Lecture 4 Shahid Iqbal - 6th Semester

Demand, Supply and Market Equilibrium

Lecture 4Shahid Iqbal

Markets & Economics

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.

Buyers determine demand.

Sellers determine supply.

Market Type: A Competitive Market

A competitive market is a market. . .with many buyers and sellers….. that is not controlled by any one person…. in which a narrow range of prices are established that buyers and sellers act upon.

Monopolistic Competition

Many sellersSlightly differentiated productsEach seller may set price for its own product

Markets and Competition

Other market Structures

MonopolyOne seller, and seller controls price

OligopolyFew sellersNot always aggressive competition

Monopolistic Competition• Differentiated products, brand preference, but entry

is NOT barred

Competition: Perfect and Otherwise

Perfect CompetitionProducts are the sameNumerous buyers and sellers so that each has no influence over price.Buyers and Sellers are price takers

Demand

Quantity demanded is the amount

of a good that buyers are willing and able

to purchase.

Determinants of demand

Following are the Factors determine the demand for a good:

Price of the good

Tastes

Information

Prices of related goods

Income

Government rules and regulations

The Basic Economic Decision-Making Units

• A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy.

• An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

Households are the consuming units in an economy.

Input Markets and Output Markets

• Output, or product, marketsare the markets in which goods and services are exchanged.

• Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged.

Input Markets

Input markets include:

• The labor market, in which households supply work for wages to firms that demand labor.

• The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.

• The land market, in which households supply land or other real property in exchange for rent.

The Circular Flow of Economic Activity

• The circular flow of economic activity shows the

connections between firms and households in input and

output markets.

Quantity Demanded

The amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price.

Demand in Output Markets

• A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices.

• Demand curves are usually derived from demand schedules.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

The Demand Curve

• The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

PRICE (PER

CALL)

QUANTITY DEMANDED (CALLS PER

MONTH)$ 0 30

0.50 253.50 77.00 3

10.00 115.00 0

ANNA'S DEMAND SCHEDULE FOR

TELEPHONE CALLS

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 This means that demand curves slope demand curves slope downward.downward.

Income and Wealth in Economics' term

• Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.

• Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stockmeasure.

Related Goods and Services in Economics

• Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower.

• Inferior Goods are goods for which demand falls when income rises.

Related Goods and Services

Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up.

Perfect substitutes are identical products.

Important

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.

Supply

Supply refers to the various quantities of a good or service that producers are willing to sell at all possible market prices. Supply can refer to the output of one producer or to the total output of all producers in the market (market supply).

Businesses provide goods and services hoping to make a profit.

Profit is the money a business has left over after it covers its costs. Businesses try to sell at prices high enough to cover their costs with some profit left over. The higher the price for a good, the more profit a business will make after paying the cost for resources.

Supply

Supply and Demand

• A competitive market:• Many buyers and sellers • Same good or service

• The supply and demand model is a model of how a competitive market works.

• Five key elements:• Demand curve• Supply curve• Demand and supply curve shifts• Market equilibrium• Changes in the market equilibrium

Demand Schedule

• A demand schedule shows how much of a good or service consumers will want to buy at different prices.

7.1

7.5

8.1

8.9

10.0

11.5

14.2

Price of coffee beans (per

pound)

Quantity of coffee beans demanded

(billions of pounds)

1.75

1.50

1.25

1.00

0.75

0.50

$2.00

Demand Schedule for Coffee Beans

Demand Curve

A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price.

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Price of coffee bean (per gallon)

Quantity of coffee beans (billions of pounds)

Demand curve, D

As price rises, the quantity demanded falls

An Increase in Demand

• An increase in the population and other factors generate an increase in demand –a rise in the quantity demanded at any given price.

• This is represented by the two demand schedules - one showing demand in 2002, before the rise in population, the other showing demand in 2006, after the rise in population.

7.17.58.18.9

10.011.514.2

8.59.09.7

10.712.013.817.0

in 2002 in 2006

$2.001.751.501.251.000.750.50

Price of coffee beans (per

pound)

Quantity of coffee beans demanded

(billions of pounds)

Demand Schedules for Coffee Beans

An Increase in Demand

A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.

Increase in Increase in population population more coffee more coffee

drinkersdrinkers

Price of coffee beans (per gallon)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50 D 1 D2

Demand curve in 2006

Demand curve in 2002

Quantity of coffee beans (billions of pounds)

Shifts of the Demand CurveA “decrease in demand”, means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1 D3)

Price

Quantity

D3 D1 D2

Increase in demand

Decrease in demand

An “increase in demand”means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1 D2)

Individual Demand Curve and the Market Demand CurveThe market demand curve is the horizontal sum of the

individual demand curves of all consumers in that market.

DDarla DDino

0 0 10 203020 0

$2

1

$2

1

$2

1

30 40 50

DMarket

(a) Darla’s Individual Demand Curve

(b) Dino’s Individual Demand Curve

(c) Market Demand Curve

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Quantity of coffee beans (pounds)

Quantity of coffee beans (pounds)

Quantity of coffee beans (pounds)

Supply Schedule

• A supply schedule shows how much of a good or service would be supplied at different prices.

Supply Schedule for Coffee Beans

Price of coffee beans(per pound)

Quantity ofcoffee beans

supplied(billions of pounds)

$2.00 11.6

1.75 11.5

1.50 11.2

1.25 10.7

1.00 10.0

0.75 9.1

0.50 8.0

Supply Curve

Quantity of coffee beans (billions of pounds)

Price of coffee beans (per pound)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

As price rises, the quantity supplied rises.

A supply curve shows graphically how much of a good or service people are willing to sell at any given price.

Supply curve, S

An Increase in Supply

• The entry of Vietnam into the coffee bean business generated an increase in supply—a rise in the quantity supplied at any given price.

• This event is represented by the two supply schedules—one showing supply before Vietnam’s entry, the other showing supply after Vietnam came in.

Supply Schedule for Coffee Beans

Quantity of beans supplied (billions of pounds)

Price of coffee beans (per pound) Before entry After entry

$2.00 11.6 13.9

1.75 11.5 13.8

1.50 11.2 13.4

1.25 10.7 12.8

1.00 10.0 12.0

0.75 9.1 10.9

0.50 8.0 9.6

An Increase in Supply

A shift of the supply curve is a change in the quantity supplied of a good at any given price.

70 9 11 13 15 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

S1 S2Price of coffee beans (per

pound)

… is not the same thing as a shift of the supply curve

A movement along the supply curve…

Quantity of coffee beans (billions of pounds)

Any “increase in supply” means a rightward shift of the supply curve: at any given price, there is an increase in the quantity supplied. (S1 S2)

Shifts of the Supply Curve

S3 S1 S2

Price

Quantity

Decrease in supply

Increase in supply

Any “decrease in supply” means a leftward shift of the supply curve: at any given price, there is a decrease in the quantity supplied. (S1 S3)

• Changes in input prices– An input is a good that is used to produce another

good.• Changes in the prices of related goods and services• Changes in technology• Changes in expectations• Changes in the number of producers

What Causes a Supply Curve to Shift?

Individual Supply Curve and the Market Supply Curve

The market supply curve is the horizontal sum of the individual supply curves of all firms in that market.

SFigueroa SBien Pho

1 2 31 22 31 4 500 0

$2

1

$2

1

$2

1

SMarket

(a) Mr. Figueroa’s Individual Supply Curve

(b) Mr. Bien Pho’s Individual Supply Curve

(c) Market Supply Curve

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Quantity of coffee beans (pounds)

Quantity of coffee beans (pounds)

Quantity of coffee beans (pounds)

Supply, Demand and Equilibrium• Equilibrium in a competitive market: when the quantity

demanded of a good equals the quantity supplied of that good.

• The price at which this takes place is the equilibrium price.

Every buyer finds a seller and vice versa.The quantity of the good bought and sold at that price is the equilibrium quantity.

Market equilibrium occurs at point E, where the supply curve and the demand curve intersect.

Price of coffee beans (per pound)

Quantity of coffee beans (billions of pounds)

70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

E EquilibriumEquilibrium price

Equilibrium quantity

Market Equilibrium

There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.

70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

8.1 11.2

E

Surplus

Quantity demanded

Quantity supplied

Price of coffee beans (per pound)

Quantity of coffee beans (billions of pounds)

Surplus

70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

9.1 11.5

E

Shortage

Quantity demanded

Quantity supplied

Price of coffee beans (per pound)

Quantity of coffee beans (billions of pounds)

There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.

Shortage

Equilibrium and Shifts of the Demand Curve

Q 2Q 1

D 2

Supply

D 1

E2

E1

P2

P1

Price of coffee beans

Quantity of coffee beans

Price rises

Quantity rises

An increase in demand…

… leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity

Technology Shifts of the Supply Curve

Price

Quantity

S1

Demand

E1

E2

An increase in supply …

P2

P1

Q1

Q2

… leads to a movement along the demand curve to a lower equilibrium price and higher equilibrium quantity.

Price falls

Quantity increases

S2

Technological innovation: In the early 1970s, engineers learned how to put microscopic electronic components onto a silicon chip; progress in the technique has allowed ever more components to be put on each chip.