Demand and Supply Analysis
Course Teacher: Dr. A. R.
Sarker
Department of Economics The University of Rajshahi
Microeconomics-1 Course: ECO 111
“Teach a Parrot to Say ‘Supply and Demand’ and You Have an Economist” --Thomas Carlyle
learning objectives
• Discuss the variables that influence demand
• Discuss the variables that influence supply
• Use a graph to illustrate market equilibrium
•
• Use demand and supply graphs to predict
changes in prices and quantities
Suppose that the quantity of aman rice supplied
depends on the price of aman rice (P) and the amount of rainfall (R). The demand for aman rice depends on the price of the rice and the level of disposable
income (I). The equations describing the supply and demand relationships are Qs = 20R + 100P and Qd = 4,000 − 100P + 10I.
a) Sketch a graph of demand and supply curves that shows the effect of an increase in rainfall on the
equilibrium price and quantity of aman rice.
b) Sketch a graph of demand and supply curves that shows the effect of a decrease in disposable income on the equilibrium price and quantity of aman rice.
The demand and supply for soft drinks are given by Qd = 20 – P and Qs = 3P, respectively.
(1)Solve for the equilibrium price and quantity.
Suppose now the government imposes a per-unit tax of $4 on the sellers.
(i)Solve for the new quantity, net price sellers received, and price consumers paid.
(ii) Calculate the government revenue from the taxation
Some Basic Issues
Supply and demand have been called the “bread and butter” of economics
Supply and demand are the two words that economists use most often.
Supply and demand are the forces that make market economies work
Modern microeconomics is about supply, demand, and market
equilibrium.
MARKETS AND COMPETITION
A market is a group of buyers and sellers of a particular good or service.
The terms supply and demand refer to the
behavior of people . . . as they interact with one
another in markets.
MARKETS AND COMPETITION
Buyers determine demand.
Sellers determine supply
Competitive Markets
A competitive market is a market in which
there are many buyers and sellers so that
each has a negligible impact on the market
price.
DEMAND
Quantity demanded is the amount of a good that buyers are willing and able to purchase.
Law of Demand
The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises.
PRICES
Absolute Price: the price of a good in monetary terms (Ex: A new Car costs $30,000).
Relative Price: the price of a good in terms of another good (Ex: A new Car costs 30
computers)
Relative price is calculated by dividing the
absolute price of one product with the absolute price of another product
(Ex: A Car costs $30,000; A Computer costs
$1,000; The relative cost of a Car is 30 Computers)
What Explains the Law of Demand?
Substitution effect The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive
relative to other goods that are substitutes. People substitute lower-priced goods for higher-priced goods.
Income effect The change in the quantity
demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.
The Law of Diminishing Utility: for a given time period, the marginal utility or satisfaction gained by consuming equal successive units of a good will
decline as the amount consumed increases.
The Demand Schedule and Curve
(a)
(b)
Market Demand versus Individual Demand
Market demand refers to the sum of all
individual demands for a particular good or service.
Graphically, individual demand curves are
summed horizontally to obtain the market
demand curve.
16
$25 1 + 0 = 1 $20 2 1 3 $15 3 3 6 $10 4 5 9 $5 5 7 12
Price Fred Mary Total Demanded
Market Demand Schedule for Compact Discs
17
12
$20
$15
$10
$5
1 2 3 4
P
5 6 7 8 9 Q
Fred’s Demand Curve
D
113
$20
$15
$10
$5
1 2 3 4
P
5 6 7 8 9 Q
Mary’s Demand Curve
D
214
$20
$15
$10
$5
3 4 5 6
P
Q
7 8 9 10 11
Market Demand Curve
D
312
Variables That Shift Market Demand
Normal good A good for which the demand increases as income rises and decreases as income falls.
Inferior good A good for which the demand increases as income falls and decreases as income rises.
Learning Objective 3.1
•
Income
Many variables other than price can
influence market demand.
Variables That Shift Market Demand
Substitutes Goods and services that can be used for the same purpose.
Complements Goods and services that are used together.
Learning Objective 3.1
•
Price of related goods
Consumers can be influenced by an advertising campaign for a product.
•
Tastes
20
Exhibit 4 Substitutes and Complements
Variables That Shift Market Demand
Demographics The characteristics of a population with respect to age, race, and gender.
Learning Objective 3.1
•
Population and demographics
•
Expected Future Prices
Consumers choose not only which
products to buy but also when to buy
them.
Variables That Shift Market Demand
Learning Objective 3.1
Variables That Shift Market Demand Curves
Variables That Shift Market Demand
TABLE
Variables That Shift Market Demand Curves (continued)
A Change in Demand versus a Change in Quantity Demanded
Learning Objective 3.1
FIGURE
A Change in Demand versus a Change in the Quantity Demanded
The Supply Side of the Market
Quantity supplied is the amount of a good that sellers/firms are willing and able to sell.
Law of Supply
The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises and vice versa.
The Supply Side of the Market
Supply schedule A table that shows the
relationship between the price of a product and the quantity of the product supplied.
Supply curve A curve that shows the relationship between the price of a product and the quantity of the product supplied.
Learning Objective 3.2
Supply Schedules and Supply Curves
The Supply Side of the Market
Learning Objective 3.2
Supply Schedules and Supply Curves
The Supply Side of the Market
Law of supply The rule that, holding
everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the
quantity supplied.
•
Explanation
• Price acts as an incentive to producers
• At some point, costs will rise
Learning Objective 3.2
The Supply Side of the Market
Law of supply: Explanation
Producers are willing to produce and sell more of their product at a high price than at a low price.
There is a direct relationship between price and quantity supplied.
Given product costs, a higher price means
greater profits and thus an incentive to increase the quantity supplied.
Beyond some level of output, producers usually encounter increasing costs per added unit of
output.
Learning Objective 3.2
The Supply Side of the Market
Learning Objective 3.2
FIGURE
Shifting the Supply Curve
The Supply Side of the Market
• Prices of substitutes in production
• Number of firms in the market
• Expected future prices
Learning Objective 3.2
Variables That Shift Supply
Technological change A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.
The following are the most important variables that shift supply:
• Prices of inputs
• Technological change
The Supply Side of the Market
Learning Objective 3.2
Variables That Shift Supply
TABLE
Variables That Shift Market Supply Curves
The Supply Side of the Market
TABLE 3
Variables That Shift Market Supply Curves (continued)
Variables That Shift Supply
The Supply Side of the Market
FIGURE
A Change in Supply versus a Change in the Quantity Supplied
A Change in Supply versus a Change in Quantity Supplied
Market Equilibrium: Putting Demand and Supply Together
FIGURE 3-7
Market Equilibrium
Learning Objective 3.3
Market Equilibrium: Putting Demand and Supply Together
Market equilibrium A situation in which
quantity demanded equals quantity supplied.
Competitive market equilibrium A market equilibrium with many buyers and many
sellers.
Learning Objective 3.3
Market Equilibrium: Putting Demand and Supply Together
Learning Objective 3.3
Surplus A situation in which the quantity supplied is greater than the quantity
demanded.
Shortage A situation in which the quantity demanded is greater than the quantity
supplied.
How Markets Eliminate Surpluses and Shortages
Market Equilibrium: Putting Demand and Supply Together
Learning Objective 3.3
FIGURE
The Effect of Surpluses and Shortages on the Market Price
How Markets Eliminate Surpluses and Shortages
Market Equilibrium: Putting Demand and Supply Together
Learning Objective 3.3
Demand and Supply Both Count
Always keep in mind that it is the interaction of demand and supply that determines the equilibrium price.
Neither consumers nor firms can dictate what the equilibrium price will be.
No firm can sell anything at any price unless it can find a
willing buyer, and no consumer can buy anything at any price without finding a willing seller.
The Effect of Demand and Supply Shifts on Equilibrium
FIGURE
The Effect of an Increase in Supply on Equilibrium
The Effect of Shifts in Supply on Equilibrium
Learning Objective 3.4
The Falling Price of LCD Televisions Making
the
Connection
Learning Objective 3.4
The Effect of Demand and Supply Shifts on Equilibrium
FIGURE 3-10
The Effect of an Increase in Demand on Equilibrium
The Effect of Shifts in Demand on Equilibrium
Learning Objective 3.4
The Effect of Demand and Supply Shifts on Equilibrium
FIGURE
Shifts in Demand and Supply over Time
The Effect of Shifts in Demand and Supply over Time
Market equilibrium
What do you think?
Is the market equilibrium always an ideal outcome for all market participants?
Price floor: A legally determined minimum price that sellers may receive.
• Minimum wage law
• Agricultural price supports
Price ceiling: A legally determined
maximum price that sellers may receive.
•
Rent control
Governments impose price ceilings is to protect consumers from situations in which they are not able to afford needed commodities.
Government intervention in the
market
0
550 700
S
D Surplus
Rice/wheat
Price Floor
Price (Tk./
Maund)
Quantity (Millions of MT per year)
2.0
1.8 2.2
Price floor
Price Floor: consequences
Rice/wheat price controls?
Market responses to a rice/wheat price floor
Stockpiles
Government purchase schemes
Production quotas
0
S
D
$1000
Price Ceiling: rent control
Price
(dollars per month)
Quantity
(apartments per month)
$1500
1 900 000 2 000 000 2 100 000
Shortage of apartments
Rent control price ceiling
Price Ceiling: rent control
Rent controls reconsidered
Shortages
Illegal markets
Less maintenance
Markets and social welfare
3-50
What do you think?
When are the prices and quantities
determined in market equilibrium socially optimal, in the sense of maximising total economic surplus?
LEARNING OBJECTIVE 1
Marginal benefit:
The additional benefit to a
consumer from consuming one more unit of a good or service.
Consumer surplus: The difference between the highest price a consumer is willing to pay and the price the consumer actually pays.
Consumers’ surplus = Maximum buying price - Price paid
Consumer Surplus and Producer
Surplus
Consumer Surplus and Producer Surplus
What is the total valuation of first 5 buyers? Ans. 255.
If the price is 43. How much is the demand? How much is the total expenditure? How much is the surplus of
each of the buyers? How much is the total consumer surplus?
Consumer Surplus and Producer Surplus
If the price is 43. How much is the demand? How much is the total expenditure? How much is the surplus of each of the buyers? How much is the total consumer surplus?
Demand is 5. Total expenditure = 43*5=215
Total consumer surplus: 255-215=40
Price
(dollars per cup)
Quantity (cups per week)
0 4
The demand curve is also the marginal benefit curve
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Demand
$7.00
$3.00
5
Joes’ marginal benefit from consuming the fourth cup is
$3.00.
$2.00
Joes’ marginal benefit from consuming the fifth cup is
$2.00.
Price
(dollars per cup)
Quantity (cups per week)
0
Total consumer surplus in the market for chai tea
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Demand
15 000
$2.00
Total consumer surplus in the
market for chai tea
Marginal cost:
The additional cost to a firm from producing one more unit of a good or service.
Producer surplus: The difference between the lowest price a firm would have been willing to
accept and the price it actually receives.
Producers’ (sellers’) surplus = Price received - Minimum selling price
Consumer Surplus and Producer
Surplus
Price
(dollars per cup)
Quantity (cups per week)
0 40
The supply curve shows marginal cost
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Supply
$1.80
50
The marginal cost of producing the 40th cup is $1.80.
$2.00
The marginal cost of producing the 50th cup is $2.00.
Producer surplus on the 40th cup sold.
Price
(dollars per cup)
Quantity (cups per week)
0
Total producer surplus in the market for chai tea
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
15 000
$2.00
Total producer surplus from
selling chai tea Supply
Price
(dollars per cup)
Quantity (cups per week)
0
Economic surplus equals the sum of consumer surplus and producer surplus
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Demand
15 000
$2.00
Consumer surplus
Supply
Producer surplus
At equilibrium, both consumers’
surplus and producers’ surplus are maximized. In short, total surplus is maximized
TS = CS + PS
CS and PS
Consumer surplus measures the net benefit (total benefit minus total price paid) to
consumers from participating in a market.
Producer surplus measures the net benefit (total benefit minus total cost of production) to producers from participating in a market.
LEARNING OBJECTIVE 1
What Consumer Surplus and
Producer Surplus Measure?
Equilibrium in a competitive market results in the economically efficient level of output
where marginal benefit equals marginal cost.
Economic surplus: The sum of consumer surplus and producer surplus.
Deadweight loss: The reduction in
economic surplus resulting from a market not being in competitive equilibrium.
The Efficiency of Competitive
Markets
A B
C
0
$3.00
$3.50
S
D Surplus
wheat
Price Floor: Figure 5.7
Price
(dollars per bushel)
Quantity (billions of bushels per year)
2.0
1.8 2.2
Consumer surplus transferred to
producers
Deadweight loss = B + C
Price floor
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
B A C
0
S
D
$1000
Price Ceiling: Figure 5.8
Price
(dollars per month)
Quantity
(apartments per month)
$1500
1 900 000 2 000 000 2 100 000
Deadweight loss = B + C Producer surplus
transferred from landlords to renters
Shortage of apartments
Rent control price ceiling
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
The Effect of a Tax on the Market for Cigarettes
Suppose the demand and supply for soft drinks is: QD = 20- P QS = 3P
a)Solve for the equilibrium price and quantity.
Suppose the government imposes a per-unit tax of $4 on the sellers.
b) Solve for the new quantity, the net price received by sellers, and the price paid by consumers.
c) Calculate the government revenue from the tax.
d) Calculate the deadweight loss resulting from the tax.
e) What fraction of the economic incidence of the tax is borne by consumers?
Consider a linear demand curve, Q = 350 - 7P.
a)Derive the inverse demand curve corresponding to this demand curve.
b) What is the choke price?
c) What is the price elasticity of demand at P = 50
Explain the law of supply and its relationship to marginal cost.
Marginal cost is the cost of producing an additional unit of a good or service. Generally, marginal cost rises on each
successive unit produced. Because of this, a producer is willing to increase production only if he or she receives a higher price for the additional units produced. If price falls, the cost of
producing the good will be more than the price the seller receives, and he or she will cut back production. The law of supply says that there is a direct relation between price and quantity supplied. As can be seen, it is marginal cost and the principle of increasing marginal cost that underlies this law.
