Transcript A Change in Supply

ECNE610
Managerial
Economics
Week 3
FEBRUARY 2014
Chapter-3
1
Dr. Mazharul Islam
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3
Demand and Supply
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Lesson Objectives
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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.
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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.
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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.
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Market Demand
The sum of the individual demands of all
consumers in the market.
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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.
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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
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Law of Demand
Why
does a change in the price
change the quantity demanded?
Two reasons:
 Substitution effect
 Income effect
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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.
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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
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Demand Curve and Demand Schedule
Price of Corn
P
CORN
P
$2
1.5
1
0.5
0.05
QD
5
8
12
16
20
$2
1.5
1
0.5
D
0.05
5
o
8
12
16
Q
20 Quantity of Corn
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A Change in Demand
(Non-price Determinants or Factors of Demand)
Five
main
factors
determinants)
that
demand are
The
(non-price
change
prices of related goods
Future
expectations
Income
Number of buyers/consumers
 Preferences (tastes)
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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).
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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.
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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)
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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.

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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.
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A Change in Demand
Price of Corn
(Determinants or Factors of Demand)
P
CORN
P
$5
4
3
2
1
QD
10 30
20 40
35 60
55 80
80 +
Increase
in Quantity
Demanded
$5
4
3
2
1
o
Increase
in
Demand
D’
D
10 20 30 40 50 60 70 80
Quantity of Corn
Q
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Demand Function

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Demand Function
Mathematical Expression:
So linear demand function is
 QD = a0-aP + bX1 – cX2 + dX3 + eX4
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
X1 = SAR10, X2 = SAR2, X3 = SAR15,000,
X4 = 30%
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Now it’s over for today. Do you
have any question?
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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.
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Supply
A Movement Along
the Supply Curve
When the price of the
good changes and
other influences on
sellers’ plans remain
the same, the quantity 10
supplied changes and
there is a movement
along the supply curve.

20
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Supply
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.

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Law of Supply
Other things remaining the same, A
direct relationship exists between price
and quantity supplied
As
Price Rises…
…Quantity Supplied Rises
As
Price Falls…
…Quantity Supplied Falls
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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
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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 .
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A Change in Supply
(Determinants or Factors of Supply)
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.
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A Change in Supply
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.
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A Change in Supply
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).
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A Change in Supply
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.
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A Change in Supply
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
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A Change in Supply
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.
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A Change in Supply
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.
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Market Equilibrium
BUSHELS
OF CORN
P
$5
4
3
2
1
QD
10
20
35
55
80
MARKET
x
200 DEMAND
B
2,000
U
Y
E
R
S
4,000
7,000
11,000
16,000
BUSHELS
OF CORN
P QS
$5
4
3
2
1
60
50
35
20
5
x
MARKET
200 SUPPLY
S 12,000
E
L
L
E
10,000
7,000
4,000
1,000
R
S
EQUILIBRIUM
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Market Equilibrium
CORN
MARKET
P QD
$5 2,000
4 4,000
3 7,000
2 11,000
1 16,000
P
$5
Surplus
S
CORN
MARKET
P QS
(put downward pressure on the price)
4
$5
4
3
2
1
3
2
Shortage
1
o
( Create market pressure for a higher price)
2
4
6 7 8
101112 14 16
12,000
10,000
7,000
4,000
1,000
D
Q
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Comparative Statics Analysis
 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.
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Example (Short-Run Analysis)
Step 1
 assume all factors
except the price of AlBaik are constant
 buyers’
demand and
sellers’ supply are
represented by lines
shown
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Example
Step 2
 begin the analysis in
equilibrium as shown
by Q1 and P1
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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
(P2).
 and a new equilibrium
quantity (Q2).
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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.
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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.
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Changes in Equilibrium
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Changes in Equilibrium
S = D
P , Q unchanged
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Changes in Equilibrium
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Changes in Equilibrium
S = D
P (unchanged) , Q
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Summary
Change in Demand
Change in Supply
Demand increases
Supply
increases
Supply
decreases
Equilibrium
price change
is indeterminate.
Demand decreases
Equilibrium
price falls.
Equilibrium
quantity increases.
Equilibrium
quantity change
is indeterminate.
Equilibrium
price rises.
Equilibrium price
change is indeterminate.
Equilibrium
quantity change
is indeterminate.
Equilibrium
quantity decreases.
Dr. Mazharul Islam