1. Chapter 2 2015 Chapter 2 Demand Supply & 2015 Market Equilibrium Prof. Dr. Mohamed I. Migdad Professor of Economics

2. Chapter 2 content: 2.1 Introduction 2.2 What Is the Market? 2.3 Consumer Demand 2.4 Firms Supply 2.5 Equilibrium between Supply and Demand 2.6 Price of Goods and Price Theory 2.7 Role of Governments in Economics 2.8 Effects of Supply and Demand Change on Market Equilibrium

3. What is the cynic? A man who knows the price of everything and the value of nothing Oscar Wilde 3

4. Market Market is the word we use daily, and simply is the place we go to purchase different goods and services. It contains system, institutions, procedures, social relation, infrastructure, where parties engage in exchange. It could be said that market is the process in which the prices of goods and services are established. 4

5. Notes 1. It is not necessary for a market to be connected with a fiscal place. It economically could mean purchasing or selling over tel. or online. 2. There is no specific market for all goods and services, each product is demanded and supplied in its special market. 5

6. Market definition A market is the institution through which buyers and sellers interact and engage in exchange. A market economy has at its heart the actions of buyers and sellers who exchange goods and services with one another. 6

7. Definition A market at its economic terms is a group of sellers and buyers desiring exchange of goods or services. 7

8. How markets work Buyers and sellers receive signals from one another in the form of prices. If buyers want to buy more of a good, prices rise and sellers respond by supplying more to the marketplace. 8

9. Markets If buyers want to buy less of a good, prices fall and sellers respond by supplying less to the marketplace. 9

10. Markets Market equilibrium occurs when the price is such that the quantity that buyers are interested in purchasing is equal to the quantity that sellers are interested in supplying to the market. 10

11. Markets The market mechanism allows an economy to simultaneously solve the three economic problems of what, how, and for whom. 11

12. Who control the market? There is no higher authority that directs the behavior of these economic agents; rather, it is the invisible hand of the marketplace that allocates final goods and services, as well as factors of production. 12

13. Economic problem The economic problem: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions? To answer the three basic questions we need to study the economic systems. 13

14. 14 Economic Systems Economic systems are the basic arrangements made by societies to solve the economic problem. They includes four systems:

15. 15 Systems 1.Islamic economy 2.Laissez-faire economies 3.Command economies 4.Mixed systems

16. 16 Islamic Economy Some people think that Islam has no economic system of its own Islamic Economics is as Old as Islam Itself

17. 17 Islamic Economy Islamic economics is accordance with Islamic law.economics Islamic law Islamic economics can refer to the application of Islamic law to economic activity either where Islamic rule is in force or where it is not;

18. 18 I.E i.e. it can refer to the creation of an Islamic economic system, or to simply following Islamic law in regards to spending, saving, investing, giving, etc. where the state does not follow Islamic law.

19. 19 Definition of Islamic economics The Islamic economics is both a science and an art which deals with the daily routine of a Muslim's economic life. i.e. how he earns his income and how he spends it. It is a science in the sense that it involves many scientific methods in the production of material goods, their distribution and consumption.

20. 20 Principles The Islamic economic system is directly guided by Allah Almighty Himself. all important aspects of the Islamic economic system and the applicable norms are thoroughly discussed in the Holy Quran

21. 21 Cont. Allah created all needed provisions so that they may consume them and may satisfy their wants

22. 22 Other principles 1. All wealth belongs to Allah (SWT( 2. The Muslims are the custodians and trustees of the wealth. 3. Hoarding the wealth is forbidden. 4. Circulating the wealth is obligatory

23. 23 المبادئ بالعربية كل الثروة مملوكة وترجع إلى الله تعالى المسلمون هم الحراس والأمناء على الثروة والمال اكتناز الثروات ممنوع تعميم وتدوير هذه الثروة واجب

24. 24 The free market system In a laissez-faire economy, individuals and firms pursue their own self-interests without any central direction or regulation. The central institution of a laissez-faire economy is the free-market system. A market is the institution through which buyers and sellers interact and engage in exchange.

25. 25 Consumer sovereignty Consumer sovereignty is the idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase ).

26. 26 Free enterprise Free enterprise: under a free market system, individual producers must figure out how to plan, organize, and coordinate the production of products and services.

27. 27 distribution of output In a laissez-faire economy, the distribution of output is also determined in a decentralized way. The amount that any one household gets depends on its income and wealth.

28. 28 Free System The basic coordinating mechanism in a free market system is price. Price is the amount that a product sells for per unit. It reflects what society is willing to pay.

29. 29 Command economies In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices. And the government determine what to produce and how much and How and for Whom to produce.

30. 30 Mixed Systems, Markets, and Governments Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to:

31. 31 goals of government in mixed economy Minimize market inefficiencies Provide public goods Redistribute income Stabilize the macro economy: ◦ Promote low levels of unemployment ◦ Promote low levels of inflation

32. 32 The Market System Relies on Supply and Demand to Solve the Trio of Economic Problems

33. Demand in Product or Output Markets 33 A household’s decision about the quantity of a particular output to demand depends on:

34. What is demand: Demand is the desire to own any thing with an ability and willingness to pay. It includes the ability and willingness to bay a commodity at a given period and price. The effective demand is the demand which combines with the ability and willingness to bay in a particular period of time. 34

35. Major Groups of Expenditures in Gaza 2011, 2012 Gaza stripMajor Groups of Expenditure % ChangeFeb. 2012Feb. 2011 -1.21151.86153.71 Food and soft drinks 0.07157.29157.18 Alcoholic Beverages and tobacco -7.74107.28116.28 Textiles, clothing and footwear 2.85129.13125.55 Housing -5.45131.94139.55 Furniture, household goods 1.31100.3199.02 Medical care -0.54127.16127.85 Transportation 1.55107.03105.40 Communications -1.6098.60100.21 Recreational, cultural goods and services 3.25111.09107.59 Education -0.53155.54156.38 Restaurants and cafes 6.94131.51122.97 Miscellaneous goods and services -0.70133.88134.83 All items of consumer price index

36. The Relationship between Price and Quantity Demanded Quantity demanded (Qd)Price (P) 20010 18015 16020 14025 12030 10035 8040

37. The demand curve The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. 37

38. Demand Curve

39. From Household Demand to Market Demand

40. Demand depends on: 1. The price of the product in question. 2. The income available to the household. 3. The household ’ s amount of accumulated wealth. 4. The prices of other products (substitutes and complements) available to the household. 40

41. Demand depends on: 5. The household ’ s tastes and preferences. 6. The household ’ s expectations about future income, wealth, and prices. 41

42. Quantity demanded Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price. Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price. 42

43. Changes in Quantity Demanded Versus Changes in Demand The most important relationship in individual markets is that between market price and quantity demanded. 43

44. continue We use the ceteris paribus or “ all else equal ” device, to examine the relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant. 44

45. continue Changes in price affect the quantity demanded per period. Changes in income, wealth, other prices, tastes, or expectations affect demand. 45

46. The demand curve The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. 46

47. Demand Table 47

48. Demand Curve 48

49. law of demand The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price. 49

50. The Law of Demand 50

51. The slope of demand curve This means that demand curves slope downward. 51

52. Other Determinants of Household Demand 1. Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. 52

53. Other determinant 2. Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure. 53

54. Other Determinants 3. Price of other goods A. Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower. B. Inferior Goods are goods for which demand falls when income rises. 54

55. Other Determinants C. Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. D. Perfect substitutes are identical products. 55

56. Other Determinants of Household Demand E. Complements are goods that “ go together ” ; a decrease in the price of one results in an increase in demand for the other, and vice versa. 56

57. The Difference between the Shift in Demand and the Change in Quantity Demanded

58. Shift of Demand Versus Movement Along a Demand Curve 58 A change in demand is not the same as a change in quantity demanded. A higher price causes lower quantity demanded and a move along the demand curve D A. Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from D A to D B.

59. A Change in Demand Versus a Change in Quantity Demanded 59 To summarize : Change in price of a good or service leads to Change in quantity demanded (Movement along the curve). Change in income, preferences, or prices of other goods or services leads to Change in demand (Shift of curve).

60. The Impact of a Change in Income 60 Higher income decreases the demand for an inferior good Higher income increases the demand for a normal good

61. The Impact of a Change in the Price of Related Goods 61 Price of hamburger rises Demand for complement good (ketchup) shifts left Demand for substitute good (chicken) shifts right Quantity of hamburger demanded per month falls

62. From Household Demand to Market Demand Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. 62

63. Market demand Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. 63

64. From Household Demand to Market Demand Assuming there are only two households in the market, market demand is derived as follows: Assuming there are only two households in the market, market demand is derived as follows: 64

65. Supply in Product or Output Markets Supply decisions depend on profit potential. Profit is the difference between revenues and costs. 65

66. The Supply Curve There are some other terms which refer to supply such as: 1)Supply Law. 2)Supply Function. 3)Supply Equation. 4)Supply Model.

67. Quantity supplied 67 A supply schedule is a table showing how much of a product firms will supply at different prices. Quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

68. Supply Schedule Quantity Supplied (Qs)Price (P) 8010 10015 12020 14025 16030 18035 20040

69. The Supply Curve

70. A supply schedule 70

71. Price and Quantity Supplied: The Law of Supply 71 A supply curve is a graph illustrating how much of a product a firm will supply per period of time at different prices.A supply curve is a graph illustrating how much of a product a firm will supply per period of time at different prices.

72. Supply Curve 72

73. The Law of Supply The law of supply states that there is a positive relationship between price and quantity of a good supplied. The law of supply states that there is a positive relationship between price and quantity of a good supplied. This means that supply curves typically have a positive slope. This means that supply curves typically have a positive slope. 73

74. The Law of Supply 74

75. Other Determinants of Supply 1.The price of the good or service. 2.The cost of producing the good, which in turn depends on: A.The price of required inputs (labor, capital, and land), B.The technologies that can be used to produce the product, 3.The prices of related products. 75

76. The Main Factors that Cause the Change in Supply and Affect the Supply Curve to Shift to the Right or to the Left 1) Technology Changes 2) Price of Factors of Production (FoP) 3) Number of Sellers 4) Sellers' Expectations 5) Tax or Subsidy 6) Price of Related Goods Produced

77. Shift of Supply Versus Movement Along a Supply Curve 77 A higher price causes higher quantity supplied, and a move along the demand curve. A change in determinants of supply other than price causes an increase in supply, or a shift of the entire supply curve, from SA to SB.

78. Shift of Supply Versus Movement Along a Supply Curve 78

79. 79 In this example, since the factor affecting supply is not the price of soybeans but a technological change in soybean production, there is a shift of the supply curve rather than a movement along the supply curve. The technological advance means that more output can be supplied for at any given price level. Shift of Supply Curve for Soybeans Following Development of a New Seed Strain

80. 80 Shift of Supply Curve for Soybeans Following Development of a New Seed Strain

81. 81 To summarize : Change in price of a good or service leads to Change in quantity supplied (Movement along the curve). Change in costs, input prices, technology, or prices of related goods and services leads to Change in supply (Shift of curve). Shift of Supply Versus Movement Along a Supply Curve

82. From Individual Supply to Market Supply The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry. The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry. Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service. Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service. 82

83. From Individual Supply to Market Supply As with market demand, market supply is the horizontal summation of individual firms ’ supply curves. As with market demand, market supply is the horizontal summation of individual firms ’ supply curves. 83

84. Market Equilibrium Market equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. Market equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change. At equilibrium, there is no tendency for the market price to change. 84

85. Market Equilibrium Only in equilibrium is quantity supplied equal to quantity demanded. 85 At any price level other than P0, such as P1, quantity supplied does not equal quantity demanded.

86. Market Equilibrium 86

87. Excess Demand Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price. Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price. 87 When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.

88. Excess Demand 88

89. Excess Supply Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price. Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price. 89 When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

90. Excess Supply 90

91. Changes in Equilibrium Higher demand leads to higher equilibrium price and higher equilibrium quantity. Higher supply leads to lower equilibrium price and higher equilibrium quantity. 91

92. Changes in Equilibrium Lower demand leads to lower price and lower quantity exchanged. Lower supply leads to higher price and lower quantity exchanged. 92

93. Relative Magnitudes of Change 93 The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

94. Relative Magnitudes of Change 94 When supply and demand both increase, quantity will increase, but price may go up or down.When supply and demand both increase, quantity will increase, but price may go up or down.

95. Price of Goods and Price Theory A measurable value is needed in order to measure the rise and fall of supply and demand Price theory, therefore, charts the movement of measurable quantities over time, and the relationship between price and other measurable variables.

96. Role of Governments in Economics Role of Governments in Economics Governments could intervene in the market in a direct or an indirect way to achieve economic or social goals. Government’s intervention is to protect both parties in the market: the sellers and the buyers.

97. 2.7.1 How Can Governments Monitor and Hold Prices 1) Using price ceiling or 2) Price floor or 3) Can provide subsidies or 4) Impose taxes

98. Price Ceiling Governments impose maximum prices on some basic products that will force suppliers to sell less than or equal to the equilibrium price The purpose of imposing a price ceiling is to make sure that the basic products are available to all customers at understandable prices.

99. The Price Ceiling

100. Effects of price ceiling If the price ceiling is above the market equilibrium price, there would be no effect; however, if the price ceiling is below the market equilibrium price, a "shortage" would be created because the quantity demanded will exceed the quantity supplied.

101. Price Floors Price floors prohibit prices below a certain minimum amount. This causes surpluses. When the price for a good is very low, this will affect the firms negatively. As a result, the government will make an intervention to protect firms, to help them make some profit or to avoid losses

102. The Price Floor

103. Effects of Price Floor A price floor can be set below the free- market equilibrium price. In this case, the price floor has no practical effect. The government has mandated a minimum price, but the market already bears a higher price

104. Effects of Price Floor By contrast, if the price floor is set above the free-market price, it will have a measurable impact on the market. It ensures prices to stay high so product can continue to be produced.

105. Effects of Price Floor A price floor which is set above the market equilibrium price has several side-effects, one of which is that consumers find that they must pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely.

106. For the government policy to be efficient and successful, the government must deal with the supply surplus through the following steps: 1) Buy the surplus from the market and either benefit from it by exporting or using it in producing, or even throwing the surplus in the sea as Brasilia deals with coffee.

107. For the government policy to be efficient and successful, the government must deal with the supply surplus through the following steps: 2 ) Increasing customs imposed on importing substitute goods which will increase consumption on goods produced locally.

108. For the government policy to be efficient and successful, the government must deal with the supply surplus through the following steps: 3) Governmental support to producers such as subsidies to farmers in the form of free transportation and providing credit facilities to encourage consumers to increase consumptions

109. Effects of Supply and Demand Change on Market Equilibrium Market equilibrium could change as a result of other factors change, either demand determinants such as number of consumers, consumer taste, and consumer expectations, or supply determinants such as number of suppliers, prices of production resources, taxes, and governmental subsidies.

110. The Five Basic Laws of Supply and Demand 1) If demand increases and supply remains unchanged, this leads to higher equilibrium price and quantity. 2) If demand decreases and supply remains unchanged, this leads to lower equilibrium price and quantity. 3) If supply increases and demand remains unchanged, this leads to lower equilibrium price and higher quantity. 4) If supply decreases and demand remains unchanged, this leads to higher equilibrium price and lower quantity. 5) If demand and supply change, the final effect will depend on the magnitude and the direction of the change.

111. The Effect on Market Equilibrium when the Number of Consumers Falls

112. The Effect on Market Equilibrium when there is a New Technology The Effect on Market Equilibrium when there is a New Technology

113. The Effect on Market Equilibrium when there is a New Technology and More Population The Effect when the Magnitude of Change in Supply is Higher than in Demand

114. The Effect on Market Equilibrium when there is a New Technology and More Population The Effect when the Magnitude of Change in Demand is Higher than in Supply

115. THE END of CHAPTER 2