2. ECNE610 Managerial Economics Week 3 FEBRUARY 2014 1 Dr. Mazharul Islam Chapter-3

3. 3 Demand and Supply Dr. Mazharul Islam 2

4. Lesson Objectives  To introduces the two most fundamental and the most powerful of all economic tools. These are Demand and Supply.  Understand market equilibrium and how the market prices and quantities are determined in the short-run and long run.  Explain law of demand and supply.  Explain the nonprice determinants of demand and supply with practical examples.  distinguish between the short-run rationing function and the long-run guiding function of price.  Explain how the concept of demand and supply can be used to analyse market conditions in which management decisions about price and allocation of resources must be made.  Use the demand and supply model to make predictions about changes in prices and quantities. 3 Dr. Mazharul Islam

5. Demand  Demand indicates the quantities of goods or services that consumers are willing and able to buy at various prices during a given time period when other things constant. If you demand something, then you 1. Want it, 2. Can afford it, and 3. Have made a definite plan to buy it. 4 Dr. Mazharul Islam

6. Market Demand Market:  A set of arrangements through which buyers and sellers carry out exchange at mutually agreeable terms.  Markets are often physical places, such as supermarkets, shopping malls etc. Market also include other mechanisms by which buyers and sellers communicate, like radio television advertisement, telephones etc. There are two types of market in the economy. These are Product market and Resource market. 5 Dr. Mazharul Islam

7. Market Demand The sum of the individual demands of all consumers in the market. 6 Dr. Mazharul Islam

8. Quantity Demand  Wants are the unlimited desires or wishes people have for goods and services. Demand reflects a decision about which wants to satisfy.  The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price. 7 Dr. Mazharul Islam

9. Law of Demand  An inverse relationship exists between price and quantity demanded when other things remaining the same. As Price Falls… …Quantity Demanded Rises As Price Rises… …Quantity Demanded Falls 8 Dr. Mazharul Islam

10. Law of Demand  Why does a change in the price change the quantity demanded ? Two reasons:  Substitution effect  Income effect 9 Dr. Mazharul Islam

11. Law of Demand  Substitution Effect When the price of a good falls, its relative price makes consumers more willing to purchase this good. Alternatively, when the price of a good increases, its relative price makes consumers less willing to purchase this good.  For example, when the price of Al-Baik declines while other prices remain constant, Al-Baik becomes relatively cheaper  consumers are more willing to purchase Al-Baik when its relative price falls  they tend to substitute Al-Baik for other goods. 10 Dr. Mazharul Islam

12. Law of Demand Income Effect: When the price of a good decreases, a person’s real income increases  increased ability to buy a good  increase in quantity demanded. When the price of a good increases  real income declines  reduces the ability to buy a good  decline in quantity demanded 11 Dr. Mazharul Islam

13. Demand Curve and Demand Schedule 12 Dr. Mazharul Islam P Q o $2 1.5 1 0.5 0.05 PQDQD $2 1.5 1 0.5 0.05 5 8 12 16 20 D Price of Corn Quantity of Corn CORN 5 8 12 16 20

14. A Change in Demand (Non-price Determinants or Factors of Demand)  Five main factors (non-price determinants) that change demand are  The prices of related goods  Future expectations  Income  Number of buyers/consumers  Preferences (tastes) 13 Dr. Mazharul Islam

15. A Change in Demand (Non-price Determinants or Factors of Demand) Changes in the prices of related goods  For substitutes goods, if an increase in the price of one the demand for the other increase and demand curve shifts to rightward and, conversely, if a decrease in the price of one shifts the demand for the other good leftward (Example: Pepsi & Coca Cola)  For complementary goods, if an increase in the price of one shifts the demand for the other leftward and a decrease in the price of one shifts the demand for the other rightward (car & petrol). 14 Dr. Mazharul Islam

16. A Change in Demand (Non-price Determinants or Factors of Demand) Future Expectation  A change in consumer expectations with respect to future prices, future incomes & credit shifts current demand  If individuals expect income to increase in the future, current demand increases and demand curve shift rightward. Vice versa also true.  If individuals expect prices to increase in the future, current demand increases and demand curve shift rightward. Vice versa also true. 15 Dr. Mazharul Islam

17. A Change in Demand (Non-price Determinants or Factors of Demand) Changes in Consumer Income  Normal goods: the demand increases when income increases and demand curve shift rightward. The demand decreases when income decreases and demand curve shift leftward (example: New car).  Inferior goods: the demand decreases when income increases and demand curve shift leftward. The demand increases when income decreases and demand curve shift rightward (example: Used car) 16 Dr. Mazharul Islam

18. A Change in Demand (Non-price Determinants or Factors of Demand) Changes in Preference (Taste)  A favorable change in consumer preferences means If consumer preferences increase for a particular good then more of this good will be demanded at each price. Demand will increase and demand curve will shift rightward.  An unfavorable change in consumer preferences will decrease demand and demand curve will shift leftward. 17 Dr. Mazharul Islam

19. A Change in Demand (Non-price Determinants or Factors of Demand) Changes in number of buyers or consumers  Increase in the number of consumers  increase in market demand it means market demand curve will shift rightward.  Decrease in the number of consumers  decrease in market demand it means market demand curve will shift leftward. 18 Dr. Mazharul Islam

20. A Change in Demand (Determinants or Factors of Demand) 19 Dr. Mazharul Islam P Q o $5 4 3 2 1 PQDQD $5 4 3 2 1 D Price of Corn Quantity of Corn CORN 10 20 30 40 50 60 70 80 D’ Increase in Demand Increase in Quantity Demanded 10 20 35 55 80 30 40 60 80 +

21. Demand Function  20 Dr. Mazharul Islam

22. Demand Function Mathematical Expression: So linear demand function is  Q D = a 0 -aP + bX 1 – cX 2 + dX 3 + eX 4 If the values of the above variables as follows, what would be the demand curve for Al-Baik? a = 100, b = 1.5, c = 5, d = 20, e = 15 What is quantity demanded for Al-Baik if X 1 = SAR10, X 2 = SAR2, X 3 = SAR15,000, X 4 = 30% 21 Dr. Mazharul Islam

23. Now it’s over for today. Do you have any question? 22 Dr. Mazharul Islam

24. Supply  Supply refers how much of a particular good producers are willing and able to sell at a given price during a given period.  Quantity supplied refers the quantity of a commodity that producers are willing to sell at a particular price at a particular point of time when other things constant. 23 Dr. Mazharul Islam

25. Supply 24 Dr. Mazharul Islam  A Movement Along the Supply Curve When the price of the good changes and other influences on sellers’ plans remain the same, the quantity supplied changes and there is a movement along the supply curve. 10 20

26. Supply 25 Dr. Mazharul Islam  A Shift of the Supply Curve If the price remains the same but some other influence on sellers’ plans changes, supply changes and the supply curve shifts.

27. Law of Supply 26 Dr. Mazharul Islam  As Price Rises… …Quantity Supplied Rises  As Price Falls… …Quantity Supplied Falls Other things remaining the same, A direct relationship exists between price and quantity supplied

28. A Change in Supply (Non-price Determinants or Factors of Supply) Six main factors (determinants) that change supply. These are as follows:  Costs Or Prices of Relevant Resources (Factors of production)  Technology  Prices of Related Goods or Services offered by the seller.  Producer Expectations on future prices.  Number of Sellers (suppliers)  Taxes, Subsidies, & State of Nature 27 Dr. Mazharul Islam

29. A Change in Supply Prices of Relevant Resource (Factors of production)  Relevant resources are those employed in the production of the good in question.  If the price of some relevant resource increases  production cost increase  Amount of production decrease  supply decreases  supply curve shifts to the left.  If the price of some relevant resource decreases  production cost decrease  Amount of production increase  supply increases  supply curve shifts to the right. 28 Dr. Mazharul Islam

30.  Technology If a more efficient technology is discovered, same resource can produce more  production costs fall  suppliers will be more willing and able to supply the good  rightward shift of the supply curve. 29 Dr. Mazharul Islam A Change in Supply (Determinants or Factors of Supply)

31. Prices of Related Goods & Services offered by sellers  For example, if the price of Soybean oil increases  to produce more they will hire more resources with bit higher price  the corn oil producers will get less resources to produce their products  supply of corn oil declines and supply curve for corn oil shifts leftward.  Conversely, a fall in the price of soybean makes corn oil production more profitable  supply for corn oil increases and supply curve shifts rightward. 30 Dr. Mazharul Islam A Change in Supply

32. Prices of Related Goods produced  Goods are complements in production if they must be produced together.  The supply of a good increases if the price of a complement in production rises (printer vs. ink jet cartridge OR a left shoe and a right). 31 Dr. Mazharul Islam A Change in Supply

33. Producer Expectations on future prices.  Changes in producer expectations with respect to the future price can change current supply.  If iPhone suppliers expect higher prices in the future, to take advantage of the future higher price they may begin to expand their product today and stock  current supply decreases  supply curve shifts leftward.  If iPhone suppliers expect lower prices in the future, they will try to sell all of their products today  current supply increases  supply curve shifts rightward. 32 Dr. Mazharul Islam A Change in Supply

34. Number of Sellers (suppliers)  If the number of producers increases, supply increases  shifts to the right  If the number of producers decreases, supply will decrease  shift to the left 33 Dr. Mazharul Islam A Change in Supply

35. Taxes, Subsidies, & State of Nature  Businesses treat most taxes as costs. An increase in sales or property taxes will increase production costs and reduce supply, supply curve shifts leftward. Vice versa also true.  If government subsidizes the production of a good, it reduce the producers production costs and supply increase and supply curve shifts rightward. 34 Dr. Mazharul Islam A Change in Supply

36. Taxes, Subsidies, & State of Nature The state of nature includes all the natural forces that influence production—for example, the weather.  Any favorable natural forces increases amount of production which turn to increase supply and shifts the supply curve rightward.  Any unfavorable natural forces decreases amount of production which turn to decrease supply and shifts the supply curve leftward. 35 Dr. Mazharul Islam A Change in Supply

37. $5 4 3 2 1 10 20 35 55 80 $5 4 3 2 1 60 50 35 20 5 200 B U Y E R S PQDQD BUSHELS OF CORN MARKET DEMAND 2,000 4,000 7,000 11,000 16,000 200 S E L E R S 12,000 10,000 7,000 4,000 1,000 PQSQS BUSHELS OF CORN MARKET SUPPLY EQUILIBRIUM Graphically… xx Market Equilibrium 36 Dr. Mazharul Islam

38. 11 7 S P Q o $5 4 3 2 1 2 4 6 8 10 12 14 16 PQDQD $5 4 3 2 1 2,000 4,000 7,000 11,000 16,000 $5 4 3 2 1 12,000 10,000 7,000 4,000 1,000 D PQSQS CORN MARKET CORN MARKET Shortage ( Create market pressure for a higher price) Surplus (put downward pressure on the price) Market Equilibrium 37 Dr. Mazharul Islam

39.  Comparative statics is a form of sensitivity (or what-if) analysis. Commonly used method in economic analysis. Process of comparative statics analysis:  state all the assumptions needed to construct the model.  begin by assuming that the model is in equilibrium.  introduce a change in the model, so a condition of disequilibrium is created.  find the new point of equilibrium.  compare the new equilibrium point with the original one. 38 Dr. Mazharul Islam Comparative Statics Analysis

40. 39 Dr. Mazharul Islam Example (Short-Run Analysis) Step 1  assume all factors except the price of Al- Baik are constant  buyers’ demand and sellers’ supply are represented by lines shown

41. 40 Dr. Mazharul Islam Example Step 2  begin the analysis in equilibrium as shown by Q 1 and P 1

42. 41 Dr. Mazharul Islam Example Step 3  assume that a new study shows Al-Baik to be the most nutritious of all fast foods.  as a result consumers increase their demand for Al-Baik. Step 4  the shift in demand results in a new equilibrium price (P 2 ).  and a new equilibrium quantity (Q 2 ).

43. 42 Dr. Mazharul Islam Sample Step 5  comparing the new equilibrium point with the original one, we see that both equilibrium price and quantity have increased.  In short-run, when the market price changes to eliminate the imbalance between quantities demanded and supplied, this price change is called ‘rationing function of price’ by economists. Do the analysis for other possible changes.

44. 43 Dr. Mazharul Islam Long-Run Analysis The long run is the period of time in which :  new sellers may enter a market.  existing sellers may exit from a market.  existing sellers may adjust fixed factors of production.  buyers may react to a change in equilibrium price by changing their tastes and preferences.

45. Changes in Equilibrium 44 Dr. Mazharul Islam

46. Changes in Equilibrium 45 Dr. Mazharul Islam S = D P, Q unchanged

47. Changes in Equilibrium 46 Dr. Mazharul Islam

48. Changes in Equilibrium 47 Dr. Mazharul Islam S = D P (unchanged), Q

49. Summary 48 Dr. Mazharul Islam Supply increases Supply decreases Demand increasesDemand decreases Change in Demand C h a n g e i n S u p p l y Equilibrium price change is indeterminate. Equilibrium quantity increases. Equilibrium price rises. Equilibrium quantity change is indeterminate. Equilibrium price falls. Equilibrium quantity change is indeterminate. Equilibrium price change is indeterminate. Equilibrium quantity decreases.