The Theory of Demand and Supply (Part II)

Ch. 3, Economics, R.A. Arnold

Market

An arrangement or place where buyers and sellers meet to trade.

Here we focus on the sellers or businesses or producers (the supply side of the market)

What is the incentive to produce and sell? Answer: Profit

Profit = Total Revenue – Total Cost

Or, Profit per unit = price per unit – cost per unit

DEMAND and SUPPLY (the two sides of a market)

DEMAND

1) The willingness and ability of buyersto purchase different quantities of a good

2) At different prices

3) During a specific period of time

SUPPLY

1) The willingness and ability of sellersto produce and offer to sell different quantities of a good

2) At different prices

3) During a specific period of time

LAW OF DEMAND AND SUPPLY(In both cases there are four ways to represent the law)

LAW OF DEMAND LAW OF SUPPLY

LAW OF DEMAND AND SUPPLY

Law of DEMAND

3. Demand schedule: The numerical tabulation of the quantity demanded of a good at different prices (numerical representation of the Law of Demand)

4. Demand curve: The graphical representation of the law of demand.

(A downward sloping line or curve; inverse relationship).

Drawn using the demand schedule.

Law of SUPPLY

3. Supply schedule: numerical tabulation of quantity supplied of a good at different prices

4. An upward sloping line or curve (indicating a direct relationship). Drawn using the supply schedule.

CHANGE IN QUANTITY SUPPLIED(Symbol: ∆QS )

Change in quantity supplied occurs when there is a change in the price (variable in the graph). It is represented by a movement along the supply curve [diagram (b) next slide]

From the next slide. ‘S’ represents ‘Supply’

And Qs represents quantity supplied.

They are DIFFERENT concepts.

CHANGE IN SUPPLY

Changes in supply (S) or shift of the supply curve occurs due to a factor other than price (outside of the graph). See diagram (a) in the last slide. These factors are connected to profit which is the main incentive to produce and sell (Profit = Revenue – Cost).

Factors that cause this shift:

1) Prices of Relevant ResourcesE.g. to produce tea we need milk. If the price of milk decreases, then it becomes cheaper to produce and sell tea. The profit from tea increases. Therefore, supply of tea increases and supply curve shifts right [like diagram (a) in the last slide].

Continued

2) TechnologyTechnological improvement → same output can be produced using less resources → cost of production decreases → profit increases and hence supply increases, curve shifts right.

E.g. during online classes, NSU needs less resource (electricity, cleaners, etc.) to produce the same amount of lectures. Profit of NSU increases. Hence, supply should increase, curve shifts right.

Continued

3) Number of sellers

If number of sellers ↑ , then supply ↑

4) Expectations of future prices

E.g. if a seller expects the price of the goods being sold will increase in the future, then instead of selling the goods now, the seller is likely to sell the goods in the future. Therefore, the current supply decreases, curve shifts left.

The Market: D and S Together

Here we look at the entire market, that is, Demand and Supply together. So we combine the demand and supply curves in the same graph (next slide).In the graph (next slide), the equilibrium point (E) where the demand and supply curves meet (i.e. Qd = Qs), gives us the equilibrium price and quantity in a market.Equilibrium Price (PE): $10 (next slide) Equilibrium Quantity: 100 units (next slide)

Surplus: Qs > Qd occurs when P > PE

Disequilibrium (next slide)

Shortage: Qd > Qs occurs when P < PE

Moving (from Disequilibrium) to Equilibrium

A market may be in any one of the three states (equilibrium, shortage or surplus).

If a market is experiencing surplus ( Qs > Qd ) , then suppliers will reduce the price to sell the excess goods. Price falls until the equilibrium price, where the market clears ( Qs = Qd )

If a market is experiencing shortage ( QD > QS ) , then buyers bid the price up (they compete with each other for the limited goods; sellers also raise the price). Price rises until the equilibrium price is reached where the market clears ( Qd = QS ).

At equilibrium, the price and Q are equal, stable (assuming ceteris paribus). The buyers and sellers do not have any incentive to change the price.