Demand and Supply analysis.pdf

PGP I

Term I

Demand function

Income and Substitution effect When price rises: Consumer feels worse of in terms of real income-income effect Goods become relatively expensivesubstitution effect

Inverse demand function

Demand relation p

8

A

B

4

4

12

qx

Demand curve p

10 8

A

B

4

4

12 20

qx

How to read the demand curve At point A, consumers are willing to pay at the most Rs.8 per piece to buy 4 units of the product. For 4 units the consumers’ willingness-to-pay is Rs.8 per unit.

If the price is Rs.8, the consumers will buy at most 4 units. A movement from A to B is possible only if the price falls, and vice versa.

A linear Demand curve

Change in income: normal vs. inferior

Violation of law of demand? 1. Stock prices and demand, gold prices and demand go up simultaneously- shift in the demand curve due to expectation. 2. People are willing to pay more for luxury products when their price increases: Veblen goods (designer watch, luxury cars, designer perfumes)-Consumers’ perception of quality change 3. Giffen good : Generally staple food, inferior goods, a large amount of income is spent on it

Complements An increase in the price of a complement causes a downward shift of the demand curve Price

B

A

Price of sugar has increased

Quantity Demand curve for Coffee

Substitute products An increase in the price of a substitute product will cause an upward shift of the demand curve. Coffee price

A

B

Price of tea has increased

Quantity of coffee

Change in income An increase in consumer income will cause an upward shift of the demand curve.

Price

A

B

Normal good: Income has increased Quantity

Taste, preference and expectations Taste and preference • Fashion and lifestyle, apart from needs, shape our demand. Price expectations • When price is expected to fall in future, some consumers prefer to wait.

Market demand curve

p

Consumer 1

p

Consumer 2

10

p

Market demand

10

6

6

6

3

3

3 10 15

q

8

q

10

23

Q

Supply relationship Supply curve summarises information from the production side.

Quantity supplied is positively related to price. A point on the supply curve tells us at a given price how much the firms are willing to supply,

or, alternatively to supply a given level of output how much price the firms are willing to accept as minimum.

A linear supply curve

Supply curve

p S 2

q

Market supply Market supply is a horizontal sum of individual supply curves Single firm’s supply 4

Market supply of 2 firms

2

5

10 15

30

Market supply curve is flatter than the single firm’s supply curve.

Shift of the supply curve Suppose wage rate increases S2 p S1

Q

Wage increase causes the supply curve to move leftward. This indicates a fall in supply. That is, at a given p firms are willing to supply less.

Market equilibrium When demand and supply are matched. p

Surplus

P1

S

E

Pe P2

Shortage Q1

Qe Q2

D Q

Change in the exogenous factors Demand and supply curve

Demand curve shifts rightward Demand curve shifts leftward Supply curve shifts rightward Supply curve shifts leftward

Equilibrium Equilibrium Price Quantity

increases

increases

decreases

decreases

decreases

increase

increases

decreases

Exercise 1 1. The price of good A goes up. As a result the demand for good B shifts to the left. From this we can infer that: A) good A is a normal good. B) good B is an inferior good. C) goods A and B are substitutes. D) goods A and B are complements. 2. Which of the following events will cause a leftward shift in the supply curve of petrol? A) A decrease in the price of petrol B) An increase in the wage rate of refinery workers C) Decrease in the price of crude oil D) An improvement in oil refining technology

Exercise 2 The inverse demand curve for product X is given by: PX = 25 - 0.005Q + 0.15PY, where PX represents price in dollars per unit, Q represents rate of sales in pounds per week, and PY represents selling price of another product Y in dollars per unit. The inverse supply curve of product X is given by: PX= 5 + 0.004Q. a. Determine the equilibrium price and sales of X. Let PY = $10. b. Determine whether X and Y are substitutes or complements.

Answer

Consumer and producer Surplus P A 50

Consumer surplus S1

40

30 E Producer surplus

20 10 C

B

D1 Q