Lecture3
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Transcript of Lecture3
Demand, Supply and Equilibrium
INSPIRING CREATIVE AND INNOVATIVE MINDS
Demand
• A market consists of:– Buyers (demand)– Sellers (supply)– Exchange
• Effective demand = the quantity of a commodity which consumers will purchase at a given price per time period.
The Demand Schedule
• A table showing the quantity demanded of a product at various prices
• E.g. Demand Schedule for Big MacsPrice Qty demanded$1 500$2 400$3 300$4 200$5 100
• Graphical representation of demand schedule
Price
Quantity
$ 5
2
1
3
4
100 200 300 400 500
The Demand Curve
The Demand For Big Mac
The Law of Demand
• As price increases the quantity demanded decreases, conversely,
as price decreases the quantity demanded increases.
• Reflects an inverse relationship ie
As Price , quantity demanded
As Price , quantity demanded
• The law of demand is caused by:– The Income Effect
– The Substitution Effect
The Law of Demand
• As prices increase, consumers will purchase fewer goods and services. Their purchasing power (or real income) decreases
Quantity demanded decreases.
• As prices decrease, the purchasing power of consumers increases
Quantity demanded increases.
The Income Effect
The Substitution Effect
• As prices increase, consumers generally purchase more of a substitute product whose price is lower.
• A substitute product is a product that performs a similar function and satisfies the same consumer need/want e.g. Tea/ Coffee
Butter/Margarine• If the price of butter increases, the quantity
demanded will fall as consumers will substitute butter with margarine.
Supply
• Definition: the quantity of a product which producers offer to the market at a certain price per unit of time.
The Law of Supply
• As price increases the quantity supplied increases, conversely
as price decreases the quantity supplied decreases.
• The law of supply is a direct relationship
between price and quantity supplied.
• As P Quantity supplied
As P Quantity supplied
The Law of Supply
• Producers will seek to maximise their profits.
ie Supplying more at higher prices and less at lower prices.
The Logic of the law of supply
The Supply Schedule
• A table showing the quantity supplied at various prices.
• Example: Supply Schedule for Big Macs
Price Qty Supplied$1 200$2 300$3 400$4 500$5 600
Price
Quantity
$
Supply Curve
1
2
3
4
5
200 300 400 500 600
The Supply Curve
Price
Quantity
S
D
Equilibrium point (E)EP
Market Equilibrium
• Supply and Demand can now be brought together, to form the price mechanism.
Market Equilibrium (E) is where:
Qty demanded = Qty supplied (intersection of demand and supply
curves) the market is cleared (no shortages or surpluses)
Price (EP) is stable
Market Disequilibrium
= where Qty Demanded is NOT EQUAL to Qty Supplied.Types:1. Market Shortage: where
Qty demanded > Qty supplied2. Market Surplus (oversupply): where
Qty supplied > Qty demanded
Price
Qty
S
DP
QS QDShortage
Market Shortage
•Caused by price being set BELOW the equilibrium.
P
Q
S
D
QD QSSurplus
Market Surplus
Caused by price being set ABOVE the equilibrium.
Changes in Demand
Certain factors (other than price changes) affect the absolute level of demand.These factors are called Conditions of Demand.Changes to the Conditions of Demand cause changes in demand and this results in shifts of the Demand curve.
Qty
Price
D D1
S
E
E1
EP
EP1
EQ EQ1
An Increase in Demand
• The entire demand curve shifts to the Right.
Price
Qty
S
DD1
E
E1
EP
EP1
EQ1 EQ
A Decrease in Demand
The entire demand curve shifts to the LeftCaused by a factor other than price
Conditions of Demand
•Change in tastes•Improvements in Technology•Real Income •Change in Population•Change in the price of Substitutes•A change in the price of other goods•Expectations of the future•Advertising
Changes in Supply
Certain factors (other than price changes) affect the absolute level of supply.These factors are called CONDITIONS OF SUPPLY and they result in shifts of the supply curve (not movements along it).
Price
Qty
S
D
S1E
E1EPEP1
EQ EQ1
An Increase in Supply
Supply curve shifts to the right.
Price
Qty
S
D
S1
E
E1EP1
EP
EQ1 EQ
A Decrease in Supply
•Supply curve shifts to the left
Conditions of Supply
•Improvements in technology•A change in production costs•A change in the price of alternative
products•Weather and seasons