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Chapter 2 market forces demand and supply

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Chapter 2 market forces demand and supply

  1. 1. CHAPTER 2 Market Forces: Demand and Supply
  2. 2. What will you learn in this module? In this module, you will learn the supply and demand function in the market and this will help you to achieve the following module outcomes.  What is the law of demand and law of supply?  What are the important factors that cause demand and supply curve to shift?  What is the consumer surplus and producer surplus?  Explain the difference between price floor and price ceilings?  Distinguish excise taxes and ad valorem taxes, how these taxes impact the market functions. 2-2
  3. 3. CHAPTER 2 Market Forces: Demand and Supply
  4. 4. LAW OF MARKETDEMAND
  5. 5. How to derive MarketDemand? • What is a “Market demand curve”? • It shows the relationship between the quantity and price per unit of a good that consumers are willing and able to purchase, holding other variables constant. • Figure on the next slide shows the straight line connecting those points called the market demand curve interpolates the quantities consumers would be willing and able to purchase at the market prices.
  6. 6. Market DemandCurve Quantity (thousands per year Demand Price ($) $40 0 20 40 $30 $20 $10 60 80
  7. 7. How to derive MarketDemand? • Please click here for video on • Market Demand Curve. How do we sum individual demand curves? https://www.youtube.com/watch?v=guKXcOtJExc • The Demand Curve • https://www.youtube.com/watch?v=kUPm2tMCbGE
  8. 8. What is the “Law of Demand” • The Law of Demand states that the quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises). • The law of demand says that • consumers will buy more when the price falls and; • consumers will buy less when the price falls.
  9. 9. Price changes lead tochanges Quantity Demanded  Changing price leads to changes in quantity demanded.  As price increase from $10 to $20, quantity decreases from 60 to 40  This change is represented by a movement along the demand curve, holding other factors constant. Quantity (thousands per year) Demand Price ($) $40 0 $30 20 40 $20 $10 60 80
  10. 10. What is the “Law of Demand” • Please click here for video on “What is Law of Demand • https://www.youtube.com/watch?v=QvGLcCTXk9o
  11. 11. Other factors can also leads changes in Quantity Demanded • Changing factors other than price (such as advertising, increase in income, increase of price of related goods) also lead to changes in demand. • These types of changes are graphically represented by a shift of the entire demand curve either rightward or leftward. • This will be covered in the next section.
  12. 12. CHAPTER 2 Market Forces: Demand and Supply
  13. 13. WHY DEMANDCURVE SHIFTS?
  14. 14. Changes in Demand • Figure: Changes in Demand. • The movement along a demand curve, such as the movement from A to B is called a change in quantity demanded.
  15. 15. Quantity0 Changes in Demand Price A B D0
  16. 16. Changes in Demand • Figure: Changes in Demand. • Whenever advertising, income or the price of related goods changes, it leads to a change in demand; the position of the entire demand curve shifts. • A rightward shift in the demand curve is called an increase in demand since more of the good is demanded at each price. • A leftward shift in the demand curve is called a decrease in demand.
  17. 17. Changes in Demand Quantity0 Price D1 Increase in demand A B D0D2 Decrease in demand
  18. 18. Why Demand CurveShifts? How Five Demand Shifters Affect Consumer Demand? 1. Consumer’s Income: Normal good, Inferior good • Normal good: A good for which an increase (decrease) in income leads to an increase (decrease) in the demand for that good. • Inferior good: A good for which an increase (decrease) in income leads to a decrease (increase) in the demand for that good.
  19. 19. Why Demand CurveShifts? 2. Prices of related goods: Substitute goods, Complement goods • Substitutes: Goods for which an increase (decrease) in the price of one good leads to an increase (decrease) in the demand for the other good. • Complements: Goods for which an increase (decrease) in the price of one good leads to a decrease (increase) in the demand for the other good.
  20. 20. Why Demand CurveShifts? 3. Advertising and Consumer tastes • Informative advertising: Advertising often provides consumers with information about the existence or quality of a product, which in turn induces more consumers to buy the product. • Persuasive advertising: Advertising can also influence demand by altering the underlying tastes of consumers.
  21. 21. Why Demand CurveShifts? 4. Population The demand for a product is also influenced by changes in the size and composition of the population. 5. Consumer Expectations Changes in consumer expectations also can change the position of the demand curve for a product. If consumers expect future prices to be higher, they will substitute current purchases for future purchases.
  22. 22. Why Demand CurveShifts? Please click here for video on: Why Demand Curve Shifts https://www.youtube.com/watch?v=T6kr-70IaHE
  23. 23. Why Demand CurveShifts? Other Factors Any variable that affects the willingness or ability of consumers to purchase a particular good is a potential demand shifter. Take a look at the figure in the next slide. You may see how advertising can influence demand by altering the underlying tastes of consumers.
  24. 24. Effect of Advertising to Demand Curve Figure: Advertising and the Demand for Clothing • Advertising done by firms causes the demand curve for clothing to shift from D1 to D2 • The old demand curve D1 shows that at Price (P) of $40 the Quantity Demanded (Q) is at 50,000. • But, when the demand curve move from D1 to D2 due to advertising, at Price (P) of $40 the Quantity Demanded (Q) increases from 50,000 to 60,000
  25. 25. 2-25 Quantity of high-style clothing 0 $50 $40 50,000 60,000 Advertising and the Demandfor Clothing Price of high-style clothing Due to an increase in advertising D2 D1
  26. 26. CHAPTER 2 Market Forces: Demand and Supply
  27. 27. DEMAND FUNCTION
  28. 28. The Demand Function • The demand function for good X is a mathematical representation describing how many units will be purchased at different prices for X, the price of a related good Y,income and other factors that affect the demand for good X. 2-28
  29. 29. The Linear DemandFunction • One simple, but useful, representation of a demand function is the linear demand function: , where: • is the number of units of good X demanded; • is the price of good X; • is the price of a related good Y; • is income; • is the value of any other variable affecting demand. 2-29
  30. 30. Understanding the LinearDemand Function • The signs and magnitude of the 𝛼coefficients determine the impact of each variable on the number of units of X demanded. 𝑄𝑋 𝑑 = 𝛼0+ 𝛼𝑋𝑃𝑋+ 𝛼𝑌𝑃𝑌+𝛼𝑀 𝑀 • For example: • 𝛼𝑋< 0 by the law of demand; • 𝛼𝑌> 0 if good Y is a substitute for good X; • 𝛼𝑀< 0 if good X is an inferior good. 2-30
  31. 31. The Linear Demand Function in Action • Suppose that an economic consultant for X Corp. recently provided the firm’s marketing manager with this estimate of the demand function for the firm’s product: Question: How many of good X will consumers purchase when per unit, per unit, and ? Are goods X and Y substitutes or complements? Is good X a normal or an inferior good? Answer: units. Goods X and Y are substitutes. Good X is an inferior good. 2-31
  32. 32. What is ConsumerSurplus? • Total consumer value is the sum of the maximum amount a consumer is willing to pay for different quantities. • Total expenditure is the per-unit market price times the number of units consumed. • Consumer surplus is the extra value that consumers derive from a good but do not pay extra for that good. • Please click here for video on: • “Consumer Surplus and Producer Surplus” • https://www.youtube.com/watch?v=jNdXt5GqoMI 2-32
  33. 33. What is ConsumerSurplus? • By the law of demand, the amount a consumer is willing to pay for an additional unit of a good falls as more of the good is consumed. • Given the demand curve in Figure: Consumer Surplus. • You may refer to your textbook for more details on the example provided in the graph. 2-33
  34. 34. Quantity in liters liter Demand $5 0 $3 $2 1 2 $1 4 5 Market Demand andConsumer Surplus 2-34 Expenditures: $(3-0) x (2-0) = $6 Consumer Surplus: 0.5($5 - $3)x(2-0) = $2 Total Consumer Value: 0.5($5 - $3)x2+(3-0)(2-0) = $8 $4 3 Consumer Surplus Price per
  35. 35. CHAPTER 2 Market Forces: Demand and Supply
  36. 36. LAW OF MARKETSUPPLY
  37. 37. Supply Side of the MarketForces • We have looked at the Demand side of the Market Forces now we will look at the Supply side of the Market Forces
  38. 38. What is Market SupplyCurve? • Market supply curve • Summarises the relationship between the total quantity that all producers are willing and able to produce at alternative prices, holding other factors constant. • Please click here for video on: • “The Supply Curve” • https://www.youtube.com/watch?v=nKvrbOq1OfI
  39. 39. What is the “Law ofSupply” • Law of supply • As the price of a good rises (falls), the quantity supplied of the good rises (falls), holding other factors constant. • Please click here for video on: • “Law of Supply” • https://www.youtube.com/watch?v=ewPNugIqCUM
  40. 40. Changes in QuantitySupplied • Changing only price leads to changes in quantity supplied. • This type of change is graphically represented by a movement along a given supply curve, holding other factors that impact supply constant. • Changing factors other than price lead to changes in supply. • These types of changes are graphically represented by a shift of the entire supply curve.
  41. 41. CHAPTER 2 Market Forces: Demand and Supply
  42. 42. LAW OF MARKETSUPPLY
  43. 43. Changes in Supply • Figure: Changes in Supply • The movement along a supply curve, such as the movement from A to B is called a change in quantity supplied.
  44. 44. Change in Supply 2-44 Quantity Price 0 A S0 B
  45. 45. Changes in Supply • Figure: Changes in Supply • Whenever there changes in input price, technology, government regulation, number of firms in the market, substitutes in production, taxes or producer’s expectation, it leads to a change in supply; the position of the entire supply curve shifts. • A rightward shift in the demand curve is called an increase in supply since more of the good is produced at each price. • A leftward shift in the demand curve is called a decrease in supply since less of the good is produced at each price.
  46. 46. Change in Supply 2-46 Quantity Price S2 0 Decrease in supply A B S0S1 Increase in supply
  47. 47. Why Supply curveShifts? The Factors Influence the Supply Shifters 1. Input Prices • In particular, as the price of an input rises, producers are willing to produce less output at each given price. 2. Technology or Government Regulation • Technological changes and changes in government regulations also can affect the position of the supply curve. Changes that make it possible to produce a given output at a lower cost.
  48. 48. Why Supply curveShifts? 3. Number of Firms • If firms enter an industry, more output is available at each given price. Similarly, as firms leave an industry, fewer units are sold at each price. • Entry • Exit 4. Substitutes in Production • Many firms have technologies that are readily adaptable to several different products.
  49. 49. Why Supply curveShifts? 5. Taxes Excise tax: A tax on each unit of output sold, where the tax revenue is collected from the supplier. Ad valorem tax: It means "according to the value". Ad valorem tax is a percentage tax; the sales tax is a well- known example. You may refer to the graph, Figure: Excise tax and Ad Valorem Tax, to have a further understanding of these taxes.
  50. 50. Why Supply curveShifts? Figure: Excise Tax – Tax on Each Unit The figure shows the old price of gasoline per unit of $1.00 When an Excise Tax (t) of $0.20 is being charged per unit of product, the new price of gasoline per unit of $1.20. At the old price, the quantity of gasoline supplied per week is S0. With the new tax, the quantity of gasoline supplied per week shift from S0 to S1
  51. 51. A per unit Excise Tax 2-51 Quantity of gasoline per week 0 t = per unit tax of 20¢ S0 S0+t t = 20¢ $1.20 $1.00 t Excise tax Price of gasoline
  52. 52. Why Supply curveShifts? Figure: Ad Valorem Tax – Percentage Tax The figure shows the old price of backpacks per unit of $10.00 When an Ad Valorem Tax (t) of 20% is being charged per unitof product, the new price of backpacks per unit is $12.00. As for the backpack with an old price of $20.00, the new an AdValorem Tax (t) of 20% will cause this backpack to be priced at $24.00. At the old price, the quantity of backpacks supplied per week is S0. With the new tax, the quantity of backpacks supplied per week shift from S0 to S1
  53. 53. An Ad ValoremTax 2-53 Quantity of backpacks per week 0 S0 S1 = 1.20 x S0 $24 Price Ad valorem tax of backpacks 1,100 $20 $12 $10 2,450
  54. 54. Why Supply curveShifts? • Once the 20 percent tax is implemented, the price required to produce each unit goes up by 20 percent at any output level. Therefore, the price will go up. An Ad Valorem Tax will rotate the supply curve counterclockwise and the new curve will shift farther away from the original curve as the price increases. You may refer to the figure below which explains why S1 is steeper than S0. 2-54
  55. 55. Why Supply curveShifts? 6. Producer Expectations • Producer Expectations about future prices also affect the position of the supply curve. • Selling a unit of output today and selling a unit of output tomorrow are substitutes in production.
  56. 56. Changes in Supply • Please click here for video on: • “The Supply Curve Shifts” • https://www.youtube.com/watch?v=5iyCwbvJc_U
  57. 57. CHAPTER 2 Market Forces: Demand and Supply
  58. 58. THE SUPPLYFUNCTION
  59. 59. The Supply Function • The supply function for good X is a mathematical representation describing how many units will be produced at different prices for X, prices of inputs W, prices of technologically related goods, and other factors that affect the supply for good X. 2-59
  60. 60. The Linear SupplyFunction • One simple, but useful, representation of a supply function is the linear supply function: , where: • is the number of units of good X produced; • is the price of good X; • is the price of an input; • is price of technologically related goods; • is the value of any other variable affecting supply. 2-60
  61. 61. Understanding the LinearSupply Function • The signs and magnitude of the 𝛽coefficients determine the impact of each variable on the number of units of X produced. 𝑄𝑋 𝑠 = 𝛽0+ 𝛽𝑋𝑃𝑋+ 𝛽 𝑊 𝑊+𝛽𝑟𝑃𝑟 • For example: • 𝛽𝑋> 0 by the law of supply. • 𝛽𝑊< 0increasing input price. • 𝛽𝑟> 0technology lowers the cost of producing good X. 2-61
  62. 62. Producer Surplus 2-62 • Producer surplus is what the producers receive in excess of the amount necessary to produce the good. • Please click here for video on: • “Consumer Surplus and Producer Surplus” • https://www.youtube.com/watch?v=jNdXt5GqoMI
  63. 63. Producer Surplus 2-63 • Figure: Producer Surplus • The gray area shows the producer surplus. • At the price of $400, producer will and able to produce quantity of 800. • So, for quantity between 0 to 799, the producer willing to produce at a price lower than $400 but it still receive $400 for it. • This is producer surplus. It is the amount producers receive in excess of the amount necessary to produce the good.
  64. 64. Producer Surplus Quantity Price Supply $400 0 800 𝑋 3 400 1 𝑃 = + 3 𝑄𝑋 𝑆 $40 0 3 Producer surplus
  65. 65. CHAPTER 2 Market Forces: Demand and Supply
  66. 66. MARKET EQUILIBRIUM
  67. 67. Market Equilibrium • The equilibrium price in a competitive market is determined by the interactions of all buyers and sellers in the market. • The price of a good in a competitive market is determined by the interaction of the market supply and market demand for the good. • When price and quantity is at an equilibrium, there is no shortage or surplus in the market. 2-67
  68. 68. Market Equilibrium • When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity demanded and quantity supplied are equal. The corresponding price is the equilibrium price or market-clearing price, the quantity is the equilibrium quantity. 2-68
  69. 69. What causes a marketequilibrium? • If only prices change, then the law of supply and demand will cause both quantity and price to revert back to the equilibrium. However, if other determinants causes changes in either demand or supply, then the market equilibrium also changes, because either the demand curve or the supply curve or both shifts. 2-69
  70. 70. Market Equilibrium • The figure depicts the market supply and demand curves for such a good. • You may refer to your textbook for more details on this. • Please click here for video on: • “Market Equilibirium” • https://www.youtube.com/watch?v=ducr0_LoL_M
  71. 71. Market Equilibrium 2-71 Quantity Price Supply 0 280 Demand Surplus Shortage 𝑃𝐻 𝑃𝑒 𝑃𝐿 𝑄0 𝑄𝑒 𝑄1
  72. 72. CHAPTER 2 Market Forces: Demand and Supply
  73. 73. PRICE RESTRICTIONS
  74. 74. Price Restrictions andMarket Equilibrium • In this section, we examine the impact of price ceilings and price floors on market allocations. • In a competitive market equilibrium, price and quantity freely adjust to the forces of demand and supply. • Please click here for video on: • “Price Ceilings and Price Floors” • https://www.youtube.com/watch?v=1EzY4Vl460U 2-74
  75. 75. Price System • The price system uses price to determine who gets a good and who does not. The price system allocates goods to consumers who are willing and able to pay the most for the goods. • If the competitive equilibrium price of a shirt is $30, consumers willing and able to pay for $30 will purchase the good; consumers unwilling or unable to pay that much will not buy the good. 2-75
  76. 76. Price Ceilings • Suppose that the government views the equilibrium price of Pe in Figure: Price Ceiling below as "too high" and passes a law prohibiting firms from charging prices above Pc. Such a price is called a price ceiling. • A price ceiling is the maximum legal price that can be charged in a market. 2-76
  77. 77. Price Ceilings 2-77 Price Supply 0 𝑃𝑐 𝑄𝑠 𝑄𝑒 𝑄𝑑 Demand 280 Quantity Shortage 𝑃𝐹 𝑃𝑒 Priceceiling Nonpecuniaryprice Lost social welfare
  78. 78. Price Floors • In contrast to the case of a price ceiling, sometimes the equilibrium competitive price may be considered too low for sellers. The best-known price floor is the minimum legal price that can be charged in a market. • If the equilibrium price is above the price floor, the price floor has no effect on the market. But if the price floor is set above the competitive equilibrium level, such as in Figure: Price Floor below, there is an effect. Quantity supplied in Qs and quantity demanded is Qd. • 2-78
  79. 79. Price Floors • In contrast to the case of a price ceiling, sometimes the equilibrium competitive price may be considered too low for sellers. • The best-known price floor is the minimum legal price that can be charged in a market. • If the equilibrium price is above the price floor, the price floor has no effect on the market. But if the price floor is set above the competitive equilibrium level, such as in Figure: Price Floor below, there is an effect. Quantity supplied in Qs and quantity demanded is Qd. • 2-79
  80. 80. Price Floors 2-80 Price Supply 0 𝑃𝑓 𝑄𝑑 𝑄𝑒 𝑄𝑠 Demand 280 Quantity Surplus 𝑃𝑒 Pricefloor Cost of purchasing excess supply
  81. 81. CHAPTER 2 Market Forces: Demand and Supply
  82. 82. COMPARATIVE STATIC ANALYSIS On Key Terms and Concepts 2-82
  83. 83. Comparative StaticAnalysis • Comparative static analysis • The study of the movement from one equilibrium to another. • Competitive markets, no price restrictions, are analyzed when: • Changes in Demand; • Changes in Supply; • Demand and supply simultaneously change. 2-83
  84. 84. Changes in Demand • Increase in demand only • Increase equilibrium price and quantity • Decrease in demand only • Decrease equilibrium price and quantity 2-84
  85. 85. Change in Demand 2-85 Quantity (thousands rented per day) Supply 0 $45 104 Demand for Rental Cars Price Demand1 $49 Demand0 100 108
  86. 86. Changes in Supply • Increase in supply only • Decrease equilibrium price and quantity • Decrease in supply only • Increase equilibrium price and quantity
  87. 87. Change in Supply 2-87 Quantity Price Supply0 0 𝑄0 Demand 𝑃0 Supply1 𝑃1 𝑄1
  88. 88. Simultaneous Shifts in Supply and Demand 2-88 Quantity Supply0 𝑃0 0 𝑃1 Supply1 Demand1 Demand0 Japan’s Sake Market Price 𝑄0 𝑄1 Supply2 𝑃2 𝑄2 A B C
  89. 89. CHAPTER 2 Market Forces: Demand and Supply
  90. 90. RECAP On Key Terms and Concepts 2-90
  91. 91. Key Concepts Chapter2 • Law of Demand • Law of Supply • Determinants of Demand (demand shifters) • Determinants of supply (supply shifters) • Market Equilibrium (diagram) • Price Ceiling and Price Floor (diagram) • Excise Tax and Ad Valorem Tax (diagram) • Equilibrium market demand and supply curve with tax • Consumer surplus • Producer surplus 2-91

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