Economic Analysis for Business Session IV: Market Forces of Supply and Demand-I Instructor Sandeep Basnyat [email protected]

Economic Analysis Economic Analysis for Businessfor Business

Session IV: Market Forces of Session IV: Market Forces of Supply and Demand-ISupply and Demand-I

InstructorInstructorSandeep BasnyatSandeep [email protected][email protected]

CHAPTER 4 THE MARKET FORCES OF

SUPPLY AND DEMAND

Markets and CompetitionMarkets and CompetitionA market is a group of buyers and

sellers of a particular product. A competitive market is one with

many buyers and sellers, each has a negligible effect on price.

A perfectly competitive market:◦ all goods exactly the same◦ buyers & sellers so numerous that no one

can affect market price – each is a “price taker”

In this chapter, we assume markets are perfectly competitive.

DemandDemandDemand comes from the behavior

of buyers. The quantity demanded of any

good is the amount of the good that buyers are willing and able to purchase.

Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal.


SUPPLY AND DEMAND

The Demand ScheduleThe Demand ScheduleDemand schedule:

A table that shows the relationship between the price of a good and the quantity demanded.

Example: Helen’s demand for lattes.

Price of

lattes

Quantity of lattes

demanded

$0.00 16

1.00 14

2.00 12

3.00 10

4.00 8

5.00 6

6.00 4 Notice that Helen’s

preferences obey the Law of Demand.

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15

Price of Lattes

Quantity of Lattes

Helen’s Demand Schedule & CurveHelen’s Demand Schedule & Curve

Price of

lattes

Quantity of lattes

demanded

$0.00 16

1.00 14

2.00 12

3.00 10

4.00 8

5.00 6

6.00 4

Demand Equation and FunctionDemand Equation and Function

According to the Law of Demand: When P increases, Q decreases, and

When P decreases, Q increases (other things remain constant)Demand equation: Qd = f (P)

• For a linear demand curve (having equal slopes),The Demand Function: Qd = a + bP

Where, b = slope of the curvea = Slope coefficient or

demand parameter

Example: Demand Equation and Example: Demand Equation and FunctionFunction

If the slope of a linear demand curve is “-20” and demand parameter is 100, find the demand equation for the curve.

Solution: Equation for the demand curve is:Qd = a + bPQd = 100 – 20P

Market Demand versus Individual DemandMarket Demand versus Individual DemandThe quantity demanded in the market is the sum of

the quantities demanded by all buyers at each price. Suppose Helen and Ken are the only two buyers in the

Latte market. (Qd = quantity demanded)

4

6

8

10

12

14

16

Helen’s Qd

2

3

4

5

6

7

8

Ken’s Qd

+

+

+

+

=

=

=

=

6

9

12

15

+ = 18

+ = 21

+ = 24

Market Qd

$0.00

6.00

5.00

4.00

3.00

2.00

1.00

Price


SUPPLY AND DEMAND

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25

P

Q

The Market Demand Curve for LattesThe Market Demand Curve for Lattes

PQd

(Market)

$0.00 24

1.00 21

2.00 18

3.00 15

4.00 12

5.00 9

6.00 6

Movement along the demand curveMovement along the demand curve

Market Demand Function and Market Demand Function and EquationEquationMarket Demand Case:

1. There are 500 consumers in an economy, each with an individual demand curve of :

Qi = 15 − P

Find the total demand from the market (Qm)

2. There are 500 consumers with individual demand curves of : Qi = 15P and

300 consumers with individual demand curves of :Qi = 30−2P,

Find the total demand (Qm) from the market.

Market Demand Function and Market Demand Function and EquationEquationMarket Demand Case:

1. There are 500 consumers in an economy, each with an individual demand curve of :

Qi = 15 − P

Find the total demand from the market (Qm)

Qm = 500(15 − P) Qm = 7500 − 500P.⇒ 2. There are 500 consumers with individual demand

curves of : Qi = 15P and

300 consumers with individual demand curves of :Qi = 30−2P,

Find the total demand (Qm) from the market.

Qm = 500(15 P) + 300(30 − 2P) = 9000 + 6900P


SUPPLY AND DEMAND

Demand Curve Shifters: Demand Curve Shifters: Determinants of DemandDeterminants of Demand

The demand curve shows how price affects quantity demanded, other things being equal.

These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).

Changes in them shift the D curve…


SUPPLY AND DEMAND

Demand Curve Shifters: No.Demand Curve Shifters: No. of buyers of buyers

An increase in the number of buyers causesan increase in quantity demanded at each price, which shifts the demand curve to the right.


SUPPLY AND DEMAND

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30

P

Q

Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example).

Demand Curve Shifters: No. of buyers


SUPPLY AND DEMAND

Demand for a normal good is positively related to income. ◦An increase in income causes increase

in quantity demanded at each price, shifting the D curve to the right.

(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)

Demand Curve Shifters: Demand Curve Shifters: incomeincome


SUPPLY AND DEMAND

Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.

Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.

Other examples: Coke and Pepsi, laptops and desktop computers, compact discs and music downloads

Demand Curve Shifters: Demand Curve Shifters: prices of prices of related goodsrelated goods


SUPPLY AND DEMAND

Two goods are complements if an increase in the price of one causes a fall in demand for the other.

Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.

Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon

Demand Curve Shifters: Demand Curve Shifters: prices of prices of related goodsrelated goods


SUPPLY AND DEMAND

Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.

Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right.

Demand Curve Shifters: Demand Curve Shifters: tastestastes


SUPPLY AND DEMAND

Expectations affect consumers’ buying decisions.

Examples:

◦If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.

◦If the economy turns bad and people worry about their future job security, demand for new autos may fall now.

Demand Curve Shifters: Demand Curve Shifters: expectationsexpectations

Summary: Variables That Affect DemandSummary: Variables That Affect Demand

Variable A change in this variable…

Price …causes a movement along the D curve

No. of buyers …shifts the D curve

Income …shifts the D curve

Price ofrelated goods …shifts the D curve

Tastes …shifts the D curve

Expectations …shifts the D curve

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : Demand curveDemand curve

A. The price of iPods falls

B. The price of music downloads falls

C. The price of compact discs falls

21

Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : A. price of iPods fallsA. price of iPods falls

22

Q2

Price of music down-loads

Quantity of music downloads

D1D2

P1

Q1

Music downloads and iPods are complements.

A fall in price of iPods shifts the demand curve for music downloads to the right.

Music downloads and iPods are complements.

A fall in price of iPods shifts the demand curve for music downloads to the right.

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : B. price of music downloads fallsB. price of music downloads falls

23

The D curve does not shift.

Move down along curve to a point with lower P, higher Q.

The D curve does not shift.

Move down along curve to a point with lower P, higher Q.



D1

P1

Q1 Q2

P2

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : C. price of CDs fallsC. price of CDs falls

24

P1

Q1

CDs and music downloads are substitutes.

A fall in price of CDs shifts demand for music downloads to the left.

CDs and music downloads are substitutes.

A fall in price of CDs shifts demand for music downloads to the left.



D1D2

Q2

Market Demand Equation and Market Demand Equation and FunctionFunction

Combining Price and Non-price determinants:Total Market demand for a product = f (Price of the Product, Prices of other goods, Income, Tastes and Preferences of Consumers, Expectations and Number of Buyers)

Or, Qd = f (P, Po, I, T, E, B)In a functional form:

Qd = a1P+ a2Po+ a3I+ a4T+ a5E+ a6B

(Q = Parameter x Notation of variable.)

Estimating Industry Demand for New Automobiles

Estimated Valuefor Independent

Parameter Variable duringIndependent Variable Estimate Coming Year

(1) (2) (3)Average Price for New Cars (P) –500 $25,000Average Price for New Luxury Cars(PX) 210 $50,000Disposable Income, per Household (I) 200 $45,000 Population (Pop) (millions) 20,000 300Average Interest Rate (i) (percent) –1,000,000 8%Industry Advertising Expenditures (A) 600 $5,000 million

Find the market (Industry) demand equation (curve) for the new automobile.

Exercise: Market Demand Exercise: Market Demand EstimationEstimation

Solution: Market Demand EquationSolution: Market Demand EquationThe demand function for the automobile industry is:

Q = Parameter x Notation for Independent Variable. Or,Q = –500P + 210PX + 200I + 20,000Pop – 1,000,000i

+ 600A

Substituting the value of all variables except “P”, Q = –500P + 210($50,000) + 200($45,000) + 20,000(300)

– 1,000,000(8) + 600($5,000)

Q = 20,500,000 – 500P or,P = 41,000 – 0.002Q

When P = $25000, Q = 8,000,000 (8 millions).If the average interest rate increases by 2%, how would it affect

the demand curve? How many cars would be sold if the average interest rate increases by 2%?

Solution: Market Demand EquationSolution: Market Demand EquationThe demand function for the automobile industry is:

Q = Parameter x Notation for Independent Variable. Or,Q = –500P + 210PX + 200I + 20,000Pop – 1,000,000i

+ 600A

Substituting the value of all variables except “P”, Q = –500P + 210($50,000) + 200($45,000) + 20,000(300)

– 1,000,000(8) + 600($5,000)

Q = 20,500,000 – 500P or,P = 41,000 – 0.002Q

When P = $25000, Q = 8,000,000 (8 millions).If the average interest rate increases by 2%, how would it affect

the demand curve? How many cars would be sold if the average interest rate increases by 2%?

(Ans: Demand Curver shifts to Left; Q = 6,000,000)


SUPPLY AND DEMAND

SupplySupplySupply comes from the behavior

of sellers. 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


SUPPLY AND DEMAND

The Supply ScheduleThe Supply Schedule

Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.

Example: Starbucks’ supply of lattes.

Notice that Starbucks’ supply schedule obeys the Law of Supply.

Price of

lattes

Quantity of lattes supplied

$0.00 0

1.00 3

2.00 6

3.00 9

4.00 12

5.00 15

6.00 18


SUPPLY AND DEMAND

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15

Starbucks’ Supply Schedule & CurveStarbucks’ Supply Schedule & Curve

Price of

lattes

Quantity of lattes supplied

$0.00 0

1.00 3

2.00 6

3.00 9

4.00 12

5.00 15

6.00 18

P

Q

Supply Equation and FunctionSupply Equation and Function

According to the Law of Supply: When P increases, Q Increases, and

When P decreases, Q decreases (other things remain constant)Supply equation: Qs = f (P)

• For a linear supply curve (having equal slopes),The Supply Function: Qs = a + bP

Where, b = slope of the curvea = Slope coefficient or

demand parameter

Market Supply versus Individual SupplyMarket Supply versus Individual SupplyThe quantity supplied in the market is the sum of

the quantities supplied by all sellers at each price. Suppose Starbucks and Jitters are the only two

sellers in this market. (Qs = quantity supplied)

18

15

12

9

6

3

0

Starbucks

12

10

8

6

4

2

0

Jitters

+

+

+

+

=

=

=

=

30

25

20

15

+ = 10

+ = 5

+ = 0

Market Qs

$0.00

6.00

5.00

4.00

3.00

2.00

1.00

Price

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

The Market Supply Curve

PQS

(Market)

$0.00 0

1.00 5

2.00 10

3.00 15

4.00 20

5.00 25

6.00 30

Movement along the supply curveMovement along the supply curve

Market Supply FunctionMarket Supply FunctionMarket Supply Case:

1. If there are 400 suppliers with individual supply curves of

Qi = 15 + 2p, then the market supply curve is:

2. If there are 500 suppliers with individual supply curves of Qi = 15+ p and 300 suppliers with individual supply curves of Qi = 30+2p, then the total supply from the market is:

Market Supply FunctionMarket Supply FunctionMarket Supply Case:

1. If there are 400 suppliers with individual supply curves of

Qi = 15 + 2p, then the market supply curve is:

Qs = 400(15 + 2p) = 6000 + 800p.

2. If there are 500 suppliers with individual supply curves of Qi = 15+ p and 300 suppliers with individual supply curves of Qi = 30+2p, then the total supply from the market is:

Qs = 500(15 + p) + 300(30 + 2p) = 16500 + 1100p.


SUPPLY AND DEMAND

Supply Curve ShiftersSupply Curve Shifters

The supply curve shows how price affects quantity supplied, other things being equal.

These “other things” are non-price determinants of supply.

Changes in them shift the S curve…


SUPPLY AND DEMAND

Supply Curve Shifters: Supply Curve Shifters: input pricesinput prices

Examples of input prices: wages, prices of raw materials.

A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.


SUPPLY AND DEMAND

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example).

Supply Curve Shifters: input prices


SUPPLY AND DEMAND

Supply Curve Shifters: Supply Curve Shifters: technologytechnology

Technology determines how much inputs are required to produce a unit of output.

A cost-saving technological improvement has same effect as a fall in input prices, shifts the S curve to the right.


SUPPLY AND DEMAND

Supply Curve Shifters: Supply Curve Shifters: No. of sellersNo. of sellers

An increase in the number of sellers increases the quantity supplied at each price,shifts the S curve to the right.


SUPPLY AND DEMAND

Supply Curve Shifters: Supply Curve Shifters: expectationsexpectations

Suppose a firm expects the price of the good it sells to rise in the future.

The firm may reduce supply now, to save some of its inventory to sell later at the higher price.

This would shift the S curve leftward.


SUPPLY AND DEMAND

Summary: Variables That Affect Summary: Variables That Affect SupplySupply

Variable A change in this variable…

Price …causes a movement along the S curve

Input prices …shifts the S curve

Technology …shifts the S curve

No. of sellers …shifts the S curve

Expectations …shifts the S curve

AA CC TT II VV E LE L EE AA RR NN II NN G 2G 2: : Supply curveSupply curve

44

Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios?

A. Retailers cut the price of the software.

B. A technological advance allows the software to be produced at lower cost.

C. Professional tax return preparers raise the price of the services they provide.

AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : A. fall in price of tax return softwareA. fall in price of tax return software

45

The S curve does not shift.

Move down along the curve to a lower P and lower Q.

The S curve does not shift.

Move down along the curve to a lower P and lower Q.

Price of tax return software

Quantity of tax return software

S1

P1

Q1Q2

P2

AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : B. fall in cost of producing the softwareB. fall in cost of producing the software

46

The S curve shifts to the right:

at each price, Q increases.

The S curve shifts to the right:

at each price, Q increases.



S1

P1

Q1

S2

Q2

AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : C. professional preparers raise their priceC. professional preparers raise their price

47

This shifts the demand curve for tax preparation software, not the supply curve.

This shifts the demand curve for tax preparation software, not the supply curve.



S1

Market Supply Equation and Market Supply Equation and FunctionFunction

Combining Price and Non-price determinants:Total Market Supply for a product = f (Price of the Product, Input Prices, Technology, Expectations and Number of Sellers)

Or, Qs = f (P, Pi, T, E, S)In a functional form:

Qd = a1P+ a2Pi+ a3T+ a4E+ a5S

(Q = Parameter x Notation of variable.)

Estimating Industry Supply for New Automobiles



(1) (2) (3)Average Price for New Cars (P) 2,000 $25,000Average Price for SUV(Psuv) -400 $35,000Average Hourly Wage Rate (W) -100,000 $85 Average Cost of Steel/Ton (S) -13,750 800Average Cost of Energy/mcf (E) –125,000 $4Average Interest Rate (i) in percent -1,000,000 8%

1. Find the market (Industry) supply equation (curve) for the new automobile.

2. Work out Practice: What happens to supply curve if any of the variable such as hourly wage rate changes.

Exercise: Market Supply EstimationExercise: Market Supply Estimation

Estimating Industry Supply for New Automobiles



(1) (2) (3)Average Price for New Cars (P) 2,000 $25,000Average Price for SUV(Psuv) -400 $35,000Average Hourly Wage Rate (W) -100,000 $85 Average Cost of Steel/Ton (S) -13,750 800Average Cost of Energy/mcf (E) –125,000 $4Average Interest Rate (i) in percent -1,000,000 8%

1. Find the market (Industry) supply equation (curve) for the new automobile. (Q = - 42000000 +2000P)

2. Work out Practice: What happens to supply curve if any of the variable such as hourly wage rate changes.

Exercise: Market Supply EstimationExercise: Market Supply Estimation

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Supply and Demand TogetherSupply and Demand Together

D S Equilibrium: P has reached

the level where

quantity supplied equals quantity demanded

D S

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Equilibrium price:Equilibrium price:

P QD QS

$0 24 0

1 21 5

2 18 10

3 15 15

4 12 20

5 9 25

6 6 30

The price that equates quantity supplied with quantity demanded


SUPPLY AND DEMAND

D S

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Equilibrium quantity:Equilibrium quantity:

P QD QS

$0 24 0

1 21 5

2 18 10

3 15 15

4 12 20

5 9 25

6 6 30

The quantity supplied and quantity demanded at the equilibrium price

Equilibrium in Automobile Equilibrium in Automobile marketmarketMarket demand curve: Qd = 20,500,000 – 500P

Market supply curve: Qs = - 42000000 +2000P

Equilibrium is at: Qd = Qs 20,500,000 – 500P = - 42000000 +2000P2500P = 62500000

Therefore, P = $25000Q = 20,500,000 – 500(25000) = 8,000,000

Numerical Problem on Demand and Numerical Problem on Demand and SupplySupply1) Suppose:Demand eqn. for a product: Qd = 286 −

20pSupply eqn. For a product: Qs = 88 +

40pFind Equilibrium Quantity and Price:

Numerical Problem on Demand and Numerical Problem on Demand and SupplySupply1) Suppose:Demand eqn. for a product: Qd = 286 − 20pSupply eqn. For a product: Qs = 88 + 40pFind Equilibrium Quantity and Price:Solution:

Qd = Qs

286 − 20p = 88 + 40p

60p = 198

P = $3.30

Q = 286 – 20(3.3) = 220

Some variations-Solved ProblemSome variations-Solved ProblemMarket Demand and Supply Case:

Given:

500 consumers with individual demand curves of Qi = 15−p

300 consumers with individual demand curves of Qi = 30−2p

Total demand from the market is: QM = 16500 − 1100p.

Find:

a) The total quantity buyers want to buy at price of $10:

b) The quantity that the 500 and 300 buyers want to buy at $10.

Some variations-Solved ProblemSome variations-Solved ProblemMarket Demand and Supply Case:

Given:

500 consumers with individual demand curves of Qi = 15−p

300 consumers with individual demand curves of Qi = 30−2p

Total demand from the market is: QM = 16500 − 1100p.

Find:

a) The total quantity buyers want to buy at price of $10:

At a price of $10, the buyers want to buy 16500− 1100 ・ 10 = 5500 units.

b) The total quantity that 500 and 300 buyers want to buy.

Each of the 500 buyers with an individual demand curves of

Qi = 15 − p wants to buy 15 − 10 = 5 units, for a total of 2500.

And each of the 300 buyers with individual demand curves of Qi = 30 − 2p wants to buy 30 − 2 ・ 10 = 10 units, for a total of 3000.

Thank youThank you

Documents

Economic Analysis for Business Session IV: Market Forces of Supply and Demand-I Instructor Sandeep Basnyat [email protected]