the price mechanism , demand and supply equilibrium (+ handwritten notes too ).ppt

8/14/2019 The Price Mechanism , Demand and Supply equilibrium (+ handwritten notes too ).ppt

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SupplyDemand


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Market Mechanism refers to a process

through which market forces of demand andsupply interact to determine price and outputof each product and service

System of economic organization featured byprivate ownership and the use of privateprofit of man made and nature made capital

Eg factories , farms owned by private

individual or firms


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Right to private property Freedom of enterprise

Freedom of choice by consumers Profit motive Inequalities of incomes


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Demand curve The law of demand The law of supply Supply curve

Equilibrium Disequilibrium Conditions of demand Conditions of supply


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A market consists of: Buyers (demand)

Sellers (supply)

Exchange

Market is a place or area where goods and services

are bought and sold.

A Market is a mechanism by which buyers andsellers interact to determine the price and

quantity of a good and service.


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Demand is :1. Desire for good

2. Backed by ability

3. And willingness to pay

Effective demand = the quantity of a

commodity which consumers will purchaseat a given price per time period


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Individual demand can be defined as quantityof a commodity that an individual is willing to

buy at a given price over a specified period oftime say per day , per week etc

Market demand is total quantity that all theusers of a commodity are willing to buy at agiven price over a specified period oftime.(sum of individual demands)


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The detailed analysis of demand and supplydemonstrates how market forces solve the

problem of what,how and whom to produce.It illustrated how prices and quantities ofvarious goods and services are determined

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As price increases the quantity demandeddecreasesConversely:

As price decreases the quantity demandedincreases

(Applicable in short run all other things

remaining constant (consumers tastes andpreferences , income ,substitutes andcomplements etc)

(cont.)


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Reflects an inverse relationship, i.e.as price , quantity demanded

as price , quantity demanded

The law of demand is caused by: The income effect

The substitution effect


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A demand schedule shows relationship between the price andquantity demanded of a good . Demand curve for almost all thecommodities slope downwards owing to inverse relationshipbetween price and quantity supplied.

A table showing the quantity demanded of a product at various

prices Example:Demand schedule of good X

Price Qty demandedRe 1 500Rs 2 400

Rs 3 300Rs 4 200Rs 5 100


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Graphical representation of demand scheduleExample: Demand curve

Quantity

Price

Rs

5

2

1

34

100 200 300 400 500


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Income effect Substitution effect


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As prices increase, consumers willpurchase fewer goods and services. Theirpurchasing power(or real income)decreases

Quantity demanded decreases As prices decrease, the purchasing power

of consumers increases

Quantity demandedincreases


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As prices increase, consumers generallypurchase more of a substitute productwhose price is lower

A substitute productis a product thatperforms a similar function and satisfies thesame consumer need/want e.g.: Tea/coffee Butter/jam

If the price of butterincreases, the quantity

demanded will fall as consumers willsubstitute butter with jam


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Expectations regarding the future prices Prestigious goods

Giffen goods


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Price of a commodity Price of related good(a) Substitute goods(b) Complementary goods Income of consumer(a) Normal goods(b)Inferior goods Necessities of life Tastes and preferences Expectations

Size and composition of population Distribution of income


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Extension in Demand- Rise in quantity demanded due to fall in price


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Contraction in demand Fall in quantity demanded due to increase in

price

3-19


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The entire demand curve shifts to theright

Q

P

D

D1

S

E

E1

Pe

Pe1

EQ EQ1


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The entire demand curve shifts to the left

Caused by a factor other than price

Q

S

DD1

E

E1

Qe1 Qe

P

Pe

Pe1


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Increase in demand means rise in demanddue to change in taste, price of substitutes,

income of consumer (forward shift) andbackward shift is vice versa

Thus demand function = f( Px+ Y + Ps+Pc+T+A)

3-22


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Definition: the quantity of a productwhich producers offer to the market ata certain price per unit of time


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As price increases the quantity supplied increases conversely

as price decreases the quantity supplied decreases The law of supply is a directrelationship between price and

quantity supplied

As price , quantity supplied

As price , quantity supplied

The logic of the law of supply: Producers will seek to maximise their profits i.e.: supplying more at

higher prices and less at lower prices. Free market or capitalist

economy, producers will produce only that good for which price ismore so that they can increase profits


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A table showing the quantity supplied atvarious prices

Example:Supply schedule of Good X

Price Qty supplied$1 200$2 300$3 400$4 500$5 600


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A graphic representation of the supplyscheduleExample: Supply curve for good X

Price

Quantity

$

Supply curve

1

2

3

45

200 300 400 500 600


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When supply of a commodity changes due tochange in factors other than price such as

technology, capital, input prices etc it iscalled increase or decrease in supply


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Supply curve shifts to the right

P

Q

S

D

S1

EE1Pe

Pe1

Qe Qe1


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Refers to the upward shift to the left ofsupply curve

Less supply at same price or same supply atmore price is called decrease in supply

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Supply curve shifts to the leftP

Q

S

D

S1

EE

1

Pe1

Pe

Qe1 Qe


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Goal of the firm Price of the good

Price of the inputs Technology Price of the related goods(a) Substitutes(b) Complements Expectations of the producer Government Policy

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Supply and demand can now be broughttogether to form the price mechanismP

Q

S

D

Equilibrium point (Pe)Pe

Qe (cont.)

shortage

Surplus


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Market equilibrium (E) is where:

Quantity demanded = quantity supplied

(intersection of demand and supply curves) The market is cleared (no shortages or

surpluses)

Price (Pe) is stable State of rest No unsold stock, no

unsupplied demand)


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In real world price keeps on changing due tochange in determinants of demand and

supply

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If supply remains constant increase in demand raises anddecrease in demand lowers the prices

Prices change directly with the change in demand

Supply constant , Demand increases, equilibrium price andquantity increases and vice versa

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Increase in supply A rightward shift in supply curve results in a new equilibrium where price is

lower and quantity is higher

Decrease in supply A leftward shift in demand curve results in new equilibrium where price is

higher and quantity is lower.

Reduces quantity raises prices.

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the price mechanism , demand and supply equilibrium (+ handwritten notes too ).ppt

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