MacroeconomicsWeek 2-3

THE MARKET FORCES OF DEMAND AND SUPPLY

THE BARTER MARKET

1 www.investopedia.com

THE CONCEPT OF MARKET

MARKETis a group of buyers and

sellers of a particular good or service. It brings

together “demanders” and “suppliers.”

BUYER“Demander

s”

SELLER“Suppliers”

GOODS PRICE

LAW OF DEMAND

DEMANDis a schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time.

Demand for Ice Cream

Price/unit

Quantity Demanded

Php 4.00 3

Php 3.00 5

Php 2.00 8

Php 1.00 10

LAW OF DEMAND

LAW OF DEMANDAll else equal, as price of a good increases, the quantity of the good that the buyer would be able and willing to buy decreases.Logic behind the Law: An individual purchases more of a product at a low price than at a high price. Diminishing marginal utility Income and substitution effects.

DEMAND RELATIONSHIP

LOGIC BEHIND THE LAW OF DEMAND

More product at a lower price

Diminishing Marginal UtilityIt is a phenomenon wherein the satisfaction or utility derived by an individual or buyer diminishes as he/she consumes additional unit of a particular good.

LOGIC BEHIND THE LAW OF DEMAND

Income effectA lower price increases the purchasing power of a buyer’s income, enabling the buyer to purchase more of a good than before.

Substitution effectSuggests that a lower price, buyers have the incentive to substitute what is now a less expensive product for similar products that are now more relatively expensive.

DETERMINANTS OF DEMAND

Price

No. of buyers

Income

Tastes

Price of substitut

es

Expectations

LAW OF DEMAND

Demand Curveis the inverse or negative relationship between the price and quantity demanded for a particular good represented in a graph.Market Demandis the summation of the quantity demanded by all consumers in the market at each various possible prices.

LAW OF DEMAND

Change in Quantity DemandedIt is a movement of the price-quantity demanded combination from one point to another on a fixed demand schedule or demand curve.

LAW OF DEMAND

Change in DemandIt is the shift in the demand curve brought about by a change in one or more of the determinants of demand.Observations Any change that raises the quantity that buyers wish to purchase at a given price shifts the demand curve to the RIGHT.

Any change that lowers the quantity that buyers wish to purchase at a given price shifts the demand curve to the LEFT.

LAW OF SUPPLY

SUPPLYis a schedule or a curve that shows the various amounts of a product that producers are willing and able to make available at each of a series of possible prices during a specified period of time.

Supply for Ice Cream

Price/unit

Quantity Supplied

Php 4.00

10

Php 3.00

8

Php 2.00

5

Php 1.00

3

LAW OF SUPPLY

LAW OF SUPPLYAll else equal, as price of a good increases, the quantity of the good that the seller would be able and willing to supply increases.

Logic behind the Law: Profit objective Increasing marginal cost

LOGIC BEHIND THE LAW OF SUPPLY

Profit objective

Increasing marginal costBeyond some quantity of production, additional resources produce less additional output.

Input prices

DETERMINANTS OF SUPPLY

Price

Technology

Taxes and

subsidiaries

DETERMINANTS OF SUPPLY

Producer’s Expectations

No. of sellers

Price of other goods

LAW OF SUPPLY

Supply Curveis the direct or positive relationship between the price and quantity supplied for a particular good represented in a graph.Market Supplyis the summation of the quantity supplied by all producers in the market at each various possible prices.

LAW OF SUPPLY

Change in Quantity SuppliedIt is a movement of the price-quantity supplied combination from one point to another on a fixed supply schedule or supply curve.

LAW OF SUPPLY

Change in SupplyIt is the shift in the supply curve brought about by a change in one or more of the determinants of supply.Observations Any change that raises the quantity that producers wish to sell at a given price shifts the supply curve to the RIGHT.

Any change that lowers the quantity that producers wish to sell at a given price shifts the supply curve to the LEFT.

MARKET EQUILIBRIUM

Equilibrium Quantityis the quantity supplied and quantity demanded when the price has adjusted to balance supply and demand.

Market Equilibriumis one point at which the demand and supply curves intersect and bought into balance.

Equilibrium Priceis the value in monetary terms that balances the demand and supply of a particular good or service.

MARKET DISEQUILIBRIUM

Market Surplusis a situation in which a quantity supplied is greater than quantity demanded.

MARKET DISEQUILIBRIUM

Market Shortageis a situation in which quantity demanded is greater than quantity supplied.

ELASTICITY

Elasticityis the degree to which a demand or supply curve reacts to a change in price.

To determine elasticity:Elasticity = (% change in quantity )

(% change in price)

DEMAND ELASTICITY

Price Elasticity of Demand (Ed)is the responsiveness (or sensitivity) of consumers to a price change.

To determine the Price Elasticity of Demand (Ed):Ed = Qd / Qd = % change in quantity demanded

P / P % change in price

DEMAND ELASTICITY

Classification of Demand Elasticity (Ed) ELASTIC DEMAND Ed is > 1 INELASTIC DEMAND Ed is < 1 UNIT ELASTIC Ed is = 1

DEMAND ELASTICITY

Extreme Cases of Demand Elasticity PERFECTLY ELASTIC Ed is = PERFECTLY INELASTIC Ed is

= 0

DEMAND ELASTICITY

Income Elasticity of Demand (Ei)is the responsiveness (or sensitivity) of consumers to a change in their incomes by buying more or less of a good.

To determine the Income Elasticity of Demand (Ei):Ei = Qd / Qd = % change in quantity demanded

Y / Y % change in income NORMAL or SUPERIOR GOODS Ei is > 1 INFERIOR GOODS Ei is < 1

DEMAND ELASTICITY

Cross Elasticity of Demand (Exy)is the responsiveness (or sensitivity) of consumers’ purchase of one product (x) to a change in the price of some other product (y).

To determine the Cross Elasticity of Demand (Exy):Exy = Qd / Qd = % change in quantity demanded for product X

Y / Y % change in price of product Y SUBSTITUTE GOODS Exy is > 1 COMPLEMENTARY GOODS Exy is < 1 INDEPENDENT GOODS Exy is = 0

SUPPLY ELASTICITY

Price Elasticity of Supply (Es)is the responsiveness (or sensitivity) of producers to a price change.

To determine the Price Elasticity of Supply (Es):Es = Qs / Qs = % change in quantity supplied

P / P % change in priceClassification of Supply Elasticity (Es) ELASTIC SUPPLY Es is > 1 UNIT ELASTIC Es is = 1

No negative elasticity for supply because price and quantity supplied move in the same direction or positive relationship.

SUPPLY ELASTICITY

Classification of Supply Elasticity (Es) ELASTIC SUPPLY Es is > 1

No negative elasticity for supply because price and quantity supplied move in the same direction or positive relationship.

INELASTIC Es is < 1

SUPPLY ELASTICITY

Price Elasticity of Supply (Es)

The degree of price elasticity depends on how easily and quickly producers or suppliers shift resources between alternative uses. The effect of price change in quantity supplied tends to increase as the time period under which we analyze the adjustment to price change lengthens.

The price elasticity of supply is greater in the long-run than in the short-run. This happens because more resources can be shifted to the production of the good in the long-run.