Chapter 3.1 KTVM

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10/17/22

Chapter 3

SUPPLY – DEMAND
THE MARKET FORCES OF SUPPLY AND DEMAND

Market
• Definition: (market)

Producer
àSUPPLY
ty
Quanti
(producer - supply) Price& d and
of goo Consumer
s
service DEMAND
(consumer - demand)

Market
• A market: a group of buyers and sellers of a
particular good or service.
• The buyers: determine the demand for the product
• The seller: determine the supply of the product

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Competition
• Most markets in the economy is highly competitive.
• Each buyer knows that there are several sellers from
which to choose.
• Each seller is aware that his product is similar to that
offered by other sellers.
• The price and quantity are not determined by any
single buyer or seller
• The price and quantity are determined by all buyers
and sellers as they interact in the marketplace

Competitive market
• A market in which there are so many buyers and so
many sellers that each has a negligible impact on the
market price.
• In this market, each seller has limited control over the
price because other sellers are offering similar
products.
• A seller has little reason to charge less than the going
price. If he charges more, buyers will make their
purchases elsewhere.
• No single buyer can influence the price of product
because each buyer purchases only a small amount

Competitive market
• To reach the highest form of competition = perfectly
competitive market, a market must have two
characteristics:
1. The goods offered for sale are all exactly the same.
2. The buyers and sellers are so numerous that no single
buyer or seller has any influence over the market.
• Buyers and sellers in perfectly competitive markets
must accept the price the market determines: they
are said to be price takers
• At the market price, buyers can buy all they want, and
sellers can sell all they want

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Competitive market
• In rice market
• There are thousands of farmers who sell rice and
millions of consumers who use rice and rice products.
• No single buyer or seller can influence the price of
rice, each takes the market price as given.

DEMAND
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Definition
• Demand
The quantity demanded: the amount of a good that buyers are
willing and able to purchase.
▫ Need
▫ Be able to purchase
▫ Willing-to-pay
• Law of demand:
• Other things being equal, when the price of a good rises, the
quantity demanded of the good falls – when the price falls, the
quantity demanded rises.
• Demand schedule:
• A table that shows the relationship between the price of a good
and the quantity demanded
• (Holding constant everything else that influences how much of the
good consumers want to pay

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Cathie’s demand schedule and demand curve

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Demand curve
• The price is on the vertical
axis
• The quantity is on the
horizontal axis
• The line relating price and
quantity demanded is
called the demand curve
• The demand curve slopes
downward: a lower price
means a greater quantity
demanded.

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Demand Function
QD = f(P) = a + b.P (b<0)

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Market Demand versus Individual Demand


• Market Demand
The sum of all the individual demands for a particular good or
service.
Sum the individual demand curves horizontally to obtain the market
demand curve.
= adding horizontally the individual demand curves

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Market Demand versus Individual Demand

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Market Demand versus Individual Demand


• Market Demand
The sum of all the individual demands for a particular good or
service.
Sum the individual demand curves horizontally to obtain the market
demand curve.
= adding horizontally the individual demand curves

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Shifts in the Demand Curve

• If something happens to alter the quantity demanded at


any given price, the demand curve shifts.

• Any change that increases the quantity demanded at every


price = shifts the demand curve to the right = an increase
in demand

• Any change that reduces the quantity demanded at every


price shifts the demand curve to the left = a decrease in
demand

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Shifts in the Demand Curve

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Variables that can shift the demand curve

1. Income
• A lower income = you have less to spend in total = you have
to spend less most goods.

• The demand for a good falls when income falls = normal


good = an increase in income leads to an increase in demand
- necessities and luxury goods

• The demand for a good rises when income falls = inferior


goods = an increase in income leads to a decrease in
demand

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Variables that can shift the demand curve

2. Prices of Related goods


• A fall in the price of one good reduces the demand for
another good = substitutes = an increase in the price of one
leads to an increase in the demand for the other.

• A fall in the price of one good raise the demand for another
good = complements = an increase in the price of one leads
to a decrease in the demand for the other

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Variables that can shift the demand curve

3. Tastes

• If you like something, you buy more of it.

• When tastes change, the demand will change.

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Variables that can shift the demand curve


4. Expectations

• An expectation about the future may affect the demand for


a good or service today.

• Ex: If you expect to earn a lower income next month, what


would you do?
• If you expect the price of something you like to fall next
week, what should you do?

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Variables that can shift the demand curve

5. Number of buyers

Market demand depends on the number of buyers.

The more people join the market, the higher quantity


demanded and the market demand would increase

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Summary

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Shifts in the Demand Curve versus Movements


along the Demand Curve

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Shifts in the Demand Curve


P (shifts the D curve)

(changes in other factors)

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Movements along the Demand Curve


P
(moves along the D curve)

(changes in price itself)

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Summing Up:
• Extension in demand is due to reduction in price.
• Increase in demand occurs due to changes in factors
other than price.
• Contraction in demand is the result of a rise in the price
commodity.
• A decrease in demand follows a change in factors other
than price.
• Changes in demand both increase and decrease are
represent shifts in the demand curve.
• Changes in the quantity demanded are represented by
move along the same demand curve.

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SUPPLY

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Definition
• Quantity supplied
The quantity supply: the amount of a good that sellers are
willing and able to sell.

• Law of supply:
Other things being equal, the quantity supplied of a good rises
when the price of the good rises.

• Supply schedule:
• A table that shows the relationship between the price of a good
and the quantity supplied.
• (Holding constant everything else that influences how much of the
good producers want to sell)

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• Supply Schedule

A table that shows the quantity


supplied at each price Chocolate
Quantity
Price
supplied
(PS)
(QS)
0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18

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P (S): QS = 0 + 3P Quantity
Price
Supplied
(PS)
(QS)
0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
Q 6.00 18

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• Supply Function

QS = f(P) = c + d.P (d>0)

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Individual Supply versus Market Supply


• Market Supply:
Price QSNoka QSBelco QSMarket
0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30

• Market supply curve: sum the individual supply curves


horizontally to obtain the market supply curve.

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Shifts in the Supply Curve

• Any change that raises quantity supplied at every price =


shifts the supply curve to the right = an increase in supply

• Any change that reduces the quantity supplied at every


price shifts the supply curve to the left = a decrease in
supply

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Shifts in the Supply Curve

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Variables that can shift the Supply curve

1. Input Prices
• When the price of one or more of inputs rises, producing is
less profitable, firms supply less.

• If input prices rise substantially, a firm might shut down


and supply no product at all.

• The supply of a good is negatively related to the price of the


inputs used to make the good.

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Variables that can shift the supply curve

2. Technology
• The technology for turning inputs into products is another
determinant of supply.

• The invention of new machine will reduce the amount of


labor necessary to make product.

• By reducing firms’ costs, the advance in technology raised


the supply of product.

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Variables that can shift the supply curve

3. Expectations

• The amount of a product a firm supplies today may depend


on its expectations about the future.

• Ex: If a firm expects the price of a product to rise in the


future, it will put some of is current production into
storage and supply less to the market today.

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Variables that can shift the supply curve


4. Number of Sellers

Market supply depends on the number of the sellers.

• If the number of sellers increases, the supply of the market


will increase.

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Summary

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SUPPLY AND DEMAND


TOGETHER

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Markets
P D
Not in Equilibrium:
S
Surplus
Surplus •Surplus (excess supply):
•quantity supplied is
greater than quantity
demanded

•Example: if P = $5,
• then QD = 9 lattes
• and QS = 25 lattes
Q •
•resulting in a surplus of
16 lattes
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Markets Not in Equilibrium: Surplus


D S
Surplus •Facing a surplus,
P
sellers try to increase
sales by cutting price.

•This causes QD to rise

•and QS to fall…

•…which reduces the


surplus.
Q

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Markets Not in Equilibrium: Surplus


P D S
Surplus
•Facing a surplus,
sellers try to increase
sales by cutting price.

•This causes QD to rise

•and QS to fall…
•Prices continue to fall
Q market reaches
until
equilibrium.

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Markets Not in Equilibrium:


Shortage •Shortage (excess demand):
P D S •quantity demanded is
greater than quantity
supplied

•Example: if P = $1,
• then Q D = 21 lattes
• and Q S = 5 lattes

•resulting in a shortage of 16
Shortage
Q
lattes

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Markets Not in Equilibrium:


Shortage
P D S •Facing a shortage,
sellers raise the price,

• causing QD to fall

• and QS to rise,

•…which reduces the


Shortage shortage.
Q

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Markets Not in Equilibrium:


Shortage •Facing a shortage,
P D S sellers raise the price,

• causing QD to fall

• and QS to rise,

•…which reduces the


shortage.
Shortage •Prices continue to rise
until market reaches
Q
equilibrium.

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Equilibrium

A situation in which the market price has reached the level


at which quantity supplied equals quantity demanded

At the equilibrium price, the quantity of the good that


buyers are willing and able to buy exactly balances the
quantity that sellers are willing and able to sell.

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Equilibrium
P D S (Equilibrium) E
-Equilibrium Price PE: the
price that balances
quantity supplied and
quantity demanded (QS =
PE E QD)
-Equilibrium quantity QE:
the quantity supplied and
the quantity demanded
at the equilibrium price.
Q

QE

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Equilibrium
P D S
P QD QS
0 24 0
1 21 5
PE E 2 18 10
3 15 15
4 12 20
5 9 25
Q 6 6 30

QE

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The Equilibrium of Supply and Demand

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The market price is not equal to the


equilibrium price – Market not in Equilibrium
P
S
Surplus
Market price is higher
PM
than equilibrium price
(PM > PE)
PE E

D
Q
QD QE QS

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The market price is not equal to the


equilibrium price – Market not in Equilibrium
P

S
Market price is lower
than equilibrium price
(PM < PE)
PE E

PM
Shortage
D
Q
QS QE QD

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Supply and Demand Together


Three steps to analyzing changes in equilibrium
1. Decide whether the event shifts the supply curve, the
demand curve, or, in some cases, both curves
2. Decide whether the curve shifts to the right or to the
left
3. Use the supply-and-demand diagram
– Compare the initial and the new equilibrium
– Effects on equilibrium price and quantity

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Summing up

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Elasticity and Its


Application

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Elasticity
Consumers usually buy more of a good:
• Its price is …
• Incomes are …
• The prices of its substitutes …
• The prices of its complements are …
•…
• The size of the change?
• Elasticity: measure how much consumers respond to
changes in variables.

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The price elasticity of demand


• Measures how much the quantity demanded
responds to a change in price.
• Demand for a good is said to be elastic If the quantity
demanded responds substantially to changes in the
price.
• Inelastic if the quantity demanded responds only
slightly to changes in the price.

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Availability of Close Substitutes


• Goods with close substitutes tend to have more
elastic demand because it is easier for consumers to
switch from that good to others.
• Ex: Pepsi & Coca: are easily substitutable
A small increase in the price of Pepsi – assuming the
price of Coca is held fixed – causes the quantity of
Pepsi sold to fall by a large amount.
A small increase in the price of eggs does not cause a
sizable drop in the quantity of eggs sold.
=>The demand for eggs is less elastic than the demand
for coke.
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Necessities versus Luxuries

• Necessities tend to have inelastic demands


• Luxuries have elastic demands.

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Computing the Price Elasticity of Demand

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Computing the Price Elasticity of Demand


Ex: a 10 percent increase in the price of a product
causes the amount of product you buy to fall by 20
percent

2: the change in the quantity demanded is twice as


large as the change in the price

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Computing the Price Elasticity of Demand

The price Elasticity of Demand

The Income Elasticity of Demand

The Cross-Price Elasticity of Demand

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The price Elasticity of Demand


• Measures the percentage change in demand for
goods - services when its price changes by 1%
%𝜟𝑸 𝜟𝑸 $
ED,P= = P
%𝜟$ 𝜟$ 𝑸
P P2
increase P
1
by 10%
The price Elasticity of Demand D
Will be equal to ……..
Q
Q2 Q1
Q decrease
by 15%
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The price Elasticity of Demand


Ex: Move from A to B:
▫ % changes in Price: ….. P
▫ % changes in Quantity: …… B
▫ ED,P : …….. $250
• Move from B to A: A
$200
▫ % changes in Price: ……..
▫ % changes in Quantity : …….. D
▫ ED,P : ……… Q
• The Midpoint Method: 8 12
▫ % changes in Price: [(250–200)/225]*100=22.2%
▫ % changes in Quantity: [(12-8)/10]*100=40%
▫ ED,P : 40/22.2=1.8

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The price Elasticity of Demand


– Elastic Demand |ED,P| > 1
– Inelastic Demand |ED,P| < 1
– Unit Elastic Demand |ED,P| = 1
– Perfectly Inelastic Demand |ED,P| = 0
– Perfectly Elastic Demand |ED,P| = ∞

The price elasticity of demand determines whether the


demad curve is steep of flat

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The price Elasticity of Demand

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The price Elasticity of Demand

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The price Elasticity of Demand

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The price Elasticity of Demand

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The price Elasticity of Demand

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The Income Elasticity of Demand


▫ Measures the percentage change in demand for a commodity or
service when income changes by 1%

%𝜟𝑸 𝜟𝑸 𝑰
ED,I = %𝜟𝑰
= 𝜟𝑰 𝑸
– ED,I < 0: inferior goods
– ED,I > 0: normal goods (>1: luxuries, <1: necessities)
– ED,I = 0: goods without depend on income

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The Cross-Price Elasticity of Demand


▫ Measure the percentage change of demand for this item when
the price of the other item changes by 1%.

%𝜟𝑸𝒙 𝜟𝑸𝒙 𝑷𝒚
▫ ED,xy = %𝜟𝑷𝒚 = 𝜟𝑷𝒚 𝑸𝒙

– ED,XY = 0: not related


– ED,XY ≠ 0: related
– (< 0: complements, > 0: substitutes)

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The Price Elasticity of Supply:

%𝜟𝑸 𝜟𝑸 𝑷
ES,P = =
%𝜟𝑷 𝜟𝑷 𝑸

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The Price Elasticity of Supply


▫ Measures the percentage change in the supply of a good or
service when its price changes by 1%

%𝜟𝑸 𝜟𝑸 𝑷
ES,P = %𝜟𝑷
= 𝜟𝑷 𝑸

– ES > 1: elastic supply


– ES < 1: inelastic supply
– ES = 1: unit elastic supply
– ES = 0: perfectly inelastic supply
– ES = ∞: perfectly elastic supply

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The Price Elasticity of Supply

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The Price Elasticity of Supply

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The Price Elasticity of Supply

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The Price Elasticity of Supply

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The Price Elasticity of Supply

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