DEMAND, SUPPLY & MARKET EQUILIBRIUM

  • View
    159

  • Download
    4

Embed Size (px)

DESCRIPTION

1.1 Introduction: Market Mechanism Principles 1.2 Demand 1.3 Supply 1.4 Market Equilibrium1.5 Change in SS & DD1.6 SS/DD Analysis Example

Text of DEMAND, SUPPLY & MARKET EQUILIBRIUM

  • CHAPTER 2: DEMAND, SUPPLY & MARKET EQUILIBRIUM 1.1 Introduction: Market Mechanism Principles 1.2 Demand 1.3 Supply1.4 Market Equilibrium1.5 Change in SS & DD1.6 SS/DD Analysis Example

  • DD & SS InteractionOutput (Product) MarketUtility (excluded)Consumer surplusFactors effect DDElasticityProductionSupplier surplusFactors effect SSElasticityMarket structureChanges in DD / SS:Equilibrium Price & QuantityInput (Factor) MarketMicroeconomics scope for UBEA 1013 Economics

  • 1.1 Introduction: Market Mechanism Principles Demand & supply interactionEconomics decision-making unitsMarket & the circulation flow

  • 1.2 Demand Definition: Demand can be defined as the purchase of product. ONE household / individualMarket demandALL Household / IndividualHousehold / individual demandDemand curve (graph)Demand function (equation)

  • Demand curve (graph):Quantity of X demanded, QdX = f (PX; PY, I, preference, and others)Demand function (equation):Factor effecting demandFactor effecting quantity demanded

  • Quantity of X demanded, QdX = f (PX; PY, I, preference, and others)Demand function (equation):Law of Demand: negative, or inverse relationship between price & quantity movement along demand curve change in quantity demandedRelationship of products: substitution or complement product: (PY) normal, luxury or inferior products: (I)(ii) Shift of DD curve: (PY, I, preference, and others) (later section) new equilibrium price & quantity

  • Law of Demand:Figure 2.3: Price & Quantity Demanded: The Law of Demand Law of Demand: negative, or inverse relationship movement along demand curve change in quantity demandedWhy?:Due to the income constraint and utility interaction.Exception?: Giffin product.

  • Shift of DD curve & Relationship of products:PY change: Substitute Substitutes are products that can replace one another Positive relationship between PY and demand for X (the substitute product): When (PY) increases, demand for X increases. Examples: Coffee & tea; Coca-cola & Pepsi ColaLaw of demandSubstitution product

  • PY change: Complement Complement are products that are consumed together Negative relationship between PY and demand for Z (the complement product): When (PY) decreases, demand for Z increases. Examples: Car & petrol; coffee & sugarLaw of demandComplement productShift of DD curve & Relationship of products:

  • Income change: Normal Product Demand increase when income increase Examples: Cloth & movieNormal productInferior productIncome change: Luxury Product Same effect as normal product but demand increase more when income increase Examples: luxury car.Income change: Inferior Product Low quality products (potato & secondhand cloth) Income increase, demand decrease (able to buy better quality product).I I Shift of DD curve & Relationship of products:

  • Necessity Product? Insignificant product? Their consumption did not effect much by change in income. Their consumption is only a very small percentage of total income. The demand curve did not shift (or shift too little that we can ignore) Examples: saltShift of DD curve & Relationship of products:

  • Other factors: Taste / preferenceOther factors: Expected future priceOther factors: Increase of buyer Demand increase when taste / preference towards the product increase (DD curve shift to the left) Examples: low fat item & fashion Demand increase when Future price of product is expected to increase (DD curve shift to the left) Examples: If petrol price to increase from 12am tomorrow, demand for petrol increase immediately (today). Increase in number of buyer, increase demand (DD curve shift to the left) Shift of DD curve & Relationship of products: continue

  • 1.3 SupplyDefinition: Supply can be defined as selling of product. ONE firmMarket supplyALL firmsIndividual (firm) supplySupply curve (graph)Supply function (equation)

  • Supply curve (graph):Quantity of X supplied, QSX = f (PX; K, L, technology, PY and others)Supply function (equation):Factor effecting supplyFactor effecting quantity supplied

  • Quantity of X demanded, QSX = f (PX; K, L, technology, PY and others)Supply function (equation):Law of Supply: positive relationship between price & quantity movement along supply curve change in quantity suppliedShift of SS curve: (K, L, technology, PY and others) (later section) new equilibrium price & quantity

  • Law of Supply:Figure 2.7: Price & Quantity Supplied: The Law of Supply Law of Supply: positive relationship movement along supply curve change in quantity suppliedWhy?:Due to the higher revenue & profit (assuming every quantity supplied can be sold).

  • Shift of SS curve:Change in K, L, technology, PY: E.g. reduced in cost of capital, reduced in wages, technology improvement, price of other product decline, expected future price to decline >>> shift the SS curve to the rightLaw of supplyShift of SS curve

  • DD & SS InteractionOutput (Product) MarketUtility (excluded)Consumer surplusFactors effect DDElasticityProductionSupplier surplusFactors effect SSElasticityMarket structureChanges in DD / SS:Equilibrium Price & QuantityInput (Factor) MarketMicroeconomics scope for UBEA 1013 Economics

  • DD & SS InteractionOutput (Product) Market1.4 Market Equilibrium3 set of market condition:(a) The quantity demanded equal the quantity supplied at the current price. This situation called equilibrium (b) The quantity demanded exceeds the quantity supplied at the current price. This situation called excess demand (c) The quantity supplied exceeds the quantity demanded at the current price. This situation called excess supply

  • (a) EquilibriumQuantity supplied = Quantity demanded(No tendency for the market price to change )Quantity supplied > Quantity demanded(Excess supply or surplus)Equilibrium quantityEquilibrium priceEquilibrium point

  • (b) Excess demand (shortage)Quantity demanded > Quantity suppliedPrice tend to rise (as buyer willing to pay more)Price increases >> quantity demanded fall (law of demand) while quantity supplied rise (law of supply). Price increase to RM 20 (all excess demand wipe out by increased in quantity supplied and reduced in quantity demanded.

  • (c) Excess supply (surplus)Quantity supplied > Quantity demandedPrice tend to drop (as seller willing to sell at lower price)Price drop >> quantity demanded rise (law of demand) while quantity supplied drop (law of supply). Price drop to RM 20 (all excess supply wipe out by decreased in quantity supplied and increased in quantity demanded.

  • Figure 2.12: Changes in Equilibrium (a) Increase in demand (b) Increase in supply (c) Decrease in demand (d) Decrease in supply 1.5 Change in Supply and Demand

  • Figure 2.13: Relative Magnitude Change: Supply Increase & Demand Decrease (a) Supply change > demand change (b) Supply change < demand change (a) Supply change > demand change (b) Supply change < demand change Figure 2.14: Relative Magnitude Change: Supply & Demand Increase

  • Relative Magnitude Change: Supply Decrease & Demand Increase (a) Supply change > demand change (b) Supply change < demand change (a) Supply change > demand change (b) Supply change < demand change Relative Magnitude Change: Supply & Demand Decrease

  • Equilibrium: Special Case(2) Horizontal SS curve:Horizontal SS exist when all suppliers fixed a price for any quantity.The equilibrium quantity is determined entirely by supply condition.The equilibrium price is determined entirely by demand condition.

  • Equilibrium: Special CaseDDQuantityS0P1P0Q0Price(3) Vertical DD curve:Example of vertical DD is demand for necessity products like salt.The equilibrium quantity is determined entirely by demand condition.The equilibrium price is determined entirely by supply condition.(4) Horizontal DD curve:Horizontal DD exist when there is only one market price consumers willing to pay.The equilibrium quantity is determined entirely by supply condition.The equilibrium price is determined entirely by demand condition.DDQuantityS0S1Q1P00PriceQ0S1

  • 1.6 Supply and Demand Analysis: An Example(a) Proton Berhad decreases the price of its car model, Proton Savvy from P0 to P1. Explain the law of demand and based on it, explain what will happen to the quantity demanded for Proton Savvy car. Sketch a graph to illustrate your explanation.

  • (b) What will be the effect of Proton Savvy car price drop to its competitor model, the Perodua MyVi? Sketch a graph to illustrate your explanation

  • (c) Assume that Proton Savvy cars need a specific regular maintenance service to bring out the performance of the car. Based on situation in (a), what will happen to the demand of that specific regular maintenance service?

  • (d) Assume Proton Savvy car has an inelastic price elasticity of demand. If Proton Berhad drops the price of its Proton Savvy car to increase its revenue from its Proton Savvy sales, do you think it is a wise strategy?Not a wise strategy.Percentage of quantity demanded increase is less than percentage of price drop.Increase in revenue due to quantity demanded increase is less than decrease in revenue due to price drop. Therefore, the net effect is that revenue will drop, not increase. End