Post on 04-Apr-2018
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The Basics of Demand,Supply and Equilibrium
Dr. Prerna Jain
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Demand
Demand is defined as the want whichis backed by willingness and ability tobuy a particular commodity in a given
period of time.
Quantity demanded (Qd)
Amount of a good or serviceconsumers are willing and able topurchase during a given period oftime
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Types of Demand
When a commodity is
demanded for its own sakeby the final consumer, it isknown as consumer goodand its demand is deriveddemand. Ex: TV,refrigerator, computer andeatables.
A final consumer is onewho derives satisfactionfrom a good without anyfurther value addition.
Derived Demand
When a commodity is
demanded for using iteither as a raw material oras an intermediary forvalue addition in any othergood or in the same good,it is known as a capitalgood and its demand is
derived demand.
Direct Demand
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Recurring Demand
Consumable goods have
recurring demand, i.e.,they are consumed atfrequent intervals, like youeat food twice a day
Replacement Demand
Goods like TV, cars,
furniture and houses areall examples of durableconsumer goods. They arepurchased to be used for along period of time. Butthey wear and tear overtime due to use or
obsolescence oftechnology; thus they needreplacement.
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ComplementaryDemand
Goods which create jointdemand arecomplementary goods;
therefore demand for onecommodity is dependentupon demand for the otherone
Competing Demand
Goods that compete witheach other to satisfy anyparticular want are called
substitutes.
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Individual Demand
Demand for an individualconsumer is normallyexpressed as individual
demand and the theory ofdemand is based onindividual demand.
Market Demand
Demand by all theconsumers for its productis known as market
demand.
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Determinants of Demand
Price of the product Normally, price has anegative effect on demand.
Income of the consumer Normally, incomebears a positive relationship with demand.Normal goods have a positive relation whereasinferior goods have negative relation.
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Price of related goods If price of a commodityincreases, its demand falls, but when demand foranother product also falls as a consequence torise in price of this commodity such goods are
complementary to each other (car and petrol).
On the other hand when demand for anothercommodity rises as a consequence of increase inprice of this commodity, they are substitutes (tea
and coffee). Thus an increase in the price of a commodity
increases the demand for its substitute andreduces the demand for its complement.
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Tastes and Preferences Tastes and preferenceshave such effect that in spite of a fall in price,demand may not increase if the good has goneout of fashion and in spite of increase in price,
demand may not decrease because of theproduct being in fashion.
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Advertising Advertising has gained remarkableground as a determinant of demand, especially inthe modern age of cut throat competition amongbrands.
Consumers expectation of future income andprice.
Population
Growth of economy
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Demand Function
Demand function
DX = f (Px, Y, Po, T, A, Ef, N)
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Milestones on the Road to
Theory of Demand and Supply Antoine- Augustin Cournot was the first scholar
to bring out the Law of Demand in 1838, but histheory could not gain popularity as it was in puremathematical terms with which the then students
of economics was unfamiliar.
In 1844 Dupuit drew the first demand curve andcalled itthe curve of consumption.
The law of demand was discovered a few years
later and given its first application by lardner in1850 to explain transportation services.
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Fleeming Jenkin was the first scholar to draw thedemand and supply curves together to explainthe determination of price in 1870. Jenkin alsowas the first to use theories of demand and
supply to make predictions about the effects oftaxes. Alfred Marshall is recognised as the firstperson to present complete and modernexplanation of demand and supply theory
through his monumental treatise to economics Principles of Economics.
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Generalized Demand Function
Qd = abP + cY + dPo + eT + fA+ gN
b, c, d, e, f, &g are slope parameters
Measure effect on Qdof changing one of thevariables while holding the others constant
Sign of parameter shows how variable isrelated to Qd
Positive sign indicates direct relationship Negative sign indicates inverse relationship
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Law of Demand
A decrease in the price of a good, all other thingsheld constant, will cause an increase in thequantity demanded of the good.
An increase in the price of a good, all otherthings held constant, will cause a decrease in thequantity demanded of the good.
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Reasons Behind Law of
Demand Price Effect: This explains why a fall in price
results in rise in demand and vice versa. Somecommodities may have multiple uses, likeelectricity, milk, coal, steel, etc. A fall in the price
of such a commodity would induce a consumer toput it to alternative uses, like electricity can beused for lighting, cooling, cooking, runningmachines, etc.
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Substitution Effect: When the price of acommodity falls, it becomes more easilyaffordable and thus more attractive to theconsumer; as also its substitute become more
expensive, assuming that its price has notchanged. The consumer tries to substitute thisparticular commodity for other commodities. As aresult, demand for the commodity rises.
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Income effect demand depends upon theincome of the consumer and law of demandassumes that income is given. When price of aparticular commodity falls, the consumers real
income rises, though money income remains thesame. Thus, with fall in the price of thecommodity, income remaining the same,purchasing power of the individual rises, inducing
the consumer to buy more of that commodity.
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Exceptions to the Law of
Demand Giffen Goods: In Ireland it was observed that the
poor population consumed two goods: meat(which was costly) and bread (which was cheap).A very strange phenomenon was observed when
the price of bread was increased, it made a largedrain on the resources of the poor people thatthey were forced to curtail their consumption ofmeat and buy more of bread which was still the
cheapest food. This implied that quantitydemanded of bread (an inferior good) increasedwith increase in its price. Sir Robert Giffen wasthe first to give an explanation to this situation
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Hence, such goods which display direct pricedemand relationship are called giffen goods.These goods are considered inferior by theconsumer, but they occupy a significant place in
the individuals consumption basket. It sohappens that people in this case, with the rise ofprice of that good (bread) are forced to reducetheir purchase of other expensive goods (say,
meat) and increase the purchase of that good(bread) in larger quantity to supplement thereduction in luxury food items. Hence thesegoods are those on which major portion ofincome is spent, hence they are termed as giffen.
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Snob Appeal There are certain goods whichhave snob value, for which the consumersmeasures the satisfaction derived not by theirutility value, but by social status. The consumers
of this particular commodity want to show it offto others, and as a result they buy less of it at alower prices and more at higher prices.
Demonstration Effect: When a persons behaviour
is influenced by observing the behaviour ofothers, this is known as demonstration effect.Fashion is one such incidence. In such a caseprice is not a governing parameter and goods are
bought even though prices are rising.
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Future expectation of prices
Goods with no substitutes Those goods whichhave no substitute, such as life saving drugs,petrol and diesel, people have no option but tobuy them, whatever be the price
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Graphing Demand Curves
A point on a demand curve showseither:
Maximum amount of a good that will be
purchased for a given price
Maximum price consumers will pay for aspecific amount of the good
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Graphing Demand Curves
Change in quantity demanded
Occurs when price changes
Movement along demand curve
Change in demand
Occurs when one of the other variables,or determinants of demand, changes
Demand curve shifts rightward orleftward
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Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
An increase in price
causes a decrease in
quantity demanded.
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Change in Quantity Demanded
Quantity
Price
P0
Q0
P1
Q1
A decrease in price
causes an increase in
quantity demanded.
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Changes in Demand
Change in Buyers Tastes
Change in Buyers Incomes
Normal Goods Inferior Goods
Change in the Number of Buyers
Change in the Price of RelatedGoods
Substitute Goods
Complementary Goods
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Change in Demand
Quantity
Price
P0
Q0 Q1
An increase in demand
refers to a rightward shift
in the market demand
curve.
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Change in Demand
Quantity
Price
P0
Q1 Q0
A decrease in demand
refers to a leftward shift
in the market demand
curve.
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Supply
Supply refers to the quantities of a good orservice that the seller is willing and able toprovide at a price, at a given point of time andvice versa.
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Supply
Six variables that influence QsPrice of good or service (P)
Input prices (PI)
Prices of goods related in production (Pr)Technological advances (T)
Expected future price of product (Pe)
Number of firms producing product (F)
Generalized supply function
( , , , , , )s I r eQ f P P P T P F
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Generalized Supply Function
k, l, m, n, r, & s are slope parameters
Measure effect on Qsof changing one of thevariables while holding the others constant
Sign of parameter shows how variable isrelated to Qs
Positive sign indicates direct relationship Negative sign indicates inverse relationship
s I r eQ h kP lP mP nT rP sF
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Generalized Supply Function
Variable Relation to Qs Sign of SlopeParameter
P
Pe
F
PI
Pr
Direct
Direct
Direct
Inverse
Inverse
Inverse for substitutes
k = Qs/ P is positive
l = Qs/ PI is negative
m = Qs/ Pr is negativem = Qs/ Pr is positive
r = Qs/ Pe is negative
s = Qs/ F is positive
Direct for complements
n = Qs/ T is positiveT
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Graphing Supply Curves
A point on a supply curve shows either:
Maximum amount of a good that will beoffered for sale at a given price
Minimum price necessary to induce producersto voluntarily offer a particular quantity forsale
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Graphing Supply Curves
Change in quantity supplied
Occurs when price changes
Movement along supply curve
Change in supply Occurs when one of the other variables, or
determinants of supply, changes
Supply curve shifts rightward or leftward
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Law of Supply
A decrease in the price of a good, all other thingsheld constant, will cause a decrease in thequantity supplied of the good.
An increase in the price of a good, all other
things held constant, will cause an increase in thequantity supplied of the good.
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Change in Quantity Supplied
Quantity
Price
P0
Q0
P1
Q1
An increase in price
causes an increase in
quantity supplied.
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Changes in Supply
Change in Production Technology
Change in Input Prices
Change in the Number of Sellers
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Change in Supply
Quantity
Price
P0
Q1Q0
An increase in supply
refers to a rightward shift
in the market supply curve.
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Change in Supply
Quantity
Price
P0
Q1 Q0
A decrease in supply refers
to a leftward shift in the
market supply curve.
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Market Equilibrium
Market equilibrium is determined atthe intersection of the marketdemand curve and the market supply
curve.
The equilibrium price causes quantitydemanded to be equal to quantity
supplied.
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Market Equilibrium
Quantity
Price
P
Q
D S
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Market Equilibrium
Quantity
Price
P0
Q0
D0 S0
Q1
P1
D1
An increase in demandwill cause the market
equilibrium price and
quantity to increase.
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Market Equilibrium
Quantity
Price
P1
Q1
S0
Q0
P0
D0D1
A decrease in demandwill cause the market
equilibrium price and
quantity to decrease.
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Market Equilibrium
Quantity
Price
P0
Q0
D0 S0
Q1
P1
An increase
in supply
will cause
the marketequilibrium
price to
decrease and
quantity toincrease.
S1
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Market Equilibrium
Quantity
Price
P1
Q1
D0
Q0
P0
A decrease in
supply will
cause the
marketequilibrium
price to
increase and
quantity todecrease.
S1 S0