Demand and Supply

Demand and
Supply
DEMAND
Relationship between demand and price
the law of demand
the income effect
the substitution effect
The demand curve

assumptions
other things being equal (ceteris paribus)
a given time period
the axes
individual's and market demand curves
The demand curve:

The demand for potatoes (monthly)
(1)
Price
(pence per kg)
(2)
Tracey's
demand
(3)
Darren's
demand
(4)
Total market
demand
(kg)
(kg)
(tonnes: 000s)
20
28
16
700
40
15
11
500
60
350
80
200
100
100
Market demand for potatoes (monthly)

Market demand
Point
Price
(pence per kg) (tonnes 000s)
100
Price (pence per kg)
20
700
80
60
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800

Market demand
Point
Price
100
80
20
700
40
500
60
40
A
20
Demand
0
0
100
200
300
400
500
600
700
800

Market demand
Point
Price
100
80
20
700
B
C
40
60
500
350
60
40
A
20
Demand
0
0
100
200
300
400
500
600
700
800

Market demand
Point
Price
100
80
60
20
700
B
C
D
40
60
80
500
350
200
40
A
20
Demand
0
0
100
200
300
400
500
600
700
800

100
Market demand
Point
Price
80
60
20
700
B
C
D
E
40
60
80
100
500
350
200
100
40
A
20
Demand
0
0
100
200
300
400
500
600
700
800
DEMAND
Other determinants of demand
tastes
number and price of substitute goods
number and price of complementary
goods
income
distribution of income
expectations
DEMAND
Movements along and shifts in the
demand curve
change in price
movement along D curve
change in any other determinant of

demand
shift in D curve
increase in demand rightward shift
decrease in demand leftward shift
An increase in demand
Price
D0
O
Q0
Q1
Quantity
D1
DEMAND
Demand functions
simple demand functions
Qd = a bP
more complex demand functions

Qd = a bP + cY + dPs ePc
estimated demand equations

problems of estimating demand equations
demand functions and the demand curve
Demand curve for equation: Qd = 10 000 200P

50
40
30
20
10
D
0
0
Q (000s)
10

50
40
Qd (000s)
30
20
10
D
0
0
Q (000s)
10

50
40
Qd (000s)
5
10
9
8
30
20
10
D
0
0
Q (000s)
10

50
40
Qd (000s)
5
10
15
9
8
7
30
20
10
D
0
0
Q (000s)
10

50
40
Qd (000s)
5
10
15
20
9
8
7
6
30
20
10
D
0
0
Q (000s)
10
Supply and Demand
Supply
SUPPLY
Relationship between supply and price
short-run supply
long-run supply
The supply curve

assumptions
other things remain equal (ceteris paribus)
a given time period
the axes
individual's and market supply curves
The supply curve:

The supply of potatoes (monthly)
Price of
potatoes
Farmer X's
supply
Total Market
supply
(pence per kg)
(tonnes)
(tonnes: 000s)
20
50
100
40
70
200
60
100
350
80
120
530
100
130
700
Market supply of potatoes (monthly)

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

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

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

100
Supply
d
80
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
d
80
a 20
b 40
c 60
d 80
e 100
60
40
20
0
0
100
200
300
400
500
600
700
800
100
200
350
530
700
SUPPLY
Relationship between supply and price
short-run supply
long-run supply
The supply curve

assumptions
other things remain equal (ceteris paribus)
a given time period
the axes
individual's and market supply curves
why supply curves generally slope up
SUPPLY
Other determinants of supply
costs of production
profitability of alternative products
(substitutes in supply)
profitability of goods in joint supply
nature and other random shocks

aims of producers
expectations of producers
SUPPLY
Movements along and shifts in the
supply curve
change in price
movement along S curve
change in any other determinant of supply

shift in S curve
increase in supply rightward shift
decrease in supply leftward shift
SUPPLY
Supply functions
simple supply functions
Qs = a + bP
more complex supply functions

Qs = a + bP + cC + dPs ePj
non-linear functions
estimated supply equations
problems of estimating supply equations
Shifts in the supply curve

P
S0
S1
Increase
Shifts in the supply curve

P
S2
Decrease
S0
S1
Increase
Supply and Demand
Price and output

determination
PRICE AND OUTPUT DETERMINATION
Equilibrium price and output

response to shortages and
surpluses
shortage (D > S)
price rises
surplus (S > D)
price falls
significance of equilibrium
Equilibrium price and output:

The Market Demand and Supply of Potatoes (Monthly)
Price of Potatoes
Total Market Demand
Total Market Supply
(pence per kilo)
(Tonnes: 000s)
(Tonnes: 000s)
20
700 (A)
100 (a)
40
500 (B)
200 (b)
60
350 (C)
350 (c)
80
200 (D)
530 (d)
100
100 (E)
700 (e)
The determination of market equilibrium

(potatoes: monthly)
E
100
Supply
d
80
Cc
60
40
20
Demand
0
0
100
200
300
400
500
600
700
800

(potatoes: monthly)
E
100
Supply
d
80
Cc
60
40
SHORTAGE
(300 000)
a
20
Demand
0
0
100
200
300
400
500
600
700
800

(potatoes: monthly)
E
100
Supply
D
80
SURPLUS
(330 000)
Cc
60
40
20
Demand
0
0
100
200
300
400
500
600
700
800

(potatoes: monthly)
E
100
Supply
d
80
60
40
20
Demand
0
0
100
200
300
Qe
400
500
600
700
800

Effects of shifts in the demand curve
movement along the supply curve and the
new demand curve
Effect of a shift in the demand curve

P
Initial equilibrium
at point g
g
Pe1
D1
O
Q e1

P
g
Pe1
D1
O
Q e1

P
g
Pe1
D2
D1
O
Q e1

P
New equilibrium at
point i
Pe2
Pe1
D2
D1
O
Q e1
Q e2

new demand curve
Effects of shifts in the supply curve

movement along demand curve and new
supply curve
Effect of a shift in the supply curve

P
S1
Initial equilibrium
at point g
Pe1
D
O
Q e1

P
S1
g
Pe1
D
O
Q e1

P
S2
S1
g
Pe1
D
O
Q e1

P
S2
S1
k
Pe3
Pe1
New equilibrium at
point k
D
O
Q e3
Q e1

new demand curve
Effects of shifts in the supply curve

movement along demand curve and new
supply curve
Identifying the position of demand and

supply curves
Problems in identifying the position and shape of the

demand curve: shift in supply curve
P
S2
30p
20p
S1
800 1000
What has caused

a movement from
point a to point b?

demand curve: shift in supply curve
P
S2
30p
20p
S1
Shift in supply
alone.
D
O
800 1000

demand curve: shift in supply and demand curves
P
30p
20p
S2
S1
Shift in both supply
and demand.
a
D2
D1
800 1000
Supply and Demand
Elasticity
ELASTICITY
Defining elasticity
the responsiveness of demand and supply
Price elasticity of demand

the responsiveness of demand to a change
in price
Market supply and demand
Price
S1
a
P1
The effect on price of a shift

in supply depends on the
responsiveness of demand
to a change in price.
D
O
Q1
Quantity

S2
S1
Price
b
P2
a
P1
D
O
Q2
Q1
Quantity

S2
S1
Price
b
P2
c
P3
a
D'
P1
D
O
Q3
Q2
Q1
Quantity
ELASTICITY
Price elasticity of demand
measurement
proportionate (or %) Qd / proportionate (or %) P
use of proportionate or percentage

changes
the sign (positive or negative)
the value (greater or less than one)
ELASTICITY
Determinants of price elasticity of
demand
number and closeness of substitute goods
the proportion of income spent on the

good
time
Price elasticity of demand and

consumer expenditure (P x Q)
Total expenditure
4
P() 2
Consumers total expenditure

=
firms total revenue
=
2 x 3m = 6m
0
0
Q (millions of units per period of time)
ELASTICITY
effects of a price change on expenditure:
elastic demand
Elastic demand between two points

Expenditure falls
as price rises
P()
b
a
10
20
ELASTICITY
elastic demand
inelastic demand
Inelastic demand between two points

Expenditure rises
as price rises
8
P()
D
0
15
20
ELASTICITY
elastic demand
inelastic demand
special cases
Totally inelastic demand (PD = 0)

D
P2
P1
Q1
Infinitely elastic demand (PD = )
b
D
P1
Q1
Q2
Unit elastic demand (PD = 1)

Expenditure
stays the same
as price changes
20
b
8
40
100
ELASTICITY
elastic demand
inelastic demand
special cases
applications to price decisions
Elastic demand between two points
Expenditure falls
as price rises
P()
b
a
10
20
Inelastic demand between two points

Expenditure rises
as price rises
8
P()
D
0
15
20
ELASTICITY
elastic demand
inelastic demand
special cases
applications to price decisions
different elasticities along a demand curve
Different elasticities along different portions of a demand curve

P
a
P1
Q1

P
a
P1
Elastic
demand
b
P2
Q1
Q2

P
a
P1
b
P2
Inelastic
demand
c
P3
Q1
Q2
Q3
ELASTICITY
Measurement of elasticity: arc
elasticity
the formula for price elasticity of demand
Q/Q P/P
using the average or 'mid-point' method
Measuring elasticity using the arc method

10
m
8
n
6
P ()
4
Demand
0
0
10
20
30
Q (000s)
40
50

10
Ped =
Q
mid Q
mid P
P = 2
P ()
Q = 10
Mid P
4
Demand
0
0
10
15
Mid Q
20
30
Q (000s)
40
50

10
Ped =
m
8
P = 2
mid Q
10
15
mid P
-2
7
P ()
Q = 10
Mid P
4
Demand
0
0
10
15
Mid Q
20
30
Q (000s)
40
50

10
Ped =
m
8
P = 2
P ()
Q
mid Q
mid P
10
-2
15
7
10/15 x -7/2
Q = 10
Mid P
4
Demand
0
0
10
15
Mid Q
20
30
Q (000s)
40
50

10
Ped =
m
8
P = 2
P ()
=
=
Q
mid Q
mid P
10
-2
15
7
10/15 x -7/2
-70/30
Q = 10
Mid P
4
Demand
0
0
10
15
Mid Q
20
30
Q (000s)
40
50

10
Ped =
m
8
P = 2
P ()
Q = 10
Mid P
=
=
=
Q
mid Q
mid P
10
-2
15
7
10/15 x -7/2
-70/30
-7/3 = -2.33
Demand
0
0
10
15
Mid Q
20
30
Q (000s)
40
50
ELASTICITY
Measurement of elasticity: point
elasticity
dQ/dP x P/Q
the elasticity of a straight-line demand

curve (constant dQ/dP)
the elasticity of a curved demand curve
dQ/dP is the tangent to the curve
Measuring elasticity at a point

Ped = (1 / slope) x P/Q
r
P
0
Q

50
r
30
P
100
40
Q

50

= -100/50 x 30/40
r
30
P
100
40
Q

50

= -100/50 x 30/40
= -60/40
r
30
P
100
40
Q

50

= -100/50 x 30/40
= -60/40
= -1.5
r
30
P
100
40
Q
ELASTICITY
Measurement of elasticity: point
elasticity
dQ/dP x P/Q
the elasticity of a straight-line demand

curve (constant dQ/dP)
the elasticity of a curved demand curve
dQ/dP is the tangent to the curve
different elasticities along a straight-line

demand curve
Different elasticities along a straight-line demand curve

10
n
8
m
6
l
4
Demand
k
0
0
10
20
30
40
50

10
(1 / slope) is constant
= -50/10 = -5
m
6
l
4
Demand
k
0
0
10
20
30
40
50

10
= -50/10 = -5
But P/Q varies:
at n, P/Q = 8/10
l
4
Demand
k
0
0
10
20
30
40
50

10
= -50/10 = -5
But P/Q varies:
at n, P/Q = 8/10
at m, P/Q = 6/20
atl l, P/Q = 4/30
P
4
Demand
k
0
0
10
20
30
40
50
ELASTICITY
Price elasticity of supply
measurement
QS/QS P/P
determinants
the amount that costs rise as output rises
time period
Supply in different time periods

P
P1
D1
O
Q1

P
P1
D2
D1
O
Q1

P
P2
Si
b
P1
D2
D1
O
Q1

P
P2
Si
SS
b
c
P3
P1
D2
D1
O
Q1
Q3

P
P2
Si
SS
b
c
P3
P4
SL
d
P1
D2
D1
O
Q1
Q3 Q4
ELASTICITY
Price elasticity of supply
measurement
QS/QS P/P
determinants
the amount that costs rise as output rises
time period
applications
ELASTICITY
Income elasticity of demand
measurement
QS/QS P/P
determinants
degree of necessity
proportion of income spent on the good
applications
Cross-price elasticity of demand

measurement
QDa/QDa Pb/Pb
determinants
closeness as substitutes or complements
applications
Supply and Demand
The Time
Dimension
THE TIME DIMENSION

Short-run and long-run price
adjustment
short- and long-run demand and supply
curves
short- and long-run adjustment to a
change in demand or supply
Response of supply to an increase in demand

P
P1
D1
O
Q1

P
P1
D2
D1
O
Q1

P
S short-run
b
P2
P1
D2
D1
O
Q1
Q2

P
S short-run
S long-run
b
P2
P3
P1
c
Supply is more elastic
in the long run.
D2
D1
O
Q1
Q2 Q3
Response of demand to an increase in supply

P
S1
a
P1
Q1

P
S1
S2
a
P1
Q1

P
S1
S2
a
P1
P2
D short-run
Q1
Q2

P
S1
S2
a
P1
P3
P2
Demand is more
elastic in the long run.
D long-run
D short-run
Q1
Q2 Q3
THE TIME DIMENSION

Short-run and long-run price adjustment
short- and long-run demand and supply curves
short- and long-run adjustment to a change in
demand or supply
Speculation
THE TIME DIMENSION

demand or supply
Speculation
stabilising speculation
Stabilising speculation: initial price fall

P
S1
P1
P2
Speculators
believe that the fall
in price to P2 is
only temporary.
D1
b
D2
Stabilising speculation: initial price fall

P
S2
S1
P1
a
c
P3
P2
D1
b
D2
Speculators
in price to P2 is
only temporary.
D3
Q
Stabilising speculation: initial price rise

P
S1
P2
P1
Speculators
believe that the
rise in price to P2
is only temporary.
D2
D1
O
Stabilising speculation: initial price rise

P
S1
S2
P2
P3
P1
Speculators
believe that the
rise in price to P2
is only temporary.
D2
D1
O
D3
Q
THE TIME DIMENSION

demand or supply
Speculation
destabilising speculation
Destabilising speculation: initial price fall

P
S1
P1
P2
a
b
Speculators
in price to P2
signifies a trend.
D1
D2
O
Destabilising speculation: initial price fall

P
S1
S2
P1
P2
P3
Speculators
in price to P2
signifies a trend.
D1
D3
O
D2
Destabilising speculation: initial price rise

P
S1
P2
P1
Speculators
believe that the
rise in price to P2
signifies a trend.
D1
O
D2
Destabilising speculation: initial price rise

P
S2
S1
P3
P2
P1
Speculators
believe that the
rise in price to P2
signifies a trend.
D3
D1
O
D2
THE TIME DIMENSION

demand or supply
Speculation
Uncertainty and risk
THE TIME DIMENSION

demand or supply
Speculation

defining risk and uncertainty
THE TIME DIMENSION

demand or supply
Speculation

reducing risks by holding stocks
THE TIME DIMENSION

demand or supply
Speculation

reducing risks by holding stocks
futures markets

Demand and Supply

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Demand and Supply

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Demand and

The demand curve

The demand curve:

Market demand for potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market demand for potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

change in any other determinant of

decrease in demand leftward shift

more complex demand functions

estimated demand equations

Demand curve for equation: Qd = 10 000 200P

Demand curve for equation: Qd = 10 000 200P

Demand curve for equation: Qd = 10 000 200P

Demand curve for equation: Qd = 10 000 200P

Demand curve for equation: Qd = 10 000 200P

Supply and Demand

The supply curve

The supply curve:

(pence per kg)

Market supply of potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

Market supply of potatoes (monthly)

Price (pence per kg)

Quantity (tonnes: 000s)

The supply curve

nature and other random shocks

change in any other determinant of supply

more complex supply functions

Shifts in the supply curve

Shifts in the supply curve

Supply and Demand

Price and output

PRICE AND OUTPUT DETERMINATION

Equilibrium price and output

Equilibrium price and output:

Total Market Demand

Total Market Supply

(pence per kilo)

The determination of market equilibrium

Price (pence per kg)

Quantity (tonnes: 000s)

The determination of market equilibrium