Applications of Supply and Demand Analysis

Appropriate to use when competition exists among buyers and sellers.

The interaction of buyers and sellers covers all types of prices and goods for which a market exists.

Interaction of supply and demand solves two major economic problems simultaneously- the quantity sold and the price.

Forces affecting supply and demand could come from any number of influences.

Assumptions of Supply and Demand Analysis

Effects of a Change In Demand During an Immediate Period Emergency

Price

Quantity

--------------------------

--------------------------P1

P0

S

D D’

0 Q0

Figure 5-1 (a) shows what happens in the immediate period (during the typhoon), as consumers brace for emergency. Supplies are fixed and demand is fairly inelastic. An increase in demand could lead to a shift of the demand schedule – more goods are bought as long as these are available. The ensuing price increase could be steep as shelves are emptied.

The initial equilibrium price is P0

and quantity is Q0 . After the increase in demand, when all supplies are being bought, the price shifts to P1, but quantity stays the same (in the immediate period the supplies are fixed.)

Figure 5-1(a)

Price

Quantity

--------------------------------

----------------------------P1

P0

D

S

S’

0 Q1

Figure 5-1(b)

---------------------------------------------------------------------

Q0

Figure 5-1(b) indicates the short-run setting of a typhoon period for a particular commodity-fish.

Fish catch will fall because fishermen will not go to the sea. The decline in fish supply will cause the new equilibrium at P1 and Q1. The price of fish will rise and quantity bought will fall.

Supply and Demand for Fish during Typhoon

Price

Quantity

----------------------------------

---------------------------

P1

P0

D

S

S’

0 Q0

--------------------------------------

----------------------------

Q1

Will the Price of Bangus Rise or Fall After a Typhoon?Normal equilibrium is P0 and Q0. during a typhoon, fish pond owners attempt to harvest bangus for fear of losing fish if the ponds overflooded and the fish got out. If flooding occurs, there will be free bangus harvests in main estuaries caught by people in the area.

On the other hand, people who normally eat other types of fish will experience a short period rise of fish prices. Other fishes will have fewer harvests because fishermen go back to safety during a typhoon and they have no catch. These people will likely cause the demand for bangus to increase (shift D to the right).

Interplay of Demand and Supply

D’

-----------------------------------------------------------------------

P2

Q2

Price stabilization is best undertaken through indirect approaches by managing the supply of the commodity.

It could mean influencing only the market conditions, mainly through the supply side, to avoid extreme swings of prices.

Includes setting the prices of commodities that are being stabilized.

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Price stabilizationPrice of grain could rise and fall during the year without price stabilization. During normal times, P0 an Q0 are equilibrium price and quantity. The price of grain could go to PP during times when supply is getting depleted(situation A). But during harvest time when supply is increasing, the price could go to PH(situation B). The objective of stabilization is to set the price towards P0.

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Rice

Pr

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Price

Quantity

------------------------------

----------------------------------PH

P0

D

S’

S

0 QH

----------------------------------------------------------------

Q0

S’’

-------------------------------------------------------------------

QP

PP

Situation A:Market supplies getting depleted.

Situation B:Market supplies

increasing

The wage rate, which represents the incomes of workers, provides some indication of the standard of living.

High wages result from the interaction of the demand and supply of labor.

In countries where the supply of labor is very abundant, many workers are willing to accept low wages in exchange for their services.

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The wage rate is determined by the balance of supply and demand for labor. The supply of labor could be available at a given wage rate, W*, if the supply of labor is infinitely elastic at that wage rate. But beyond a given point such as point a, when the labor available at that wage is fully employed, at point L*, the supply schedule of labor could rise as shown in the figure.

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Wage rate

Demand for Labor

Supply of Labor

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Population GrowthAssume two countries identical in all aspects including their initial level of population. But A has a 1.0% per annum growth of population; B has 2.0%. What happens 10 years later?

In country A, with a lower population growth, the supply curve of labor turns up more quickly than SB. 10 years later A has higher wages than B because the labor supply is greater in B where the population growth is higher.

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Growth in Demand for LaborThe two countries are identical in all aspects, except that country T has a stronger demand for labor than country P 10 yrs. later. Policies in T encourage a growth demand for labor that is faster than in P.Initially the two countries have an identical demand for labor. 10 yrs. later, because of sound economic policies and growth of business investment and productivity, the demand for labor is higher in T than in P.The result, T is securely on a rising portion of the S schedule for labor. Also, amount of new employment is more than in P. L10 Years Later in T is higher than in P. as important, W10 Years Later in T is much higher than in P.

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Labor Migration and WagesAt equilibrium before in-migration, Urbanya has a a higher wage than Probinsya which will induce labor to move to Urbanya. Suppose this movement is about 100 thousand man-years for a given year, the labor supply in Probinsya falls from SP to S’P by the amount equal to 100 thousand man-years. But the labor supply schedule for Urbanya rises from SU to S’U . In probinsya, equilibrium wage goes up from WP

to W’P while in Urbanya, wage goes down from WU to W’U.

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Effects of a Commodity TaxThe supply schedule before tax is S and after tax is STAX. A commodity tax has the effect of raising the price of the good and reducing the quantity sold. The extent of the changes in price and quantity depends on the elasticity of supply and demand.

Equilibrium before tax is P0 and Q0. the supply schedule after tax, STAX, intersect the demand curve at a ne equilibrium price, PTAX. The new equilibrium quantity after tax is QTAX. It is clear from this that the new price is higher than the old price and the quantity after tax is smaller than the quantity before tax.

Commodity Taxation: Price and Quantity After Tax

Price

Quantity

----------------------------------

----------------------------PTax

P0

D

S

STAX

0 QTAX

--------------------------------------

--------------------------

Q0

Foreign exchange is the term used to denote the value of foreign money in terms of local money.

The exchange rate for the US dollar is the peso cost of buying a US dollar.

The peso appreciates in value when the amount of pesos to acquire a US dollar becomes smaller which makes peso more valuable.

Peso depreciates when the price of the US dollar increases in terms of pesos.

It is important to value foreign currency because the country earns dollars when it imports and spends dollars when it buys foreign goods.

Exchange Rate of the Peso: The Value of Foreign Money

Devaluation indicates an official action of the government to reduce the value of the currency.

Foreign Exchange Market consists of the interaction of countries to buy or to sell foreign currencies.

Principal currencies are US dollar, Japanese yen and Europe’s Euro.

Exchange Rate of the Peso: The Value of Foreign Money

Supply of Foreign Exchange Consists of the receipts of dollars that the country earns or receives. The following activities contribute to supply of dollars.

Export earningsForeign tourism in the countryUse of services sold by Philippine companies: transport,

telecommunications and others.Remittances of OFWProceeds from foreign loansShort-term inflows of foreign capital for investment in the country

or deposit of foreign money in any Philippine-based bank.

Exchange Rate of the Peso: The Value of Foreign Money

Demand for Foreign Exchange Consists of the payments for the volume of imports that the country

buys to support the needs of businesses and citizens during a given period.

These payments include:Imports of goods for consumption and for investment.Filipinos travel abroad for tourism or for business.Filipinos and Philippine institutions use the service of foreign

companies.

Exchange Rate of the Peso: The Value of Foreign Money

Foreign Exchange Market and Effects of Capital FlowAt a, the supply schedule is positively sloped which is a typical supply schedule. When the peso price of the dollar is low, suppliers are not willing to sell their dollars for they get fewer pesos for their dollars. But when the peso price of the dollar is high, then suppliers will receive more pesos for every dollar they sell.

In b, “good” developments dominate among the transitory factors, capital inflow increase so an upward shift of the supply schedule for dollars happens.

In c, “bad” developments dominate capital inflows decrease, so a downward shift of the supply schedule for dollars happens.

Interaction of Supply and Demand