demand & supply iimm
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The Market Forces of Supply and Demand
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The Market Forces of Supply and Demand
Supply and demand are the two words that economists use most often.
Supply and demand are the forces that make market economies work.
Modern microeconomics is about supply, demand, and market equilibrium.
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Markets
A market is a group of buyers and sellers of a particular good or service.
The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.
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Markets Buyers determine demand.
Sellers determine supply.
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Demand
Quantity demanded is the amount
of a good that buyers are willing and able
to purchase.
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Law of Demand
The law of demand states that, ceteris paribus, there is an
inverse relationship between price and quantity demanded.
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Demand Schedule
The demand schedule is a table that shows the relationship
between the price of the good and the quantity demanded.
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Demand Schedule
Price Quantity 0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00 0
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Demand Curve
The demand curve is the downward-sloping line relating price to quantity
demanded.
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Demand Curve
Rs.32.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Price Quantity 0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00 0
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Ceteris Paribus
Ceteris paribus is a Latin phrase that means all variables other than the
ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.”
The demand curve slopes downward because, ceteris paribus, lower prices
imply a greater quantity demanded!
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Ceteris Paribus
Ceteris Paribus means “other things being equal”. What other things?
Consumer income. Consumer preferences. Fashion. Price of related goods. Government policies. Weather conditions.
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Market Demand
Market demand refers to the sum of all individual demands for a particular good or service.
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Determinants of Demand Market price : A larger quantity is demanded at
a lower price & vice versa. Tastes, habits and preferences : Demand depends
upon a persons tastes, habits and preferences. Demand for ice – creams, bhel – puri etc depends upon an individual’s tastes. Tea, betal leafs, tobacco etc is a matter of habits. People with different tastes & habits have different preferences. A strict veg. will have no demand for fish and a person who likes non – veg will purchase fish even at a high price.
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Expectations : If a consumer expects that the prices of a product are going to rise in future, the demand may increase and vice – versa.
Consumer income : A rich consumer demands more goods than a poor consumer.
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Prices of related goods ( substitutes and complementary ) : When a desire or a want can be satisfied by alternative similar goods, they are called as substitutes. Eg. Peas and beans, groundnut oil and mustard oil, tea or coffee, jowar or bajra etc.
Demand for a commodity depends on the relative prices of the substitutes. There will be more demand for a commodity if it’s substitutes are highly priced.
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Complementary products : When, in order to satisfy a given want, two or more goods are needed in combination, these goods are referred to as complementary goods. Eg. car and petrol, pen and ink, shoes and socks, guns and bullets. Complementary goods are always in Joint Demand. Thus, when the price of a complementary product will fall, the demand for its complementary product will increase.
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Change in Quantity Demanded versus Change in Demand
Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of
the product.
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Changes in Quantity Demanded
0
D1
Price of Cigarettes per Pack
Number of Cigarettes Smoked per Day
A tax that raises the price of cigarettes
results in a movement along the
demand curve.
A
C
20
2.00
Rs.4.00
12
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Change in Quantity Demanded versus Change in Demand
Change in Demand A shift in the demand curve, either to
the left or right. Caused by a change in a
determinant other than the price.
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Changes in Demand
0
D1
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
D3
D2
Increase in demand
Decrease in demand
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Change in Quantity Demanded versus Change in Demand
Variables that Affect Quantity
Demanded
A Change in This Variable . . .
Price Represents a movementalong the demand curve
Income Shifts the demand curve
Prices of relatedgoods
Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number ofbuyers
Shifts the demand curve
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Two Simple Rules for Movements vs. Shifts
Rule OneWhen an independent variable changes and
that variable does not appear on the graph, the curve on the graph will shift.
Rule TwoWhen an independent variable does appear
on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.
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Consumer IncomeNormal Good
Rs.3.00
2.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Increasein demand
An increase
in income...
D1
D2
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Consumer IncomeInferior Good
Rs.3.00
2.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Decreasein demand
An increase
in income...
D1D2
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Exceptions to the law of Demand
Law of Demand is a universal phenomenon. Very rarely, it is so observed that with a fall in price, demand also falls and a increase in price increases demand.
The demand curve in such cases is upward sloping.
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Exceptions to the law of Demand
A few such exceptions are seen in case of: Giffen Goods : In cases of some inferior goods,
as observed by Robert Giffen, when price falls, there is a fall in the demand for these products.
Eg. This was observed by Giffen in Italy when consumers purchased less of cheap potatoes when the price went down and purchased meat from the savings.
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Exceptions to the law of Demand
Snob Appeal : Goods that are used as “Status Symbol” eg. Rolls Royce cars, Johney Walker Scotch Whisky, Diamonds etc.
The demand for these goods increases even if the price is increased because these goods are purchased for their “exclusiveness” which increases with an increase in price.
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Exceptions to the law of Demand
Speculation : When the consumers understand that there is a increase in price of a product and they are expecting a further rise, they will not mind purchasing more of that product even if it’s price is increased.
Consumer’s psychology : Many consumers do not purchase products at the time of “discount sales” etc assuming that the quality of the products may have been compromised.
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Law of Supply
The law of supply states that, ceteris paribus, there is a direct (positive)
relationship between price and quantity supplied.
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Supply
Quantity supplied is the amount of a good that sellers are willing and able
to sell.
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Supply Schedule
The supply schedule is a table that shows the relationship between the price of the good and the quantity
supplied.
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Supply Schedule
Price Quantity Rs.0.0 0
0.50 0 1.00 1 1.50 2 2.00 3 2.50 4 3.00 5
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Supply Curve
The supply curve is the upward-sloping line relating price to quantity
supplied.
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Supply Curve
Rs.3.002.502.00
1.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Price Quantity 0.00 0 0.50 0 1.00 1 1.50 2 2.00 3 2.50 4 3.00 5
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Market Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.
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Determinants of Supply Market price : The single largest factor that
affects supply is the price. More commodities will be supplied at a higher price and vice versa.
Input prices : When the factors of production are available at low price, more investment is encouraged. This increases supply.
Technology : The improvement in the technique of production leads to increased supply.
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Natural conditions : The supply of agricultural commodities depends upon the natural conditions. Whenever there is good monsoon, conductive temperature, the supply of such products increases.
Transport conditions : Difficulties in transport may cause a temporary decrease in supply. So, even at rising price, quantity supplied may decrease.
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Expectations : When a seller expects a further rise in the price, he may withhold the supply and hence the supply may decrease.
Prices of other products : The prices of substitutes or related products can influence the supply. If the prices of wheat are increasing, farmers may grow more of wheat and less of rice. If the price of sugar rises, the price of jaggary will also rise.
Govt. policy : If the policies of the govt. are liberalized, more firms may tend to enter the market and hence supply may rise.
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Change in Quantity Supplied versus Change in Supply
Change in Quantity Supplied Movement along the supply curve. Caused by a change in the market price
of the product.
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Change in Quantity Supplied
1 5
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
S
1.00A
CRs.3.00
A rise in the price of ice cream cones
results in a movement along the supply curve.
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Change in Quantity Supplied versus Change in Supply
Change in Supply A shift in the supply curve, either to the
left or right. Caused by a change in a determinant
other than price.
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Change in Supply
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
S1 S2
S3
Increase in Supply
Decrease in Supply
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Change in Quantity Supplied versus Change in Supply
Variables that Affect Quantity Supplied
A Change in This Variable . . .
Price Represents a movement along the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
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Shifts in Curves versus Movements along Curves
A shift in the supply curve is called a change in supply.
A movement along a fixed supply curve is called a change in quantity supplied.
A shift in the demand curve is called a change in demand.
A movement along a fixed demand curve is called a change in quantity demanded.
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Supply and Demand Together
Equilibrium Price The price that balances supply and
demand. On a graph, it is the price at which the supply and demand curves intersect.
Equilibrium Quantity The quantity that balances supply and
demand. On a graph it is the quantity at which the supply and demand curves intersect.
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Supply and Demand Together
Price Quantity Rs 0 0 0.50 0 1.00 1 1.50 4 2.00 7 2.50 10 3.00 13
Price Quantity Rs 0 19 0.50 16 1.00 13 1.50 10 2.00 7 2.50 4 3.00 1
Demand Schedule
Supply Schedule
At Rs.2.00, the quantity demanded is equal to the quantity supplied!
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Supply
Demand
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
Equilibrium of Supply and Demand
21 3 4 5 6 7 8 9 10 12110
Rs.3.002.502.00
1.501.00
0.50
Equilibrium
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Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
21 3 4 5 6 7 8 9 10
12110
Rs.3.002.50
2.00
1.501.00
0.50
Supply
Demand
Surplus
Excess Supply
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Surplus
When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.
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Excess Demand
Quantity ofIce-Cream Cones
Price ofIce-Cream
Cone
Rs.2.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Supply
Demand
Rs.1.50
Shortage
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Shortage
When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.
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Three Steps To Analyzing Changes in Equilibrium
Decide whether the event shifts the supply or demand curve (or both).
Decide whether the curve(s) shift(s) to the left or to the right.
Examine how the shift affects equilibrium price and quantity.
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
2. ...resultingin a higherprice...
Rs.2.50
103. ...and a higherquantity sold.
New equilibrium
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S2
How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. Shortage of milk reducesthe supply of ice cream...
Newequilibrium
2. ...resultingin a higherprice...
Rs.2.50
3. ...and a lowerquantity sold.