Demand and supply
analysis
Learning Objectives
• Develop the concepts of demand and
supply.
• Discuss the factors that lead to shifts
in the demand and supply curves.
• Explain how prices and output are
determined in product markets
through the interaction of demand
and supply.
Copyright 2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
2
Slides prepared by Muni Perumal, University of Canberra, Australia.
Markets
• A market is any institutional
structure, or mechanism, that brings
together buyers and sellers of
particular goods and services
• Markets exists in many forms
• They determine the price and
quantity of a good or service
transacted Copyright 2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
3
Slides prepared by Muni Perumal, University of Canberra, Australia.
Buyers and Sellers
• Buyers and sellers in a market can be
• Households
• Business firms
• Government agencies
• All three can be both buyers and sellers in the same market, but are
not always
• For purposes of simplification this text will usually follow these
guidelines
• In markets for consumer goods, we’ll view business firms as the
only sellers, and households as only buyers
• In most of our discussions, we’ll be leaving out the “middleman”
Determinants of Demand
• Price Of Product
• Income Of Consume
• Price Of Related Good
• Tastes And Preferences
• Advertising
• Consumer's Expectation
• Growth Of Economy
• Seasonal Conditions
Law of Demand
• The inverse relationship between the price
and the quantity demanded of a good or
service during some period of time
Copyright 2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
7
Slides prepared by Muni Perumal, University of Canberra, Australia.
The Law of Demand
• The law of demand
states that there is a
negative, or inverse,
relationship between
price and the quantity of
a good demanded and its
price.
• This means that
demand curves slope
downward.
Demand function
• The demand for product X can be written in functional form as:
The Demand Curve
• The demand curve shows how much of a good consumers are willing
to buy as the price per unit changes holding non price factors
constant.
Why the demand curve slope downwards?
1. Income effect
2. Substitution effect
3. Diminishing marginal utility
4. New consumers
Copyright 2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
11
Slides prepared by Muni Perumal, University of Canberra, Australia.
The Demand Schedule and The Demand Curve
• Demand schedule
• A list (price- quantity combination) showing the quantity of a good that
consumers would choose to purchase at different prices, with all other variables
held constant
• The market demand curve (or just demand curve) shows the relationship between
the price of a good and the quantity demanded , holding constant all other variables
that influence demand
• Each point on the curve shows the total buyers would choose to buy at a specific
price
• Law of demand tells us that demand curves virtually always slope downward
Demand Schedule
Demand Schedule › Demand Curve
Individual and Market Demand
• Demand for a good or service can be defined for an
individual household, or for a group of households that
make up a market.
• Market demand is the sum of all the quantities of a
good or service demanded per period by all the
households buying in the market for that good or
service.
• Market demand is derived by horizontally summing
individual demand curves
From Household Demand to Market
Demand
• Assuming there are only two households in the
market, market demand is derived as follows:
Factors causing a shift in the demand curve(Change in demand)
• Tastes and preferences—If the consumer’s tastes and preferences for a
commodity are greater, its demand would be larger and the demand curve
would be at a higher level.
• Income of the people--- An increase in income increases the purchasing
power of the consumer and thus, consumers who could not purchase the
commodity can purchase it after the income increase causing an increase in
demand.
• Changes in prices of related goods-- When the price of a substitute good
increased the demand for the commodity considered will increase and vice-
versa
• Eg. Tea and coffee. When the price of a complementary good increased
demand for the commodity considered will also decrease because
complementary goods are the ones that should be used together. Eg. Motor
vehicles and fuel.
Factors causing a shift in the demand curve(Change in demand)
• Number of consumers in the market—When the number of
consumers in the market is high quantity demanded will be high.
• Consumer expectations with regard to future prices—As discussed
early.
• Income distribution--- Where the income distribution of the society
is equal purchasing power of all consumers will increase raising the
demand for the commodities.
Change in quantity demanded Vs. Change in demand
• Changes in the price of a product affect the
quantity demanded per period
• Changes in any other factor, income or preferences,
affect demand
Change in demand Vs. Change in quantity demanded
• A shift of the entire demand curve to a new position is called change
in demand.
• Changes in non-price determinates of demand
Quantity demanded
• Fluctuations in price, another determinant of demand cause
movement along the demand curve.
A Change in Demand Versus a Change in
Quantity Demanded
To summarize:
Change in price of a good or service
leads to
Change in quantity demanded
(Movement along the curve).
Change in income, preferences, or
prices of other goods or services
leads to
Change in demand
(Shift of curve).
The Impact of a Change in
Income
• Higher income • Higher income
decreases the demand increases the demand
for an inferior good for a normal good
The Impact of a Change in
the Price of Related Goods
• Demand for complement good
(ketchup) shifts left
• Demand for substitute good (chicken)
shifts right
• Price of hamburger rises
• Quantity of hamburger
demanded falls
Supply Analysis
Supply
• Market quantity supplied (or quantity supplied) is the
specific amount of a good that all sellers in the market would
choose to sell over some time period, given
• A particular price for the good
• All other constraints on firms
• The various amounts of a product that producers are willing
and able to supply at various prices during some specific
period.
The Law of Supply
• States that when the price of a good rises and
everything else remains the same, the quantity of
the good supplied will rise
• The words, “everything else remains the same” are
important
• In the real world many variables change simultaneously
• However, in order to understand the economy we must first
understand each variable separately
• We assume “everything else remains the same” in order to
understand how supply reacts to price
The Law of Supply
Price of soybeans per bushel ($)
6 • The law of supply
5 states that there is a
4 positive relationship
3 between price and
2 quantity of a good
1 supplied.
0
• This means that supply
0 10 20 30 40 50
Thousands of bushels of soybeans curves typically have a
produced per year
positive slope.
Determinants of Supply
• The price of the good or service.
• The cost of producing the good, which in turn
depends on:
• The price of required inputs (labor, capital, and
land),
• The technologies that can be used to produce
the product,
• The prices of related products.
The Supply Schedule and The Supply
Curve
• Supply schedule—shows quantities of a good or service firms would
choose to produce and sell at different prices, (so again P-Q
combination but??)with all other variables held constant
• Supply curve—graphical depiction of a supply schedule
• Shows quantity of a good or service supplied at various prices, with all other
variables held constant
The Supply Curve and
the Supply Schedule
• A supply curve is a graph illustrating how much
of a product a firm will supply at different prices.
CLARENCE BROWN'S
6
Price of soybeans per bushel ($)
SUPPLY SCHEDULE
FOR SOYBEANS
5
QUANTITY
SUPPLIED 4
PRICE (THOUSANDS
(PER OF BUSHELS 3
BUSHEL) PER YEAR)
$ 2 0 2
1.75 10
1
2.25 20
3.00 30 0
4.00 45
5.00 45 0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Figure 4: The Supply Curve
Price per When the price is $2.00
Bottle per bottle, 40,000 bottles
S
are supplied (point F).
$4.00 G
At $4.00 per bottle,
2.00 F quantity supplied is
60,000 bottles (point G).
40,000 60,000 Number of Bottles
per Month
From Individual Supply
to Market Supply
• The supply of a good or service can be defined for an
individual firm, or for a group of firms that make up a
market or an industry.
• Market supply is the sum of all the quantities of a
good or service supplied per period by all the firms
selling in the market for that good or service.
Market Supply
• As with market demand, market supply is the
horizontal summation of individual firms’ supply
curves.
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Shifts vs. Movements Along the
Supply Curve
• A change in the price of a good causes a movement along the supply
curve
• In Figure 4
• A rise (fall) in price would cause a rightward (leftward) movement along
the supply curve
• A drop in transportation costs will cause a shift in the supply curve
itself
• In Figure 5
• Supply curve has shifted to the right of the old curve (from Figure 4) as
transportation costs have dropped
• A change in any variable that affects supply—except for the good’s price
—causes the supply curve to shift
Figure 5: A Shift of The Supply Curve
Price per A decrease in transportation
Bottle costs shifts the supply curve for
maple syrup from S1 to S2. S1 S2
At each price, more bottles
are supplied after the shift
$4.00 J
G
60,000 80,000 Number of Bottles
per Month
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 leftward
(rightward)
• Technology
• Cost-saving technological advances increase the supply of
a good, shifting the supply curve to the right
Factors That Shift the Supply Curve
• Number of Firms
• An increase (decrease) in the number of sellers—with no
other changes—shifts the supply curve to the right (left)
• Expected Price
• An expectation of a future price increase (decrease) shifts
the current supply curve to the left (right)
Factors That Shift the Supply Curve
• 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
Figure 6(a): Changes in Supply and
in Quantity Supplied
Price Price increase moves S
us rightward along
supply curve
P2
P1
Price decrease
moves us leftward
P3 along supply curve
Q3 Q1 Q2 Quantity
Figure 6(b): Changes in Supply and in Quantity
Supplied
Price Entire supply curve shifts S1
rightward when: S2
• price of input ↓
• price of alternate good ↓
• number of firms ↑
• expected price ↓
• technological advance
• favorable weather
Quantity
Figure 6(c): Changes in Supply and in Quantity
Supplied
Price
Entire supply curve shifts S2
leftward when: S1
• price of input ↑
• price of alternate good ↑
• number of firms ↓
• expected price ↑
• unfavorable weather
Quantity
A Change in Supply Versus
a Change in Quantity Supplied
To summarize:
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).
In Summary: Factors That Shift The Supply
Curve
• The short list of shift-variables for supply that we have discussed is far from
exhaustive
• In some cases, even the threat of such events can cause serious effects on
production
• Basic principle is always the same
• Anything that makes sellers want to sell more or less of a good at any given price will
shift supply curve
Market Equilibrium
Equilibrium: Putting Supply and Demand
Together
• When a market is in equilibrium
• Both price of good and quantity bought and sold have settled into a state of rest
• The equilibrium price and equilibrium quantity are values for price and quantity in
the market but, once achieved, will remain constant
• Unless and until supply curve or demand curve shifts
• The equilibrium price and equilibrium quantity can be found on the vertical
and horizontal axes, respectively
• At point where supply and demand curves cross
Market Equilibrium
• Only in equilibrium is
quantity supplied equal
to quantity demanded.
• At any price level
other than P0, the
wishes of buyers
and sellers do not
coincide.
Market Disequilibria
• Excess demand, or shortage,
is the condition that exists
when quantity demanded
exceeds quantity supplied at
the current price.
• When quantity demanded
exceeds quantity
supplied, price tends to
rise until equilibrium is
restored.
Market Disequilibria
• Excess supply, or surplus, is
the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
• When quantity supplied
exceeds quantity
demanded, price tends to
fall until equilibrium is
restored.
Price Ceilings
and Price Floors
• Price Ceiling
• is a legally established maximum price which a seller can charge or a buyer
must pay.
• Price Floor
• is a legally established minimum price which a seller can charge or a buyer
must pay.
51
A Binding Price Ceiling
Price
S
Price
PE Ceiling
PC
Shortag
e D
Q QE Q Quantity/time
S D
52
Price Floors
• When the Government imposes a price floor (i.e., a
legal minimum price at which a good can be sold) two
outcomes are possible:
• The price floor is not binding.
• The price floor is a binding constraint on the market,
creating surpluses.
53
A Binding Price Floor
Price S
Surplus
PF
Price Floor
PE
Q QE Q Quantity/time
D S
54
Market Impacts
of a Price Floor
• A Binding Price Floor creates. . .
• Surpluses (QS > QD)
• Surpluses create :
• Discrimination criteria set by buyers
• Examples:
• Agricultural Price Supports
55
Increases in Demand and Supply
• Higher demand leads to higher • Higher supply leads to lower
equilibrium price and higher equilibrium price and higher
equilibrium quantity. equilibrium quantity.
Decreases in Demand and Supply
• Lower demand leads to • Lower supply leads to higher
lower price and lower price and lower quantity
quantity exchanged. exchanged.
Relative Magnitudes of Change
• The relative magnitudes of change in supply and
demand determine the outcome of market equilibrium.
Relative Magnitudes of Change
• When supply and demand both increase, quantity
will increase, but price may go up or down.
Predicting Changes in Price and Quantity
Increase in Both Demand
and Supply
An increase in demand and
an increase in supply
increase the equilibrium
quantity.
The change in equilibrium
price is uncertain because the
increase in demand raises the
equilibrium price and the
increase in supply lowers it.
Predicting Changes in Price and Quantity
Decrease in Both Demand
and Supply
A decrease in both demand
and supply decreases the
equilibrium quantity.
The change in equilibrium
price is uncertain because
the decrease in demand
lowers the equilibrium price
and the decrease in supply
raises it.
Predicting Changes in Price and Quantity
Decrease in Demand and
Increase in Supply
A decrease in demand and
an increase in supply lowers
the equilibrium price.
The change in equilibrium
quantity is uncertain because
the decrease in demand
decreases the equilibrium
quantity and the increase in
supply increases it.
Predicting Changes in Price and Quantity
Increase in Demand and
Decrease in Supply
An increase in demand and a
decrease in supply raises the
equilibrium price.
The change in equilibrium
quantity is uncertain because
the increase in demand
increases the equilibrium
quantity and the decrease in
supply decreases it.
