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Some key terms
Marketa set of arrangements by which buyers and sellers are in contact to exchange goods or services
Demandthe quantity of a good buyers wish to purchase at each conceivable price
Supplythe quantity of a good sellers wish to sell at each conceivable price
Equilibrium priceprice at which quantity supplied = quantity demanded
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What, How and for Whom
The market:determines what goods are being produced
• there may be goods for which no consumer is prepared to pay a price at which firms would be willing to supply
decides how much of a good should be produced
• by finding the price at which the quantity demanded equals the quantity supplied
tells us for whom the goods are produced
• those consumers willing to pay the equilibrium price
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Law of Demand
A decrease in the price of a good, all other things held constant, will cause an increase in the quantity demanded of the good.An increase in the price of a good, all other things held constant, will cause a decrease in the quantity demanded of the good.
Quantity Demanded: The amount purchased at a particular price for a given time period
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Law of Demand
There is an inverse relationship between the price of a good and the quantity of the good demanded per time period.
Substitution Effect (If PA relative to PB DA )Income Effect (If PA DA as purchasing power of individual’s income increases).
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The Demand Curve
Quantity
Price
P0
Q0
P1
Q1
An increase (decrease) in price causes a decrease(increase) in quantity demanded.
Demand Curve: Shows the relationship between P and Q, ceteris paribus
Demand Schedule
P Qd
£2.5 50 units
2.00 75
1.50 100
1.25 150
1.00 200
0.50 250
Demand Curve
There is an inverse relationship between P and Qd, ceteris paribus
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Changes in Demand
NON-PRICE DETERMINANTS OF DEMAND
Change in Buyers’ TastesChange in Buyers Incomes
Normal GoodsInferior Goods
Expectations of Future Price ChangesChange in the Price of Related Goods
Substitute GoodsComplementary Goods
Change in the Number of Buyers
““OTHER THINGSOTHER THINGS””
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Change in Demand
Quantity
Price
P0
Q0 Q1
An increase (decrease) in demand refers to a rightward (leftward)shift in the market demand curve.
A change in any of the “other things” will affect the position of Demand
D0D2
D1
Q2
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Two ways to Reduce the Quantity Demanded
A movement alongthe demand curve from A to BIt represents consumer reaction to a price change
AP0
Q0 Quantity
Pric
e
D
Q1
P1
The Case of Cigarettes (1)
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A movement of the demand curve from D0 to D1 leads to a decrease in demand at each priceThe shift of demand curve may come about due to Ministry of Health announcements, health warnings on cigarette packages, banning of ads on TV, non-smoking in restaurants, offices and public places, etc
DC
P1
Q4 Q3
D1
Quantity
Pric
e
P0
B
D0
A
Q2Q0
Two ways to Reduce the Quantity Demanded
The Case of Cigarettes (2)
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Individual Consumer’s DemandQdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X by an individual per time period
PX = price per unit of commodity X ∆QdX/∆PX < 0
I = consumer’s income ∆QdX/∆I > 0 for normal good; ∆QdX/∆I < 0 inferior good
PY = price of related (substitute or complement) commodity ∆QdX/∆PY > 0 if X and Y are substitutes; ∆QdX/∆PY < 0 if X and Y are complements
T = tastes of the consumer
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Market Demand FunctionQX = f(PX, N, I, PY, T)
quantity demanded of commodity X
price per unit of commodity X
number of consumers on the market
consumer income
price of related (substitute or complementary) commodity Y
consumer tastes
QX =
PX =
N =
I =
PY =
T =
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Market Demand Function --An Example
DB = 67938 – 83.4PB + 73N + 16.5Y + 2907t
If we substitute in the above equation, actual values for the explanatory vbls., we get:
DB = 67938 – 83.4PB + 73(700K) + 16.5 ( 5525m) + 2907(32)
DB = 303026 – 83.4PB
Using OLS, the demand in Cyprus for BENZINE was estimated (for the period 1970-2000)
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By then substituting alternative prices for PB, we construct a demand schedule for the year.
If PB = £550: DB = 303026 – 83.4(550)
= 257156 tons
If PB =£600: DB = 303026 – 83.4(600)
= 252986 tons
If PB = £450: DB = 303026 – 83.4(450)
= 265496 tons
Market Demand Function --An Example (2)
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The Market Demand Curve (3)
Quantity
Price of Benzine
Demand Schedule
P Qd
£600 252986 tons
£550 257156 tons
£450 265496 tons
The alternative values of P and Qd give us a demand schedule
From which we can construct a demand curve
Let’s now substitute values for the non-price vbls. For instance for 2002 (t=33): N=705K, Y=6000M
D’B = 314334 – 83.4(PB) . This is the dotted demand curve.
Same slope (- 83.4), but higher intercept (314334 instead of 303026)
DB = 303026 – 83.4(PB)
D’B = 314334 – 83.4(PB)
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Market Demand Function --An Example
Ds = 7609 – 1606Ps + 59N + 947Y + 479Pw- 271t
If we substitute in the above equation, actual values for the explanatory vbls., we get:
Ds = 7,609 – 1,606Ps + 59(150.72m.)+ 947(17,600) + 479($2.94) – 271(1)
Ds = 19,306 – 1,606Ps
Using OLS, the demand for sweet potatoes was estimated as follows (for the period 1949-1979)
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By then substituting alternative prices for Ps, we get the final demand for the year. If Ps = $5:
Ds = 19,306 – 1,606(5) = 10,312
If Ps = $ 7 Ds = 19,306 – 1,606(7)
= 8,064 tons
If Ps = $ 4 Ds = 19,306 – 1,606(4)
= 12,882 tons
Market Demand Function --An Example (2)
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The Market Demand Curve (3)
Quantity
Price of Potatoes
$4$5
Demand Schedule
P Qd
$7 8,064 tons
$5 10,312
$4 12,882
The alternative values of P and Qd give us a demand schedule
From which we can construct a demand curve
Let’s now substitute values for the non-price vbls. For instance for 1972 (t=24): N=208m., Y=31,900, Pw=$2.41
D’s = 17,598 – 1,606(Ps) . This is the dotted demand curve to the left.
Same slope (1,606), but lower intercept (17,598 instead of 19,306)
D’s = 17,598 – 1,606(Ps)
Ds = 19,306 – 1,606(Ps)
$7
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Law of Supply
A decrease in the price of a good, all other things held constant, will cause a decrease in the quantity supplied of the good.An increase in the price of a good, all other things held constant, will cause an increase in the quantity supplied of the good.
Quantity Supplied: The amount offered for in the market at a particular price at a given time.
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The Supply Curve
Quantity
Price
P1
Q1
P0
Q0
An increase (decrease)in price causes an increase (decrease) in quantity supplied.
Supply Curve
Supply Schedule
P Qd
£2.5 200 units
2.00 150
1.50 100
1.25 50
1.00 10
0.50 0
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Changes in Supply
Change in Production TechnologyChange in Input PricesChange in the Number of SellersTaxes/subsidies and legal restrictionsFuture Price Expectations of SellersWeather & other “exogenous” factors
A change in any of these “other things” will affect the position of the Supply Curve (but NOTNOT itsits slope
What are these “other things” for Supply?
NON-PRICE DETERMINANTS OF SUPPLY
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Change in Supply
Quantity
Price
P0
Q1Q0
An increase (decrease) in supply refers to a rightward (leftward) shift in the market supply curve.
S0S2S1
Q2
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Market Equilibrium
Equilibrium: A position of balance, from which there are no inherent forces or tendencies to move away.Market equilibrium is determined at the intersection of the market demand curve and the market supply curve.Equilibrium price: The price at which the quantity demanded is equal to the quantity supplied; there is no surplus (excess supply), nor shortage (excess demand)
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Quantity
Price
Po
Qo
D S
E
P Qd Qs
2.50 50 200
2.00 75 150
1.50 100 100
1.25 150 50
1.00 200 10
0.50 250 0
Market Equilibrium is at E where quantity demanded equals quantity supplied.
This is at Po
(£1.50) and Qo(100 units)
Market Equilibrium
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Demand and Supply of Potatoes(Hypothetical Values)
100
80
60
40
20
0
Price (cents per kilo)
0
26.9
53.5
80.1
106.7
133.3
Quantity Demanded
94.5
70.9
47.3
23.7
0
-23.5
Quantity Supplied
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Assume, for example, that the Cyprus Potato Board has estimated the demand and supply of potatoes to be the following:
Demand equation: P = 100 – 0.75 Q(where – 0.75 reflects the negative slope of D)
Supply equation: P = 20 + 0.85 Q(where + 0.85 reflects the positive slope of S)
where, P is in CYP (C£) and Q is in tons.
Solving for Q, we have: 100 – 0.75 Q = 20 + 0.85 Q1.4 Q = 80Q* = 50
Substituting Q = 50 in the demand eq. gives us P* = 62.5
Therefore, the equilibrium quantity would be 50 tons of potatoes, and the equilibrium price would be C£ 62.5 per ton.
D & S of Potatoes: Algebraic Solution
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Market Equilibrium and Disequilibrium
If price were below P0there would be excess demand
consumers wish to purchase more than producers wish to supply
D
DS
S
Q0
P0E
Pric
e
Quantity
•
P1 ••
excess supply
P2 • •excess demand
If price were above P0there would be excess supply
producers wish to supply more than consumers wish to purchase
Surplus or
or shortage
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A Shift in Demand (1)
S
S
E1
Pr ic
e
Quantity
If, for instance, the price of a substitute good decreases ...less will be demanded ateach price.
D0
D0
E0
Q0
P0
The demand curve shiftsfrom D0D0 to D1D1.
D1
D1
Q1
P1
So, the market moves to a new equilibrium at E1, with lower price and quantity
If price stayed at P0 there would be excess supply.
Excess Supply
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Quantity
Price
P0
Q0
D0 S0
Q1
P1
D1
An increase in demand will cause the market equilibrium price and quantity to increase.
So, the market moves to a new equilibrium point at E1
Assume consumers expect the price of oil to increase (due to the possibility of a war, say the war in Iraq. This will tend to increase their current demand .
E1
E0
A Shift in Demand (2)
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D
D
Q0
P0 E0
Pric
e
Quantity
Suppose safety at workregulations (due to EU) are tightened, leading toincreasing producers’ costs
S0
S0
S1
S1
The supply curve shifts to S1S1
If price stayed at P0 there would be excess demand
Q1
P1
E2
So the market moves to a new equilibrium at E2
Other factors leading to the same result: Oils shortage, winter freeze, drought
A Shift in Supply (1)
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(Technical Innovation)
Quantity
Price
P0
Q0
D0 S0
Q1
P1
An increase in supplywill cause the market equilibrium price to decrease and quantity to increase.
S1
E0
E1
A Shift in Supply (2)
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A Market in Disequilibrium (Price Controls)
Suppose a disastrous wheat harvest moves the supply curve from S0 to S1
Quantity
Pric
e
P1
Q1
D
P0
E1
E0excess demand
Q0
S1
RATIONING is needed to cope with the resulting excess demand. This was the case in ex-Soviet Russia and China.
S0
The government may try to protect the poor, setting a price ceiling for bread at P0 which is below P1, the new equilibrium price levelThe result is excess demand
(shortage)
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Price Supports
Quantity
Price
P0
Q0
D SSurplus
PS
The Cyprus gov’tsupports farmers (in the context of CAP), by ensuring them a price support for their produce (milk, potatoes, cereals, meat, wine, etc) at P1 which is above P0, the equilibrium price
The result is excess supply (surplus)
QSQD
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Price and Quantity Changes
In practice, we cannot plot ex ante demand curves and supply curvesSo,historical data and the supposition that the observed values are equilibrium ones are usedSince other things are often not constant, some detective work is required this is where our theory comes in useful
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Demand Faced by a Firm
Market StructureMonopolyOligopolyMonopolistic CompetitionPerfect Competition
Type of GoodDurable GoodsNondurable GoodsProducers’ Goods - Derived Demand
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Determinants of Demand for a Product
QX = f (PX, AX ,OX , FX … Yc , Tc , Ec ….
… PY, AY ,OY , FY … G, N, FX, W…)
Strategic vbls.
Competitor vbls.
Consumer vbls.
Environmental vbls.
Uncontrolled Variables
Controlled vbls. Uncontrolled vbls.
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