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Demand and Supply Analysis

Demand
Prices are determined by interaction of demand and supply.

Demand of a good is the quantity that buyers are willing to purchase


as the price per unit of good changes.

QD = QD (P)

Law of demand : Other things being equal, when the price falls, the quantity
demanded increases.
Demand Curve
Demand schedule
Price of Ice
Price of ice-cream (Rs) Quantity of ice-cream cream (Rs.)
demanded
0.00 12
30
5.00 10 25
10.00 8
20
15.00 6
20.00 4
15
25.00 2 10
30.00 0 5
Demand curve- How the quantity 0
demanded of the good changes as its 2 4 6 8 10 12
price varies. Quantity of Ice cream
Market demand versus Individual demand
The quantity demanded in a market is the sum of the quantities demanded
by all the buyers at each price.
Price of Ice Price of Ice Price of Ice
cream (Rs.) cream (Rs.) cream (Rs.)

30 30 30

25
P-1 25
P-2 25
Market demand
20 20 20 curve
15 + 15
= 15

10 10 10
5 5 5

0 0 0
2 4 6 8 10 12 2 4 6 8 10 12 2 4 6 8 10 12 14 16 18 20
Quantity of Ice cream Quantity of Ice cream Quantity of Ice cream

Market demand curve is found by adding horizontally the individual


demand curves.
Factors impacting demand
Price movement along the curve

Income- higher is the income, more


is the money that consumers can Shifting of the curve
spend.

QD = D (P, I)
Shift in demand curve
Increase/ decrease in demand

Any change that increases the quantity demanded at every price.


The demand curve would shift to the right.

Any change that decreases the quantity demanded at every price.


The demand curve would shift to the left.
Why does the demand curve shift?
Income higher income would lead to increase in quantity demanded.
Normal goods
Inferior goods

Prices of related goods


Substitutes- increase in price of one good would lead to increase in quantity
demanded of its substitute.

Complements- increase in price of one good would lead to decrease in quantity


demanded of its compliment
Why does the demand curve shift?
Tastes

Expectations - if you expect to earn a higher income in future, you may


choose to save less now and spend more of your current income.

Number of buyers - With increase in number of buyers market demand


would be higher at every price.
Supply
Supply curve examine the behavior of sellers.

The quantity supplied of any good or service is the amount that


sellers are willing to sell at a given price.
QS = QS (P)

Law of supply : Other things being equal, when the price increases, the
quantity supplied by the sellers increases.
Supply Curve
Supply schedule
Price of Ice
Price of ice-cream (Rs) Quantity of ice-cream cream (Rs.)
supplied
0.00 0
30 Supply curve
5.00 0 25
10.00 1
20
15.00 2
20.00 3
15
25.00 4 10
30.00 5 5
Supply curve- How the quantity supplied 0
of the good changes as its price varies. 2 4 6 8 10 12
Quantity of Ice cream
Market supply versus supply of individual
seller
The quantity supplied in a market is the sum of the quantities supplied by
all the sellers at each price.
Price of ice- Quantity of ice-cream Quantity of ice- Market supply
cream (Rs) supplied (S-1) cream supplied (S-2)
0.00 0 0 0
5.00 0 0 0
10.00 1 0 1
+ =
15.00 2 2 4
20.00 3 4 7
25.00 4 6 10
30.00 5 8 13

Market supply curve is found by adding horizontally the individual


supply curves.
Shift in supply curve
Increase/ decrease in supply

Any change that increases the quantity supplied at every price.


The supply curve would shift to the right.

Any change that decreases the quantity supplied at every price.


The supply curve would shift to the left.
Shift in supply curve vs movement along
curve

Movement along supply curve


Response of quantity supplied to change in price.

Shift in supply curve


Change in input prices Increase in input prices would lead to
decrease in quantity supplied.
Shift in supply curve vs movement along
curve
Shift in supply curve

Technology- advancement in technology would increase productivity


and hence leads to increase in supply.

Expectations - if the firm expects the price of a good to rise in future,


then it would supply less today.

Number of sellers- With increase in number of sellers market supply


would be higher at every price.
Equilibrium
Price (Rs.
It is the situation in which market per unit)
price has reached the level at which
quantity supplied equals quantity Supply curve
demanded.
Surplus

Equilibrium price is market clearing P1


price. P0

P2 Demand curve
There is no excess demand or
excess supply. Shortage
Q0 Quantity
Change in Market Equilibrium
Price (Rs.
Shift in demand curve per unit)
S

Increase in income rightward shift


of demand curve.

Consumers are willing to pay a P1


higher price.
P0
D
Firms are willing to produce a
greater quantity. D

Q0 Q1 Quantity
Change in Market Equilibrium
Price (Rs.
Shift in supply curve per unit)
S
S
Decrease in price of raw materials:
Rightward shift of supply curve.

Lower costs result in increase in


production at lower prices. P0
P1
Lower prices would increase the
demand. D

Q0 Q1 Quantity
Change in Market Equilibrium
Price (Rs.
Shift in both demand and supply per unit)
S
curve S

Change in prices and quantity


would depend on
Relative shift of demand and supply
curves respectively. P1
Shape (elasticity) of demand and P0
D
supply curve.
D

Q0 Q1 Quantity
Elasticities of demand and supply
How sensitive demand and supply curves are?
Elasticity- percentage change that will occur in one variable in
response to a one percent increase in another variable.
Price elasticity of demand- percentage change in quantity
demanded of a good resulting from a one percent increase in its
price.
EP = (%Q)/(%P)
EP = (Q)/Q/(P)/P
EP = P/Q (Q)/(P)
Elasticities of demand and supply
Price elasticity of demand- Will be positive or negative?
Price elasticity is greater than 1, then demand is price elastic because
percentage decline in quantity demanded is greater than percentage
increase in price.

Price elasticity is less than 1, then demand is price inelastic.

Price elasticity depends on availability of substitutes.

Price elasticity changes along demand curve so must be measured at


a particular point on the demand curve.
Elasticities of demand and supply
Price
Calculate the elasticity when P = 2 and Q
=4: P = 4-(1/2)Q 4 EP =-
Q = 8-2P
(Q)/(P) = -2
As we move down the curve, the ratio P/Q
falls. EP = -1
2
There is a decrease in magnitude of
elasticity as one moves down the curve.
Slope of demand curve = (P2 P1)/
(Q2 Q1) = (P)/(Q)= 1/elasticity. EP = 0
4 8 Quantity
Steeper the slope lesser is the elasticity.
Elasticities of demand and supply
Infinitely Elastic demand Completely Inelastic demand
Price Price D

What is (Q)/(P)? What is (Q)/(P)?

P*
D

Quantity Q* Quantity
Other elasticities
Income elasticity of demand: Percentage change in the quantity
demanded resulting from 1-percent increase in income.
EI = I/Q (Q)/(I)

Cross-price elasticity of demand: Percentage change in the quantity


demanded of one good resulting from a 1-percent increase in
the price of another.
EQaPb = Pb/Qa (Qa)/(Pb)

Substitutes: Positive
Complements: Negative
Other elasticities
Price elasticity of supply: Percentage change in the quantity
supplied resulting from 1-percent increase in price.

ES = P/Q (Q)/(P) Positive