Demand curve

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An example of a demand curve shifting In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. !" #he demand curve for all consumers together follows from the demand curve of every individual consumer$ the individual demands at each price are added together. Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the e%uilibrium price &the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price' and the e%uilibrium %uantity &the amount of that good or service that will be produced and bought without surplus(excess supply or shortage(excess demand' of that market. )" In a monopolistic market, the demand curve facing the monopolist is simply the market demand curve.

*haracteristics
According to convention, the demand curve is drawn with price on the vertical axis and %uantity on the hori+ontal axis. #he function actually plotted is the inverse demand function. #he demand curve usually slopes downwards from left to right, that is, it has a negative association &for two theoretical exceptions, see -eblen good and .iffen good'. #he negative slope is often referred to as the /law of demand/, which means people will buy more of a service, product, or resource as its price falls. #he demand curve is related to the marginal utility curve, since the price one is willing to pay depends on the utility. 0owever, the demand directly depends on the income of an individual while the utility does not. #hus it may change indirectly due to change in demand for other commodities.

1inear demand curve

#he demand curve is often graphed as a straight line of the form 2 3 a 4 b5 where a and b are parameters. #he constant 6a7 6embodies7 the effects of all factors other than price that affect demand. If income were to change, for example, the effect of the change would be represented by a change in the value of a and be reflected graphically as a shift of the demand curve. #he constant 6b7 is the slope of the demand curve and shows how the price of the good affects the %uantity demanded. 8" #he graph of the demand curve uses the inverse demand function in which price is expressed as a function of %uantity. #he standard form of the demand e%uation can be converted to the inverse e%uation by solving for 5 or 5 3 a(b 4 2(b. 8" 9ore plainly, in the e%uation 5 3 a 4 b2, /a/ is the intercept where %uantity demanded is +ero &where the demand curve intercepts the : axis', /b/ is the slope of the demand curve, /2/ is %uantity and /5/ is price.

;hift of a demand curve

#he shift of a demand curve takes place when there is a change in any non4price determinant of demand, resulting in a new demand curve. <" =on4price determinants of demand are those things that will cause demand to change even if prices remain the same>in other words, the things whose changes might cause a consumer to buy more or less of a good even if the good?s own price remained unchanged. @" ;ome of the more important factors are the prices of related goods &both substitutes and complements', income, population, and expectations. 0owever, demand is the willingness and ability of a consumer to purchase a good under the prevailing circumstances, so, any circumstance that affects the consumer?s willingness or ability to buy the good or service in %uestion can be a non4price determinant of demand. As an example, weather could be a factor in the demand for beer at a baseball game. When income rises, the demand curve for normal goods shifts outward as more will be demanded at all prices, while the demand curve for inferior goods shifts inward due to the increased attainability of superior substitutes. With respect to related goods, when the price of a good &e.g. a hamburger' rises, the demand curve for substitute goods &e.g. chicken' shifts out, while the demand curve for complementary goods &e.g. tomato sauce' shifts in &i.e. there is more demand for substitute goods as they become more attractive in terms of value for money, while demand for complementary goods contracts in response to the contraction of %uantity demanded of the underlying good' <"

Demand shifters

*hanges in disposable income *hanges in tastes and preferences 4 tastes and preferences are assumed to be fixed in the short4run. #his assumption of fixed preferences is a necessary condition for aggregation of individual demand curves to derive market demand.

*hanges in expectations. *hanges in the prices of related goods &substitutes and complements' 5opulation si+e and composition

Changes that decrease demand

;ome circumstances which can cause the demand curve to shift include$

decrease in price of a substitute increase in price of a complement decrease in income if good is normal good increase in income if good is inferior good

Factors affecting market demand

9arket or aggregate demand is the summation of individual demand curves. In addition to the factors which can affect individual demand there are three factors that can affect market demand &cause the market demand curve to shift'$

a change in the number of consumers, a change in the distribution of tastes among consumers, a change in the distribution of income among consumers with different tastes. A"

;ome circumstances which can cause the demand curve to shift in include$

decrease in price of a substitute

increase in price of a complement decrease in income if good is normal good increase in income if good is inferior good

9ovement along a demand curve

#here is movement along a demand curve when a change in price causes the %uantity demanded to change.
<"

It is important to distinguish between movement along a demand curve, and a shift in a demand curve.

9ovements along a demand curve happen only when the price of the good changes. B" When a non4price determinant of demand changes the curve shifts. #hese /other variables/ are part of the demand function. #hey are /merely lumped into intercept term of a simple linear demand function./
B"

#hus a change in a non4price

determinant of demand is reflected in a change in the x4intercept causing the curve to shift along the x axis. C"

Discreteness of amounts
If a commodity is sold in whole units, and these are substantial for a consumer, then the individual demand curve can hardly be approximated by a continuous curve. It is a set function of the price, defined by a price above which no unit is bought, a price range for which one is bought, etc.

Dnits of measurement
If the local currency is dollars, for example, then the units of measurement of the variable /price/ are /dollars per unit of the good/ and the units of measurement of /%uantity/ are /units of the good per time &e.g., per week or per year'. #hus %uantity demanded is a flow variable.

5rice elasticity of demand &5ED'

Main article: Price elasticity of demand 5ED is a measure of the sensitivity of the %uantity variable, 2, to changes in the price variable, 5. Elasticity answers the %uestion of how much the %uantity will change in percentage terms for a !F change in the price, and is thus important in determining how revenue will change.

#he elasticity of demand indicates how sensitive the demand for a good is to a price change. If the 5ED is between +ero and ! demand is said to be inelastic, if 5ED e%uals !, the demand is unitary elastic and if the 5ED is greater than ! demand is elastic. A low coefficient implies that changes in price have little influence on demand. A high elasticity indicates that consumers will respond to a price rise by buying a lot less of the good and that consumers will respond to a price cut by buying a lot more.

#axes and subsidies

A sales tax on the commodity does not directly change the demand curve, if the price axis in the graph represents the price including tax. ;imilarly, a subsidy on the commodity does not directly change the demand curve, if the price axis in the graph represents the price after deduction of the subsidy. If the price axis in the graph represents the price before addition of tax and(or subtraction of subsidy then the demand curve moves inward when a tax is introduced, and outward when a subsidy is introduced.

Supply and demand is an economic model of price determination in a market. It

concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity. The four basic laws of supply and demand are: !" !. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity #. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.

$. If demand remains unchanged and supply increases, then it leads to lower equilibrium price and higher quantity.
4. If demand remains unchanged and supply decreases, then it leads to higher equilibrium price and lower quantity.

Graphical representation of supply and demand

%lthough it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the standard graphical representation, usually attributed to %lfred &arshall, has price on the vertical a'is and quantity on the hori(ontal a'is, the opposite of the standard convention for the representation of a mathematical function. )ince determinants of supply and demand other than the price of the good in question are not e'plicitly represented in the supply*demand diagram, changes in the values of these variables are represented by moving the supply and demand curves (often described as +shifts+ in the curves). ,y contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Supply schedule
% supply schedule is a table that shows the relationship between the price of a good and the quantity supplied. % supply curve is a graph that illustrates that relationship. -nder the assumption of perfect competition, supply is determined by marginal cost. .irms will produce additional output as long as the cost of producing an e'tra unit of output is less than the price they will receive. ,y its very nature, conceptuali(ing a supply curve requires that the firm be a perfect competitor /that is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question +If this firm is faced with this potential price, how much output will it be able to and willing to sell0+ If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not +faced with+ any price, and the question is meaningless. 1conomists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms2 supply curves are added hori(ontally to obtain the market supply curve.

1conomists also distinguish the short*run market supply curve from the long*run market supply curve. In this conte't, two things are assumed constant by definition of the short run: the availability of one or more fi'ed inputs (typically physical capital), and the number of firms in the industry. In the long run, firms have a chance to ad3ust their holdings of physical capital, enabling them to better ad3ust their quantity supplied at any given price. .urthermore, in the long run potential competitors can enter or e'it the industry in response to market conditions. .or both of these reasons, long*run market supply curves are flatter than their short*run counterparts.

The determinants of supply follow: !. 4roduction costs, how much a good costs to be produced #. The technology used in production, and5or technological advances $. % good2s own price 6. .irms2 e'pectations about future prices 7. 8umber of suppliers

Demand schedule
% demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, tastes and preferences, the price of substitute goods, and the price of complementary goods, remain the same. .ollowing the law of demand, the demand curve is almost always represented as downward*sloping, meaning that as price decreases, consumers will buy more of the good. #" 9ust as the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves. $" :onsumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time. %s described above, the demand curve is generally downward*sloping, there may be rare e'amples of goods that have upward*sloping demand curves. Two different hypothetical types of goods with upward*sloping demand curves are ;iffen goods (an inferior but staple good) and <eblen goods (goods made more fashionable by a higher price). ,y its very nature, conceptuali(ing a demand curve requires that the purchaser be a perfect competitor/that is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question +If this buyer is faced with this

potential price, how much of the product will it purchase0+ If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not +faced with+ any price, and the question is meaningless. %s with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals2 demand curves are added hori(ontally to obtain the market demand curve.

The determinants of demand follow: !. Income #. Tastes and preferences $. 4rices of related goods and services 6. :onsumers2 e'pectations about future prices and incomes that can be checked 7. 8umber of potential consumers

Microeconomics
Equilibrium
1quilibrium is defined to be the price*quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. &arket 1quilibrium: % situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply. :omparative static analysis: 1'amines the likely effect on the equilibrium of a change in the e'ternal conditions affecting the market. :hanges in market equilibrium:* 4ractical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the

respective curves. :omparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium.

=emand curve shifts: &ain article: =emand curve >hen consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. %t each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. % movement along the curve is described as a +change in the quantity demanded+ to distinguish it from a +change in demand,+ that is, a shift of the curve. there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market e'pectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. 8ote in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (?!, 4!) to the point ?#, 4#). If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted@ but the equilibrium quantity and price are different as a result of the change (shift) in demand. The movement of the demand curve in response to a change in a non*price determinant of demand is caused by a change in the '*intercept, the constant term of the demand equation.

)upply curve shifts: &ain article: )upply (economics) >hen technological progress occurs, the supply curve shifts. .or e'ample, assume that someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Atherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2/an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. %s a result of a supply curve shift, the price and the quantity move in opposite directions. If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. ,ut due to the change (shift) in supply, the equilibrium quantity and price have changed. The movement of the supply curve in response to a change in a non*price determinant of supply is caused by a change in the y*intercept, the constant term of the supply equation. The supply curve shifts up and down the y a'is as non*price determinants of demand change.

Partial equilibrium
&ain article: 4artial equilibrium 4artial equilibrium as the name suggests takes into consideration only a part of the market, ceteris paribus to attain equilibrium. 9ain proposes (attributed to ;eorge )tigler): +% partial equilibrium is one which is based on only a restricted range of data, a standard e'ample is price of a single product, the prices of all other products being held fi'ed during the analysis.+ 6" The supply*and*demand model is a partial equilibrium model of economic equilibrium, where the clearance on the market of some specific goods is obtained independently from prices and quantities in other markets. In other words, the prices of all substitutes and complements, as well as income levels of consumers are constant. This makes analysis much simpler than in a general equilibrium model which includes an entire economy. Bere the dynamic process is that prices ad3ust until supply equals demand. It is a powerfully simple technique that allows one to study equilibrium, efficiency and comparative statics. The stringency of the simplifying assumptions inherent in this approach make the model considerably more tractable, but may produce results which, while seemingly precise, do not effectively model real world economic phenomena.

4artial equilibrium analysis e'amines the effects of policy action in creating equilibrium only in that particular sector or market which is directly affected, ignoring its effect in any other market or industry assuming that they being small will have little impact if any. Bence this analysis is considered to be useful in constricted markets. CDon >alras first formali(ed the idea of a one*period economic equilibrium of the general economic system, but it was .rench economist %ntoine %ugustin :ournot and 1nglish political economist %lfred &arshall who developed tractable models to analy(e an economic system.

Other markets
The model of supply and demand also applies to various specialty markets. The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate. 7" % number of economists (for e'ample 4ierangelo ;aregnani, E" Fobert C. <ienneau, G" and %rrigo Apocher H Ian )teedman I"), building on the work of 4iero )raffa, argue that this model of the labor market, even given all its assumptions, is logically incoherent. &ichael %nyadike*=anes and >yne ;odley J" argue, based on simulation results, that little of the empirical work done with the te'tbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly e'ists for that model. ;raham >hite !K" argues, partially on the basis of )raffianism, that the policy of increased labor market fle'ibility, including the reduction of minimum wages, does not have an +intellectually coherent+ argument in economic theory. This criticism of the application of the model of supply and demand generali(es, particularly to all markets for factors of production. It also has implications for monetary theory !!" not drawn out here. In both classical and Leynesian economics, the money market is analy(ed as a supply*and* demand system with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fi' its value regardless of the interest rate@ in this case the money supply is totally inelastic. An the other hand, !#" the money supply curve is a hori(ontal line if the central bank is targeting a fi'ed interest rate and ignoring the value of the money supply@ in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate. !$"

Empirical estimation
=emand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneousequation methods of estimation in econometrics. )uch methods allow solving for the model*

relevant +structural coefficients,+ the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in +structural estimation.+ Typically, data on e'ogenous variables (that is, variables other than price and quantity, both of which are endogenous variables) are needed to perform such an estimation. %n alternative to +structural estimation+ is reduced*form estimation, which regresses each of the endogenous variables on the respective e'ogenous variables.

Macroeconomic uses of demand and supply

=emand and supply have also been generali(ed to e'plain macroeconomic variables in a market economy, including the quantity of total output and the general price level. The %ggregate =emand*%ggregate )upply model may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. :ompared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate supply. =emand and supply are also used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate labor supply and labor demand to wage rates.

History
%ccording to Bamid ). Bosseini, the power of supply and demand was understood to some e'tent by several early &uslim scholars, such as fourteenth*century &amluk scholar Ibn Taymiyyah, who wrote: +If desire for goods increases while its availability decreases, its price rises. An the other hand, if availability of the good increases and the desire for it decreases, the price comes down.+ !6"

9ohn Cocke2s !EJ! work Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of oney. !7" includes an early and clear description of supply and demand and their relationship. In this description demand is rent: MThe price of any commodity rises or falls by the proportion of the number of buyer and sellersN and Mthat which regulates the price... of goods" is nothing else but their quantity in proportion to their rent.N The phrase +supply and demand+ was first used by 9ames =enham*)teuart in his Inquiry into the Principles of Political !economy, published in !GEG. %dam )mith used the phrase in his !GGE book "he #ealth of $ations, and =avid Ficardo titled one chapter of his !I!G work Principles of Political %conomy and "a&ation +An the Influence of =emand and )upply on 4rice+. !E" In "he #ealth of $ations, )mith generally assumed that the supply price was fi'ed but that its +merit+ (value) would decrease as its +scarcity+ increased, in effect what was later called the law of demand also. Ficardo, in Principles of Political %conomy and "a&ation, more rigorously laid

down the idea of the assumptions that were used to build his ideas of supply and demand. %ntoine %ugustin :ournot first developed a mathematical model of supply and demand in his !I$I Researches into the athematical Principles of #ealth, including diagrams. =uring the late !Jth century the marginalist school of thought emerged. This field mainly was started by )tanley 9evons, :arl &enger, and CDon >alras. The key idea was that the price was set by the most e'pensive price, that is, the price at the margin. This was a substantial change from %dam )mith2s thoughts on determining the supply price. In his !IGK essay +An the ;raphical Fepresentation of )upply and =emand+, .leeming 9enkin in the course of +introduc ing" the diagrammatic method into the 1nglish economic literature+ published the first drawing of supply and demand curves therein, !G" including comparative statics from a shift of supply or demand and application to the labor market. !I" The model was further developed and populari(ed by %lfred &arshall in the !IJK te'tbook Principles of %conomics. !E"

Criticisms
%t least two assumptions are necessary for the validity of the standard model: first, that supply and demand are independent@ and second, that supply is +constrained by a fi'ed resource+@ If these conditions do not hold, then the &arshallian model cannot be sustained. )raffa2s critique focused on the inconsistency (e'cept in implausible circumstances) of partial equilibrium analysis and the rationale for the upward slope of the supply curve in a market for a produced consumption good. !J" The notability of )raffa2s critique is also demonstrated by 4aul %. )amuelson2s comments and engagements with it over many years, for e'ample: +>hat a cleaned*up version of )raffa (!J#E) establishes is how nearly empty are all of &arshall2s partial equilibrium bo'es. To a logical purist of >ittgenstein and )raffa class, the arshallian partial equilibrium bo' of constant cost is even more empty than the bo' of increasing cost.+. #K" %ggregate e'cess demand in a market is the difference between the quantity demanded and the quantity supplied as a function of price. In the model with an upward*sloping supply curve and downward*sloping demand curve, the aggregate e'cess demand function only intersects the a'is at one point, namely, at the point where the supply and demand curves intersect. The )onnenscheinO&antelO=ebreu theorem shows that the standard model cannot be rigorously derived in general from general equilibrium theory. #!" The model of prices being determined by supply and demand assumes perfect competition. ,ut:

+economists have no adequate model of how individuals and firms ad3ust prices in a competitive model. If all participants are price*takers by definition, then the actor who ad3usts prices to eliminate e'cess demand is not specified+. ##" ;oodwin, 8elson, %ckerman, and >eissskopf write: +If we mistakenly confuse precision with accuracy, then we might be misled into thinking that an e'planation e'pressed in precise mathematical or graphical terms is somehow more rigorous or useful than one that takes into account particulars of history, institutions or business strategy. This is not the case. Therefore, it is important not to put too much confidence in the apparent precision of supply and demand graphs. )upply and demand analysis is a useful precisely formulated conceptual tool that clever people have devised to help us gain an abstract understanding of a comple' world. It does not/ nor should it be e'pected to/give us in addition an accurate and complete description of any particular real world market.+ #$"

,F1%L 1<18 4AI8T

In economics H business, specifically cost accounting, the break-e en point (,14) is the point at which cost or e'penses and revenue are equal: there is no net loss or gain, and one has +broken even+. % profit or a loss has not been made, although opportunity costs have been +paid+, and capital has received the risk*ad3usted, e'pected return. !" .or e'ample, if a business sells fewer than #KK tables each month, it will make a loss, if it sells more, it will be a profit. >ith this information, the business managers will then need to see if they e'pect to be able to make and sell #KK tables per month. If they think they cannot sell that many, to ensure viability they could: !. Try to reduce the fi'ed costs (by renegotiating rent for e'ample, or keeping better control of telephone bills or other costs) #. Try to reduce variable costs (the price it pays for the tables by finding a new supplier) $. Increase the selling price of their tables.
Any of these would reduce the break even point. In other words, the business would not need to sell so many tables to make sure it could pay its fixed costs.

Computation
In the linear :ost*<olume*4rofit %nalysis model, #" the break-e en point (in terms of -nit )ales (P)) can be directly computed in terms of Total Fevenue (TF) and Total :osts (T:) as:

where:

!"C is !otal "i#ed Costs, P is $nit Sale Price, and % is $nit %ariable Cost.

The ,reak*1ven 4oint can alternatively be computed as the point where :ontribution equals .i'ed :osts. The quantity is of interest in its own right, and is called the -nit :ontribution &argin (:): it is the marginal profit per unit, or alternatively the portion of each sale that contributes to .i'ed :osts. Thus the break*even point can be more simply computed as the point where Total :ontribution Q Total .i'ed :ost:

In currency units (sales proceeds) to reach break*even, one can use the above calculation and multiply by 4rice, or equivalently use the :ontribution &argin Fatio (-nit :ontribution &argin over 4rice) to compute it as: FQ:, >here F is revenue generated, : is cost incurred i.e. .i'ed costs R <ariable :osts or ? S 4(4rice per unit) Q T.: R ? S <:(4rice per unit), ? S 4 * ? S <: Q T.:, ? S (4 * <:) Q T.:, or, ,reak 1ven %nalysis ? Q T.:5c5s ratioQ,reak 1ven TT

Mar&in of Safety
&argin of safety represents the strength of the business. It enables a business to know what is the e'act amount it has gained or lost and whether they are over or below the break even point. $" margin of safety Q (current output * breakeven output) margin of safetyU Q (current output * breakeven output)5current output V !KK >hen dealing with budgets you would instead replace +:urrent output+ with +,udgeted output+. If 45< ratio is given then profit5 4< ratio

'reak E en (nalysis
,y inserting different prices into the formula, you will obtain a number of break even points, one for each possible price charged. If the firm changes the selling price for its product, from W# to W#.$K, in the e'ample above, then it would have to sell only (!KKK5(#.$ * K.E))Q 7IJ units to break even, rather than G!7.

To make the results clearer, they can be graphed. To do this, you draw the total cost curve (T: in the diagram) which shows the total cost associated with each possible level of output, the fi'ed cost curve (.:) which shows the costs that do not vary with output level, and finally the various total revenue lines (F!, F#, and F$) which show the total amount of revenue received at each output level, given the price you will be charging. The break even points (%,,,:) are the points of intersection between the total cost curve (T:) and a total revenue curve (F!, F#, or F$). The break even quantity at each selling price can be read off the hori(ontal a'is and the break even price at each selling price can be read off the vertical a'is. The total cost, total revenue, and fi'ed cost curves can each be constructed with simple formulae. .or e'ample, the total revenue curve is simply the product of selling price times quantity for each output quantity. The data used in these formulae come either from accounting records or from various estimation techniques such as regression analysis.

(pplication
The break*even point is one of the simplest yet least used analytical tools in management. It helps to provide a dynamic view of the relationships between sales, costs and profits. % better understanding of break*even, for e'ample, is e'pressing break*even sales as a percentage of actual sales/can give managers a chance to understand when to e'pect to break even (by linking the percent to when in the week5month this percent of sales might occur).

The break*even point is a special case of Target Income )ales, where Target Income is K (breaking even). This is very important for financial analysis.

)imitations

,reak*even analysis is only a supply side (i'e' costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. It assumes that fi'ed costs (.:) are constant. %lthough this is true in the short run, an increase in the scale of production is likely to cause fi'ed costs to rise. It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i'e' linearity) It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period). In multi*product companies, it assumes that the relative proportions of each product sold and produced are constant (i'e', the sales mi' is constant).

&arket structure
In economics, market structure is the number of firms producing identical products which are homogeneous. The types of market structures include the following:

&onopolistic competition, also called competitive market, where there is a large number of firms, each having a small proportion of the market share and slightly differentiated products. Aligopoly, in which a market is dominated by a small number of firms that together control the ma3ority of the market share.
o

=uopoly, a special case of an oligopoly with two firms.

&onopsony, when there is only one buyer in a market. Aligopsony, a market where many sellers can be present but meet only a few buyers. &onopoly, where there is only one provider of a product or service.

8atural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the si(e of the firm. % firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more speciali(ed firms.

4erfect competition, a theoretical market structure that features no barriers to entry, an unlimited number of producers and consumers, and a perfectly elastic demand curve.

The imperfectly competitive structure is quite identical to the realistic market conditions where some monopolistic competitors, monopolists, oligopolists, and duopolists e'ist and dominate the market conditions. The elements of &arket )tructure include the number and si(e distribution of firms, entry conditions, and the e'tent of differentiation. . Monopolistic competition is a type of imperfect competition such that one or two producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. !" In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition@ the market becomes more like a perfectly competitive one where firms cannot gain economic profit. In practice, however, if consumer rationality5innovativeness is low and heuristics are preferred, monopolistic competition can fall into natural monopoly, even in the complete absence of government intervention. #" In the presence of coercive government, monopolistic competition will fall into government*granted monopoly. -nlike perfect competition, the firm maintains spare capacity. &odels of monopolistic competition are often used to model industries. Te'tbook e'amples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The +founding father+ of the theory of monopolistic competition is 1dward Bastings :hamberlin, who wrote a pioneering book on the sub3ect, "heory of onopolistic Competition (!J$$). $" 9oan Fobinson published a book "he %conomics of imperfect competition( with a comparable theme of distinguishing perfect from imperfect competition' &onopolistically competitive markets have the following characteristics:

There are many producers and many consumers in the market, and no business has total control over the market price. :onsumers perceive that there are non*price differences among the competitors2 products. There are few barriers to entry and e'it. 6" 4roducers have a degree of control over price.

oligopoly

Aligopoly is a common market form. %s a quantitative description of oligopoly, the four*firm concentration ratio is often utili(ed. This measure e'presses the market share of the four largest firms in an industry as a percentage. .or e'ample, as of fourth quarter #KKI, <eri(on, %THT, )print, and T*&obile together control IJU of the -) cellular phone market.

Aligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. >here there is a formal agreement for such collusion, this is known as a cartel. % primary e'ample of such a cartel is A41: which has a profound influence on the international price of oil. .irms often collude in an attempt to stabili(e unstable markets, so as to reduce the risks inherent in these markets for investment and product development. citation needed" There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies)Ofor e'ample, in some industries there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership. In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater when there are more firms in an industry than if, for e'ample, the firms were only regionally based and did not compete directly with each other. Thus the welfare analysis of oligopolies is sensitive to the parameter values used to define the market2s structure. In particular, the level of dead weight loss is hard to measure. The study of product differentiation indicates that oligopolies might also create e'cessive levels of differentiation in order to stifle competition. Aligopoly theory makes heavy use of game theory to model the behavior of oligopolies:

% monopoly (from ;reek monos XYZ[\ (alone or single) Rpol (to sell)) e'ists when a specific person or enterprise is the only supplier of a particular commodity (this contrasts with a monopsony which relates to a single entity2s control of a market to purchase a good or service, and with oligopoly which consists of a few entities dominating an industry). !" &onopolies are thus characteri(ed by a lack of economic competition to produce the good or service and a lack of viable substitute goods. #" The verb +monopoli(e+ refers to the process by which a company gains the ability to raise prices or e'clude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the

power, to charge high prices. $" %lthough monopolies may be big businesses, si(e is not a characteristic of a monopoly. % small business may still have the power to raise prices in a small industry (or market). 6" % monopoly is distinguished from a monopsony, in which there is only one buyer of a product or service @ a monopoly may also have monopsony control of a sector of a market. Cikewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. &onopolies, monopsonies and oligopolies are all situations such that one or a few of the entities have market power and therefore interact with their customers (monopoly), suppliers (monopsony) and the other companies (oligopoly) in a game theoretic manner O meaning that e'pectations about their behavior affects other players2 choice of strategy and vice versa. This is to be contrasted with the model of perfect competition in which companies are +price takers+ and do not have market power. citation needed" >hen not coerced legally to do otherwise, monopolies typically ma'imi(e their profit by producing fewer goods and selling them at higher prices than would be the case for perfect competition. )ometimes governments decide legally that a given company is a monopoly that doesn2t serve the best interests of the market and5or consumers. ;overnments may force such companies to divide into smaller independent corporations as was the case of -nited )tates v. %THT, or alter its behavior as was the case of -nited )tates v. &icrosoft, to protect consumers.
citation needed"

&onopolies can be established by a government, form naturally, or form by mergers. % monopoly is said to be coercive when the monopoly actively prohibits competitors by using practices (such as underselling) that derive from its market or political influence. There is often debate of whether market restrictions are in the best long*term interest of present and future consumers. citation needed" In many 3urisdictions, competition laws restrict monopolies. Bolding a dominant position or a monopoly of a market is not illegal in itself, however certain categories of behavior can, when a business is dominant, be considered abusive and therefore incur legal sanctions. % government* granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic interest group. 4atents, copyright, and trademarks are sometimes used as e'amples of government granted monopolies, but they rarely provide market power.

Value added tax

Value added tax or VAT is an indirect tax, which is imposed on goods and services at each stage of production, starting from raw materials to final product. VAT is levied on the value additions at different stages of production. VAT is widely applied in the European countries. However, now a number of countries

across the globe have adopted this tax system. VAT was first introduced in France as taxe sur la valeur a outee or TVA. !n "#$%, the French economist, &aurice 'aure, the oint director of the French tax authority, the (irection generale des impost, initiated the concept of VAT, which came into effect on April "), "#$%. !nitially introduced for large businesses of France, with the passage of time, VAT was employed for all business sectors of the country. !n France, value added tax is considered to be one of the ma or sources state finance. Value added tax, also *nown as goods and services tax or +,T proves to be beneficial for the government. Through implementation of this tax system, government can raise revenues invisibly, where the tax is not shown on the bill paid by the buyer. VAT is different from sales tax in various aspects. -hile sales tax is to be paid on the total value of the goods and services, VAT is levied on every exchange of the product, so that consumers do not have to carry the total cost of tax. However, VAT is generally not applied on export goods to avoid double taxation on the final product. However, if VAT is charged on export goods, the tax amount is usually refunded to the tax payer. Value added tax can also be recovered. The individual consumers cannot recover VAT on purchases made by them. However, businesses can recover VAT on the services and materials, which are bought by them in order to continue the supply of the products and services. VAT was introduced to arrest the increasing smuggling and cheating, which were resultants of high sales tax and tariffs. !nitiated in France, VAT is used as an instrument of taxation in all the member states of the European .nion. (ifferent VAT rates are employed in different member states of E.. The minimum VAT rate for the E. members is "$/. However, the reduced rate of VAT can be as low as )/. The rate is determined by the VAT authorities of different countries. There are also some countries, where VAT has been introduced to replace sales tax. !ndia is one such country, where the system of VAT has been adopted for replacing the sales taxation system. The value added tax serves as the solution for different problems related to the sales tax system. .nli*e sales tax, in VAT, there is provision for input tax credit or !T0. (ue to the simplicity of the VAT system, the entire taxation system on consumer products and services has become easier

uantity theory of money

In monetary economics, the quantity theory of money is the theory that money supply has a direct, proportional relationship with the price level. The theory was challenged by Leynesian economics, !" but updated and reinvigorated by the monetarist school of economics. >hile mainstream economists agree that the quantity theory

holds true in the long run, there is still disagreement about its applicability in the short run. :ritics of the theory argue that money velocity is not stable and, in the short*run, prices are sticky, so the direct relationship between money supply and price level does not hold.
Alternative theories include the real bills doctrine and the more recent fiscal theory of the price level.

Ori&ins and de elopment of the quantity theory

The quantity theory descends from :opernicus, #" followers of the )chool of )alamanca, 9ean ,odin, $" and various others who noted the increase in prices following the import of gold and silver, used in the coinage of money, from the 8ew >orld. The Mequation of e'changeN relating the supply of money to the value of money transactions was stated by 9ohn )tuart &ill 6" who e'panded on the ideas of =avid Bume. 7" The quantity theory was developed by )imon 8ewcomb, E" %lfred de .oville, G" Irving .isher, I" and Cudwig von &ises J" in the latter !Jth and early #Kth century, while it had been argued against by Larl &ar'. !K" The theory was influentially restated by &ilton .riedman in response to Leynesianism. !!" %cademic discussion remains over the degree to which different figures developed the theory. !#" .or instance, ,ieda argues that :opernicus2s observation &oney can lose its value through e'cessive abundance, if so much silver is coined as to heighten people2s demand for silver bullion. .or in this way, the coinage2s estimation vanishes when it cannot buy as much silver as the money itself contains ]". The solution is to mint no more coinage until it recovers its par value. !#" amounts to a statement of the theory, !$" while other economic historians date the discovery later, to figures such as 9ean ,odin, =avid Bume, and 9ohn )tuart &ill. !#" !6" Bistorically, the main rival of the quantity theory was the real bills doctrine, which says that the issue of money does not raise prices, as long as the new money is issued in e'change for assets of sufficient value. !7"

Equation of e#chan&e
In its modern form, the quantity theory builds upon the following definitional relationship.

where is the total amount of money in circulation on average in an economy during the period, say a year. is the transactions velocity of money, that is the average frequency across all transactions with which a unit of money is spent. This reflects availability of financial institutions, economic variables, and choices made as to how fast people turn over their money. and are the price and quantity of the i*th transaction. is a column vector of the , and the superscript ! is the transpose operator. is a column vector of the . &ainstream economics accepts a simplification, the equation of e'change:

where is the price level associated with transactions for the economy during the period is an inde' of the real value of aggregate transactions. The previous equation presents the difficulty that the associated data are not available for all transactions. >ith the development of national income and product accounts, emphasis shifted to national*income or final*product transactions, rather than gross transactions. 1conomists may therefore work with the form

where is the velocity of money in final e'penditures. is an inde' of the real value of final e'penditures. %s an e'ample, might represent currency plus deposits in checking and savings accounts held by the public, real output (which equals real e'penditure in macroeconomic equilibrium) with the corresponding price level, and the nominal (money) value of output. In one empirical formulation, velocity was taken to be Mthe ratio of net national product in current prices to the money stockN. !E" Thus far, the theory is not particularly controversial, as the equation of e'change is an identity. % theory requires that assumptions be made about the causal relationships among the four variables in this one equation. There are debates about the e'tent to which each of these variables is

dependent upon the others. >ithout further restrictions, the equation does not require that a change in the money supply would change the value of any or all of , , or . .or e'ample, a !KU increase in could be accompanied by a !KU decrease in , leaving unchanged. The quantity theory postulates that the primary causal effect is an effect of on P.

( rudimentary ersion of the quantity theory

This section2s factual accuracy is disputed. )September *+,,The equation of e'change can be used to form a rudimentary version of the quantity theory of the effect of monetary growth on inflation.

If

and

were constant, then:

and thus

where is time. That is to say that, if and were constant, then the inflation rate (the rate of growth of

the price level) would e'actly equal the growth rate inflation rate is a function of the monetary growth rate.

of the money supply. In short, the

Cess restrictively, with time*varying V and ., we have the identity

which says that the inflation rate equals the monetary growth rate plus the growth rate of the velocity of money minus the growth rate of real e'penditure. If one makes the quantity theory assumptions that, at least in the long run, (i) the monetary growth rate is controlled by the central bank, (ii) the growth rate of velocity is purely determined by the evolution of payments mechanisms, and (iii) the growth rate of real e'penditure is determined by the rate of

technological progress plus the rate of labor force growth, then while the inflation rate need not equal the monetary growth rate, an & percentage point rise in the monetary growth rate will result in an & percentage point rise in the inflation rate.

Cambrid&e approach
.urther information: :ambridge equation 1conomists %lfred &arshall, %.:. 4igou, and 9ohn &aynard Leynes (before he developed his own, eponymous school of thought) associated with :ambridge -niversity, took a slightly different approach to the quantity theory, focusing on money demand instead of money supply. They argued that a certain portion of the money supply will not be used for transactions@ instead, it will be held for the convenience and security of having cash on hand. This portion of cash is commonly represented as /, a portion of nominal income ( ). The :ambridge economists also thought wealth would play a role, but wealth is often omitted for simplicity. The :ambridge equation is thus:

%ssuming that the economy is at equilibrium ( ), is e'ogenous, and / is fi'ed in the short run, the :ambridge equation is equivalent to the equation of e'change with velocity equal to the inverse of /:

The :ambridge version of the quantity theory led to both Leynes2s attack on the quantity theory and the &onetarist revival of the theory. !G"

*uantity theory and e idence

%s restated by &ilton .riedman, the quantity theory emphasi(es the following relationship of the nominal value of e'penditures and the price level to the quantity of money :

The plus signs indicate that a change in the money supply is hypothesi(ed to change nominal e'penditures and the price level in the same direction (for other variables held constant). .riedman described the empirical regularity of substantial changes in the quantity of money and in the level of prices as perhaps the most*evidenced economic phenomenon on record. !I" 1mpirical studies have found relations consistent with the models above and with causation

running from money to prices. The short*run relation of a change in the money supply in the past has been relatively more associated with a change in real output than the price level in (!) but with much variation in the precision, timing, and si(e of the relation. .or the long*run, there has been stronger support for (!) and (#) and no systematic association of and . !J"

Principles
The theory above is based on the following hypotheses:
!. The source of inflation is fundamentally derived from the growth rate of the money

supply.
". The supply of money is e'ogenous. #. The demand for money, as reflected in its velocity, is a stable function of nominal

income, interest rates, and so forth. 6. The mechanism for in3ecting money into the economy is not that important in the long run. 7. The real interest rate is determined by non*monetary factors: (productivity of capital, time preference).

Decline of money-supply tar&etin&

%n application of the quantity*theory approach aimed at removing monetary policy as a source of macroeconomic instability was to target a constant, low growth rate of the money supply. #K" )till, practical identification of the relevant money supply, including measurement, was always somewhat controversial and difficult. %s financial intermediation grew in comple'ity and sophistication in the !JIKs and !JJKs, it became more so. %s a result, some central banks, including the -.). .ederal Feserve, which had targeted the money supply, reverted to targeting interest rates. ,ut monetary aggregates remain a leading economic indicator. #!" with +some evidence that the linkages between money and economic activity are robust even at relatively short*run frequencies.+ ##"

Criticisms
9ohn &aynard Leynes critici(ed the quantity theory of money in "he 0eneral "heory of %mployment1 Interest and oney. Leynes had originally been a proponent of the theory, but he presented an alternative in the 0eneral "heory. Leynes argued that price level was not strictly determined by money supply. :hanges in the money supply could have effects on real variables like output. !" Cudwig von &ises agreed that there was a core of truth in the ?uantity Theory, but critici(ed its focus on the supply of money without adequately e'plaining the demand for money. Be said the theory +fails to e'plain the mechanism of variations in the value of money

Monetary economics is a branch of economics that historically prefigured and remains

integrally linked to macroeconomics. !" &onetary economics provides a framework for analy(ing money in its functions as a medium of e'change, store of value, and unit of account. It considers how money, for e'ample fiat currency, can gain acceptance purely because of its convenience as a public good. #" It e'amines the effects of monetary systems, including regulation of money and associated financial institutions $" and international aspects. 6" &odern analysis has attempted to provide a micro*based formulation of the demand for money 7" and to distinguish valid nominal and real monetary relationships for micro or macro uses, including their influence on the aggregate demand for output. E" Its methods include deriving and testing the implications of money as a substitute for other assets G" and as based on e'plicit frictions. I" Fesearch areas have included:

empirical determinants and measurement of the money supply, whether narrowly*, broadly*, or inde'*aggregated, in relation to economic activity J" debt*deflation and balance*sheet theories, which hypothesi(e that over*e'tension of credit associated with a subsequent asset*price fall generate business fluctuations through the wealth effect on net worth. !K" and the relationship between the demand for output and the demand for money !!" monetary implications of the asset*price5macroeconomic relation !#" the quantity theory of money, !$" monetarism, !6" and the importance and stability of the relation between the money supply and interest rates, the price level, and nominal and real output of an economy. !7" monetary impacts on interest rates and the term structure of interest rates !E" lessons of monetary5financial history !G" transmission mechanisms of monetary policy as to the macroeconomy !I" the monetary5fiscal policy relationship to macroeconomic stability !J" neutrality of money vs. money illusion as to a change in the money supply, price level, or inflation on output #K" tests, testability, and implications of rational*e'pectations theory as to changes in output or inflation from monetary policy #!" monetary implications of imperfect and asymmetric information ##" and fraudulent finance #$" game theory as a modeling paradigm for monetary and financial institutions #6"

the political economy of financial regulation and monetary policy #7"