demand and supply concept
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Demand
Desire + ability to pay + willingness to pay
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Price Income Prices of related goods Taste and preferences Customs and traditions Government policy Advertising Population Location Service Quality
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A decrease in the price of a good, all other things held constant, will cause an increase in the quantity demanded of the good and
an increase in the price of a good will cause a decrease in the quantity demanded of the good.
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Quantity
Price
P0
Q0
P1
Q1
An increase in price causes a decrease in quantity demanded.
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Quantity
Price
P0
Q0
P1
Q1
A decrease in price causes an increase in quantity demanded.
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Quantity
Price
P0
Q0 Q1
An increase in demand refers to a rightward shift in the market demand curve.
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Quantity
Price
P0
Q1 Q0
A decrease in demand refers to a leftward shift in the market demand curve.
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Law of diminishing marginal utility Income effect Substitution effect Multiplicity of uses
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Giffen Goods Prestigious goods Buyers illusions Necessary goods Brand loyalty Monopoly Speculation
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Elasticity is a measure of responsiveness of one variable to another variable.
Can involve any two variables. An elastic relationship is responsive. An inelastic relationship is unresponsive.
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Price Elasticity of demand Income elasticity of demand Cross Elasticity of demand Promotional Elasticity of demand
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p=%Q/%P An elastic response is one where
numerator is greater than denominator. i.e., %Q>%P so Ep
An inelastic response is one where numerator is smaller than denominator. i.e., %Q<%P so Ep
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Perfectly Elastic D Ep
infinite Perfectly Inelastic
DP
Q
P
Q
Ep 0
D
D
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Q1 Q2 Q2’
P1
P2
D’D
D’ is relatively more elasticthan D
P
Q
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Point elasticity Point elasticity is
responsiveness at a point along the demand function
Ep Q/Q1
P/P1simplifying:Ep
Q/P)* P1 /Q1
Price (Rs.)
QQ1
P1
D
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Point elasticity Point elasticity is
responsiveness at a point along the demand function
Ep Q/Q1
P/P1simplifying:Ep
Q/P)* P1 /Q1
Price (Rs.)
QQ1
P1
D
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Point elasticityEp
Q/P)* P1 /Q1
Suppose P=17000 Q=56-0.002*17000 Q=56-34=22 Plug into equation gives:
Ep -0.002)* 17000 /22
Ep =-34/22=-1.54
Price (Rs)
Q22
17k
D
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Arc elasticity is simply an average elasticity along a range of the demand curve.
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The end-point problem – the percentage change differs depending on whether you view the change as a rise or a decline in price.
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Arc elasticity: Responsiveness along a
range of D. function
Ep Q/((Q1+ Q2)/2)
P/((P1+ P2)/2)
simplifying:EpQ/P)*((P1+P2)/(Q1+Q2))
Price ($)
QQ2
P2
P1
Q1
Avg. responsiveness
D
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Arc elasticityEp
Q/P)*((P1+P2)/(Q1+Q2)) Look at P range 16k -
17k Q=56-0.002*17000 Q=56-34=22 Plug into equation
gives:Ep
-0.002)*(33000/46)Ep
=-66/46=-1.43
Price ($)
Q22
17k
D
24
16k
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Nature of commodityAvailability of substituteMultiplicity of usesHabitProportion of income spentPrice range
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Pricing DecisionTaxationLabor market International trade
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EI = % Qd / % Id
Measures the sensitivity of DEMAND to changes in disposable income.
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Shows the relationship between quantity demanded and disposable income given a constant price.
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DisposableIncome
Qd/ut
Engel Curve for a Normal GoodEI > 0
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Luxury Goods are Normal Goods but they have an
EI >= 1Quantity demanded is very
senstive to changes in disposable income
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“Necessities” are Normal Goods but
0 < EI < 1Quantity demand is not very
sensitive to changes in disposable income
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DisposableIncome
Qd/ut
Engel Curve for an Inferior GoodEI < 0
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Normal Goods (EI >0) Luxury Goods (EI >= 1) Necessitites (0 < EI < 1)
Inferior Goods (EI < 0)
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Measures how sensitive DEMAND for a commodity is to changes in the price of a substitute or compliment commodity
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Ecp of x,y =
% Qx / % Py
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Ecp > 0 Substitute
Ecp < 0 Compliment
Ecp = 0 Independent
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Rate of change in demand for a commodity due to a change in promotion expenditure
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For many crops, a strange situation arises a bad crop year results in a good year for farm incomes, and a good crop year results in a bad year for farm incomes.
How can this happen to farm community?
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Price elasticity gives us the answer:
Bad crop year: supply decreases, prices for farm products rise, but quantity demanded doesn’t fall very much. The quantity demanded of farm products is not very responsive to changes in prices
Good crop year: supply increases, prices for farm products fall, but quantity demanded doesn’t increase very much. The quantity demanded of farm products is not very responsive to changes in prices
It is easy to show this with a graph. But first we need yet another concept: Total Revenue = Price x Quantity
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TR = P x Q If P goes down Q goes up, but what
happens to TR? If P goes up Q goes down, but what
happens to TR?Elasticity can answer the question….
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During bad crop years, prices rise and quantity falls (but not that much) so total revenue to farmers goes up.
During good crop years, prices fall and quantity increases (but not that much) so total revenue to farmers goes down.
The graphs….
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An Increase in Supply in the Market for Wheat
Copyright©2003 Southwestern/Thomson Learning
Quantity ofWheat
0
Price ofWheat
3. . . . and a proportionately smallerincrease in quantity sold. As a result,revenue falls from $300 to $220.
Demand
S1 S2
2. . . . leadsto a large fallin price . . .
1. When demand is inelastic,an increase in supply . . .
2
110
$3
100
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It is an objective assessment or estimation of future course of demand
- Micro level- Industry level- Macro level
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Production planning Evolving sales policy Fixing sales targetsDetermining price policy Inventory controlDetermining short-term financial
planning
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Business planning
Manpower planning
Long-term financial planning
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Consumers interview Sales force pollingExperts opinionDelphiEnd- useMarket ExperimentationTrend projectionCausal regression
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Price Input Price Technology Government
regulations and taxes Number of firms Substitutes in
production Producer expectations
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An equation representing the supply curve:
QxS = f(Px , PR ,W, H,)
QxS = quantity supplied of good X.
Px = price of good X. PR = price of a related good W = price of inputs (e.g., wages) H = other variable affecting supply
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A decrease in the price of a good, all other things held constant, will cause a decrease in the quantity supplied of the good and an increase in the price of a good will cause an increase in the quantity supplied of the good.
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Quantity
Price
P1
Q1
P0
Q0
A decrease in price causes a decrease in quantity supplied.
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Quantity
Price
P0
Q0
P1
Q1
An increase in price causes an increase in quantity supplied.
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Quantity
Price
P0
Q1Q0
An increase in supply refers to a rightward shift in the market supply curve.
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Quantity
Price
P0
Q1 Q0
A decrease in supply refers to a leftward shift in the market supply curve.
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Balancing supply and demand Qx
S = Qxd
Steady-state
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Price
Quantity
S
D
8
7
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Price
Quantity
S
D
5
6 12
Shortage12 - 6 = 6
6
7
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Price
Quantity
S
D
9
14
Surplus14 - 6 = 8
6
8
8
7
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Higher demand leads to higher equilibrium price and higher equilibrium quantity.
Higher supply leads to lower equilibrium price and higher equilibrium quantity.
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Lower demand leads to lower price and lower quantity exchanged.
Lower supply leads to higher price and lower quantity exchanged.
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• The relative magnitudes of change in supply and demand determine the The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.outcome of market equilibrium.
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• When supply and demand both increase, quantity will increase, but When supply and demand both increase, quantity will increase, but price may go up or down.price may go up or down.
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Price Ceilings The maximum legal price that can be
charged. Examples:
▪ Rent control Act.▪ Proposed restrictions on ATM fees.
Price Floors The minimum legal price that can be
charged. Examples:
▪ Minimum wage.▪ Agricultural price supports.
2-60
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Price
Quantity
S
D
P*
Q*
P Ceiling
Q s
PF
Shortage
Q d
2-61
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The dollar amount paid to a firm under a price ceiling, plus the nonpecuniary price.
PF = Pc + (PF - PC) PF = full economic price PC = price ceiling PF - PC = nonpecuniary price
2-62
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Ceiling price of gasoline: $1. 3 hours in line to buy 15 gallons of gasoline
Opportunity cost: $5/hr. Total value of time spent in line: 3 $5 =
$15. Non-pecuniary price per gallon:
$15/15=$1. Full economic price of a gallon of gasoline:
$1+$1=2.
2-63
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For example, ceiling price of apartments: PFor example, ceiling price of apartments: PCeilingCeiling = = Rs.4,800 per month.Rs.4,800 per month.
Apartment seekers in Bangalore often require the Apartment seekers in Bangalore often require the services of a real estate agent or apartment services of a real estate agent or apartment broker to assist them in securing an apartment broker to assist them in securing an apartment lease. Typical broker fees are one month's rent.lease. Typical broker fees are one month's rent.
For example, suppose you stay for 4 years, or 48 For example, suppose you stay for 4 years, or 48 months.months.
• Non-pecuniary price per month: Rs.4,800/48 = Non-pecuniary price per month: Rs.4,800/48 = Rs.100 per month.Rs.100 per month.
Full economic price of apartments: PFull economic price of apartments: Pfullfull = = Rs(4,800+100) = Rs.4,900.Rs(4,800+100) = Rs.4,900.
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Price
Quantity
S
D
P*
Q*
Surplus
PF
Qd QS
2-65
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Full Economic Price The dollar amount paid to a supplier under a price floor,
minus the non-pecuniary (non-money) price suppliers loose through their competition to sell the goods.
The Full Price falls unless the government supports the price floor. Minimum wages.
PFloor = price ceilingPFull = PFloor + (PFull - PFloor)
PFull = full economic price PFull - PFloor = non-pecuniary price
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For example, floor price of labor in California: PFor example, floor price of labor in California: PFloorFloor = $8 per = $8 per hour.hour.
For example, $5 per hour is wasted to get the $8 per hour job.For example, $5 per hour is wasted to get the $8 per hour job. Dressing for success to work at McDonalds.Dressing for success to work at McDonalds. Being agreeable or attractive to your boss.Being agreeable or attractive to your boss. Showing up early and staying late, off the clock.Showing up early and staying late, off the clock.
Full economic price of an hour of labor: PFull economic price of an hour of labor: PFullFull = $(8–5) = $3 = $(8–5) = $3 per hour.per hour.
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Demand and supply functions for a product are:
Qd = 10,000 – 4P Qs = 2,000 + 6P If the government imposes a sales
tax of Rs.100 per unit, what will be the new equilibrium price?
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The supply and demand function for a product is as follows:
Qd = 6,000 – 3PQs = 3,000 + 4.5PThe Government imposes a excise
duty of Rs.20 per unit. What is the proportion of tax that is borne by the producer ?