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SUPPLY

 Definition of supply

 Supply is the amount of a particular


product or service that a firm would be
willing and able to offer for sale at a
particular price during a given period of
time.
Law of Supply

 The higher the price the higher is the


quantity supplied and vice versa.

An increase in price will lead to an


increase in quantity supplied, and the
lower price will lead to a decrease in
quantity supply.
Supply schedule:

Price Quantity
$0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5
Supply Curve
Price of
Ice-Cream
Cone
$3.0 Price Quantity
0 $0.00 0
2
.50 0.50 0
2 1.00 1
.00 1.50 2
1 2.00 3
.50 2.50 4
1
.00
3.00 5
0
.50
Quantity
0 1 2 3 4 5 6 7 8 9 1 1 1 of Ice-
0 1 2 Cream
Determinants of supply

 Price of the good itself


 Number of sellers
 Technology
 Resource Prices
 Taxes and subsidies
 Expectations of producers
 Prices of other goods the firm could produce
 Supply function:

 Qs = f( Px, Pn, Ns, Cost, Tech., W, G)


Distinction between changes in quantity
supplied and changes in supply
 Changes in
quantity supplied P2 b S

 A movement P1 a
along the supply
curve due to the
changes in the
price of the good
itself. Q1 Q2
Quantity
Price

 Changes in supply
S1 S2

 The shifts of the P0 c d


supply curve to the
left or right due to
the changes in the
non-price
determinants of Q1 Q2
Quantity
supply
Price and output determination:
(Market Structure)

 What is the equilibrium price?

 The price towards which the economy


tends’
 The price where the quantity demanded
equal to quantity supplied.
Equilibrium price and quantity
Equilibrium Price
◆ The price that balances supply and demand. On
a graph, it is the price at which the supply and
demand curves intersect.
Equilibrium Quantity
◆ The quantity that balances supply and demand.
On a graph it is the quantity at which the supply
and demand curves intersect.
Demand Supply
Schedule Schedule
Price Quantity Price Quantity
$0.00 19 $0.00 0
0.50 16 0.50 0
1.00 13 1.00 1
1.50 10 1.50 4
2.00 7 2.00 7
2.50 4 2.50 10
3.00 1 3.00 13

At $2.00, the quantity demanded is


equal to the quantity supplied!
Equilibrium of
Supply
Price of and Demand
Ice-Cream
Cone
Supply
$3.0
0
2
.50
2
.00
1
.50
1
.00
0 Demand
.50 Quantity
0 1 2 3 4 5 6 7 8 9 1 1 1 of Ice-
0 1 2 Cream
Price of
Ice-Cream
Cone
Supply
$3.0 Surplus
0
2
.50
2
.00
1
.50
1
.00
0 Demand
.50 Quantity
0 1 2 3 4 5 6 7 8 9 1 11 12 of Ice-
0 Cream
Surplus:
 When the price is above the equilibrium
price, the quantity supplied exceeds
the quantity demanded. There is
excess supply or a surplus. Suppliers
will lower the price to increase sales,
thereby moving toward equilibrium
Excess Demand
Price of
Ice-Cream
Cone
Supply

$2.00

$1.50

Shortage Demand

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of
Ice-Cream Cones
Shortage:
 When the price is below the equilibrium
price, the quantity demanded exceeds the
quantity supplied. There is excess
demand or a shortage. Suppliers will raise
the price due to too many buyers chasing
too few goods, thereby moving toward
equilibrium.
The Supply & Demand
for Tennis Shoes

$90
S
$60
$30
D
1,000 2,000 3,000 4,000 Q
The Supply & Demand
for Tennis Shoes

$90
S
Surplus
$60
Shortage
$30
D
1,000 2,000 3,000 4,000 Q
What causes a change in
market equilibrium?

A change in demand
A change in supply
What can cause a shift in a demand
curve?

a. Number of buyers in the market


b. Tastes and preferences
c. Income
d. Expectations of consumers
e. Prices of related goods
Three Steps To Analyzing Changes
in Equilibrium
◆ Decide whether the curve(s) shift(s) to the
left or to the right.
◆ Decide whether the event shifts the supply
or demand curve (or both).
◆ Examine how the shift affects equilibrium
price and quantity.
P The Effects of Shift in Demand
on Market Equilibrium

S
$900
Shortage
$600
$300 D2
D1
4 8 12 16 Q
The Effects of Shift in Demand
on Market Equilibrium

S
Surplus
$20

$10 D1
D2
10 20 30 40
Increase in
Quantity
Supplied

Increase in
Equilibrium
Price
Increase in
Demand
Decrease in
Quantity
Demanded

Increase in
Equilibrium
Price
Decrease
in Supply
7. ELASTICITY OF DEMAND

 Definition:
Elasticity means responsiveness or sensitivity.
Therefore elasticity of demand means the
responsiveness of demand due to the
changes of the factors that influence demand.
Types of Elasticity:
 Price elasticity of demand
 Cross elasticity of demand
 Income elasticity of demand
 Price elasticity of supply
i. Price Elasticity of Demand (Ep)

 Ep measures the responsiveness of the


quantity demanded due to the change in
its price.
 Ep tries to measure how much does
demand has decreased when price
increased
 Calculating price elasticity of demand;
Formula:
Ep = - % ∆ in Qd for product X
% ∆ in P of product X
= - % ∆ in Q
% ∆ in P
= - ∆ Q x P0
∆P Q0
= - (Q1 – Q0) x P0
(P1 – P0) Q0
 Example:
Price(RM) Quantity Demanded
2.00 10
3.00 5

 Calculate the price elasticity of demand


when price increases from RM2.00 to
RM3.00.
 Formula:
Ep = - ∆ Q x P0
∆P Q0
= - (Q1 – Q0) x P0
(P1 – P0) Q0
= - (5 – 10) x 2
(3 – 2) 10
= 1
Degrees of Price Elasticity of Demand

 Elastic demand (Ep > 1)


Percentage change in quantity demanded is
greater then the percentage change in price.
P
 %Δ Q > %Δ P
D

Q
ii. Inelastic demand (Ep < 1)

 Percentage change in quantity is less than the


percentage change in price.
P D

 %Δ Q < %Δ P

Q
iii. Unitary elastic (Ep = 1)

 Percentage change in quantity demanded is


equal to the percentage
P change in price.

 %Δ Q = %Δ P

X
iv. Perfectly Elastic (Ep = ∞)

 Percentage change in quantity demanded


is infinite in relation to the percentage
change in price. P

P0 D

Q
v. Perfectly Inelastic (Ep = 0 )

 Quantity demanded does not change as


the price changes.
P D

P2

P1

Q0 Q
Determinants of Price Elasticity of Demand
 Availability of substitutes

Normally, the larger the number of substitutes


available, the greater the elasticity of demand for a
product. When substitutes are not readily available,
the elasticity of demand is likely to be less.

 Relative importance of the goods in the budget

If the goods take a large portion of an individuals


budget, the demand tends to be elastic. Examples are
cars, electrical appliances and other luxury goods.
Therefore a small increase in the price of the goods
will have a very large effect on the demand for the
goods.
 The amount of time available to adjust to the price
change (Time dimension)

In the short run, demand is less elastic. In the long run


demand is likely to be more elastic simply because
consumers can make adjustment and fine other
substitutes.

 The importance of goods – necessity or luxury

The demand for necessity such as rice is inelastic,


great increase in price will not reduce the demand for
rice very much. On the other hand the demand for
luxury goods or less important goods are elastic.
 Income level

Those with higher income are less sensitive to price


changes, therefore their demand is inelastic. Whereas
those from lower income group are sensitive to price
changes and their demand is more elastic.

 Habits

If goods consume becomes habits, the demand for the


particular goods are inelastic. Example is demand for
cigarette by smokers.
Relationship between price elasticity of
demand and total revenue (TR)
 TR = price x quantity
 TR increases or decreases when there is price
changes depend on the price elasticity of demand.

i. If demand is elastic, to increase TR,


price should be decreased.

ii. If demand is inelastic, to increase TR,


price should be increased.

iii. If demand is unitary elastic, change in


price would not affect and change in TR.
Cross Elasticity of Demand (Ec)

 Ec measures the responsiveness of quantity demanded


for one product to a change in the price of another
product.
Qx = f(Py)

 Two possibilities:
Ec = +ve
- an increase in Py would increase the demand for
good x, goods x and y are substitutes

Ec = -ve
- an increae in Py would reduce the demand for
good x, goods x and y are complementary goods.
 Formula:
Ec = % ∆ in Qx
% ∆ in Py
= ∆ Qx x Py0
∆ Py Qx0
= (Qx1 – Qx0) x Py0
 (Py1 – Py0) Qx0
 Example:
Price of Y Quantity x Quantity Y
RM10 60 15
RM18 40 25
RM25 20 30

 Calculate the cross elasticity of demand for good


x when the price of y increases from RM18 to
RM25
Answer:
Formula :

= ∆ Qx x Py0
∆ Py Qx0
= (Qx1 – Qx0) x Py0
(Py1 – Py0) Qx0
= 30 - 25 x 18
25 - 18 25
= 0.51

 Conclusion;
If Ec is positive, goods x and y are substitutes
Income Elasticity of Demand (Ey)

 Ey measures the responsiveness of quantity


demanded to a change in income.

 Three possibilities:
i. If Ey is positive = normal goods -
Ey >1 - luxury
Ey ≤ 1 – necessity
ii. If Ey is negative = inferior goods
iii. If Ey is zero = essential goods
 Formula:
Ey = % ∆ in Q
% ∆ in Y
= ∆Q x Y
∆Y Q
= (Q1 – Q0) x Y0
(Y1 – Y0) Q0
 Example:
Income Qty A Qty B Qty C
100 10 20 20
120 15 20 18
150 17 20 14

Calculate the income elasticity of demand for


goods A, B and C when income increases from
RM120 to RM150.
 Good A:
Ey = (QA1 – QA0) x Y0
(Y1 – Y0) QA0

= (17 – 15) x 120


(150 – 120) 15

= 0.53

 Since Ey is positive and < 1, good A is a necessity


 Good B:
Ey = (QB1 – QB0) x Y0
(Y1 – Y0) QB0

= (20 – 20) x 120


(150 – 120) 20

= 0 (Good B is inferior good)


 Good C:
Ey = (QC1 – QC0) x Y0
(Y1 – Y0) QC0

= (14 – 15) x 120


(150 – 120) 15

= - 0.27

 Good C is an inferior good


Price Elasticity of Supply

 Measure “The responsiveness of quantity


supplied to a change in price.“

 Elasticity of supply can be determined by


comparing the % change in quantity
supplied with the % change in the price of
the product. I
Types of Price Elasticity of Supply
P
 Elastic Supply ( fairly
S
elastic)
 % change in
quantity supplied is
greater than %
change in price.

 Es =% Δ QS > % Δ P Q
P
S
 2. Inelastic Supply
(fairly inelastic)

 % change in quantity
supplied is less than
% change in price.

Q
 Es =% Δ QS > % Δ P
S1
S2
 Unitary Elastic

 % change in
quantity supplied
is equal to the %
change in price

Es =% Δ QS > % Δ P
Q
 Perfectly Inelastic
% change in quantity supplied is zero
despite the change in the price.
P
S
Perfectly Elastic

% change in quantity supplied is


infinitely large compared to the %
change in price.
P

P0 S

Q
 mathematical formula

 Es = % change in quantity supplied


% change in price

= % Δ QS
%ΔP
= Δ QS x P0
ΔP Q0

= Q1 - Q0 x P0
P1 - P0 Q0
 When the price of cars in RM 20,000 each the supply is 1000 units
per month. When price increase to RM 30,000 each, the supply is
1200 units per month.
Therefore, the elasticity of supply of cars is :-

 = % Δ QS
 %ΔP
 = Δ QS x P0
 ΔP Q0

 = Q1 - Q0 x P0
 P1 - P0 Q0

 = 0.4
Factors Influencing Elasticity of Supply
1. TIME
In the short run, supply would be inelastic, it is not
possible to increase supply immediately in response to
change in price. However, in the long run, supply would
be more responsive to price changes, i.e. is more elastic.

In the long run sellers or producers can fully adjust their


supply to the change in prices.

2. NATURE OF THE GOOD


If it takes too long to produce a product, supply is fairly
inelastic. Otherwise supply will be elastic. For example,
the supply of agricultural product (primary products) is
fairly inelastic whereas the supply of manufactured
goods (secondary products) is fairly elastic.
3. COST AND FEASIBILITY OF STORAGE
If the change in supply requires only a small change in
production costs, most likely supply will be elastic.
However if the change in supply involves a major change
in costs supply tends to be inelastic.
Goods that are too costly to be stored will have a low
elasticity of supply.

4. SUBSTITUTABILITY OF FACTORS OR INPUTS USED


If land, labor and capital can produce one commodity
and these factors can be readily switched to produce
another good, then supply of the factors is elastic.
But if the production of its output require very
specialized inputs, supply tends to be more elastic.
5.PERISHABILITY
If the product is a easily perishable, especially
agricultural product, then the supply would be
inelastic. Such products would not be sensitive
to price changes, for example, vegetables.
Hence, an increase in price will not bring about a
distinctive change or rise in the quantity
supplied.
Theory of Consumer Behavior
 The theory of consumer behavior uses
indifference curves and budget line to
explain the conditions of consumers
equilibrium or how consumer maximize
utility
Assumptions:
 A rational consumer will try to dispose of all his or her
income in a manner to maximize his or her utility

 Consumer knows his or her preferences and decides his


or her consumption based on them.

 Consumers preference are consistent

 Consumer react to prices and react by reconciling their


wants with their budget.
Indifference curve
Product Y
 Indifference
curve is a locus
of various A

combinations of
B
two goods which C
yields the same
or equal
0 Product X
satisfaction.
Indifference Curve
 Properties of Indifference curve:
i. downward sloping – explains the tradeoff
between the two goods for the consumer
to be equally satisfied.

ii. The further they are from the origin, the


higher the utility level the represent.

iii. They do not intersect each other


 Map of Indiference curves
Product Y

IC3
IC2
IC1

Product X
Budget Line
 Budget line shows the alternative
combinations of two goods which can be
purchased with a given money income
based on the prices of the gods.
Budget Line:
Y
 Given : Money income
= RM100, 4
 Px = 20
 Py = 25

 Slope of budget line:


 = Price of X
X
Price of Y 5
Consumer equilibrium:
Y

 Consumer will be
in equilibrium if the
indifference curve a

is tangent to the e

budget line. IC2

b IC1

0 X