Session 1 Demand & Supply Final 18 Dec 11 1

7/29/2019 Session 1 Demand & Supply Final 18 Dec 11 1

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What is Economics?

Economics is the social science that

studies the production, distribution, andconsumption of goods and services. It isalso concerned with the allocation ofscare resources to alternative uses so as

to achieve maximum possible satisfaction.

1Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM, Navi Mumbai


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The term economics comes from theancient Greek oikonomia ,management of a household,administration from oikos , house +

nomos , custom or law. Hencerules of the house(hold).

Lord Robbins defines economics as ascience which studies human behavioras a relationship between ends andscare means which have alternative

uses. Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai 2


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Micro Vs. Macro Economics

Micro Economics

It deals with the behavior of individualeconomic units like consumers, workers,investors & owners of land.

Consumers make purchasing decisions.

Their decisions are influenced by changingprices & incomes.

Firms decide how many workers to hire & howmuch to produce.

Their decisions are influenced by technology &rivalry in the market place.

It also looks at how economic units interact toform larger units- markets & industries.3Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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Micro Vs. Macro Economics Cont

Macro Economics

Macroeconomics, on the other hand, isthe field of economics that studies thebehavior of the economy as a whole and

not just on specific companies, butentire industries and economies.

It examines the aggregate behavior of

the economy how the actions of all theindividuals and firms in the economyinteract to produce a particular level of

economic performance as a whole. Itneeds to be built on microeconomic4Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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It looks at economy-wide phenomenasuch as Gross National Product (GDP)and how it is affected by changes in

unemployment, national income, rate ofgrowth, and price levels. For example,macroeconomics would look at how anincrease/decrease in net exports would

affect a nation's capital account or howGDP would be affected byunemployment rate.

Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai 5


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Scarcity and Optimal Choices

One recurring theme in microeconomics is about

limits: Consumers have limited incomes to spend.

Firms are sometimes constrained by theexisting technology.

Workers have a limited number of hours towork or rest.

Given the limited means, the question ofoptimal choices arise.

That is, optimal allocation of scarce resources

in general. Objectives/Goals

Limited resources

6Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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Themes of Micro Economics Prices:

-Trade-offs are often based on prices facedby consumers and producers.

-Workers make decisions based on prices forlabour wages

-Firms make decisions based on wages andprices for inputs and on prices for thegoods they produce.

-How are prices determined?

Centrally planned economics-governmentscontrol prices.

Market economics-prices determined by

interaction of market participants. 7Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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What is Managerial Economics?

Douglas - Managerial economics is .. theapplication of economic principles andmethodologies to the decision-making processwithin the firm or organization.

Pappas & Hirschey - Managerial economicsapplies economic theory and methods tobusiness and administrative decision-making.

Salvatore- Managerial economics refers to theapplication of economic theory and the tools ofanalysis of decision science to examine how an

organisation can achieve its objectives most



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What is Managerial EconomicsCont?

Howard Davies and Pun-LeeLam-Managerial economics is theapplication of economic analysis to

business problems; it has its origin intheoretical microeconomics.

Spencer & Siegelman- Managerialeconomics is the integration ofeconomic theory with business practicefor the purpose of facilitating decision-

making and forward planning bymana ement.9Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi Mumbai


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Features of Managerial Economics It is concerned with decision-making of

economic nature. Allocation of scarceresources at the disposable of the firm.

It is goal-oriented , descriptive & prescriptive.

It is pragmatic.

It is both conceptual & metrical.

It provides a link between traditionaleconomics and the decision sciences.

It not only deals with private firms but alsopublic enterprises. 10Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,NaviMumbai


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The Nature of ManagerialEconomics

Business Decision

Making Decision Sciences:OptimizationTechniques:

Differential CalculusStatistical

Estimation Linear

ProgrammingGame Theory

EconomicTheory:

Micro EconomicsMacro

EconomicsManagerialEconomics:

Use of Economic

Theory & Techniquesof Decision Sciencesfor Solving BusinessDecision Problems

Optimal Solution to

Business DecisionProblems 11Dr.(Mrs.) Sarita Kumari,Associate

Professor,IIBM,Navi Mumbai


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Scope of Managerial Economics

Managerial economics has a closeconnection with economic theory(microeconomics as well as macro

economics),operation research,statistics, mathematics and the theoryof decision-making.

Managerial economics also drawstogether and relates ideas from variousfunctional areas of management like

production , marketing , financialaccountin & ro ect mana ement etc.12Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi

Mumbai


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Scope of Managerial EconomicsCont

The following aspects constitute

managerial

economics' subject matter:

Objectives of a business firm.

Demand analysis & demand forecasting.Production & cost.

Competition.

Pricing & output.Profit.

Investment & capital budgeting.

Product policy, sales promotion & 13Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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Role of Managerial Economist inDecision-Making

1) Specific Decisions: Production scheduling.

Demand forecasting.

Market research. Economic analysis of the industry.

Investment appraisal.

Security management analysis. Advise on trade.

Pricing & related decisions.

14Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi Mumbai


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Role of Managerial Economist in Decision-Making Cont

2) General Tasks:a)External Factors:

General economic conditions of economy.

Demand for product.

Input costs. Market conditions.

Firms share in the market.

Governments economic policies.

b)Internal Factors: Production.

Sales.

Inventory schedules of the firm.

15Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi


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Markets

Markets are an important mechanism for

solving the problem of optimal use ofscarce resources.

Buyers and sellers

Buyers:

-Consumers, who buy goods and services.

-Firms, which buy labour, capitalequipment, etc.

Sellers:

-Consumers as workers sell their labour

services. 16Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi Mumbai


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Markets Cont

Markets as a collection of buyers andsellers of a particular

product/products.

An industry is a collection of firms

while a market consists of bothfirms(as sellers) and consumers(asbuyers).

17Dr.(Mrs.) Sarita Kumari,Associate Professor,IBM,Navi Mumbai


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Markets Cont

Market definition (the extent of market) canbe important.

Market definition identifies which buyers and

sellers should be included in a given market.

To determine which buyers and sellers toinclude, we need to determine the extent of

market.

Its boundaries-both geographically and termsof the range of the products.



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Market Definition-Geographic

Some markets have restrictive geographicboundaries.

Consider market for housing.

It is city-specific.

Dwellers in a particular city will not want tostay in houses long distance away, eventhough this may be cheaper.

Homes and lands cannot be shifted closer tocities.



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Market Definition-Range ofProducts

Consider cars

Are petrol cars and fuel cell powered cars(REVA) in the same market?

Sometimes the degree of substitution dependson the current prices. Fuel cell powered carsmay not be substitutes for petrol-run cars at

current petrol prices, but may becomesubstitutes if the price of petrol increasessufficiently.



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Demand

The individual demand for a commodity is the

amount of it that a consumer will purchase orwill be ready to take off from the market atvarious given prices in a given period of time.

Thus demand implies both the desire topurchase and the ability to pay for a good.

The Law of Demand : There is inverse

relationship between price and quantitydemanded, other things(incomes , tests &preferences , prices of related goods, &expectations etc.) remaining the same. It is

illustrated through a Demand Schedule & aDemand Curve. 21Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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Demand Schedules

A market consists of the buyers and sellers of agood or service: abstraction from any conceptof specific time and location of a market.

Individual Demand Schedule shows therelationship between the amounts of thecommodity the individual is ready to buy atvarious prices.

The Market Demand Schedule shows theamounts of the commodity that buyers areprepared to buy at different prices.



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Demand Schedule & Demand CurvePrice of Commodity X( RS.)

Quantity Demanded

1210

1020

830

640450

260

Price The

demand curve is a graphical

relationship between the price of a

goodand the quantity demanded. 23Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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The downward sloping demand curve obeys thelaw of demand.

The slope is negative(but may not be constant)at all points of the demand curve. Reasons are :

- Income Effect: When price of a commodity fallsconsumers real income increases . Thisincrease in real income induces the consumerto buy more of that commodity.

- Substitution Effect: When the price of acommodity falls, it becomes relatively cheaperthan other commodities . This induces theconsumers to substitute the commodity whose



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Demand depends on many things. It isexpected to depend, in addition to the ownprice, on incomes, tastes & preferences,prices of related goods and expectations, etc.

A change in own price leads to movementalong the demand curve. This is called aschange in quantity demanded.

A change in any of the other factors (excludingown price) leads to a shift in the entire curve.This is called as shift in demand curve.



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Changes in Quantity Demanded

B A taxthat raises the price of

Pricecommodity results in a

of Commodity X Amovement along the

demand curve

Quantity of commodity X



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Shifts in the Demand Curve

Price of

Good x Increase

in

demand

Decreasein

demandQuantity Demanded of

Commodity X



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When demand curve is drawn, the focus is onlyon the relationship between price & quantitydemanded. It can also be done by assumingthat everything else is being kept fixed atcertain levels.

How do we expect the other things toinfluence demand?

If I(income) increases, we expect more to bedemanded at every price-the demand curvewill shift to the right and vice-versa.



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Consumer Income-Normal Good

Price of Good X An

Increase in IncomeIncrease in

Demand

uantit of Good X29Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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However, there may be some inferior goodswhose demand falls as income increases.

For example, an increase in the incomes ofpoor farmers might lead them to buy more ofrice and wheat and less of coarse cereals like

jowar, and bajra.Price of Good XDecrease

in Demand

An Increase in Income

30

Dr.(Mrs.) Sarita

Kumari,AssociateProfessor,IIBM,Navi Mumbai


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If T (tastes & preferences) change such thatbuyers like a commodity more, again thedemand increases.

Tastes & Preferences can change for manyreasons:

Demographic Changes

If population comes to consist of largerproportion of older people, this will affectpattern of demand.

New Information

Dissemination of the information on harmfulside effects of drugs can lead to fall in demandfor these drugs.

Government Decisions

Ban on advertisin of certain oods can31Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi Mumbai


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Prices of Related Goods:

If the price of a substitute rises, weexpect the demand to rise, too (as priceof coffee increases, the demand curvefor tea moves upward and to the right).

If the price of a complement rises, weexpect the demand to fall(as price of

petrol rises, the demand curve forvehicles moves downward and to theleft).



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Market Demand

The market demand for a good or service isthe sum total of all individual demands.

The market demand at any price is the sum ofthe individual quantities demanded at thatprice.

Graphically the market demand curve is thehorizontal summation of the individualdemand curves.



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Market Demand Cont



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Market Demand Cont

Determinants of Market Demand:

Price of the good or service (P)

Income of the consumer (I)

Tastes and Preferences of theconsumer(T & P)

Prices of other Related Goods andServices (PO)


Market Demand Cont


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Market Demand Cont

The Market Demand Equation:

QD = f(P,I,T,PO)

To quantify..the linear form is

QD = B + aPP + aII + aTT + aOPO

The coefficients aP, aI, aT, and aO indicate the

change in quantity demanded of one-unitchanges in the associated variables.

aP= Holding the other three variables

constant, quantity demanded changes byaP units for each one-unit change in price.

QD= B + aPP (Keeping I, T and PO constant),

aP


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Supply

Supply of a commodity is the entireschedule of the quantities of a

commodity that would be offered forsale at all possible prices during aperiod of time.

The law of supply states that quantitysupplied of a commodity generallyvaries directly with price.



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Supply Schedules

Individual Supply Schedule shows therelationship between the amounts of

the commodity supplied at variousprices.

The Market Supply Schedule shows theamounts of the commodity that sellersare prepared to sell at different prices.



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Supply Schedule and Supply Curve



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The upward sloping supply curve obeysthe law of supply. The slope is positive.

Like demand supply also depends onmany things like:

Own price.

Technological knowledge.

The prices of inputs.

The prices of related goods produced.

Expectations, etc.

40Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM, Navi Mumbai


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How do other things influence supply?

A change in technology that allows thecommodity to be produced more cheaply shouldshift the supply curve downwards and to theright.

If input prices increase, exactly the oppositeshould happen.

As wages rise, the supply of goods and servicesis reduced, because wages are the input priceof labour. Labour sometimes accounts for abouttwo-thirds of all input costs, and thus wageincreases create supply reductions(a higherprice is necessary to provide the samequantity) for most goods and services.



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Changes in Quantity Supplied

A rise in the price of nutrition barresults in a movement along thesupply curve.

BPrice of

Nutrition Bar

A

uantit of Nutrition Bar 42Dr.(Mrs.) Sarita Kumari,Associate Professor,IIBM,Navi Mumbai


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Shifts in Supply Curve

A shift in the supply curve, either to theleft or right.

Caused by a change in a determinant

other than price.Decrease

Price of Good X in supply

Increase insupply



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Equilibrium

The demand and supply curves

intersect to determine the marketequilibrium.

Equilibrium : a price & quantity pair.

Reason of calling it equilibrium:

-If the market is at price P* and quantitydemanded and supplied Q* (P*,Q*)there are no forces to move it awayfrom (P*,Q*).

-If the market is not at equilibrium, it

tends to come back to equilibrium. 44Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi Mumbai

The Eq ilibri m of S ppl &


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The Equilibrium of Supply &Demand



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Solving for Equilibrium Price

Equation of demand curve:

Qd = 1200-10P

Equation of supply curve:

Qs = 300 + 20PAt equilibrium Qd = Qs

1200-10P = 300 + 20P

Solving P = 30Qd = Qs = 900



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Surplus:

When price> equilibrium price, then

quantity supplied> quantity demanded.- There is excess supply or a surplus.

- Suppliers will lower the price to increasesales, thereby moving toward

equilibrium. Shortage:

When price quantity supplied.- There is excess demand or a shortage.

- Suppliers will raise the price due to toomany buyers chasing too few goods,

thereby moving toward equilibrium. 47Dr.(Mrs.) Sarita Kumari,Associate Professor, IIBM,Navi Mumbai


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D Excess supply S

P

P Excess demand

SD

P*

Q*



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Shifts in Equilibrium

More interesting is the case wherethere are shifts in supply and/ordemand curves

As a result, the equilibrium shifts.

Sometimes, it is useful to predict thedirection of shift.



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THANK YOU

Session 1 Demand & Supply Final 18 Dec 11 1

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