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Transcript of Economic Analysis for Business Session IV: Market Forces of Supply and Demand-I Instructor Sandeep...
Economic Analysis Economic Analysis for Businessfor Business
Session IV: Market Forces of Session IV: Market Forces of Supply and Demand-ISupply and Demand-I
InstructorInstructorSandeep BasnyatSandeep [email protected][email protected]
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Markets and CompetitionMarkets and CompetitionA market is a group of buyers and
sellers of a particular product. A competitive market is one with
many buyers and sellers, each has a negligible effect on price.
A perfectly competitive market:◦ all goods exactly the same◦ buyers & sellers so numerous that no one
can affect market price – each is a “price taker”
In this chapter, we assume markets are perfectly competitive.
DemandDemandDemand comes from the behavior
of buyers. The quantity demanded of any
good is the amount of the good that buyers are willing and able to purchase.
Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
The Demand ScheduleThe Demand ScheduleDemand schedule:
A table that shows the relationship between the price of a good and the quantity demanded.
Example: Helen’s demand for lattes.
Price of
lattes
Quantity of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4 Notice that Helen’s
preferences obey the Law of Demand.
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15
Price of Lattes
Quantity of Lattes
Helen’s Demand Schedule & CurveHelen’s Demand Schedule & Curve
Price of
lattes
Quantity of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
Demand Equation and FunctionDemand Equation and Function
According to the Law of Demand: When P increases, Q decreases, and
When P decreases, Q increases (other things remain constant)Demand equation: Qd = f (P)
• For a linear demand curve (having equal slopes),The Demand Function: Qd = a + bP
Where, b = slope of the curvea = Slope coefficient or
demand parameter
Example: Demand Equation and Example: Demand Equation and FunctionFunction
If the slope of a linear demand curve is “-20” and demand parameter is 100, find the demand equation for the curve.
Solution: Equation for the demand curve is:Qd = a + bPQd = 100 – 20P
Market Demand versus Individual DemandMarket Demand versus Individual DemandThe quantity demanded in the market is the sum of
the quantities demanded by all buyers at each price. Suppose Helen and Ken are the only two buyers in the
Latte market. (Qd = quantity demanded)
4
6
8
10
12
14
16
Helen’s Qd
2
3
4
5
6
7
8
Ken’s Qd
+
+
+
+
=
=
=
=
6
9
12
15
+ = 18
+ = 21
+ = 24
Market Qd
$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25
P
Q
The Market Demand Curve for LattesThe Market Demand Curve for Lattes
PQd
(Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
Movement along the demand curveMovement along the demand curve
Market Demand Function and Market Demand Function and EquationEquationMarket Demand Case:
1. There are 500 consumers in an economy, each with an individual demand curve of :
Qi = 15 − P
Find the total demand from the market (Qm)
2. There are 500 consumers with individual demand curves of : Qi = 15P and
300 consumers with individual demand curves of :Qi = 30−2P,
Find the total demand (Qm) from the market.
Market Demand Function and Market Demand Function and EquationEquationMarket Demand Case:
1. There are 500 consumers in an economy, each with an individual demand curve of :
Qi = 15 − P
Find the total demand from the market (Qm)
Qm = 500(15 − P) Qm = 7500 − 500P.⇒ 2. There are 500 consumers with individual demand
curves of : Qi = 15P and
300 consumers with individual demand curves of :Qi = 30−2P,
Find the total demand (Qm) from the market.
Qm = 500(15 P) + 300(30 − 2P) = 9000 + 6900P
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Demand Curve Shifters: Demand Curve Shifters: Determinants of DemandDeterminants of Demand
The demand curve shows how price affects quantity demanded, other things being equal.
These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).
Changes in them shift the D curve…
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Demand Curve Shifters: No.Demand Curve Shifters: No. of buyers of buyers
An increase in the number of buyers causesan increase in quantity demanded at each price, which shifts the demand curve to the right.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30
P
Q
Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example).
Demand Curve Shifters: No. of buyers
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Demand for a normal good is positively related to income. ◦An increase in income causes increase
in quantity demanded at each price, shifting the D curve to the right.
(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)
Demand Curve Shifters: Demand Curve Shifters: incomeincome
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.
Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.
Other examples: Coke and Pepsi, laptops and desktop computers, compact discs and music downloads
Demand Curve Shifters: Demand Curve Shifters: prices of prices of related goodsrelated goods
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Two goods are complements if an increase in the price of one causes a fall in demand for the other.
Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.
Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon
Demand Curve Shifters: Demand Curve Shifters: prices of prices of related goodsrelated goods
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.
Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right.
Demand Curve Shifters: Demand Curve Shifters: tastestastes
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Expectations affect consumers’ buying decisions.
Examples:
◦If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.
◦If the economy turns bad and people worry about their future job security, demand for new autos may fall now.
Demand Curve Shifters: Demand Curve Shifters: expectationsexpectations
Summary: Variables That Affect DemandSummary: Variables That Affect Demand
Variable A change in this variable…
Price …causes a movement along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price ofrelated goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : Demand curveDemand curve
A. The price of iPods falls
B. The price of music downloads falls
C. The price of compact discs falls
21
Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?
AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : A. price of iPods fallsA. price of iPods falls
22
Q2
Price of music down-loads
Quantity of music downloads
D1D2
P1
Q1
Music downloads and iPods are complements.
A fall in price of iPods shifts the demand curve for music downloads to the right.
Music downloads and iPods are complements.
A fall in price of iPods shifts the demand curve for music downloads to the right.
AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : B. price of music downloads fallsB. price of music downloads falls
23
The D curve does not shift.
Move down along curve to a point with lower P, higher Q.
The D curve does not shift.
Move down along curve to a point with lower P, higher Q.
Price of music down-loads
Quantity of music downloads
D1
P1
Q1 Q2
P2
AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : C. price of CDs fallsC. price of CDs falls
24
P1
Q1
CDs and music downloads are substitutes.
A fall in price of CDs shifts demand for music downloads to the left.
CDs and music downloads are substitutes.
A fall in price of CDs shifts demand for music downloads to the left.
Price of music down-loads
Quantity of music downloads
D1D2
Q2
Market Demand Equation and Market Demand Equation and FunctionFunction
Combining Price and Non-price determinants:Total Market demand for a product = f (Price of the Product, Prices of other goods, Income, Tastes and Preferences of Consumers, Expectations and Number of Buyers)
Or, Qd = f (P, Po, I, T, E, B)In a functional form:
Qd = a1P+ a2Po+ a3I+ a4T+ a5E+ a6B
(Q = Parameter x Notation of variable.)
Estimating Industry Demand for New Automobiles
Estimated Valuefor Independent
Parameter Variable duringIndependent Variable Estimate Coming Year
(1) (2) (3)Average Price for New Cars (P) –500 $25,000Average Price for New Luxury Cars(PX) 210 $50,000Disposable Income, per Household (I) 200 $45,000 Population (Pop) (millions) 20,000 300Average Interest Rate (i) (percent) –1,000,000 8%Industry Advertising Expenditures (A) 600 $5,000 million
Find the market (Industry) demand equation (curve) for the new automobile.
Exercise: Market Demand Exercise: Market Demand EstimationEstimation
Solution: Market Demand EquationSolution: Market Demand EquationThe demand function for the automobile industry is:
Q = Parameter x Notation for Independent Variable. Or,Q = –500P + 210PX + 200I + 20,000Pop – 1,000,000i
+ 600A
Substituting the value of all variables except “P”, Q = –500P + 210($50,000) + 200($45,000) + 20,000(300)
– 1,000,000(8) + 600($5,000)
Q = 20,500,000 – 500P or,P = 41,000 – 0.002Q
When P = $25000, Q = 8,000,000 (8 millions).If the average interest rate increases by 2%, how would it affect
the demand curve? How many cars would be sold if the average interest rate increases by 2%?
Solution: Market Demand EquationSolution: Market Demand EquationThe demand function for the automobile industry is:
Q = Parameter x Notation for Independent Variable. Or,Q = –500P + 210PX + 200I + 20,000Pop – 1,000,000i
+ 600A
Substituting the value of all variables except “P”, Q = –500P + 210($50,000) + 200($45,000) + 20,000(300)
– 1,000,000(8) + 600($5,000)
Q = 20,500,000 – 500P or,P = 41,000 – 0.002Q
When P = $25000, Q = 8,000,000 (8 millions).If the average interest rate increases by 2%, how would it affect
the demand curve? How many cars would be sold if the average interest rate increases by 2%?
(Ans: Demand Curver shifts to Left; Q = 6,000,000)
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
SupplySupplySupply comes from the behavior
of sellers. The quantity supplied of any
good is the amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
The Supply ScheduleThe Supply Schedule
Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.
Example: Starbucks’ supply of lattes.
Notice that Starbucks’ supply schedule obeys the Law of Supply.
Price of
lattes
Quantity of lattes supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15
Starbucks’ Supply Schedule & CurveStarbucks’ Supply Schedule & Curve
Price of
lattes
Quantity of lattes supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
P
Q
Supply Equation and FunctionSupply Equation and Function
According to the Law of Supply: When P increases, Q Increases, and
When P decreases, Q decreases (other things remain constant)Supply equation: Qs = f (P)
• For a linear supply curve (having equal slopes),The Supply Function: Qs = a + bP
Where, b = slope of the curvea = Slope coefficient or
demand parameter
Market Supply versus Individual SupplyMarket Supply versus Individual SupplyThe quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price. Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied)
18
15
12
9
6
3
0
Starbucks
12
10
8
6
4
2
0
Jitters
+
+
+
+
=
=
=
=
30
25
20
15
+ = 10
+ = 5
+ = 0
Market Qs
$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
The Market Supply Curve
PQS
(Market)
$0.00 0
1.00 5
2.00 10
3.00 15
4.00 20
5.00 25
6.00 30
Movement along the supply curveMovement along the supply curve
Market Supply FunctionMarket Supply FunctionMarket Supply Case:
1. If there are 400 suppliers with individual supply curves of
Qi = 15 + 2p, then the market supply curve is:
2. If there are 500 suppliers with individual supply curves of Qi = 15+ p and 300 suppliers with individual supply curves of Qi = 30+2p, then the total supply from the market is:
Market Supply FunctionMarket Supply FunctionMarket Supply Case:
1. If there are 400 suppliers with individual supply curves of
Qi = 15 + 2p, then the market supply curve is:
Qs = 400(15 + 2p) = 6000 + 800p.
2. If there are 500 suppliers with individual supply curves of Qi = 15+ p and 300 suppliers with individual supply curves of Qi = 30+2p, then the total supply from the market is:
Qs = 500(15 + p) + 300(30 + 2p) = 16500 + 1100p.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Supply Curve ShiftersSupply Curve Shifters
The supply curve shows how price affects quantity supplied, other things being equal.
These “other things” are non-price determinants of supply.
Changes in them shift the S curve…
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Supply Curve Shifters: Supply Curve Shifters: input pricesinput prices
Examples of input prices: wages, prices of raw materials.
A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example).
Supply Curve Shifters: input prices
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Supply Curve Shifters: Supply Curve Shifters: technologytechnology
Technology determines how much inputs are required to produce a unit of output.
A cost-saving technological improvement has same effect as a fall in input prices, shifts the S curve to the right.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Supply Curve Shifters: Supply Curve Shifters: No. of sellersNo. of sellers
An increase in the number of sellers increases the quantity supplied at each price,shifts the S curve to the right.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Supply Curve Shifters: Supply Curve Shifters: expectationsexpectations
Suppose a firm expects the price of the good it sells to rise in the future.
The firm may reduce supply now, to save some of its inventory to sell later at the higher price.
This would shift the S curve leftward.
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
Summary: Variables That Affect Summary: Variables That Affect SupplySupply
Variable A change in this variable…
Price …causes a movement along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve
AA CC TT II VV E LE L EE AA RR NN II NN G 2G 2: : Supply curveSupply curve
44
Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios?
A. Retailers cut the price of the software.
B. A technological advance allows the software to be produced at lower cost.
C. Professional tax return preparers raise the price of the services they provide.
AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : A. fall in price of tax return softwareA. fall in price of tax return software
45
The S curve does not shift.
Move down along the curve to a lower P and lower Q.
The S curve does not shift.
Move down along the curve to a lower P and lower Q.
Price of tax return software
Quantity of tax return software
S1
P1
Q1Q2
P2
AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : B. fall in cost of producing the softwareB. fall in cost of producing the software
46
The S curve shifts to the right:
at each price, Q increases.
The S curve shifts to the right:
at each price, Q increases.
Price of tax return software
Quantity of tax return software
S1
P1
Q1
S2
Q2
AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : C. professional preparers raise their priceC. professional preparers raise their price
47
This shifts the demand curve for tax preparation software, not the supply curve.
This shifts the demand curve for tax preparation software, not the supply curve.
Price of tax return software
Quantity of tax return software
S1
Market Supply Equation and Market Supply Equation and FunctionFunction
Combining Price and Non-price determinants:Total Market Supply for a product = f (Price of the Product, Input Prices, Technology, Expectations and Number of Sellers)
Or, Qs = f (P, Pi, T, E, S)In a functional form:
Qd = a1P+ a2Pi+ a3T+ a4E+ a5S
(Q = Parameter x Notation of variable.)
Estimating Industry Supply for New Automobiles
Estimated Valuefor Independent
Parameter Variable duringIndependent Variable Estimate Coming Year
(1) (2) (3)Average Price for New Cars (P) 2,000 $25,000Average Price for SUV(Psuv) -400 $35,000Average Hourly Wage Rate (W) -100,000 $85 Average Cost of Steel/Ton (S) -13,750 800Average Cost of Energy/mcf (E) –125,000 $4Average Interest Rate (i) in percent -1,000,000 8%
1. Find the market (Industry) supply equation (curve) for the new automobile.
2. Work out Practice: What happens to supply curve if any of the variable such as hourly wage rate changes.
Exercise: Market Supply EstimationExercise: Market Supply Estimation
Estimating Industry Supply for New Automobiles
Estimated Valuefor Independent
Parameter Variable duringIndependent Variable Estimate Coming Year
(1) (2) (3)Average Price for New Cars (P) 2,000 $25,000Average Price for SUV(Psuv) -400 $35,000Average Hourly Wage Rate (W) -100,000 $85 Average Cost of Steel/Ton (S) -13,750 800Average Cost of Energy/mcf (E) –125,000 $4Average Interest Rate (i) in percent -1,000,000 8%
1. Find the market (Industry) supply equation (curve) for the new automobile. (Q = - 42000000 +2000P)
2. Work out Practice: What happens to supply curve if any of the variable such as hourly wage rate changes.
Exercise: Market Supply EstimationExercise: Market Supply Estimation
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Supply and Demand TogetherSupply and Demand Together
D S Equilibrium: P has reached
the level where
quantity supplied equals quantity demanded
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium price:Equilibrium price:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The price that equates quantity supplied with quantity demanded
CHAPTER 4 THE MARKET FORCES OF
SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium quantity:Equilibrium quantity:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The quantity supplied and quantity demanded at the equilibrium price
Equilibrium in Automobile Equilibrium in Automobile marketmarketMarket demand curve: Qd = 20,500,000 – 500P
Market supply curve: Qs = - 42000000 +2000P
Equilibrium is at: Qd = Qs 20,500,000 – 500P = - 42000000 +2000P2500P = 62500000
Therefore, P = $25000Q = 20,500,000 – 500(25000) = 8,000,000
Numerical Problem on Demand and Numerical Problem on Demand and SupplySupply1) Suppose:Demand eqn. for a product: Qd = 286 −
20pSupply eqn. For a product: Qs = 88 +
40pFind Equilibrium Quantity and Price:
Numerical Problem on Demand and Numerical Problem on Demand and SupplySupply1) Suppose:Demand eqn. for a product: Qd = 286 − 20pSupply eqn. For a product: Qs = 88 + 40pFind Equilibrium Quantity and Price:Solution:
Qd = Qs
286 − 20p = 88 + 40p
60p = 198
P = $3.30
Q = 286 – 20(3.3) = 220
Some variations-Solved ProblemSome variations-Solved ProblemMarket Demand and Supply Case:
Given:
500 consumers with individual demand curves of Qi = 15−p
300 consumers with individual demand curves of Qi = 30−2p
Total demand from the market is: QM = 16500 − 1100p.
Find:
a) The total quantity buyers want to buy at price of $10:
b) The quantity that the 500 and 300 buyers want to buy at $10.
Some variations-Solved ProblemSome variations-Solved ProblemMarket Demand and Supply Case:
Given:
500 consumers with individual demand curves of Qi = 15−p
300 consumers with individual demand curves of Qi = 30−2p
Total demand from the market is: QM = 16500 − 1100p.
Find:
a) The total quantity buyers want to buy at price of $10:
At a price of $10, the buyers want to buy 16500− 1100 ・ 10 = 5500 units.
b) The total quantity that 500 and 300 buyers want to buy.
Each of the 500 buyers with an individual demand curves of
Qi = 15 − p wants to buy 15 − 10 = 5 units, for a total of 2500.
And each of the 300 buyers with individual demand curves of Qi = 30 − 2p wants to buy 30 − 2 ・ 10 = 10 units, for a total of 3000.
Thank youThank you