Economic Analysis for Business Session IV: Market Forces of Supply and Demand-I Instructor Sandeep Basnyat

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Markets and Competition A market is a group of buyers and sellers of a particular product. A competitive market is one with many buyers and sellers, each has a negligible effect on price. A perfectly competitive market: ◦ all goods exactly the same ◦ buyers & sellers so numerous that no one can affect market price – each is a “price taker” In this chapter, we assume markets are perfectly competitive.

Demand Demand comes from the behavior of buyers. The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND The Demand Schedule Demand schedule: A table that shows the relationship between the price of a good and the quantity demanded. Example: Helen’s demand for lattes. Price of lattes Quantity of lattes demanded $  Notice that Helen’s preferences obey the Law of Demand.

Price of Lattes Quantity of Lattes Helen’s Demand Schedule & Curve Price of lattes Quantity of lattes demanded $

Demand Equation and Function According to the Law of Demand: When P increases, Q decreases, and When P decreases, Q increases (other things remain constant) Demand equation:Qd = f (P) For a linear demand curve (having equal slopes), The Demand Function: Qd = a + bP Where,b = slope of the curve a = Slope coefficient or demand parameter

Example: Demand Equation and Function If the slope of a linear demand curve is “-20” and demand parameter is 100, find the demand equation for the curve. Solution: Equation for the demand curve is: Qd = a + bP Qd = 100 – 20P

Market Demand versus Individual Demand The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price. Suppose Helen and Ken are the only two buyers in the Latte market. (Q d = quantity demanded) Helen’s Q d Ken’s Q d = = = = =18 +=21 +=24 Market Q d $ Price

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q The Market Demand Curve for Lattes P Q d (Market) $ Movement along the demand curve

Market Demand Function and Equation Market Demand Case: 1. There are 500 consumers in an economy, each with an individual demand curve of : Qi = 15 − P Find the total demand from the market (Qm) 2. There are 500 consumers with individual demand curves of : Qi = 15P and 300 consumers with individual demand curves of : Qi = 30−2P, Find the total demand (Qm) from the market.

Market Demand Function and Equation Market Demand Case: 1. There are 500 consumers in an economy, each with an individual demand curve of : Qi = 15 − P Find the total demand from the market (Qm) Qm = 500(15 − P) ⇒ Qm = 7500 − 500P. 2. There are 500 consumers with individual demand curves of : Qi = 15P and 300 consumers with individual demand curves of : Qi = 30−2P, Find the total demand (Qm) from the market. Qm = 500(15 P) + 300(30 − 2P) = P

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Demand Curve Shifters: Determinants of Demand The demand curve shows how price affects quantity demanded, other things being equal. These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price). Changes in them shift the D curve…

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Demand Curve Shifters: No. of buyers An increase in the number of buyers causes an increase in quantity demanded at each price, which shifts the demand curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example). Demand Curve Shifters: No. of buyers

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Demand for a normal good is positively related to income. ◦ An increase in income causes increase in quantity demanded at each price, shifting the D curve to the right. (Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.) Demand Curve Shifters: income

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Two goods are substitutes if an increase in the price of one causes an increase in demand for the other. Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right. Other examples: Coke and Pepsi, laptops and desktop computers, compact discs and music downloads Demand Curve Shifters: prices of related goods

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Two goods are complements if an increase in the price of one causes a fall in demand for the other. Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left. Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon Demand Curve Shifters: prices of related goods

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right. Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right. Demand Curve Shifters: tastes

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Expectations affect consumers’ buying decisions. Examples: ◦ If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now. ◦ If the economy turns bad and people worry about their future job security, demand for new autos may fall now. Demand Curve Shifters: expectations

Summary: Variables That Affect Demand VariableA change in this variable… Price…causes a movement along the D curve No. of buyers…shifts the D curve Income…shifts the D curve Price of related goods…shifts the D curve Tastes…shifts the D curve Expectations…shifts the D curve

A C T I V E L E A R N I N G 1 : Demand curve A. The price of iPods falls B. The price of music downloads falls C. The price of compact discs falls 21 Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

A C T I V E L E A R N I N G 1 : A. price of iPods falls 22 Q2Q2 Price of music down- loads Quantity of music downloads D1D1 D2D2 P1P1 Q1Q1 Music downloads and iPods are complements. A fall in price of iPods shifts the demand curve for music downloads to the right. Music downloads and iPods are complements. A fall in price of iPods shifts the demand curve for music downloads to the right.

A C T I V E L E A R N I N G 1 : B. price of music downloads falls 23 The D curve does not shift. Move down along curve to a point with lower P, higher Q. The D curve does not shift. Move down along curve to a point with lower P, higher Q. Price of music down- loads Quantity of music downloads D1D1 P1P1 Q1Q1 Q2Q2 P2P2

A C T I V E L E A R N I N G 1 : C. price of CDs falls 24 P1P1 Q1Q1 CDs and music downloads are substitutes. A fall in price of CDs shifts demand for music downloads to the left. CDs and music downloads are substitutes. A fall in price of CDs shifts demand for music downloads to the left. Price of music down- loads Quantity of music downloads D1D1 D2D2 Q2Q2

Market Demand Equation and Function Combining Price and Non-price determinants: Total Market demand for a product = f (Price of the Product, Prices of other goods, Income, Tastes and Preferences of Consumers, Expectations and Number of Buyers) Or, Qd = f (P, Po, I, T, E, B) In a functional form: Q d = a 1 P+ a 2 Po+ a 3 I+ a 4 T+ a 5 E+ a 6 B (Q = Parameter x Notation of variable.)

Estimating Industry Demand for New Automobiles Estimated Value for Independent Parameter Variable during Independent Variable Estimate Coming Year (1) (2) (3) Average Price for New Cars (P) –500 $25,000 Average Price for New Luxury Cars(PX)210 $50,000 Disposable Income, per Household (I) 200 $45,000 Population (Pop) (millions) 20, Average Interest Rate (i) (percent) –1,000,000 8% Industry Advertising Expenditures (A)600 $5,000 million Find the market (Industry) demand equation (curve) for the new automobile. Exercise: Market Demand Estimation

Solution: Market Demand Equation The demand function for the automobile industry is: Q = Parameter x Notation for Independent Variable. Or, Q = –500P + 210PX + 200I + 20,000Pop – 1,000,000i + 600A Substituting the value of all variables except “P”, Q = –500P + 210($50,000) + 200($45,000) + 20,000(300) – 1,000,000(8) + 600($5,000) Q= 20,500,000 – 500Por, P = 41,000 – 0.002Q When P = $25000, Q = 8,000,000 (8 millions). If the average interest rate increases by 2%, how would it affect the demand curve? How many cars would be sold if the average interest rate increases by 2%?

Solution: Market Demand Equation The demand function for the automobile industry is: Q = Parameter x Notation for Independent Variable. Or, Q = –500P + 210PX + 200I + 20,000Pop – 1,000,000i + 600A Substituting the value of all variables except “P”, Q = –500P + 210($50,000) + 200($45,000) + 20,000(300) – 1,000,000(8) + 600($5,000) Q= 20,500,000 – 500Por, P = 41,000 – 0.002Q When P = $25000, Q = 8,000,000 (8 millions). If the average interest rate increases by 2%, how would it affect the demand curve? How many cars would be sold if the average interest rate increases by 2%? (Ans: Demand Curver shifts to Left; Q = 6,000,000)

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Supply comes from the behavior of sellers. The quantity supplied of any good is the amount that sellers are willing and able to sell. Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND The Supply Schedule Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied. Example: Starbucks’ supply of lattes.  Notice that Starbucks’ supply schedule obeys the Law of Supply. Price of lattes Quantity of lattes supplied $

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Starbucks’ Supply Schedule & Curve Price of lattes Quantity of lattes supplied $ P Q

Supply Equation and Function According to the Law of Supply: When P increases, Q Increases, and When P decreases, Q decreases (other things remain constant) Supply equation:Qs = f (P) For a linear supply curve (having equal slopes), The Supply Function: Qs = a + bP Where,b = slope of the curve a = Slope coefficient or demand parameter

Market Supply versus Individual Supply The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. Suppose Starbucks and Jitters are the only two sellers in this market. (Q s = quantity supplied) Starbucks Jitters = = = = =10 +=5 +=0 Market Q s $ Price

P Q The Market Supply Curve P Q S (Market) $ Movement along the supply curve

Market Supply Function Market Supply Case: 1. If there are 400 suppliers with individual supply curves of Qi = p, then the market supply curve is: 2. If there are 500 suppliers with individual supply curves of Qi = 15+ p and 300 suppliers with individual supply curves of Qi = 30+2p, then the total supply from the market is:

Market Supply Function Market Supply Case: 1. If there are 400 suppliers with individual supply curves of Qi = p, then the market supply curve is: Qs = 400(15 + 2p) = p. 2. If there are 500 suppliers with individual supply curves of Qi = 15+ p and 300 suppliers with individual supply curves of Qi = 30+2p, then the total supply from the market is: Qs = 500(15 + p) + 300(30 + 2p) = p.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters The supply curve shows how price affects quantity supplied, other things being equal. These “other things” are non-price determinants of supply. Changes in them shift the S curve…

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: input prices Examples of input prices: wages, prices of raw materials. A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example). Supply Curve Shifters: input prices

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: technology Technology determines how much inputs are required to produce a unit of output. A cost-saving technological improvement has same effect as a fall in input prices, shifts the S curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: No. of sellers An increase in the number of sellers increases the quantity supplied at each price, shifts the S curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: expectations Suppose a firm expects the price of the good it sells to rise in the future. The firm may reduce supply now, to save some of its inventory to sell later at the higher price. This would shift the S curve leftward.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Summary: Variables That Affect Supply VariableA change in this variable… Price…causes a movement along the S curve Input prices…shifts the S curve Technology…shifts the S curve No. of sellers…shifts the S curve Expectations…shifts the S curve

A C T I V E L E A R N I N G 2 : Supply curve 44 Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost. C. Professional tax return preparers raise the price of the services they provide.

A C T I V E L E A R N I N G 2 : A. fall in price of tax return software 45 The S curve does not shift. Move down along the curve to a lower P and lower Q. The S curve does not shift. Move down along the curve to a lower P and lower Q. Price of tax return software Quantity of tax return software S1S1 P1P1 Q1Q1 Q2Q2 P2P2

A C T I V E L E A R N I N G 2 : B. fall in cost of producing the software 46 The S curve shifts to the right: at each price, Q increases. The S curve shifts to the right: at each price, Q increases. Price of tax return software Quantity of tax return software S1S1 P1P1 Q1Q1 S2S2 Q2Q2

A C T I V E L E A R N I N G 2 : C. professional preparers raise their price 47 This shifts the demand curve for tax preparation software, not the supply curve. Price of tax return software Quantity of tax return software S1S1

Market Supply Equation and Function Combining Price and Non-price determinants: Total Market Supply for a product = f (Price of the Product, Input Prices, Technology, Expectations and Number of Sellers) Or, Qs = f (P, Pi, T, E, S) In a functional form: Q d = a 1 P+ a 2 Pi+ a 3 T+ a 4 E+ a 5 S (Q = Parameter x Notation of variable.)

Estimating Industry Supply for New Automobiles Estimated Value for Independent Parameter Variable during Independent Variable Estimate Coming Year (1) (2) (3) Average Price for New Cars (P) 2,000$25,000 Average Price for SUV(Psuv)-400 $35,000 Average Hourly Wage Rate (W) -100,000$85 Average Cost of Steel/Ton (S) -13, Average Cost of Energy/mcf (E) –125,000 $4 Average Interest Rate (i) in percent-1,000,000 8% 1.Find the market (Industry) supply equation (curve) for the new automobile. 2.Work out Practice: What happens to supply curve if any of the variable such as hourly wage rate changes. Exercise: Market Supply Estimation

Estimating Industry Supply for New Automobiles Estimated Value for Independent Parameter Variable during Independent Variable Estimate Coming Year (1) (2) (3) Average Price for New Cars (P) 2,000$25,000 Average Price for SUV(Psuv)-400 $35,000 Average Hourly Wage Rate (W) -100,000$85 Average Cost of Steel/Ton (S) -13, Average Cost of Energy/mcf (E) –125,000 $4 Average Interest Rate (i) in percent-1,000,000 8% 1.Find the market (Industry) supply equation (curve) for the new automobile. (Q = P) 2.Work out Practice: What happens to supply curve if any of the variable such as hourly wage rate changes. Exercise: Market Supply Estimation

P Q Supply and Demand Together D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded

D S P Q Equilibrium price: PQDQD QSQS $ The price that equates quantity supplied with quantity demanded

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND D S P Q Equilibrium quantity: PQDQD QSQS $ The quantity supplied and quantity demanded at the equilibrium price

Equilibrium in Automobile market Market demand curve: Qd= 20,500,000 – 500P Market supply curve: Qs = P Equilibrium is at: Qd = Qs 20,500,000 – 500P = P 2500P = Therefore, P = $25000 Q = 20,500,000 – 500(25000) = 8,000,000

Numerical Problem on Demand and Supply 1) Suppose: Demand eqn. for a product: Q d = 286 − 20p Supply eqn. For a product: Q s = p Find Equilibrium Quantity and Price:

Numerical Problem on Demand and Supply 1) Suppose: Demand eqn. for a product: Q d = 286 − 20p Supply eqn. For a product: Q s = p Find Equilibrium Quantity and Price: Solution: Q d = Q s 286 − 20p = p 60p = 198 P = $3.30 Q = 286 – 20(3.3) = 220

Some variations-Solved Problem Market Demand and Supply Case: Given: 500 consumers with individual demand curves of Qi = 15−p 300 consumers with individual demand curves of Qi = 30−2p Total demand from the market is: QM = − 1100p. Find: a) The total quantity buyers want to buy at price of $10: b) The quantity that the 500 and 300 buyers want to buy at $10.

Some variations-Solved Problem Market Demand and Supply Case: Given: 500 consumers with individual demand curves of Qi = 15−p 300 consumers with individual demand curves of Qi = 30−2p Total demand from the market is: QM = − 1100p. Find: a) The total quantity buyers want to buy at price of $10: At a price of $10, the buyers want to buy 16500− 1100 ・ 10 = 5500 units. b) The total quantity that 500 and 300 buyers want to buy. Each of the 500 buyers with an individual demand curves of Qi = 15 − p wants to buy 15 − 10 = 5 units, for a total of And each of the 300 buyers with individual demand curves of Qi = 30 − 2p wants to buy 30 − 2 ・ 10 = 10 units, for a total of 3000.

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