BE Lecture 2 Demand & Supply

Business Environment
Lecture 2 Demand & Supply
Learning Objectives

Understand the meaning of demand Be able to distinguish between movements and shifts of the demand curve, and the factors that cause shifts Understand the meaning of supply Be able to distinguish between movements along, and shifts of the supply curve, and the factors that cause shifts Understand the concept of equilibrium Know the meaning of excess demand and excess supply Be able to apply demand and supply analysis to a number of economic or market situations. Consider cases of intervention in a free market: the housing market
DEMAND
Demand (D)
Effective demand is what is being considered
Factors affecting demand

Price (P) Income (Y) Relative prices of other goods Taste, preference, & fashion Population All these factors change over time, to identify the effects of each individually we have to assume that only one factor is changing. Ceteris paribus: all other things being held constant.
Demand (D)
Price (P): For a normal good, a price increase = a reduction in quantity demanded. For two reasons:
Substitution effect: Price of this good rises and the price of other goods unchanged, consumers will buy less of this good and more of other goods, which have become relatively cheaper. Income effect: Price of this good rises but consumers buy the same amount, it will take a larger proportion of their income, they will have to buy less of other goods. So demand may decrease as price rises because consumers cannot afford to buy as much.
The Demand Curve shows the relationship between the price of the good and the quantity consumers want to purchase, ceteris paribus, other factors remaining unchanged.
100
Market demand for potatoes (monthly)
Market demand Point Price (pence per kg) (tonnes 000s)
A
Price (pence per kg)
80
20
700
60
40
A
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
Quantity (tonnes: 000s)

100
A
80
20 40
700 500
60
40
A
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
100
A
80
20 40 60
700 500 350
B C C
60
40
A
20
Demand
0 0 100 200 300 400 fig 500 600 700 800

100
A
80
20 40 60 80
700 500 350 200
60
B C D
40
A
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
100
Market demand for E potatoes (monthly)
A
80
20 40 60 80 100 B
700 500 350 200 100
60
B C D E
40
A
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
Shifts in demand curves
If a factor other than the price of the good changes, then the demand curve will shift. Factors causing the demand curve to shift:
Income (Y)
As income increases = usually demand increases Substitutes: alternatives: bus or tube, if tube fares went up and bus fares did not the demand for bus travel increases. Complements: goods used together: cars and petrol, if the price of petrol goes up the demand for cars decreases
Relative prices of other goods

Taste, preference, & fashion Population: demand usually increases as pop increases.
An increase in demand
P Price
D0
O Q0 Q1 fig 2.2 Quantity
D1
A decrease in demand
P Price
D1
O Q0 Q1 fig 2.2 Quantity
D0
SUPPLY
Supply (S)
Factors affecting supply Price of the good Costs of production Price of other goods Nature: random shocks Producers objectives Regulation Taxes and subsidies Expectations of future price changes All these factors change over time, to identify the effects of each individually we have to assume that only one factor is changing. Ceteris paribus: all other things being held constant.
The Supply Curve
It is normally assumed that as the price rises the quantity supplied will increase. The supply curve slopes upward. Assuming price is the only factor that is rising. An upward sloping supply curve is likely because firms assumed to be maximising profits. If the price risies it is likely to become profitable to increase output, because the increase in price more than offsets the increases in costs.
Market supply of potatoes (monthly)

100
Supply
80
a
60
20 100
40
20
0 0 100 200 300 400 500 600 700 800

100
Supply
80
a b
60
20 100 40 200
40
20
0 0 100 200 300 400 500 600 700 800

100
Supply
80
60
a b c
20 100 40 200 60 350
40
20
0 0 100 200 300 400 500 600 700 800

100
Supply
80
d
a b c d
60
20 40 60 80
100 200 350 530
40
20
0 0 100 200 300 400 500 600 700 800

100
Supply
80
60
a 20 b 40 c 60 d 80 e 100
100 200 350 530 700
40
20
0 0 100 200 300 400 500 600 700 800
Shifts in the supply curve
If any factor other than the price of the product changes then the supply curve is assumed to shift. For example: Higher fertilizer prices would decrease in wheat supply, farmers would require higher prices to offset the cost increase. A improvement in technology, higher yielding wheat varieties, would lead to an increase in supply, improved productivity would offset lower prices.

P
S0
fig

P
S0 S1
Increase
fig

P
S2 S0 S1
Decrease
Increase
fig
MARKET EQUILIBRIUM
Market equilbrium
Equilibrium a point of balance, from which there is no inherent tendency to move. Markets are in equilibrium when at the current price the amount consumers want to buy is equal to the amount producers want to sell. So there are no unsatisfied buyers and no unplanned change in stocks. If any significant factor affecting supply or demand changes the equilibrium will change.
Equilibrium price and output:

The Market Demand and Supply of Potatoes (Monthly)
Price of Potatoes
(pence per kilo)
Total Market Demand

(Tonnes: 000s)
Total Market Supply

(Tonnes: 000s)
20 40 60 80 100
700 (A) 500 (B) 350 (C) 200 (D) 100 (E)
100 (a) 200 (b) 350 (c) 530 (d) 700 (e)
The determination of market equilibrium

E
(potatoes: monthly)
100
D
e Supply d
80
Cc
60
40
a
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
100
The determination of market equilibrium (potatoes: monthly) E e

Supply D
80
SURPLUS (330 000)

Cc
60
40
a
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
100

Supply
D
80
Cc
60
40
b
a
SHORTAGE (300 000)
20
Demand
0 0 100 200 300 400 fig 500 600 700 800
100

Supply
D
80
60
40
a
20
Demand
0 0 100 200 300
Qe 400 fig
500
600
700
800
Effect of a shift in the demand curve

S
An increase in demand
g
Pe1
D1
O
Qe1
fig

S
g
Pe1
D1
O Q e1
fig

S
g
Pe1
D2
D1
O Q e1
fig

S
i
Pe2
g
Pe1
D2
D1
O Q e1
fig
Q e2

S
A decrease in demand
g
Pe1
D2
O Q e1
fig
D1
Q

S
Pe1
Pe2
m n
D2
O Q e2 Q e1
fig
D1
Q
Effect of a shift in the supply curve

S1
A decrease in supply
Pe1
D
O
fig
Q e1

S1
g
Pe1
D
O
fig
Q e1

S2 S1
g
Pe1
D
O
fig
Q e1

S2 S1 k
Pe3
j
Pe1
D
O Q e3
fig
Q e1

S1 S2
An increase in supply
Pe1
D
O
fig
Q e1

S1 S2
g
Pe1
Pe2
p q
D
O
fig
Q e1 Q e2
Markets that are not Free
Normally governments work with, and favour free markets In some cases, governments may not wish to have a free market Rented Housing
Rented Housing: an example of a maximum price ceiling
P(H) rent
P (rent in a free market)

controlled rent price excess demand = shortage of rented housing
D O Qs
Qd
Summary

Q demanded decreases as P increases Other factor affecting D changes D curve shifts Quantity S increases as P increases Other factor affecting S changes S curve shifts Market equilibrium where S = D Changing S or D factors will shift equilibrium Intervening in markets can cause problems Competition is needed for markets to operate effectively

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Business Environment

Lecture 2 Demand & Supply

Effective demand is what is being considered

Factors affecting demand

Market demand for potatoes (monthly)

Market demand Point Price (pence per kg) (tonnes 000s)

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Market demand Point Price (pence per kg) (tonnes 000s)

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Market demand Point Price (pence per kg) (tonnes 000s)

700 500 350

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Market demand Point Price (pence per kg) (tonnes 000s)

700 500 350 200

Quantity (tonnes: 000s)

Market demand for E potatoes (monthly)

Market demand Point Price (pence per kg) (tonnes 000s)

700 500 350 200 100

Quantity (tonnes: 000s)

Shifts in demand curves

Relative prices of other goods

The Supply Curve

Market supply of potatoes (monthly)

0 0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

0 0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

20 100 40 200 60 350

0 0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

100 200 350 530

0 0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

100 200 350 530 700

0 0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Shifts in the supply curve

Shifts in the supply curve

Shifts in the supply curve

Shifts in the supply curve

Equilibrium price and output:

Total Market Demand

Total Market Supply

The determination of market equilibrium

Price (pence per kg)

Quantity (tonnes: 000s)

The determination of market equilibrium (potatoes: monthly) E e

Price (pence per kg)

SURPLUS (330 000)