Time
$12
11
10
9
8
7
6
5
4
3
2
1
Price
Ela
stic
Dem
and
0 10 20 30 40 50 60 70 80 90 100 110 120
UnitE
lastic
Inelastic
Dem
and
Elasticity changes along the
demand curve from elastic at
the top to inelastic at the
bottom
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Other Types of Elasticity
58
Cross elasticity of demand
Income elasticity of demand
Elasticity of supply
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Cross Elasticity of Demand
59
A measure of the responsiveness of the
quantity demanded of one product as a
result of a change in the price of anotherproduct
Aproductofpricein thechangepercentage
Bproductofdemandedquantityin thechangepercentagedemandofelasticityCross =
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Cross Elasticity of Demand
60
Substitute goods Functionally equivalent goods
Complementary goodsGoods that are used together A change in the price of one product,
if it is substitute or complementaryproduct, can affect the quantitydemanded of the other
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Cross Elasticity of Demand
61
The coefficient of cross elasticity canbe positive or negative
Positive in the case of substitutes Negative in the case of complements
The larger the coefficient, the greater
the cross elasticity
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Income Elasticity of Demand
62
A measure of the responsiveness of
quantity demanded to a change in
income
incomeinchangepercentage
quantityinchangepercentagedemandofelasticityIncome =
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Income Elasticity of Demand
63
Normal goods Positive coefficient
Demand varies in the same directionas income
Inferior goods Negative coefficient Demand varies inversely with changes
in income
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Elasticity of Supply
64
A measure of responsiveness of quantity
supplied to a change in price
priceinchangepercentage
suppliedquantityinchangepercentagesupplyofelasticityPrice =
Time and Elasticity of Supply
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Time and Elasticity of Supply Immediate
65
P
Q Q/t
D1
S
D
P
Demand increases fromD to
D1 and because the sellers
cannot adjust the quantity
supplied on such short notice,
the only impact is an increase
in priceP1
Time and Elasticity of Supply
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Time and Elasticity of Supply Short Run
66
P2
P
Q Q2 Q/t
D1
S
D
P In the short run, the
seller has sufficient
time to vary some
productive resources
supply becomesmore elastic and the
quantity supplied
increases, causing the
price to fall
Time and Elasticity of Supply
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Time and Elasticity of Supply Long Run
67
P3
P
Q Q3 Q/t
D1
S
D
P Over the long run,
the supply curve
becomes still more
elastic because
producers canvary all productive
resources and
make use of new
technology
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Effects of a Tax on Cigarettes
D
S
Price per Pack
($)
40 50
D
S
Quantity (millions of packs)
5.25
5.00
Quantity (millions of packs)
S + $1
5.75
5.00
48 50
S+ $1
e e
R R
Price per Pack
($)
Note that the same $1 tax has a much larger impact on quantity when
d d i l ti th h it i i l ti