ECNE610 Managerial Economics Week 3 FEBRUARY 2014 1 Dr. Mazharul Islam Chapter-3.

ECNE610ManagerialEconomics

Week 3

FEBRUARY 2014

1

Chapter-3

3 Demand and Supply

2

Lesson Objectives To introduces the two most fundamental and the most

powerful of all economic tools. These are Demand and Supply.

Understand market equilibrium and how the market prices and quantities are determined in the short-run and long run.

Explain law of demand and supply. Explain the nonprice determinants of demand and

supply with practical examples. distinguish between the short-run rationing function

and the long-run guiding function of price. Explain how the concept of demand and supply can be

used to analyse market conditions in which management decisions about price and allocation of resources must be made.

Use the demand and supply model to make predictions about changes in prices and quantities.

3

Demand Demand indicates the quantities of

goods or services that consumers are willing and able to buy at various prices during a given time period when other things constant.

If you demand something, then you1. Want it,2. Can afford it, and3. Have made a definite plan to buy it.

4

Market DemandMarket:A set of arrangements through which buyers and sellers carry out exchange at mutually agreeable terms. Markets are often physical places, such as supermarkets, shopping malls etc. Market also include other mechanisms by which buyers and sellers communicate, like radio television advertisement, telephones etc.There are two types of market in the economy. These are Product market and Resource market.

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Market DemandThe sum of the individual demands of all consumers in the market.

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Quantity DemandWants are the unlimited desires or wishes people have for goods and services. Demand reflects a decision about which wants to satisfy.The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price.

7

Law of Demand An inverse

relationship exists between price and quantity demanded when other things remaining the same.

As Price Falls… …Quantity

Demanded RisesAs Price Rises… …Quantity

Demanded Falls

8

Law of DemandWhy does a change in the price change the quantity demanded? Two reasons:

Substitution effect Income effect

9

Law of Demand Substitution EffectWhen the price of a good falls, its relative price

makes consumers more willing to purchase this good.

Alternatively, when the price of a good increases, its relative price makes consumers less willing to purchase this good.

For example, when the price of Al-Baik declines while other prices remain constant, Al-Baik becomes relatively cheaper consumers are more willing to purchase Al-Baik when its relative price falls they tend to substitute Al-Baik for other goods.

10

Law of Demand

• Income Effect:When the price of a good decreases, a

person’s real income increases increased ability to buy a good increase in quantity demanded.

When the price of a good increases real income declines reduces the ability to buy a good decline in quantity demanded

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Demand Curve and Demand Schedule

12

P

Q

o

$2

1.5

1

0.5

0.05

P QD

$21.5

10.5

0.05

58121620 D

Price of Corn

Quantity of Corn

CORN

5 8 12 16 20

A Change in Demand (Non-price Determinants or Factors of Demand)

Five main factors (non-price determinants) that change demand are

The prices of related goodsFuture expectationsIncomeNumber of buyers/consumers Preferences (tastes)

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Changes in the prices of related goodsFor substitutes goods, if an increase in the price of one the demand for the other increase and demand curve shifts to rightward and, conversely, if a decrease in the price of one shifts the demand for the other good leftward (Example: Pepsi & Coca Cola)For complementary goods, if an increase in the price of one shifts the demand for the other leftward and a decrease in the price of one shifts the demand for the other rightward (car & petrol).

14


Future ExpectationA change in consumer expectations with respect to future prices, future incomes & credit shifts current demand

If individuals expect income to increase in the future, current demand increases and demand curve shift rightward. Vice versa also true.

If individuals expect prices to increase in the future, current demand increases and demand curve shift rightward. Vice versa also true.

15


Changes in Consumer Income Normal goods: the demand increases

when income increases and demand curve shift rightward. The demand decreases when income decreases and demand curve shift leftward (example: New car).

Inferior goods: the demand decreases when income increases and demand curve shift leftward. The demand increases when income decreases and demand curve shift rightward (example: Used car)

16


Changes in Preference (Taste) A favorable change in consumer preferences means If consumer preferences increase for a particular good then more of this good will be demanded at each price. Demand will increase and demand curve will shift rightward. An unfavorable change in consumer preferences will decrease demand and demand curve will shift leftward.

17


Changes in number of buyers or consumers

Increase in the number of consumers increase in market demand it means market demand curve will shift rightward.

Decrease in the number of consumers decrease in market demand it means market demand curve will shift leftward.

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A Change in Demand (Determinants or Factors of Demand)

19

P

Qo

$5

4

3

2

1

P QD

$54321

D

Price of Corn

Quantity of Corn

CORN

10 20 30 40 50 60 70 80

D’

Increasein

Demand

Increasein QuantityDemanded

1020355580

30406080 +

Demand Function

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Demand FunctionMathematical Expression:So linear demand function isQD = a0-aP + bX1 – cX2 + dX3 + eX4

If the values of the above variables as follows, what would be the demand curve for Al-Baik?a = 100, b = 1.5, c = 5, d = 20, e = 15

What is quantity demanded for Al-Baik if X1 = SAR10, X2 = SAR2, X3 = SAR15,000,

X4 = 30%

21

Now it’s over for today. Do Now it’s over for today. Do you have any question? you have any question?

22

SupplySupply refers how much of a

particular good producers are willing and able to sell at a given price during a given period.

Quantity supplied refers the quantity of a commodity that producers are willing to sell at a particular price at a particular point of time when other things constant.

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Supply

24

A Movement Along the Supply Curve

When the price of the good changes and other influences on sellers’ plans remain the same, the quantity supplied changes and there is a movement along the supply curve.

10

20

Supply

25

A Shift of the Supply Curve

If the price remains the same but some other influence on sellers’ plans changes, supply changes and the supply curve shifts.

Law of Supply

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As Price Rises…

…Quantity Supplied Rises

As Price Falls…

…Quantity Supplied Falls

Other things remaining the same, A direct relationship exists between price and quantity supplied

A Change in Supply (Non-price Determinants or Factors of Supply)

Six main factors (determinants) that change supply. These are as follows:

Costs Or Prices of Relevant Resources (Factors of production)

TechnologyPrices of Related Goods or

Services offered by the seller. Producer Expectations on future

prices.Number of Sellers (suppliers)Taxes, Subsidies, & State of Nature

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A Change in SupplyPrices of Relevant Resource (Factors of production)

Relevant resources are those employed in the production of the good in question.

If the price of some relevant resource increases production cost increase Amount of production decrease supply decreases supply curve shifts to the left.

If the price of some relevant resource decreases production cost decrease Amount of production increase supply increases supply curve shifts to the right .

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TechnologyIf a more efficient technology is

discovered, same resource can produce more production costs fall suppliers will be more willing and able to supply the good rightward shift of the supply curve.

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A Change in Supply (Determinants or Factors of Supply)

Prices of Related Goods & Services offered by sellers

For example, if the price of Soybean oil increases to produce more they will hire more resources with bit higher price the corn oil producers will get less resources to produce their products supply of corn oil declines and supply curve for corn oil shifts leftward.

Conversely, a fall in the price of soybean makes corn oil production more profitable supply for corn oil increases and supply curve shifts rightward.

30

A Change in Supply

Prices of Related Goods produced

Goods are complements in production if they must be produced together.

The supply of a good increases if the price of a complement in production rises (printer vs. ink jet cartridge OR a left shoe and a right).

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A Change in Supply

Producer Expectations on future prices. Changes in producer expectations with respect to the future price can change current supply.If iPhone suppliers expect higher prices in the future, to take advantage of the future higher price they may begin to expand their product today and stock current supply decreases supply curve shifts leftward.If iPhone suppliers expect lower prices in the future, they will try to sell all of their products today current supply increases supply curve shifts rightward.

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A Change in Supply

Number of Sellers (suppliers)If the number of producers increases, supply increases shifts to the right

If the number of producers decreases, supply will decrease shift to the left

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A Change in Supply

Taxes, Subsidies, & State of NatureBusinesses treat most taxes as costs. An increase in sales or property taxes will increase production costs and reduce supply, supply curve shifts leftward. Vice versa also true.If government subsidizes the production of a good, it reduce the producers production costs and supply increase and supply curve shifts rightward.

34

A Change in Supply

Taxes, Subsidies, & State of NatureThe state of nature includes all the natural forces that influence production—for example, the weather.

Any favorable natural forces increases amount of production which turn to increase supply and shifts the supply curve rightward.

Any unfavorable natural forces decreases amount of production which turn to decrease supply and shifts the supply curve leftward.

35

A Change in Supply

$54321

1020355580

$54321

60503520 5

200

B

U

Y

E

R

S

P QD

BUSHELSOF CORN

MARKET

DEMAND

2,0004,0007,000

11,00016,000

200

S

E

L

L

E

R

S

12,00010,000

7,0004,0001,000

P QS

BUSHELSOF CORN

MARKET

SUPPLY

EQUILIBRIUMGraphically…

x x

Market Equilibrium

36

117

SP

Qo

$5

4

3

2

1

2 4 6 8 10 12 14 16

P QD

$54321

2,0004,0007,000

11,00016,000

$54321

12,00010,000

7,0004,0001,000

D

P QS

CORNMARKET

CORNMARKET

Shortage ( Create market pressure for a higher price)

Surplus

(put downward pressure on the price)

Market Equilibrium

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Comparative statics is a form of sensitivity (or what-if) analysis. Commonly used method in economic analysis.

Process of comparative statics analysis: state all the assumptions needed to construct

the model. begin by assuming that the model is in

equilibrium. introduce a change in the model, so a condition

of disequilibrium is created. find the new point of equilibrium. compare the new equilibrium point with the

original one.

38Comparative Statics Analysis

39Example (Short-Run Analysis)

Step 1 assume all factors

except the price of Al-Baik are constant

buyers’ demand and sellers’ supply are represented by lines shown

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Example Step 2 begin the analysis

in equilibrium as shown by Q1 and P1

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Example Step 3 assume that a new study

shows Al-Baik to be the most nutritious of all fast foods.

as a result consumers increase their demand for Al-Baik.

Step 4 the shift in demand

results in a new equilibrium price (P2).

and a new equilibrium quantity (Q2).

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Sample Step 5 comparing the new equilibrium point with the

original one, we see that both equilibrium price and quantity have increased.

In short-run, when the market price changes to eliminate the imbalance between quantities demanded and supplied, this price change is called ‘rationing function of price’ by economists.

Do the analysis for other possible changes.

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Long-Run Analysis The long run is the period of time in which:

new sellers may enter a market. existing sellers may exit from a market. existing sellers may adjust fixed factors of

production. buyers may react to a change in equilibrium

price by changing their tastes and preferences.

Changes in Equilibrium

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45

SS = D P , Q unchanged = D P , Q unchanged


46


47

SS = D P (unchanged) , Q= D P (unchanged) , Q

Summary

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Supply increases Supply decreases

Demand increases Demand decreases

Change in Demand

Ch

an

ge

in

Su

pp

ly

Equilibrium price changeis indeterminate. Equilibrium quantity increases. Equilibrium

price rises. Equilibrium quantity change is indeterminate.

Equilibrium price falls. Equilibrium quantity change is indeterminate. Equilibrium price change is indeterminate. Equilibrium quantity decreases.

ECNE610 Managerial Economics Week 3 FEBRUARY 2014 1 Dr. Mazharul Islam Chapter-3.

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Transcript of ECNE610 Managerial Economics Week 3 FEBRUARY 2014 1 Dr. Mazharul Islam Chapter-3.