micro economics (shubham suman)

17
MICROECONOMICS Project Report On Demand, Supply & Concept of Equilibrium & Consumer Surplus & Pricing Shubham Suman Page 1

Upload: shubhaminoffice012

Post on 01-Feb-2015

520 views

Category:

Education


0 download

DESCRIPTION

Demand, Supply & Concept of Equilibrium & Consumer Surplus & Pricing

TRANSCRIPT

Page 1: Micro economics (Shubham Suman)

MICROECONOMICS

Project Report

On

Demand, Supply & Concept of Equilibrium

&

Consumer Surplus & Pricing

Submitted to: Submitted By: Prof. Raj Kishan Nair Shubham Suman FT-IB-11-344

Shubham Suman Page 1

Page 2: Micro economics (Shubham Suman)

Demand, Supply and The Concept Of Equilibrium

CONCEPT OF DEMAND

Demand is defined as the quantity of a good or services that consumers are willing and able to buy at given price in a given time period. Each of us has an individual demand for particular goods and services and the level of demand at each market price reflects the value that consumers place on a product and their expected satisfaction gained from purchase and consumption.

The Demand Curve

A Demand curve shows the relationship between the price of an item and the quantity demanded over a period of time. There are two reasons why more is demanded as price falls.

1. The income Effect :

There is an income effect when the price of a good falls because the consumer can maintain current consumption for less expenditure. Provided that the good is normal, some of the resulting increase in real income is used by consumers to buy more of this product.

2. The Substitution Effect :

There is also a substitution effect when the price of a good falls because the product is now relatively cheaper than an alternative item and so some consumers switch their spending from the good in competitive demand to this product.

If the price of denim paint is 300 pesos, how many pairs are we inclined to purchase versus when its price is 400 pesos?

The law of demand asserts that the quantity demanded of a good and services is negatively or inversely related to its own price, i.e. when the price of movie ticket goes up, we are willing to purchase fewer ticket. There are two reasons why price and quantity demanded are inversely related. Price is an obstacle to consumption. The higher the price of good, the greater is its opportunity cost in term of other goods that must be given up, and therefore the less consumers would want to buy of the item.

The second reason for the negative relationship between price and quantity demanded has to do with our budget as consumers. Paying a higher for some amount or a commodity effectively reduces our income. It takes more pesos to buy a given quantity at a higher price. Fewer movies ticket will be sold at 60 pesos partly because those who do watch movies at that high price will rapidly deplete their budget for entertainment or leisure. Therefore, at higher prices, consumer are forced less of all the commodities they usually buy.

The demand function can be illustrated in two different ways: via a schedule or table and a graph. An example of demand schedule for denim pants. A demand schedule is a numerical

Shubham Suman Page 2

Page 3: Micro economics (Shubham Suman)

tabulation of the quantity demanded at selected prices, assuming other things are held constant. From the table, we can see that as price increases, quantity demanded decrease. For instance, 6 pairs of pants are demanded at 100pesos but quantity demanded becomes 4 pairs at 200 pesos.

Demand schedule for denim pantsPrice of denim pants(In pesos) quantity demanded

per month (no of pairs)0 850 7100 6150 5200 4250 3300 2350 1400 0

Figure: 1.1

A demand curve is a representation of the demand schedule. The demand curve is drawn as downward sloping to illustrate the inverse relationship between price and quantity demanded. Figure 1.1 is a sample demand curve based on the demand schedule given in table 1.1

P

400

300

200

100

D

0 2 4 6 8

Figure 1:1 demand curve. The demand curve is downward sloping illustrating the inverse relationship between price and quantity demanded.

Determinants of Demand

Factors influencing Individual Demand: An individual’s demand for a commodity is generally determined by such factors as:

A. Price of the Product :

Normally a larger quantity is demanded at a lower price than at a higher price.

Shubham Suman Page 3

PRICE (IN PESOS)

QUANTITY

Page 4: Micro economics (Shubham Suman)

B. Income :

With increase in income one can buy more goods. Thus a rich consumer usually demands more and more goods than a poor consumer.

C. Tastes and Habits :

Demand for several products like ice-cream, chocolates, bhel-puri, etc depend on individual’s tastes. Demand for tea, betel, tobacco, etc, is a matter of habit.

D. Consumers Expectations :

When a consumer expects its prices to fall in future, he will tend to buy less at the present prevailing price. Similarly, if he expects its price to rise in future, he will tend to buy more at present.

E. Advertisement Effect :

In modern times, the preferences of a consumer can be altered by advertisement and sales propaganda although to a certain extent only.

CONCEPT OF SUPPLY

Supply is one of the forces that determine the price in the market. Supply is a commodity refers to the quantity of a product which a seller is willing and able to sell at a given price per unit of time. The relationship between amounts supplied and market prices is expressed in the supply schedule or table, a graph or supply equation. A supply curve is a graphical representation of the supply schedule while a supply function mathematically represents the relationship between price and quantity supplied.

A demand curve, a supply curve has a positive slope, reflecting the law of supply. The law of supply states that quantity supplied is positively related to price. I.e., firms offer large amount at higher prices and smaller amounts at lower prices. In this case, price is the reward for production so that higher market prices bring forth larger quantities. Higher prices provide firms with extra funds to purchase more resources or inputs to increase production. Higher prices also act as a signal to producers that consumers value their goods highly and desire more of them.

Definition of supply

According to Meyers : supply may be defined as a schedule of the amount of a product that would be offered for sale at all possible prices at any one instant of time, or a during any one period of time, for example, a day, a month, a year and so on, in which the conditions of supply remain the same.According to Anatol Mirad: The quantity supplied is defined as the quantity of a commodity offered for sale at a given price in a given market at a given time. Supply is always expressed with reference to a particular price and a particular time period.

Shubham Suman Page 4

Page 5: Micro economics (Shubham Suman)

The Supply Curve

Price usually is a major determinant in the quantity supplied. For a particular good with all other factors held constant, a table can be constructed of prices and quantity supplied based on observed data. Such a table is called a supply schedule, as shown in the following example:

Supply schedulePrice Quantity supplied

01 1002 2003 3004 4005 50

By graphing this data, one obtains the supply curve as shown below:

Supply Curve

y S

5

4

3

2

1

0 10 20 30 40 50 x

As with the demand curve, the convention of the supply curve is to display quantity supplied on the x-axis as the independent variable and price on the y-axis as the dependent variable. The law of supply states that the higher the price, the larger the quantity supplied, all other thing constant. The law of supply is demonstrated by the upward slope of the supply curve.

As with the demand curve, the supply curve often is approximated as a straight line to simplify analysis. A straight-line supply function would have the following structure:

Quantity = a+ (b x price)

Where a and b are constant for each supply curve.

A change in price results in a change in quantity supplied and represents movement along the supply curve.

Shubham Suman Page 5

PRICE

Quantity supplied

Page 6: Micro economics (Shubham Suman)

Shifts in the Supply curve

While changes in price result in movement along the supply curve, change in other relevant factors causes a shift in supply, that is , a shift of the supply curve to the left or right. Such a shift results in change in quantity supplied for a given price level. If the change causes an increase in the quantity supplied at each price, the supply curve would shift to the right:

y S S1

5

4

3

2

1 0 x

10 20 30 40 50

There are several factors that may cause a shift in a good’s curve. Some supply-shifting factors include:

1. Price of other goods : -

The supply of one goods may decrease if the price of another goods increases, causing producers to reallocate resources to produce larger quantities of the more profitable goods.

2. Number of sellers : -

More sellers result in more supply, shifting the supply curve to the night.

3. Price of relevant inputs:-

If the cost of resources used to produce a goods increase, sellers will be inclined to supply the same quantity at a given price, and the supply curve will shift to the left.

4. Technology:-

Technological advances that increase production efficiency shift the supply curve to the right.

Shubham Suman Page 6

PRICE

Quantity supplied

Page 7: Micro economics (Shubham Suman)

5. Expectations :-

If the sellers expect prices to increase, they may decrease the quantity currently y supplied at a given price in order to be able to supply more when the supply at a given price in order to be able to supply more when the price increases, resulting in a supply curve shift to the left.

CONCEPT Of EQUILIBRIUAM

The intersection of the supply and demand curve establishes equilibrium. Equilibrium prices are prices that equate buyer’s willingness to pay for the last units of output (price along demand curve) with seller’s willingness to sell (cost represented by the supply curve). Thus prices are said to represent marginal evaluation of goods and services. At this equilibrium price, there is neither a shortage nor surplus in the market. Furthermore the autonomous actions of buyers and sellers tend to move markets toward equilibrium.

P S

D

Q

Change in Market Equilibrium:

Equilibrium price and quantity are determined by the intersection of supply and demand. A change in supply or demand will necessarily change the equilibrium price, quantity or both. it is highly unlikely that the change in supply and demand perfectly offset one another so that equilibrium remain the same.

Example:

1. If there is an exporter who is willing to export orange from Europe to Asia, he will increase the demand for Europe’s oranges. An increase in demand will create a shortage, which increases the equilibrium price and equilibrium quantity.

Shubham Suman Page 7

Price

Quantity

Page 8: Micro economics (Shubham Suman)

2. If there is an importer who is willing to import orange from Europe to Africa, he will increase the supply for Europe’s orange. An increase in supply will create a surplus, which lowers the equilibrium price and increase the equilibrium quantity

New equilibrium following shifts in supply

S

S1

P1

P3

D

Q1 Q3

When the supply curve shift to the right, the market clears at a lower price P3 and a larger price Q3.In this graph, demand is constant, and supply increases. As the supply curve (supply 1) has shown, the new curve is located on the right side of the original supply curve.

The new curve intersects the original demand curve at a new point. At this point, the equilibrium price (market price) is lower, and the equilibrium quantity is higher.

New equilibrium following shifts in demand

When the demand curve shift to the right, the market clears at a higher price P3 and a larger quantity Q3

Shubham Suman Page 8

Price

Quantit

Page 9: Micro economics (Shubham Suman)

S

P3

P1

D1

D

Q1 Q3

In this graph, supply is constant, demand increases. As the new demand curve (demand 1) has shown, the new curve is located on the right hand side of the original demand curve.

The new curve intersects the original supply curve at a new point. At this point the equilibrium price (market price) is higher, and equilibrium quantity is higher also.

Shubham Suman Page 9

Pric

Quantity

Page 10: Micro economics (Shubham Suman)

Consumer Surplus And Pricing

Consumer Surplus:

Consumer Surplus is a difference between the maximum amount that a consumer is willing to pay for a goods and amount that the consumer actually pays. Suppose, for example, a consumer goes out for shopping for a CD player and that consumer is willing to spend Rs. 250 and consumer find that the player is on sale Rs. 150,. The Rs. 100 difference is his or her consumer surplus.

The determination of consumer surplus is illustrated in figure, which depicts the market demand curve for some goods.

10

  9

8

7

6

5 S4 S3 S2 S1

4

3

2

1

0

0 1 2 3 4 5 6 7 8 9 10

Calculation of consumer surplus

The market price is $5, and the equilibrium quantity demanded is 5 units of the goods. The market demand curve that consumers are willing to pay $9 for the first unit of the goods, $8 for the second unit, $7 for the third unit, and $6 for the fourth unit.

However, they can purchase 5th units of the goods for just $5per unit. The surplus from the first unit purchased is therefore $9-$5 = $4. Similarly, their surpluses from the second, third and fourth units purchased are $3, $2, and $1, respectively. These surplus are illustrated the vertical bars drawn in figure. The sum total of these surpluses is the consumer surplus:$4+$3+$2+$1 = $10

Shubham Suman Page 10

TOPIC-2

Price of goods in $

Equilibrium Price

Market DemandCurve

Units demand

Page 11: Micro economics (Shubham Suman)

Price Subsidies

Sometimes governments try to assist low-income consumers by subsidizing the prices of “essential” goods and services. France and Russia, for example, have taken this approach at various points by subsidizing the price of bread. But as the following example illustrate, such subsidies are like price ceilings in that they reduce total economic surplus.\

By how much subsidies reduce total economic surplus in the market for bread?

A small island nation imports bread for its population at the world price of $2 per loaf. If the domestic demand curve for bread is as shown this figure by how much will total economic surplus define in this market if the government provides a $1 per loaf subsidy?

5

4

3

World price = $2

1

0 2 4 6 8

With no subsidy, the equilibrium price of bread in this market would be the world price of $2 per loaf, and the equilibrium quantity would be 4,000,000 loaves per month. The shaded triangle in this figure. Represents consumer economic surplus for buyers in the domestic bread market. The height of this triangle is $2 per loaf, and its base is 4,000,000 loaves per month, so its area is equal to (½) (4,000,000 loaves/month) ($2/loaf) = $4,000,000 per month. Because the country can import as much bread as it wishes as the marginal cost of each loaf of bread to sellers is exactly the same as the price buyers pay, producer surplus in this market is zero. So total economic surplus is exactly equal to consumer surplus, which, again, is $4,000,000 per month.

Shubham Suman Page 11

Consumer surplus = $4,000,000/month

Quantity (millions of loaves/month)

Price of bread ($/loaf)

Page 12: Micro economics (Shubham Suman)

Price Subsidies

Sometimes governments try to assist low-income consumers by subsidizing the prices of “essential” goods and services. France and Russia, for example, have taken this approach at various points by subsidizing the price of bread. But as the following example illustrate, such subsidies are like price ceilings in that they reduce total economic surplus.\

By how much subsidies reduce total economic surplus in the market for bread?

A small island nation imports bread for its population at the world price of $2 per loaf. If the domestic demand curve for bread is as shown this figure by how much will total economic surplus define in this market if the government provides a $1 per loaf subsidy?

5

4

3

World price = $2

1

0 2 4 6 8

With no subsidy, the equilibrium price of bread in this market would be the world price of $2 per loaf, and the equilibrium quantity would be 4,000,000 loaves per month. The shaded triangle in this figure. Represents consumer economic surplus for buyers in the domestic bread market. The height of this triangle is $2 per loaf, and its base is 4,000,000 loaves per month, so its area is equal to (½) (4,000,000 loaves/month) ($2/loaf) = $4,000,000 per month. Because the country can import as much bread as it wishes as the marginal cost of each loaf of bread to sellers is exactly the same as the price buyers pay, producer surplus in this market is zero. So total economic surplus is exactly equal to consumer surplus, which, again, is $4,000,000 per month.

Shubham Suman Page 12

Consumer surplus = $4,000,000/month

Quantity (millions of loaves/month)

Price of bread ($/loaf)