Sessions 5 & 6

Sessions 5 & 6 The Market Forces of Demand and Supply (With inputs from N. Gregory Mankiw: Principles of Economics, 4th Edition, Chapter 4)

Session Objectives: 

What factors affect buyers’ demand for goods?



How factors affect sellers’ supply of goods?



How do supply and demand determine the equilibrium price and quantity of a good sold?



Analysing changes in equilibrium

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Markets and Competition 

A market is an exchange relationship between buyers and sellers



Markets may be highly organized (e.g., wholesale fruit market) or less organized (e.g., market for ice cream).



A competitive market is one where



there are large number of buyers and sellers; each buyer and seller has perfect knowledge about the market conditions no single buyer and seller can influence the market price – each is a price-taker and must the market determined price

 

Assumption! Markets are perfectly competitive [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Demand The demand comes from the behaviour of buyers 

The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase



One important determinant of quantity demanded is the price of the product



Other things equal, the quantity demanded is negatively related to the price. This relationship is true for most goods in the economy and hence called the law of demand

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Demand Schedule and Demand Curve 







Demand schedule: table that shows relationship between price of a good and quantity demanded Demand curve: graph that shows relationship between price of a good and quantity demanded Draw the demand curve for ice cream cones Anything Striking! [MBA - 2008-10] 13.08.2008 & 18.08.2008

Price of IceCream Cone (in Rs.)

Quantity of Cones Demanded

0

12

5

10

10

8

15

6

20

4

25

2

30

0

Dr. Jaydeep Mukherjee Ravenshaw University

Market Demand 

The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price



Graphically market demand curve is the horizontal summation of individual demand curves Caution!



What about the assumption of perfect competition? [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Demand Curve 

The demand curve shows the relationship between quantity demanded and price of a commodity, other things being equal.

 

These “other things” are non-price determinants of demand



If the “other things” changes, there is a shift in demand curve

If the quantity demanded changes because of a change in price of a product, it is reflected by a movement along the demand curve Quick Thinking! What can be the “other things” that may affect demand? A shift in demand curve is called change in demand; while a movement along a fixed [MBA - 2008-10] demand curve is called a change in quantity demanded 13.08.2008 & Dr. Jaydeep Mukherjee 18.08.2008 Ravenshaw University

Shifts in the Demand Curve “Other Things” include 

Number of buyers



Consumer Income



Prices of Related Goods



Tastes



Expectations

A Problem! What will happen to the demand for ice cream cones, if there is an increase in the number of buyers? [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Demand Curve Change in income 

As income increases, if the demand for the good also increases then it is called a normal good.



As income increases, if the demand for the good decreases then it is called an inferior good.



For a normal good, an increase (decrease) in income causes increase (decrease) in quantity demanded at each price, shifting the demand curve to the right (left). [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Demand Curve Change in prices of related goods 

If an increase in price of one commodity causes an increase in the demand for another commodity, then the two are substitutes 



Tea and Coffee: An increase in price of coffee increases demand for tea, shifting the demand curve for tea to the right

If an increase in price of one commodity causes a decrease in the demand for another commodity, then the two are complements 

Tea and Sugar: An increase in price of sugar decreases demand for tea, shifting the demand curve for tea to the left.

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Demand Curve Expectations about future affect consumers’ buying decisions Quick Thinking! 

If people expect their incomes to rise, what will happen to the demand for ice cream cones?



If you expect the price of ice cream to fall tomorrow, what will happen to its demand? [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Demand Curve Class Assignment! 

What happens to the demand for computers, if

•

price of software falls?

•

price of computer falls?

•

price of hardware falls?

Read the case study on two ways to reduce the quantity of smoking demanded from Mankiw [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Supply The supply comes from the behaviour of sellers 

The quantity supplied of any good is the amount of the good that sellers are willing and able to sell



One important determinant of quantity supplied is the price of the product



Other things equal, the quantity supplied is positively related to the price. This relationship is true for most goods in the economy and hence called the law of supply

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Supply Schedule and Supply Curve 







Supply schedule: table that shows relationship between price of a good and quantity supplied Supply curve: graph that shows relationship between price of a good and quantity supplied Draw the supply curve for ice cream cones Again, anything striking?

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Price of IceCream Cone (in Rs.)

Quantity of Cones Supplied

0

0

5

3

10

6

15

9

20

12

25

15

30

18

Dr. Jaydeep Mukherjee Ravenshaw University

Market Supply 

The quantity supplied in a market is the sum of the quantities supplied by all the sellers at each price



Graphically market supply curve is the horizontal summation of individual supply curves Again! What about the assumption of perfect competition?

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Supply Curve 

The supply curve shows the relationship between quantity supplied and price of a commodity, other things being equal.

 

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



If the “other things” changes, there is a shift in supply curve

If the quantity supplied changes because of a change in price of a product, it is reflected by a movement along the supply curve

Quick Thinking! What can be the “other things” that may affect supply?

A shift in supply curve is called change in supply; while a movement along a fixed supply curve is called a change in quantity supplied [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Supply Curve “Other Things” include 

Number of sellers



Input prices



Technology



Expectations

A Problem! What will happen to the supply for ice cream cones, if there is an increase in the number of sellers? [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Supply Curve Change in input prices (like wages, prices of raw materials) and Technology Think! What happens to the supply of ice cream cones if the price of sugar falls? If there is a technological improvement? 

A fall in input price/cost-saving technological improvements makes production more profitable at each output price



So firms supply a larger quantity at each price, and the supply curve shifts to the right. [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Shifts in the Supply Curve Class Assignment! 

What happens to the supply for tax return preparation software, if

•

retailers cut the price of the software?

•

a technological advance allows the software to be produced at lower cost?

•

professional tax return preparers raise the price of the services they provide?

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

a

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Supply and Demand Together Combining what we have learnt so far, gives market equilibrium, where quantity demanded equals quantity supplied 

Equilibrium price 



Equilibrium quantity 



the price that balances quantity demanded and quantity supplied

the quantity demanded and quantity supplied at the equilibrium price

Graphically, equilibrium price and quantity are determined by the point of intersection of demand and supply curves Quick Activity! Determine the equilibrium price and quantity for ice cream cone

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Supply and Demand Together 

When market price > equilibrium price, then quantity supplied > quantity demanded



There is an excess supply or surplus



Suppliers will compete with one another, lowering prices to increase sales, thereby moving towards equilibrium



When market price < equilibrium price, then quantity demanded > quantity supplied



There is an excess demand or a shortage



With too many buyers chasing too few goods, suppliers will raise the price, thereby moving towards equilibrium.

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Supply and Demand Together Summary of the lessons learnt so far! 

The activities of many buyers and sellers automatically push the market price towards the equilibrium price



Once the market reaches its equilibrium, all buyers and sellers are satisfied, and there is no upward and downward pressure on price



The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance is referred to as law of supply and demand [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Changes in Equilibrium A Three-Step Program! 

Decide whether the event shifts the supply or demand curve (or both)



Decide in which direction the curve shifts



Use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Changes in Equilibrium Think! 

Suppose a month ago, a cyclone destroyed part of sugarcane crop in Orissa and drives up the price of sugar. At present a heat wave is going on in Bhubaneswar. Discuss how these events affect the market for ice cream.



The demand and supply functions of a product are given as P = 50 – 0.5 Qd, Qs = 28 + 10P. Find the equilibrium price of the product. What will happen to the market if price is Rs. 4? Rs. 8? [MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University

Summary

[MBA - 2008-10] 13.08.2008 & 18.08.2008

Dr. Jaydeep Mukherjee Ravenshaw University