The Market Forces of Demand and Supply: Look For The Answers To These Questions
The Market Forces of Demand and Supply: Look For The Answers To These Questions
The Market Forces of Demand and Supply: Look For The Answers To These Questions
CHAPTER
4
Arjun Madan Ph D
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Demand
A schedule of the quantities of a good that buyers
are willing and able to purchase at each possible
price during a period of time, ceteris paribus. [all
other things held constant]
Law of demand
Other things being equal, the higher the price of
the commodity, less is the quantity demanded and
lower the price, more is the quantity demanded.
Demand
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Types of Demand
Direct / Autonomous Demand
Demand for goods meant for final consumption
Derived Demand
Demand is derived from the demand for final
commodity
Types of Demand
Competitive Demand
Demand for substitutes
Composite Demand
Commodities which have several uses
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Demand Function
Is the functional relationship between the price of
the good and the quantity of that good purchased in
a given time period [UT], income, other prices and
preferences being held constant.
Individual demand function can be expressed as:
Q = f (PX, I, Pr , P, A); where:
I = income, Pr = prices of related goods, P = preferences
A = Advertisement
Q = f (PX, holding I, Pr , P, A, etc. constant);
Thus, an individual demand function would be:
Q = f (PX)
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Qd = a b Px
Where,
a is a constant intercept term
b is the coefficient showing the slope of demand curve.
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Qd = a + b1Px+b2P1+b3P2+b4I+b5A+b6
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B $ . 50 15 . Demand is a schedule of
quantities
C $ . 75 12 . 5 that will be
DP > 0 DQ < 0 purchased
D $ 1. 00 [+.75] 10 . [-7.5]
at a schedule
E $ 1. 25 7.5 of prices during a given
F $ 1. 50 5. time period, cet. par.
G $ 1. 75 2.5
As the price is increased,
the quantity purchased
H $ 2 . 00 0 decreases.
Q = 20 - 10P
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2.25
P = $2, Then Q = 0 P = $1.75, then Q = 2.5
2.00
1.75 . . P = $1.50, then Q = 5
1.50
1.25 . . P = $1.25, Q = 7.5
P = $1, then Q = 10
..
1.00
.75 P = 0, then Q = 20
.50
.25 Demand
2 4 6 8 10 12 14 16 18 20 22 24 QUANTITY
The demand function can be represented as a table, {CUPS/UT}
an equation or a graph.
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An Illustration
D1 = 25 1.0P
D2 = 20 0.5P
D3 = 15 0.5P
Solution
Market demand is the sum of individual demands:
Dm = (25 1.0P)+(20 0.5P)+(15 0.5P)
Dm = 60 2.0P
Quantity to be sold 20 kgs, so the price should be
set such that demand is for 20 kgs
Dm = 60 2.0P
20 = 60 2.0P
P = 20
Thus, demand by each buyer would be
D1 = 5 , D2 = 10 and D3 = 5
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Practice Problem
Suppose the estimated demand function for shirts
in a departmental store is as follows:
Q = 300 1.5 P
Practice Problem 1
At Rs 90, the demand for shirt is estimated to be:
Q = 300 1.5 (90)
= 300 135
= 165 shirts
At Rs. 100, then the demand would be:
Q = 300 1.5 (100)
= 300 150
= 150 shirts
At what price demand would be zero?
Qd = 300 1.5P
let us put Qd = 0
300 1.5P = 0
1.5P = 300
P = 300 / 1.5 = Rs. 200
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Practice Problem 2
Qd = 400 4 P
Practice Problem
a)
P = 10: Qd = 400 - 4 x 10 = 360
P = 12: Qd = 400 4 X 12 = 352
P = 15: Qd = 400 4 X 15 = 340
P = 20: Qd = 400 4 X 20 = 320
P = 25: Q = 400 4 X 25 = 300
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Practice Problem
b) Qd = 400 4 P, c) Qd = 400 - 4P
let us put Qd = 0 Let Qd = 380
400 4P = 0
380 = 400 4 P
4P = 400
By manipulation
P = 400 / 4 = 100
4P = 400 380 = 20
At price Rs 100 per P = 20 / 4 = 5
bottle, the demand will be To sell 3,80,000 he
zero should charge Rs 5 per
bottle
Illustration
Demand for a goods is given by the equation:
DX = 1500 - 10PX + 4Y 15PY.
Find the demand equation for good X in terms of
price for P(PX) when
Y = 500, and
PY = 60
Solution !
DX = 1500 - 10PX+ 4Y 15PY
1500 10PX + 4(500) 15(60)
= 2600 10PX
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Illustration
Truett and Ruett (1980) described the following demand function for
a brand X of microwave ovens
Qx = f (Px, Pz, Nw, Y, A)
Where Qx = quantity demanded per year for brand X of microwave
ovens in a city,
Px = price of X brand
Pz = price of Z brand
Nw= number of working women
Y = mean annual household income
A = annual advertising expenditure
Assuming hypothetical data, we may state the demand estimation
as under :
Qx = 11,93,200 100Px + 20 Pz + 0.002 Nw + 1.8Y + 0.3A
On this basis, given that Px = 8000, Pz = 9000, Nw = 800,000 in a
city, Y = 100,000 A = 60,000 28
Solution
Qx = 11,93,200 (100 x 8000) + (20 x 9000) +
(0.002 x 800,000) + (1.8 x 100,000) + (0.3 x 60,000)
= 11,93,200 (800,000 + 180,000 + 1600 + 180,000
+ 18000)
= 11,93,200 11,79,600
= 13,600
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Determinants of Demand
Price of the Product
Income
Consumer tastes, preferences, needs, etc.
Availability and Price of related goods
substitutes and compliments
Fashion
Advertisements
Population- size, composition, density, and Income
distribution,
Future expectations of consumers
Exceptions
1. Giffen Goods (Inferior Goods)
3. Speculation/Future Expectation
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Rule One
When an independent variable changes and that
variable does not appear on the graph, the curve on
the graph will shift.
Rule Two
When an independent variable does appear on the
graph, a movement along the existing curve will
occur.
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2.00 A
D1
0
12 20 Number of Cigarettes
Smoked per Day
Change in Demand
A shift in the demand curve, either to the
left or right.
Caused by a change in a determinant other
than the price.
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Consumer Income
Normal Good
Price of Ice-
Cream Cone
$3.00 An increase
2.50 in income...
Increase
in demand
2.00
1.50
1.00
D2
0.50
D1
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
Consumer Income
Inferior Good
Price of Bus
ticket
$3.00
2.50 An increase
2.00
A1
A in income...
1.50
1.00
Decrease
0.50 in demand
D2 D1
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Bus rides
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Supply
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
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Determinants of Supply
Price of the commodity
Cost of production
State of technology
Number of firms
Government policies
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Supply Function
Sx = f(Px, C, T, G, N)
Px, = price of the product
C, = cost of production
T, = state of technology
G, = government policies
N = number of firms
Holding other factors constant, supply function
would be : Sx = f(P)
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Supply Schedule
Observation Price Quantity
Supplied
The information can be represented
A $1 6
on a graph by plotting each
B $2 10 price quantity combination.
C $3 14
D $4 18
E
F $5 22
P
Both the graph and the table $5
.
represent a supply
relationship: Q = 2 + 4P
$4
$3
. .
A supply schedule can be $2
displayed as a table or a curve.$1 .
2 4 6 8 10 12 14 Q
46
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Supply Schedule
2 4 6 8 10 12 14 16 Q
/ut
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Change in Supply
A change in supply is caused by a change in any
variable, other than price, that influences supply.
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Supply Schedule
Given the supply schedule,
Observation Price Quantity
An increase in the prices Supplied
of inputs would make it A $1 46
more expensive to produce
B $2 810
each unit of output,
C $3 1214
therefore, the supply
decreases D $4 1618
E
F $5 20
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P a shift to the left
$5 is a decrease in supply
The decreased quantity
$4
at each price shifts the
$3 supply curve to the left!
$2 The development of a new
technology that reduces the
$1
cost of production will shift
2 4 6 8 10 12 14 16 the supply function to the right
Q
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Equilibrium
A state of rest or balance due to the equal action of
opposing forces.
Equal balance between any power or influence [Websters
Encyclopedic Unabridged Dictionary of the English Language]
Market Equilibrium
Equilibrium Quantity=4
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654
Market Equilibrium
At prices above the equilibrium price, quantity
supplied is greater than quantity demanded,
resulting in a temporary surplus.
In a surplus situation, producers will try to reduce price to
entice consumers to buy more denim pants. Actions by
both producers and the public will wipe out the temporary
surplus.
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100
90 Given a demand
80 function [which
$70
70 represents the
behavior or choices
60 of buyers,
50 and a supply function
40 that represents the
30 behavior of
20 sellers,
10
10 20 30 40 50 60
60 70 80 90 100 110 120 130
Qx/ UT
Where the quantity that people want to buy is equal to the quantity
that the producers want to sell, there is an equilibrium quantity.
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded.
surplus = 45
100
$90
90
80 At $90 there is a surplus
equilibrium price of 45 units [80-35=45]
$70
70
equilibrium quantity
60
50
40
30
20
10
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surplus = 45
100
$90
90
80
$70
70
60
lower
price
. At a price of $90 a surplus
of 45 units exists
Suppliers have more to sell than
buyers will purchase at a price of $90.
50 To get rid of these unsold
40 Quantity units [inventory], the
Quantity
30
demanded
supplied sellers lower
increases
20
decreases the price.
10
10 20 30 35
40 50 60
60 70 8090
80 100 110 120 130
Qx/ UT
As the price of the good is reduced, the quantity supplied decreases.
The quantity demanded increases as the price falls.
As the price moves toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.
Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases.
At the higher price the quantity supplied increases
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660
100 demand
increases
90
$89 The market for good X is
80 price in equilibrium at Px = $70
rises
$70
70
60
50
40
30 equilibrium
quantity
20 increases
10
10 20 30 40 50 60
60 70 808090 100 110 120 130 Qx/ UT
An increase in the price of a
substitute [good Y] causes the The increase in the demand for
demand for good X to increase. good X results in an increase in
both the equilibrium price and
As a result of the increased demand, quantity.
market forces push Px up.
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100
90 Given a demand function,
80 an equilibrium is defined.
$70
70
A decrease in demand,
60
establishes a new equilibrium
$50.89
50
at a lower price and
40
quantity.
30
20
10
100
90 S2
80 supply
$70
70 increases
price
60 falls
50
$50
40
30
20
10
6070 80 86
10 20 30 40 50 60 90 100 110 120 130
Qx/ UT
Given an equilibrium
condition in a market, Quantity Identify factors that increase supply:
1. fall in price of inputs
an increase in supply will increases 2. improved technology
increase the equilibrium 3. increase in number of sellers
quantity and decrease 4. fall in return in alternative
equilibrium P. uses of inputs
5. or, . . .
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100 demand
increases S2If both supply and
90 and decrease
80 demand decrease,
price might price
+DP and the DP will be
$70
70 go up or down increase indeterminate and
60 or stay the same -DP price the equilibrium Q
increase
will decrease.
50 results in
increase
a market
40
supply force to
results in
D2
30
increases aincrease
market Q
20
force to
10 increase Q
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10 20 30 3540 49
50 60
60 70 80 90 100 110 120 Qx/ UT
the quantity decreases to 49
Illustration
Demand for wrist watches by Beyond Time Ltd.
for the year 2012 was given by
Qd = 1000 P and
supply is given by : Qs = 100 +4P
What is the equilibrium price?
What is the excess demand or supply if the price
is:
a) Rs 500
b) Rs100
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Solution
At equilibrium quantity Qd = quantity supplied Qs
Therefore, 1000 P = 100 + 4P
5P = 1000 100
P = 180
A) when price is Rs 500
Qd = 1000 500 = 500,
Qs = 100 + 4(500) = 2100
Therefore, excess supply = 2100 500 = 1600
B) when price is Rs 100
Qd = 1000 100 = 900
Qs = 100 + 4(100) = 500
Excess demand is 900 500 = 400 68
Illustration
Demand for X is given as
Dx = 1500 10Px + 4Y 15Py
Where Y = consumers income, and
Py is the price of related goods
Find demand equation for X in terms of price of X
(Px) when Y is Rs 500 and Py is Rs 60.
Supply function is given by the equation
Sx = 800 + 2Px
Find equilibrium price and quantity.
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Solution
Demand function by substituting the values of Y and Py
Dx = 1500 10Px + 4Y 15Py
1500 10Px + 4 (500) 15 (60) = 2600 10Px
Given the supply function:
Sx = 800 + 2Px equilibrium will occur when Dx = Sx
2600 10Px = 800 + 2Px
12Px = 2600 800
Px = 150
Equilibrium quantity is Dx = 2600 10Px
2600 10 (150)
Dx = 1100
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STEP 3, cont.
P1
But if supply
increases more P2
than demand,
D1 D2
P falls.
Q
Q1 Q2
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CONCLUSION:
How Prices Allocate Resources
One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
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