Presentation No.

3 DEMAND & SUPPLY

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Review of demand and supply definitions and concepts. Influencing factors of the demand and the supply. Market Equilibrium and Market Intervention Price Elasticity

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Yield Management (5249)

1. Basic Concepts: Definitions

Market is the social institution in which goods, services and production factors (labor, land, capital) are exchanged free and voluntarily among sellers and buyers. Place where consumers and producers can freely act (selling or buying) searching their own interests (invisible hand A Smith). Production is the process of transforming available resources into goods and services which are used to satisfy wants and needs commonly known as consumption. Supply and Demand are the forces that make the market to work. Price system is the mechanism by which buyers and sellers express their desires and arrive at an agreement reaching market equilibrium and the exchange of goods and services.

Market intervention: Price Control

Rationing: the prices direct (allocate) the stock of a good (service) toward the users that more value it. (- rate control) Assigning: the prices attract resources toward those sectors in which benefits are produced, and they deviate them of the sectors in which losses are produced. (capacity management)

1.a Demand and Demand Chart

It reflects the quantity of a good that the buyers want and they can buy.

The demand of a good can be expressed by a demand chart where the different quantities demanded according to the price are collected. It reflects the different calculations pricebenefit that the buyers of a good do:

Cost: the market price of any good. Benefit: satisfaction that the good provides.

Demand Curve

The demand curve is the graphic representation of the relation among the price of a good and the quantity demanded.
Nevertheless, the demand of a good does not depend alone of its price. What other factors influence in the demand?

The demand equation

The demand equation is the mathematical function that collects the relation among the quantity demands of a good and other variables

QA = D (PA, Y, PB, G, N)
PA = Price of analyzed good Y = Disposable income PB = Price of substitute or complementary goods G = Inclinations and preferences of the consumers N = Scale (size) of the market (population) E = Expectations (on future levels of income or prices)

PA = Price of the analyzed good

We have seen that the demand curve has a

negative slope.
Demand Law: The quantity demanded of a good decreases when its price increases and increases when price decreases, being maintained all others variables constant (ceteris paribus).

Example of a demand curve equation:

QA = 10,000 200 PA
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1.b Supply and the chart of supply

It shows the different quantities of a good that the producers are willing and can offer (supply) in exchange for a price. Similar to the demand, the supply can be specified inside a chart of offerings that reflect the different quantities supplied (offered) to different prices. It reflects the different calculations costbenefit that the producers of a good do:

Cost: the production cost of goods.

Benefit: the market price of any good.

The supply curve

The supply curve is the graphic representation of the relation among the price of a good and the quantity offered.
The offering of the market can also be expressed through a function of offering (supply) where all the factors that influence the quantity offered are reflected.

The supply equation

It collects the existing mathematical relation among the quantity offered of a good, the price and the others variable that influence in the decisions of production.

QA = S (PA, PB, r, z, H, E, M)
PA = Price of the analyzed good PB = Price of substitute or complementary goods r = The price of the productive factors z = Technology cost H = The number of competitor suppliers E = Expectations on variations in the prices M= Weather and environmental changes (i.e. agricultural products)

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PA = Price of the analyzed good

We have seen that the supply curve has a positive slope. The Law of supply express the direct relation that exists between the price and the quantity supplied (offered): upon increasing the price, the quantity supplied also increases. (ceteris paribus)

Example of a supply curve equation:

QA = 500 + 1000 P

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2.a Changes in the demanded quantity versus shifts in the demand curve

The changes in the components of the function of demand causes different movements in the curve of demand
PA = Price of analyzed good (independent variable) Movements along the curve of demand

Y = Disposable income PB = Price of substitute goods G = Inclinations and preferences N = Scale (size) of the market E = Expectations (ceteris paribus)

Displacements of the curve of demand

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Changes in the demanded quantity: Movements along the curve of the demand
Price ($) D PA A

Caused by the changes in the price ($)

PB

B
D QA QB Quantity

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Shifts in the demand (cont): Displacements of the demand curve

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2.b Changes in the supplied quantity versus shifts in the supply curve

The changes in the components of the function of supply causes different movements in the curve of supply
PA = Price of analyzed good (independent variable) PB = Price of substitute goods r = Price of the productive factors z = Technology cost H = The number of competitors E = Expectations M= Weather (ceteris paribus) Movements along the curve of supply

Displacements of the curve of supply

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Changes on the supplied quantity: Movements along the curve of the supply
Price ($)

Caused by changes in the price ($)

S

PB
PA

QA

QB

Q Quantity

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Changes on the supply: Displacements of the curve of supply

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3.a The Market Equilibrium

It will be reached there where concur the demand of the consumers with the offering of the producers. Meet of quantities and prices. The price of equilibrium is that in which it empties the market so that the quantity demanded and offered is the same one. Therefore, the equilibrium is found in the intersection of the curve of demand with the curve of supply.

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The Market Equilibrium

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The Market Equilibrium: Situations out of equilibrium (Surplus)

When the price is over the

price of equilibrium, it generates a surplus (excess of supply).

Surplus

The

market will seek the equilibrium reducing the quantity supplied and increasing the quantity demanded.

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The Market Equilibrium: Situations out of equilibrium (Shortage)

When the price is lower to
the price of equilibrium, it

generates a shortage
(excess of demand)

The market will seek the

equilibrium increasing the quantity offered and
Shortage

reducing the quantity

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demanded.

EXAMPLE
A hotel manager has studied the supply and demand behavior of the market and as a result he (she) has generated the following results (shown in the next table of Price ($ per room per night) vs Number of Rooms Supplied and Demanded).

Price ($ / room) 0.00 50.00 65.00 80.00 95.00 110.00 125.00 140.00 155.00

Supply (rooms) 0 0 10 15 20 25 30 40 50

Demand (rooms) 70 60 50 40 30 25 20 15 10

1 . Based on these results, draw the supply and demand curves and show the equilibrium point of the market 2. If the manager use a price of $80 /room, what is the shortage of rooms?
3. If the manager use a price of $140 /room, what is the surplus of rooms?

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A. Scenario: when Prices are increasing

In the hospitality industry, the demand is generated by the customers and the supply is controlled by the hoteliers.

Prices are adjusted UP ($/night/room)

The supply increases

High P. Low P.

The demand decreases

Qo < Qd

Shortage

Quantity (Rooms)

B. Scenario: when Prices are decreasing

In the hospitality industry, the demand is generated by the customers and the supply is controlled by the hoteliers.

Prices are adjusted DOWN ($/night/room)

Qo > Qd
High P.

The supply decreases

Low P.

The demand increases

Surplus

Quantity (Rooms)

Both (supply and demand) curves can displace at the same time to reach market equilibrium

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3.b Market intervention

The fact that the results of equilibrium are efficient does
not mean that they are desirable in absolute terms. For instance, it could occur that the markets get in equilibrium but many people have not access to determined goods of first need. (i.e. food)

The

worry by the population welfare can motivate the government to alter the results of the market: by implementing :

Policy of price control (price floor and price ceiling) Taxes

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Policy of price control: Floor (minimum) Price

It is the price of a good

established by law and supported by the offering P of the State to buy that PMIN good to that floor price established. The floor price is over the price of equilibrium, a surplus is produced (excess of offering) that is bought by the State.
PE

Surplus

D QD QE QO Q

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Policy of price control Ceiling (maximum) Price

Level above which the

law does not permit to rise the price of a good. The maximum or ceiling price is lower to

PE

the price of equilibrium,PMAX

shortage is produced (excess of demand).

Shortage QO QE QD

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4. Price Elasticity
Definition: the measure of responsiveness in the quantity demanded for a good as a result of change in price of the same good. It is a measure of how consumers react to a change in price.
Formula: the formula used to calculate price elasticity for a given product is:

Point-price elasticity = (P/Q) * ( Q/P)

Where Q = Quantity P = Price. (Q/P) = is the derivative of the demand function.

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Elasticity - Example
Suppose a certain good (say, laserjet printers) has a demand curve Q = 1,000 0.6P. We wish to determine the point-price elasticity of demand at P = $80 and P =$40. First, we take the derivative of the demand function (Q vs P):

Next, we apply the equation for point-price elasticity, to the ordered pairs ($40, 976) and ($80, 952). We have at P=40, point-price elasticity e = 0.6(40/976) = 0.02. and at P=80, point-price elasticity e = 0.6(80/952) = 0.05.

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Elasticity

In simpler words, demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, and very elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Inelastic demand means a producer can raise prices without much hurting demand for its product, and elastic demand means that consumers are sensitive to the price at which a product is sold and will not buy it if the price rises by what they consider too much. Drinking water is a good example of a good that has inelastic characteristics in that people will pay anything for it (high or low prices with relatively equivalent quantity demanded), so it is not elastic. On the other hand, demand for sugar is very elastic because as the price of sugar increases, there are many substitutions which consumers may switch to.

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Elasticity - Summary
Value
n=0 (1 < n < 0) n = 1 ( < n < 1) n =

Meaning
Perfectly inelastic. Relatively inelastic. Unit (or unitary) elastic. Relatively elastic. Perfectly elastic.

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Perfectly inelastic demand

Perfectly elastic demand

The end !!!

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