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1 CHAPTER 2: DEMAND, SUPPLY & MARKET EQUILIBRIUM 1.1 Introduction: Market Mechanism Principles 1.2 Demand 1.3 Supply 1.4 Market Equilibrium 1.5 Change.

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Presentation on theme: "1 CHAPTER 2: DEMAND, SUPPLY & MARKET EQUILIBRIUM 1.1 Introduction: Market Mechanism Principles 1.2 Demand 1.3 Supply 1.4 Market Equilibrium 1.5 Change."— Presentation transcript:

1 1 CHAPTER 2: DEMAND, SUPPLY & MARKET EQUILIBRIUM 1.1 Introduction: Market Mechanism Principles 1.2 Demand 1.3 Supply 1.4 Market Equilibrium 1.5 Change in SS & DD 1.6 SS/DD Analysis Example

2 2 DD & SS Interaction Output (Product) Market Utility (excluded) Consumer surplus Factors effect DD Elasticity Production Supplier surplus Factors effect SS Elasticity Market structure Changes in DD / SS: Equilibrium Price & Quantity Input (Factor) Market Microeconomics scope for UBEA 1013 Economics

3 3 1.1 Introduction: Market Mechanism Principles Demand & supply interaction Economics decision-making units Market & the circulation flow

4 4 1.2 Demand Definition: “Demand” can be defined as the purchase of product. ONE household / individual Market demand ALL Household / Individual Household / individual demand Demand curve (graph)Demand function (equation)

5 5 Demand curve (graph): Quantity of X demanded, Q d X = f (P X ; P Y, I, preference, and others) Demand function (equation): Factor effecting demand Factor effecting quantity demanded

6 6 Quantity of X demanded, Q d X = f (P X ; P Y, I, preference, and others) Demand function (equation): Law of Demand: – negative, or inverse relationship between price & quantity – movement along demand curve – change in quantity demanded (i)Relationship of products: – substitution or complement product: ( P Y ) – normal, luxury or inferior products: ( I ) (ii) Shift of DD curve: ( P Y, I, preference, and others ) – (later section) new equilibrium price & quantity

7 7 Law of Demand: Figure 2.3: Price & Quantity Demanded: The Law of Demand Law of Demand: – negative, or inverse relationship – movement along demand curve – change in quantity demanded Why?: Due to the income constraint and utility interaction. Exception?: Giffin product.

8 8 Shift of DD curve & Relationship of products: P Y change: Substitute – Substitutes are products that can replace one another – Positive relationship between P Y and demand for X (the substitute product): When (P Y ) increases, demand for X increases. – Examples: Coffee & tea; Coca-cola & Pepsi Cola Law of demandSubstitution product

9 9 P Y change: Complement – Complement are products that are consumed together – Negative relationship between P Y and demand for Z (the complement product): When (P Y ) decreases, demand for Z increases. – Examples: Car & petrol; coffee & sugar Law of demandComplement product Shift of DD curve & Relationship of products:

10 10 Income change: Normal Product – Demand increase when income increase – Examples: Cloth & movie Normal product Inferior product Income change: Luxury Product – Same effect as normal product but demand increase more when income increase – Examples: luxury car. Income change: Inferior Product – Low quality products (potato & secondhand cloth) – Income increase, demand decrease (able to buy better quality product). I ↑ Shift of DD curve & Relationship of products:

11 11 Necessity Product? Insignificant product? – Their consumption did not effect much by change in income. Their consumption is only a very small percentage of total income. – The demand curve did not shift (or shift too little that we can ignore) – Examples: salt Shift of DD curve & Relationship of products:

12 12 Other factors: Taste / preference Other factors: Expected future price Other factors: Increase of buyer – Demand increase when taste / preference towards the product increase (DD curve shift to the left) – Examples: low fat item & fashion – Demand increase when Future price of product is expected to increase (DD curve shift to the left) – Examples: If petrol price to increase from 12am tomorrow, demand for petrol increase immediately (today). – Increase in number of buyer, increase demand (DD curve shift to the left) Shift of DD curve & Relationship of products: … continue

13 Supply Definition: “Supply” can be defined as selling of product. ONE firm Market supply ALL firms Individual (firm) supply Supply curve (graph) Supply function (equation)

14 14 Supply curve (graph): Quantity of X supplied, Q S X = f (P X ; K, L, technology, P Y and others) Supply function (equation): Factor effecting supply Factor effecting quantity supplied

15 15 Quantity of X demanded, Q S X = f (P X ; K, L, technology, P Y and others) Supply function (equation): Law of Supply: – positive relationship between price & quantity – movement along supply curve – change in quantity supplied Shift of SS curve: (K, L, technology, P Y and others) – (later section) new equilibrium price & quantity

16 16 Law of Supply: Figure 2.7: Price & Quantity Supplied: The Law of Supply Law of Supply: – positive relationship – movement along supply curve – change in quantity supplied Why?: Due to the higher revenue & profit (assuming every quantity supplied can be sold).

17 17 Shift of SS curve: Change in K, L, technology, P Y : – E.g. reduced in cost of capital, reduced in wages, technology improvement, price of other product decline, expected future price to decline >>> shift the SS curve to the right Law of supply Shift of SS curve

18 18 DD & SS Interaction Output (Product) Market Utility (excluded) Consumer surplus Factors effect DD Elasticity Production Supplier surplus Factors effect SS Elasticity Market structure Changes in DD / SS: Equilibrium Price & Quantity Input (Factor) Market Microeconomics scope for UBEA 1013 Economics

19 19 DD & SS Interaction Output (Product) Market 1.4 Market Equilibrium 3 set of market condition: (a) The quantity demanded equal the quantity supplied at the current price. This situation called “equilibrium” (b) The quantity demanded exceeds the quantity supplied at the current price. This situation called “excess demand” (c) The quantity supplied exceeds the quantity demanded at the current price. This situation called “excess supply”

20 20 (a) Equilibrium Quantity supplied = Quantity demanded (No tendency for the market price to change ) Quantity supplied > Quantity demanded (Excess supply or surplus) Equilibrium quantity Equilibrium price Equilibrium point

21 21 (b) Excess demand (shortage) Quantity demanded > Quantity supplied Price tend to rise (as buyer willing to pay more) Price increases >> quantity demanded fall (law of demand) while quantity supplied rise (law of supply). Price increase to RM 20 (all excess demand wipe out by increased in quantity supplied and reduced in quantity demanded.

22 22 (c) Excess supply (surplus) Quantity supplied > Quantity demanded Price tend to drop (as seller willing to sell at lower price) Price drop >> quantity demanded rise (law of demand) while quantity supplied drop (law of supply). Price drop to RM 20 (all excess supply wipe out by decreased in quantity supplied and increased in quantity demanded.

23 23 Figure 2.12: Changes in Equilibrium (a) Increase in demand (b) Increase in supply (c) Decrease in demand (d) Decrease in supply 1.5 Change in Supply and Demand

24 24 Figure 2.13: Relative Magnitude Change: Supply Increase & Demand Decrease (a) Supply change > demand change (b) Supply change < demand change (a) Supply change > demand change (b) Supply change < demand change Figure 2.14: Relative Magnitude Change: Supply & Demand Increase

25 25 Relative Magnitude Change: Supply Decrease & Demand Increase (a) Supply change > demand change (b) Supply change < demand change (a) Supply change > demand change (b) Supply change < demand change Relative Magnitude Change: Supply & Demand Decrease D1D1 D0D0 D1D1 D0D0 S1S1 S0S0 S1S1 S0S0 P0P0 P1P1 Q0Q0 Q1Q1 P0P0 P1P1 Q0Q0 Q1Q1 00 Price Quantity Price Quantity ↓ SS > ↑ DD ↓ SS < ↑ DD D0D0 D1D1 D1D1 D0D0 S1S1 S0S0 S1S1 P0P0 P1P1 Q0Q0 Q1Q1 P1P1 P0P0 Q1Q1 Q0Q0 00 Price Quantity Price ↓ SS > ↓ DD ↓ SS < ↓ DD

26 26 DD SS Decrease Unchanged Increase DecreaseUnchangedIncrease Unchanged Q down [Note 1] P down Q down P up Q up P up [Note 3] Q up [Note 4] P down Q up P up Q down P down [Note 2] Note 1: P up if ∆ DD < ∆ SS Note 2: Q up if ∆ DD < ∆ SS Note 3: Q up if ∆ DD > ∆ SS Note 4: P up if ∆ DD > ∆ SS

27 27 Equilibrium: Special Case SS Quantity D0D0 D1D1 P1P1 P0P0 Q 0 Price (1) Vertical SS curve: Example of vertical SS is supply of durian. The equilibrium quantity is determined entirely by supply condition. The equilibrium price is determined entirely by demand condition. (2) Horizontal SS curve: Horizontal SS exist when all suppliers fixed a price for any quantity. The equilibrium quantity is determined entirely by supply condition. The equilibrium price is determined entirely by demand condition. SS Quantity D0D0 D1D1 Q1Q1 P0P0 0 Price Q0Q0

28 28 Equilibrium: Special Case DD Quantity S0S0 P1P1 P0P0 Q 0 Price (3) Vertical DD curve: Example of vertical DD is demand for necessity products like salt. The equilibrium quantity is determined entirely by demand condition. The equilibrium price is determined entirely by supply condition. (4) Horizontal DD curve: Horizontal DD exist when there is only one market price consumers willing to pay. The equilibrium quantity is determined entirely by supply condition. The equilibrium price is determined entirely by demand condition. DD Quantity S0S0 S1S1 Q1Q1 P0P0 0 Price Q0Q0 S1S1

29 Supply and Demand Analysis: An Example (a) Proton Berhad decreases the price of its car model, Proton Savvy from P 0 to P 1. Explain the law of demand and based on it, explain what will happen to the quantity demanded for Proton Savvy car. Sketch a graph to illustrate your explanation.

30 30 (b) What will be the effect of Proton Savvy car price drop to its competitor model, the Perodua MyVi? Sketch a graph to illustrate your explanation

31 31 (c) Assume that Proton Savvy cars need a specific regular maintenance service to bring out the performance of the car. Based on situation in (a), what will happen to the demand of that specific regular maintenance service?

32 32 (d) Assume Proton Savvy car has an inelastic price elasticity of demand. If Proton Berhad drops the price of its Proton Savvy car to increase its revenue from its Proton Savvy sales, do you think it is a wise strategy? Not a wise strategy. Percentage of quantity demanded increase is less than percentage of price drop. Increase in revenue due to quantity demanded increase is less than decrease in revenue due to price drop. Therefore, the net effect is that revenue will drop, not increase. End


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