Demand and Supply_Concepts and Applications (2)(1) [Compatibility Mode]

8/3/2019 Demand and Supply_Concepts and Applications (2)(1) [Compatibility Mode]

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Demand and Supply:Concepts and Applications

Demand and Supply: Concepts and Applications

Outline

History of Demand and Supply

Law of Demand and Demand Curve Derivation

Law of Supply and Supply Curve Derivation

Equilibrium

Shift in Demand and Supply Curve

Interaction between Demand and Supply

Applications: Interest Rate and Exchange rate.

Case Study


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History of Demand and Supply

Adam Smith(1723-1790)

Relative price of a good was determined by

relative labor costs

Demand/supply curve are horizontal

This is partly correct explanation

During Smiths time, the primary costs of

producing goods were associated mainly with

labor.


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History of Demand and Supply (continued)

David Ricardo (1772-1823)

Law of diminishing returns

Upward sloping supply/demand curve


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History of Demand and Supply (continued)

Alfred Marshal (1842-1924)

Marginalism

Willingness to pay declines: diminishing

marginal utility

Increasing marginal costs: law of diminishing

returns


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Definition of Demand

An economic principle that describes a

consumers desire and willingness to pay a

price for a specific good or service.

Latent Demand

Effective Demand


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The Law of Demand

The law of demandholds that other things

equal, as the price of a good or service rises, its

quantity demanded falls.

The reverse is also true: as the price of a good or

service falls, its quantity demanded increases.


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Demand Curve

The demand curve has a negative slope, consistent withthe law of demand.


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Downward Sloping


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Movements Along Demand Curve

Quantity

Price

P2

Q2 Q1 Q3

P1

P3

Price increase moves usleftwardalong demandcurve

Price decrease moves usrightwardalong demandcurve


The Law of Supply

The law of supply holds that other things equal,

as the price of a good rises, its quantity

supplied will rise, and vice versa.

Why do producers produce more output when

prices rise?

They seek higher profits

They can cover higher marginal costs of production


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Supply Curve

The supply curve has a positive slope, consistent withthe law of supply.


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Upward Sloping

Equilibrium

In economics, an equilibrium is a situation in

which:

there is no inherent tendency to change,

quantity demanded equals quantity supplied, and

the market just clears.


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Equilibrium

Equilibrium occurs at a price of $3 and a quantity of 30

units.


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Eqm (P,Q)=(3,30)

Shortages and Surpluses

A shortage occurs when quantity demanded

exceeds quantity supplied.

A shortage implies the market price is too low.

A surplus occurs when quantity supplied

exceeds quantity demanded.

A surplus implies the market price is too high.


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Income: Factors That Shift The Demand

Curve

An increase in income has effect of shiftingdemand for normal goods to the right

However, a rise in income shifts demand forinferior goods to the left

Examples: Lemon (used Car), health clubmemberships, etc.

A rise in income will increase the demand for anormal good, and decrease the demand for an

inferior good.


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Wealth: Factors That Shift The Demand

Curve

Your wealthat any point in timeis the total

value of everything you own minus the total

dollar amount you owe

An increase in wealth will

Increase demand (shift the curve rightward) for anormal good

Decrease demand (shift the curve leftward) for an

inferior good



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Prices of Related Goods: Factors that Shift

the Demand Curve

Substitutegood that can be used in place of someother good and that fulfills more or less the same

purpose, e.g., tea and coffee.

A rise in the price of a substitute increases the demand for a

good, shifting the demand curve to the right

Complementused together with the good we areinterested in, e.g., sugar and tea.

A rise in the price of a complement decreases the

demand for a good, shifting the demand curve to the

left


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Other Factors That Shift the Demand Curve

Population As the population increases in an area

Number of buyers will ordinarily increase

Demand for a good will increase

Expected Price An expectation that price will rise (fall) in the future shifts the current

demand curve rightward (leftward)

Tastes Combination of all the personal factors that go into determining how a

buyer feels about a good When tastes change toward a good, demand increases, and the demand

curve shifts to the right

When tastes change away from a good, demand decreases, and thedemand curve shifts to the left


Shift in the Demand Curve

This demand curve has shifted to the right. Quantitydemanded is now higher at any given price.


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Shift Rightward

Equilibrium After a Demand Shift

The shift in the demand curve moves the market

equilibrium from point A to point B, resulting in ahigher price and higher quantity.


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New Eqm (P,Q)=(4,40)


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Factors That Shift the Supply Curve

Input prices

A fall (rise) in the price of an input causes an increase

(decrease) in supply, shifting the supply curve to the right

(left)

Price of Related Goods

When the price of an alternate good rises (falls), the supply

curve for the good in question shifts rightward (leftward)

Technology

Cost-saving technological advances increase the supply of a

good, shifting the supply curve to the right


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Number of Firms

An increase (decrease) in the number of sellers

with no other changesshifts the supply curve tothe right (left)

Expected Price

An expectation of a future price increase (decrease)shifts the current supply curve to the left (right)


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Changes in weather

Favorable weather

Increases crop yields

Causes a rightward shift of the supply curve for that crop

Unfavorable weather

Destroys crops

Shrinks yields

Shifts the supply curve leftward

Other unfavorable natural events may effect all firms

in an area Causing a leftward shift in the supply curve


Shift in the Supply Curve

For an given rental price, quantity supplied is now lowerthan before.


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Shift Upward


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Equilibrium After a Supply Shift

The shift in the supply curve moves the market equilibrium from

point A to point B, resulting in a higher price and lower quantity.


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New Eqm(P,Q)=(4,20)

Price Ceilings & Floors

Aprice ceiling is a legal maximum that can becharged for a good.

Results in a shortage of a product

Common examples include edible oil price.

Aprice flooris a legal minimum that can becharged for a good.

Results in a surplus of a product

Common examples minimum wage for RMG


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Price Ceiling

A price ceiling is set at $2 resulting in a shortage of20 units.


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Upward Pressure on Price

Price Floor

A price floor is set at $4 resulting in a surplus of 20units.


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Downward Pressure on Price


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Interactions Between Demand and Supply

Say's law is an economic proposition named

after the French businessman and economist

Jean-Baptiste Say (17671832).

The proposition that "supply creates its own

demand

The production of goods will generatesufficient demand to ensure that they are sold.


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Interactions Between Demand and Supply

Keynesian economics advocates active demandmanagement policies- monetary and fiscal policy to

stabilize output.

It advocates a mixed economy, predominantly privatesector, but with a moderate role of government and

public sector.

It lost some influence following the stagflation of the1970s.

The advent of the global financial crisis in 2007 has

caused a resurgence in Keynesian thought.


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Interest Rate Determination

Interplay between Dd and Ss determines interest rate.

Money demand refers to the demand by households,businesses and the government, for highly liquid

assets such as currency and checking accountdeposits.

Money demand is affected by the desire to buy things

in the near future, but is also affected by theopportunity cost of holding money.

The opportunity cost is the interest earnings one givesup on other assets in order to hold money.


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A country's money supply is mostly the amount of

coin and currency in circulation and the total valueof all checking accounts in banks.

If interest rates rises, households and businesses

will likely allocate more of their asset holdingsinto interest bearing accounts (usually not

classified as money) and will hold less in the formof money.

Money supply and money demand will equalizeonly at one average interest rate.


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Equilibrium of Money Demand and Money Supply

MS

MDr

r0

Money


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Exchange Rate Determination

In the flexible exchange rate, it is the interplay

between supply and demand of the foreign

exchange

Demand of the foreign exchange : Import

payments, Foreign debt payment etc.

Supply of the foreign exchange : Exports,Remittances, FDI, foreign aid etc.


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Foreign Exchange Market: If Import

payment rises, others remain same

ForeignExchange

Taka perdollar

80

73F

Q3 Q4

S

D2

F'

D1


Case study- 1

US-Iraq War: Impact on Oil andGas Price


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Using Supply and Demand: The

Invasion of Kuwait

Why did Iraqs invasion of Kuwait cause the

price of oil to rise?

Immediately after the invasion, United States led aworldwide embargo on oil from both Iraq and

Kuwait

A significant decrease in the oil industrysproductive capacity caused a shift in the supplycurve to the left

Price of oil increased


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The Market For Oil: Supply Shock

Inflation

P2

D

E'

P1E

Q2 Q1

S2

S1

Barrels of Oil

Priceper

Barrel of

Oil


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Using Supply and Demand: The

Invasion of Kuwait

Why did the price of natural gas rise as well?

Oil is a substitute for natural gas

Rise in the price of a substitute increases demand

for a good

Rise in price of oil caused demand curve for naturalgas to shift to the right

Thus, the price of natural gas rose


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The Market For Natural Gas: Demand

Pull Inflation

Cubic Feetof Natural

Gas

Price perCubic Footof Natural

Gas

P4

P3F

Q3 Q4

S

D2

F'

D1



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Case study-2Price of Cucumber During Ramadan


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Demand Pull Inflation

Price of Cucumber Before Ramadan: 40 Tk.

Per KG

Price of Cucumber During Ramadan: Upward

pressure


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The Market For Cucumber

Cucumber

Price per KG

50

40F

Q3 Q4

S

D2

F'

D1


Thank You All


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Demand and Supply_Concepts and Applications (2)(1) [Compatibility Mode]

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