Managerial Economics & DEMAND

Analysis of Demand & Supply &

Market Equilibrium

Concept of Market A market is a mechanism by which

buyers and sellers interact to determine the price and quantity of a good or service

Demand side of the market for a product refers to all its consumers and the price they are willing to pay for buying a certain quantity of a product during a period of time.

What is Demand??? Demand is the desire or want

backed up by money

Always related to price and time

Statement of Law of Demand“All other things remaining constant, higher the price of a commodity, smaller is the quantity demanded and lower the price, larger the quantity demanded”

Dx = f (Px)

Reasons for Inverse Relationship Income effect- the decline in the price of a commodity

leads to an equivalent increase in the income of a consumer because he has to spend less to buy the same quantity of goods. The part of the money left can be used for buying some more units of commodity. For e.g.- suppose the price of mangoes falls from Rs.100/- per

dozen to 50/- per dozen. Then with the same amount of 100/- you can buy one more dozen, i.e.,2 dozens at Rs. 50/-

Substitution effect- When the price of a commodity falls, the consumer tends to substitute that commodity for other commodity which is relatively expensive. For e.g. – Suppose the price of the Urad falls, it will be used by

some people in place of other pulses. Thus the demand will increase.

Assumptions Underlying the Law No change in Consumer’s Income No change in Consumer’s

Preferences No change in Fashion No change in Price of related goods No Expectation of future price

changes or shortages

Individual Demand Schedule

Tabular representation of Quantity of a commodity that an individual is willing and able to purchase over a given period of time at each price of the commodity, while holding constant all other relevant economic variables on which demand depends.

Individual Demand Schedule

Price of Com X(Rs per kg)

Quantity demanded of Com X (Qty in kg)

80 2

70 4

60 6

50 10

Market demand ScheduleTabular representation of Quantity of a commodity that all individuals are willing and able to purchase over a given period of time at each price of the commodity, while holding constant all other relevant economic variables on which demand depends.

Market Demand SchedulePrice in (Rs) Units of Commodity X Market

demanded per day Demand by Individuals or Total A B C

4 1 1 3 53 2 3 5 102 3 5 7 151 5 9 10 24

Determinants of Individual Demand Income Price of Substitute & Complementary

products Taste & Preferences Advertisement Expectation regarding future price

changes Climatic Conditions

Determinants of Market Demand Price of Product Distribution of Income & wealth Community’s Common Habits and Scale of

Preferences Spending Habits of People Growth of Population Age Structure and Sex ratio of Population Future Expectations Level of Taxation Fashions Climate Conditions Customs Advertisement

Multivariate Demand Function

Dx = D (Px, Py, Pz, B, W, A, E, T, U)

Here Dx, stands for demand for item x (say, a car) Px, its own price (of the car) Py, the price of its substitutes (other brands/models) Pz, the price of its complements (like petrol) B, the income (budget) of the purchaser (user/consumer) W, the wealth of the purchaser

A, the advertisement for the product (car) E, the price expectation of the user T, taste or preferences of user U, all other factors.

Demand equation D= a – bP Where ‘a’ is constant parameter

signifying initial demand irrespective of price

‘b’ represents slope of demand curve functional relationship between price

and demand, having minus sign denotes negative function

Exceptions to Law of Demand

Conspicuous consumption – The goods which are purchased for ‘Snob appeal’ are

called as the conspicuous consumption. For e.g.- diamonds. They are the prestige goods. They would like to hold it only when they are costly and rare.

Speculative market: in this case the higher the price the higher will be the

demand. It happens because of the expectation to increase the price in the future.

For e.g. shares, lotteries

Contd… Giffens goods: It is a special type of inferior goods where the fall in

the price results into the decrease In the quantity demanded. This happens because of people’s preference for superior commodity

Consumer’s Psychological bias: Many a times consumer judges the quality of a good

from its price. Such consumers may purchase high price goods because of the feeling of possessing a better quality.

The exceptional demand curve shows a positive relation between the price and the quantity demanded.

Shifts in Demand Curve Extension and Contraction of Demand occurs

due to changes in price, other factors remaining constant When more of a commodity is purchased with a fall in price

then it is known as extension of Demand and vice versa Refer to movement along same demand curve

Increase and Decrease in Demand refers to changes in demand due to factors other than price An increase in demand signifies that more will be purchased

at a given price than before . Refer to movement from one demand curve to another

Reasons for shifts (increase or decrease in Demand)

Changes in Income Changes in Taste, habits and Preferences Change in Fashions and Customs Change in Distribution of Wealth Change in Substitutes Change in demand for Complementary

goods Advertisement and Publicity Persuasion Change in level of taxation

Nature of Demand Demand for Consumer’s goods &

Producer's goods Autonomous & Derived Demand Demand for Durables and Non-

Durables (Perishables) Joint Demand and Composite

Demand

Supply Analysis Supply during a given period of time means

the quantities of goods which are offered for sale at particular prices

Supply is what seller is able and willing to offer for sale

Supply and Stock are related but distinct terms-Supply comes out of Stock

Stock determines potential supply Stock is outcome of production

Determinants of Supply Cost of factors of production State of Technology Factors outside Economic Sphere

such as weather conditions, natural calamities, etc

Tax and Subsidy

Law of Supply“Other things remaining same , supply of a commodity rises with a rise in price and falls with a fall in price”

Supply schedule

Assumptions : Cost of production is unchanged Technology is constant Govt policies are unchanged No change in Transport costs No speculation Prices of other goods constant

Positions: Supply Curve Extension and Contraction : refer to

change in supply due to price, other things remaining same. Movement along the supply curve

Increase and Decrease in Supply: refer to change in supply due to determinants other than price Shifts in Supply Curve

Causes for change in Supply

Change in Cost of Production Supply also depends on Natural

Factors Change in Technique of Production Policies of Government Business Combines

When market is in Equilibrium?

Equilibrium price of a commodity is price at which quantity demanded of commodity equals quantity supplied and market clears

Equilibrium is condition which once achieved tends to persist in time.

Equilibrium of Supply and Demand

S

D

E

D&S

Price

Excess Supply

Excess Demand

Effect of Shift in Supply or Demand Demand & Supply shifts

Effect on price and quantity

If demand rises

Demand curve shifts to right

Both P & Q increases

If demand falls Demand curve shifts to left

Both P & Q falls

If supply rises Supply curve shifts to right

P falls but Q increases

If supply falls Supply curve shifts to left

P increases & Q decreases

Simultaneous shifts of Supply and Demand

New equilibrium price and quantity may be greater than, equal or even less than initial equilibrium levels depending on the magnitude and direction of two curves

If both D & S shift to right by same amount , the equilibrium point shifts to right by same amount and hence equilibrium price remains same.

Impact of Excise tax on Price and Quantity

An excise is a tax on each unit of commodity

If collected from sellers tax causes supply curve to shift upward by the amount of tax

Result is that consumers purchase a smaller quantity at a higher price while sellers receive a smaller net price after payment of tax

Impact of Excise tax on Price and Quantity

D

S0

S1

E0

TaxE1

Q0Q1

T

PoP1

Impact of Rent Control on Housing Markets

Rent control is a type of price ceiling or maximum rent set below equilibrium price that government use for making rented housing affordable, however the effect has been opposite ie shortage of apartments

Rent Control create shortages

Shortage

S

D

E

1.2 1.6 2Millions of Apartments

$1400Monthly Rent$1000

$600

Thank You