Demand Model

UNIT 2

Supply and Demand Model

The English historian Thomas Carlyle once said: Teach any parrot the words supply and demand and youve got an economist.

Demand & Supply Model

The supply and demand model is a basic workhorse of economics. We will consider each of its pieces. Then, we will use it to answer some basic questions. Note: When employing supply and demand we are considering perfectly competitive markets. For now that simply means all buyers and sellers are assumed to be price takers.

Demand
Demand means the willingness and capacity to pay. Prices are the tools by which the market coordinates individual desires.

Demand (Verbal)
The demand describes the relation between a goods price and the maximum quantity that consumers are willing and able to buy at that price, ceteris paribus.
Ceteris paribus means holding all the other demand function variables constant at some given level.

The Law of Demand

Law of demand there is an inverse relationship between price and quantity demanded, keeping other things constant.
Quantity demanded rises as price falls, other things constant. Quantity demanded falls as prices rise, other things constant.

The Law of Demand

What accounts for the law of demand?
People tend to substitute for goods whose price has gone up.
Income effect Substitution effect

The Demand Curve

The demand curve is the graphic representation of the law of demand. The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes down.

The Demand Table

The demand schedule assumes all the following:
As price rises, quantity demanded declines. The schedule assumes that everything else is held constant. All the products involved are identical in shape, size, quality, etc.

From a Demand Table to a Demand Curve

A Demand Table
Price per DVDs (in dollars) Price per DVD rentals cassette demanded per week $6.00 5.00 4.00 3.50 3.00 2.00 1.00 .50 0 E D G C F B A 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of DVDs demanded (per week) Demand for DVDs

A Demand Curve

A B C D E

$0.50 1.00 2.00 3.00 4.00

9 8 6 4 2

A Sample Demand Curve

Price (per unit)

PA

D 0
Quantity demanded (per unit of time)

QA

The Law of Demand

The demand curve is downward sloping for the following reasons:
At lower prices, existing demanders buy more. At lower prices, new demanders enter the market.

Demand Schedule and Demand Curve for DVDs

Other Things Constant

Other things constant places a limitation on the application of the law of demand.
All other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not. These factors may include changing tastes, prices of other (related) goods, income of the consumer, advertising and even the weather.

Movements vs. Shifts

A movement along the demand curve for X would be caused by a change in Px. A shift of the entire demand curve would be caused by a change in one of the ceteris paribus demand variables.
This would be referred to as an increase or decrease in demand.

The Demand Curve (Verbal)

The Law of Demand states that the relationship between a goods price and the quantity demanded of that good is negative. Example: when the price of a good falls from 25 to 10, the quantity demanded rises from 15 to 30. This is referred to as a change in quantity demanded and in this case an increase in quantity demanded. Own-price changes cause movements along a given demand curve.

Demand vs. Quantity Demanded

Demand is the amount of a product that people are willing and able to purchase at each possible price during a given period of time. The quantity demand is the amount of a product that people are willing and able to purchase at one, specific price.

Change in Quantity Demanded

Specifically decrease in quantity demanded

Price (per unit)

$2

B Change in quantity demanded (a movement along the curve)

$1

D1 0 100 200 Quantity demanded (per unit of time)

Change in Quantity Demanded

Specifically increase in quantity demanded

Price (per unit)

$2

A Change in quantity demanded (a movement along the curve)

$1

D1 0 100 200 Quantity demanded (per unit of time)

Shifts in Demand Versus Movements Along a Demand Curve

Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant. Graphically, it refers to the entire demand curve.

Shifts in Demand Versus Movements Along a Demand Curve

Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price. Graphically, it refers to a specific point on the demand curve.

Shifts in Demand Versus Movements Along a Demand Curve

A movement along a demand curve is the graphical representation of the effect of a change in price on the quantity demanded.

Shifts in Demand Versus Movements Along a Demand Curve

A shift in demand is the graphical representation of the effect of anything other than price on demand.

Shift in Demand
Specifically decrease in demand

Price (per unit)

$2

Change in demand (a shift of the curve)

$1

A D0 D1

250 100 200 Quantity demanded (per unit of time)

Shift in Demand
Specifically increase in demand

Price (per unit)

$2

Change in demand (a shift of the curve)

$1

B D1 D0

250 100 200 Quantity demanded (per unit of time)

Factors that Shift Demand

Number Of Buyers Consumer Income Price of Related Goods

Demand
Tastes And Preferences Taxes & Subsidies Expectations

A1

Income
An increase in income will increase demand for normal goods. An increase in income will decrease demand for inferior goods.

Slide 27 A1 Define Normal and Inferior goods

AMNA, 5/29/2008

A2

Price of Other Goods

When the price of a substitute good falls, demand falls for the good whose price has not changed. When the price of a complement good falls, demand rises for the good whose price has not changed.

Slide 28 A2 Define substitute and complementary goods

AMNA, 5/29/2008

Tastes
A change in taste will change demand with no change in price.

Expectations
If you expect your income to rise, you may consume more now. If you expect prices to fall in the future, you may put off purchases today.

Taxes and Subsidies

Taxes levied on consumers increase the cost of goods to consumers, thereby reducing demand. Subsidies have an opposite effect.

Change in Demand vs. Change in the Quantity Demanded

Individual and Market Demand Curves

A market demand curve is the horizontal sum of all individual demand curves.
This is determined by adding the individual demand curves of all the demanders.

Individual and Market Demand Curves

Sellers estimate total market demand for their product which becomes smooth and downward sloping curve.

From Individual Demands to a Market Demand Curve

(1) (2) (3) Price per Alices Bruces cassette demand demand (2) Cathys demand (3) Market demand

$4.00
Price per cassette (in dollars)

3.50 3.00 2.50 2.00 1.50 1.00 0.50 0

G F E D C B A
Cathy Bruce Alice Market demand

A $.0.50 B 1.00 C 1.50 2.00 D 2.50 E 3.00 F 3.50 G 4.00 H

9 8 7 6 5 4 3 2

6 5 4 3 2 1 0 0

1 1 0 0 0 0 0 0

16 14 11 9 7 5 3 2

2 4

6 8 10 12 14 16

Quantity of cassettes demanded per week

McGraw-Hill/Irwin

2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Changes in Demand and Quantity Demanded

Change in Quantity Demanded movement along the same demand curve in response to a price change. Change in Demand - shift in entire demand curve in response to a change in a determinant of demand (a ceteris paribus variable)

Demand Concepts
The demand function for X: QD = f(PX, Ps, Pc, I, T&P, Pop)
Where:
QD = quantity demanded PX = Xs price Ps = the price of substitutes Pc = the price of complements I=income T&P=tastes and preferences Pop=population in market or market size

Supply Model UNIT 3

Supply
Individuals control the factors of production inputs, or resources, necessary to produce goods. Individuals supply factors of production to intermediaries or firms.

Supply
The analysis of the supply of produced goods has two parts:
An analysis of the supply of the factors of production to households and firms. An analysis of why firms transform those factors of production into usable goods and services.

The Law of Supply

There is a direct relationship between price and quantity supplied.
Quantity supplied rises as price rises, other things constant. Quantity supplied falls as price falls, other things constant.

Law of Supply
Law of Supply As the price of a product rises, producers will be willing to supply more. The height of the supply curve at any quantity shows the minimum price necessary to induce producers to supply that next unit to market.

The Law of Supply

The law of supply is accounted for by two factors: When prices rise, firms substitute production of one good for another. Assuming firms costs are constant, a higher price means higher profits.

The Supply Curve

The supply curve is the graphic representation of the law of supply. The supply curve slopes upward to the right. The slope tells us that the quantity supplied varies directly in the same direction with the price.

A Sample Supply Curve

Price (per unit)

PA

QA Quantity supplied (per unit of time)

Supply Curve DVDs

Shifts in Supply Versus Movements Along a Supply Curve

Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

Shifts in Supply Versus Movements Along a Supply Curve

Quantity supplied refers to a specific amount that will be supplied at a specific price.

Shifts in Supply Versus Movements Along a Supply Curve

Changes in price causes changes in quantity supplied represented by a movement along a supply curve.

Shifts in Supply Versus Movements Along a Supply Curve

A movement along a supply curve the graphic representation of the effect of a change in price on the quantity supplied.

Shifts in Supply Versus Movements Along a Supply Curve

If the amount supplied is affected by anything other than a change in price, there will be a shift in supply.

Shifts in Supply Versus Movements Along a Supply Curve

Shift in supply the graphic representation of the effect of a change in a factor other than price on supply.

Change in Quantity Supplied

Specifically increase in quantity supply

S0

Price (per unit)

$20 A

B Change in quantity supplied (a movement along the curve)

$15

1,250 1,500 Quantity supplied (per unit of time)

Change in Quantity Supplied

Specifically decrease in quantity supply

S0

Price (per unit)

$20 B

A Change in quantity supplied (a movement along the curve)

$15

1,250 1,500 Quantity supplied (per unit of time)

Shift in Supply
Specifically increase in supply

S0 S1

Price (per unit)

$15

B Shift in Supply (a shift of the curve)

1,250 1,500 Quantity supplied (per unit of time)

Shift in Supply
Specifically decrease in supply

S1 S0

Price (per unit)

$15

A Shift in Supply (a shift of the curve)

1,250 1,500 Quantity supplied (per unit of time)

Factors that Shift Supply

Resource Prices

Prices of Related Goods and Services

Technology And Productivity

Supply

Number Of Producers

Expectations Of Producers

Price of Inputs (Resource Prices)

When costs go up, profits go down, so that the incentive to supply also goes down.

Technology
Advances in technology reduce the number of inputs needed to produce a given supply of goods. Costs go down, profits go up, leading to increased supply.

Expectations
If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later.

Number of Suppliers
As more people decide to supply a good the market supply increases (Rightward Shift).

Change in Supply vs. a Change in the Quantity Supplied

Individual and Market Supply Curves

The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

From Individual Supplies to a Market Supply

(1) (2) (4) (5) (3) Quantities Price Ann's Barry's Charlie's Market Supplied (per DVD) Supply Supply Supply Supply A B C D E F G H I $0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 0 1 2 3 4 5 6 7 8 0 0 1 2 3 4 5 5 5 0 0 0 0 0 0 0 2 2 0 1 3 5 7 9 11 14 15

From Individual Supplies to a Market Supply

$4.00 3.50
Price per DVD

Charlie

Barry

Ann

Market Supply H G F

3.00 2.50 2.00 1.50 1.00 0.50 0 A B C CA D E

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Quantity of DVDs supplied (per week)

Price of Related Goods or Services

The opportunity cost of producing and selling any good is the forgone opportunity to produce another good. If the price of alternate good changes then the opportunity cost of producing changes too! Example Mc Donald selling burgers vs. nuggets.

Price of Related Goods or Services

If the price of good x increases and the suppliers increase its production, the supply of good y will also increase as the goods x and y are complementary goods. Example Meat and Leather goods

Taxes and Subsidies

When taxes go up, costs go up, and profits go down, leading suppliers to reduce output. When government subsidies go up, costs go down, and profits go up, leading suppliers to increase output.

Equilibrium Effects of shift in Demand and supply on Market Equilibrium

UNIT 4

Equilibrium
Equilibrium is a concept in which opposing dynamic forces cancel each other out. In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price. Equilibrium isnt inherently good or bad, it is simply a state in which dynamic pressures offset each other.

Equilibrium
Equilibrium price the price toward which the invisible hand drives the market. Equilibrium quantity the amount bought and sold at the equilibrium price.

What Equilibrium Isnt

When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

Excess Supply
Excess supply a surplus, the quantity supplied is greater than quantity demanded Prices tend to fall.

Excess Demand
Excess demand a shortage, the quantity demanded is greater than quantity supplied Prices tend to rise.

Price Adjusts
The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall. When quantity demanded equals quantity supplied, prices have no tendency to change ~ Equilibrium

The Graphical Interaction of Supply and Demand

Price (per DVD) $3.50 $2.50 $1.50 Quantity Supplied 7 5 3 Quantity Demanded 3 5 7 Surplus (+) Shortage (-) +4 0 -4

The Graphical Interaction of Supply and Demand

$5.00 4.00 Price per DVD 3.50 3.00 2.50 2.00 1.50 1.00 1 Excess demand E C A Excess supply

2 3 4 5 6 7 8 9 10 11 12 Quantity of DVDs supplied and demanded

Equilibrium (Graph)

Shifts in Supply and Demand

Shifts in either supply or demand change equilibrium price and quantity.

Increase in Demand
An increase in demand creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and quantity are reached.

Effect of Shift in Demand on Equilibrium

S0 B $2.50 2.25 A Excess demand

D0 0

D1

8 9 10 Quantity of DVDs (per week)

The Effects of a Shift of the Demand Curve

Decrease in Supply
A decrease in supply creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and lower quantity are reached.

Effect of Shift in Supply on Equilibrium

S1 S0 C $2.50 2.25 B Excess demand A D0 0 8 9 10 Quantity of DVDs (per week)

Q.1. Change in Quantity Supplied versus Change in Supply (movement along the curve or shift of the curve)?
Variables that Affect quantity supplied Technology Price of inputs Expectations Price Number of suppliers Price of related goods Govt. policies A change in this variable