Presentation on theme: "Sotiris Georganas City University London"— Presentation transcript:
1 Sotiris Georganas City University London EC 1008 Introduction to Microeconomics Lecture 2: Analyzing markets: supply and demand
2 Learning outcomes To understand the demand and supply function To outline the laws of demand and supplyTo analyse what causes movements and shiftsTo understand the concepts of equilibrium and comparative statics
3 BackgroundUnderstanding how markets work is a key part of a course in economicsIn particular you need to understand the key role played by prices
4 Markets Differ in a number of important ways Number of buyers and sellersLevel of informationKnowledge about the product and different pricesHow easy it is to set up in businessBarriers to entryCan service/product be easily copied?
5 Perfect competition One type of market structure A market is perfectly competitive if no participant has market powerMarket power: the power to set the price of the goodKey AssumptionsNumerous (many!) buyers and sellersPerfect informationFree entry and exit
6 Demand, supply and (goods) markets Consumer demandSupply by firms
7 DemandDemand: the amount of a good or service that consumers are willing and able to purchase at each priceCan be different from the amount purchasedReflects the degree of value/pleasure/utility consumers place on the good/serviceDifferent people will value the same good/service differently
8 Determinants of demand by consumers for goods and services What?
9 Determinants of demand by consumers for goods and services IncomePreferencesGood’s priceOther goods’ prices
10 Demand Market demand function: relationship between quantity demanded of a particular product and all factors that influence demandQdx= f(Px, Py, I,....)Quantity demanded is the ‘dependent’(endogenous) variablePrice, income etc are the independent variables
11 Demand curves Isolate the impact of price Qdx = f(Px) ceteris paribus (demand depends on price, holding all else equal)Complication – demand curves are drawn with price (independent variable) on the vertical axisWhy ?Walras (1834 – 1910) developed the theory, with quantity the dependent variableMarshall (1842 – 1924) developed graphical representation (probably following Cournot’s work 30 years earlier), with price as the dependent variableToday we use Walrasian theory, but the Marshallian representation
12 Since price is the vertical axis we use the inverse demand for graphs Inverse demand : Px = g(Qdx)“Price as a function of quantity”Direct demand : Qdx = f(Px)Where g=f-1
15 Law of demand Isolate the impact of price ↑ Px ⇒ ↓ Qdx (Ceteris paribus)↓ Px ⇒ ↑ Qdx (Ceteris paribus)Why?Substitution effect - as price rises consumers have an incentive to switch to cheaper alternativesIncome effect - a rise in price reduces consumers’ `real’ income so they purchase less of a `normal’ good
16 Movements along and shifts in the demand curve We can use this model of demand to analyse the effect on demand of changes in price and other variables, such as income.We distinguish between these by use of special terms:– Movement along the demand curve, for price changes– Shift in the demand curve, for changes in other variables
19 Types of goodsSubstitutes: If price of X increases and demand for Y goes up, X and Y are substitutes.Complements: If price of X increases and demand for Y goes down, X and Y are complements.Normal Goods: If increase in income leads to increase in demandInferior goods: If increase in income leads to decrease in demand.Examples?
21 SupplySupply – the amount of a good or service producers are willing to offer for sale at each and every priceMarket supply function – relationship between quantity supplied and all the factors that influence that supplySupply curve isolates the impact of priceQsx = f(Px) ceteris paribusInverse supply curve: Px=g(Qsx)As before, g=f-1
22 Determinants of supply TechnologyGood’s priceOther goods’ prices
23 Supply simple supply functions Qs =a+bP more complex supply functions Qs =a+bP+dPi –ePja simple demand function Qd =a-bP
26 Law of supply ↑ Px ⇒ ↑ Qsx (ceteris paribus) Why? Higher price, ceteris paribus, the more profitable the good. Acts as an incentiveIn the short run, existing suppliers switch more resources into producing good XThe existing producers increase supply because it is profitable to produce more – has to do with the cost function.
32 Effect of a shift in the demand curve on equilibrium
33 Effect of a shift in the supply curve on equilibrium
34 Example Demand and supply curves are: Qd= a-bP (1) Qs= c+dP (2) We need to solve for equilibrium price and quantity (P* , Q*)Set quantity demanded and supplied equal, and solve for P.(1)=(2) =>a-bP*=c+dP* => a-c= bP*+dP* => a-c= (b+d)P* =>P*=(a-c)/(b+d) (3)Insert result (3) into (1) =>Q*=a-b( (a-c)/(b+d) )So if, for example, a=30, b=1, c=0, d=2,we haveP*=30/3 = 10 and Q*= 30-(10)=20 units
35 Learning outcomes To understand the demand and supply function To outline the laws of demand and supplyTo analyse what causes movements and shiftsTo understand the concepts of equilibrium and comparative statics