Basics of Market Supply and Market Equilibrium with Excercises

1. BASICS OF SUPPLY & MARKET
EQUILIBRIUM

2.  SUPPLY: Various quantities of commodities
which a seller is willing (& able) to sell at
different prices in a given market, at a point of
time, other things remaining same
 SUPPLY SCHEDULE: Tabular representation of
data on quantity supplied & price of the good

3. SUPPLY CURVE: curve showing relationship b/w
quantity supplied & price (direct relation)
QUANTITY SUPPLIED
O
PRICE
X
Y
S

4. DETERMINANTS OF SUPPLY
• Price of commodity
• Prices of related goods
• Prices of factors of production
• Objectives of producer
• State of technology employed
• Future price expectations
• Imposition of taxes/ subsidies
• No of producers

5. SUPPLY FUNCTION
Sx = f (PX,, PI, PR, T, Pe, F)
Where
SX : Amount supplied of good X
PX : Price of good X
PR : : Prices of other goods in market
PI : Prices of factors of production needed to
produce good X
T : State of technology used by producer
Pe : Expectations about future prices
F : No of firms
O : Objective of producer

6. Generalized Supply Function
s I r eQ h kP lP mP nT rP sF= + + + + + +
k, l, m, n, r, & s are slope parameters
Measure effect on Qs of changing one of the variables
while holding the others constant
Sign of parameter shows how variable is related to Qs
Positive sign indicates direct relationship
Negative sign indicates inverse relationship

7. Generalized Supply Function
Variable Relation to Qs Sign of Slope Parameter
P
PI
Pr
T
Pe
F
k = ∆Qs/∆P is positive
l = ∆Qs/∆PI is negative
m = ∆Qs/∆Pr is negative
m = ∆Qs/∆Pr is positive
n = ∆Qs/∆T is positive
r = ∆Qs/∆Pe is negative
s = ∆Qs/∆F is positive
Direct
Direct
Inverse for substitutes
Direct for complements
Direct
Inverse
Inverse

8. LAW OF SUPPLY
Other things remaining same, more of a
commodity is supplied at a higher price &
less of it is supplied at a lower price

9. CHANGE IN QUANTITY SUPPLIED
(MOVEMENT ALONG A CURVE) VERSUS
CHANGE IN SUPPLY (SHIFT OF CURVE)
 MOVEMENT ALONG A SUPPLY CURVE:
change in quantity supplied due to a change in
its own price
 SHIFT OF SUPPLY CURVE: change in supply
due to change in all other factors affecting
supply, other than the change in its own price

10. CHANGE IN QUANTITY SUPPLIED-
CONTRACTION OF SUPPLY
Quantity
Price
P1
Q1
P0
Q0
A decrease in
price causes a
decrease in
quantity supplied.

11. CHANGE IN QUANTITY SUPPLIED-
EXTENSION OF SUPPLY
Quantity
Price
P0
Q0
P1
Q1
An increase in
price causes an
increase in
quantity supplied.

12. CHANGES IN SUPPLY
 Change in Production Technology
 Change in Input Prices
 Change in the Number of Sellers

13. CHANGE IN SUPPLY- INCREASE IN SUPPLY
An increase in supply
refers to a rightward
shift in the market
supply curve.
Quantity
Price
P0
Q1Q0

14. CHANGE IN SUPPLY- DECREASE IN SUPPLY
Quantity
Price
P0
Q1 Q0
A decrease in supply
refers to a leftward
shift in the market
supply curve.

15. MARKET EQUILIBRIUM

16. MARKET EQUILIBRIUM
 Determined at the intersection of the market
demand curve and the market supply curve
 At the point of intersection, Qd = Qs
 Consumers can purchase all they want &
producers can sell all they want at the “market-
clearing” price
 Associated price: Equilibrium price
 Associated quantity: Equilibrium quantity

17. MARKET EQUILIBRIUM
A market is in
equilibrium
when price
adjusts so that
quantity
demanded
equals
quantity
supplied
Quantity
Supply
Price
Equilibrium
point
Demand

18. MARKET EQUILIBRIUM
E
Shortage
D
S
Q
Price
Excess• If price is
greater than
equilibrium level
there will be a
surplus which
forces price down
• If price is less
than equilibrium
level there will be
a shortage which
forces price up

19. Price (Rs) Qty
Demande
d
Qty
Supplied
Surplus/
Shortage
Pressure
on price
425 100 500 +400
375 200 400 +200
325 300 300 Market
clears
=
275 400 200 -200
225 500 100 -400
MARKET EQUILIBRIUM

20. IF PRICE IS TOO LOW…
Price
Quantity
S
D
5
6 12
Shortage
12 - 6 = 6
6
7

21. IF PRICE IS TOO HIGH…
Price
Quantity
S
D
9
14
Surplus
14 - 6 =
8
6
8
8
7

22. CHANGES IN MARKET EQUILIBRIUM
An increase in demand will
cause the market
equilibrium price and
quantity to increase.
Quantity
Price
P0
Q0
D0 S0
Q1
P1
D1

23. CHANGES IN MARKET EQUILIBRIUM
A decrease in demand will
cause the market
equilibrium price and
quantity to decrease.
Quantity
Price
P1
Q1
S0
Q0
P0
D0D1

24. CHANGES IN MARKET EQUILIBRIUM
A decrease in supply
will cause the
market equilibrium
price to increase and
quantity to decrease.
Quantity
Price
P1
Q1
D0
Q0
P0
S1 S0

25. CHANGES IN MARKET EQUILIBRIUM
An increase in
supply will cause the
market equilibrium
price to decrease and
quantity to increase.
Quantity
Price
P0
Q0
D0 S0
Q1
P1
S1

26. AN INCREASE IN DEMAND COMBINED WITH AN
INCREASE IN SUPPLY
Initial Demand
Supply
Price
Quantity0
E1
P1
Q1 Q2
New Demand
New Supply
E2

27. SIMULTANEOUS SHIFTS
 When demand & supply shift simultaneously
 Can predict either the direction in which price
changes or the direction in which quantity changes,
but not both
 The change in equilibrium price or quantity is said
to be indeterminate when the direction of change
depends on the relative magnitudes by which
demand & supply shift

28. S
D’
S’’
S’
D
SIMULTANEOUS SHIFTS: (↑D, ↑S)
Q
Price may rise or fall; Quantity rises
P
•
A
Q
P
B
•P’
Q’ Q’’
C•P’’

29. D
SIMULTANEOUS SHIFTS: (↓D, ↑S)
S
D’
S’’
S’
Q
Price falls; Quantity may rise or fall
P
•
A
Q
P
B
•P’
Q’ Q’’
C•P’’

30. S’’
SIMULTANEOUS SHIFTS: (↑D, ↓S)
D
S
D’
S’
Q
Price rises; Quantity may rise or fall
P
•
A
Q
P
B
•P’
Q’Q’’
C•P’’

31. SIMULTANEOUS SHIFTS: (↓D, ↓S)
S’’
D
S
D’
S’
Q
Price may rise or fall; Quantity falls
P
•
A
Q
P
B•P’
Q’Q’’
C•P’’

32. SIMULTANEOUS CHANGE IN THE DEMAND AND
THE SUPPLY
 If the increase or decrease in the demand and the supply
is of equal magnitude, then the price at old and new
equilibrium will remain equal
 If the increase in the demand is of greater magnitude
than in supply, then the new equilibrium price will be
higher than the old equilibrium price, and vice versa
 If the supply increases in greater proportion than the
demand, the new equilibrium price will be lower than the
old equilibrium price

33. CEILING & FLOOR PRICES
 Ceiling price
 Maximum price government permits sellers to charge
for a good
 When ceiling price is below equilibrium, a shortage
occurs
 Floor price
 Minimum price government permits sellers to charge
for a good
 When floor price is above equilibrium, a surplus
occurs

34. CEILING & FLOOR PRICES (FIGURE 2.11)
Qx
Quantity
Price(dollars)
Qx
Px Px
Quantity
Price(dollars)
Sx
Dx
2
50
1
6222
3
32 84
Panel A – Ceiling price
Sx
Dx
2
50
Panel B – Floor price

35. LEARNING
How managers can use economic theory to make
predictions about the effect of exogenous events
upon prices- what to expect about price & quantity
in specific markets when certain variables change
or are expected to change.

36. EXERCISE 1
 Suppose the dd & ss curves for a given product have foll
eqs:
Qd = 1000- 10 P
Qs = -100 +10 P
 At what Price will Qd = 0?
 At what Price will Qd = 200?
 Write the dd eq with Price as a function of Qd.
 Determine the market eqm Price & Qty traded by buyers
& sellers.

37. EXERCISE 2
 Complete the foll
table
 Identify eqm P &
Q
Price Qs Qd Qs-Qd
0 0 600
20 100 500
40 200 -200
60 300 300
80 400 200 200
100 500 400

38. EXERCISE 3
Employ a dd curve to explain what would
happen to the dd for:
 New cars, if consumer income increased
 Cream, if coffee prices increased 400%.
 DVD players, if price of video discs fell 50%.