Demand and supply functions in economics

Demand and supply functions in economics

1. 1
9 : Theory of Demand

2. 2
Prof. Trupti Mishra, School of Management, IIT Bombay
Definition of Demand
Laws of Demand
Exception to law of Demand
Factors influencing Demand
Recap from last session

3. Change in quantity demanded
Occurs when price changes
Movement along demand curve

Change in demand
Occurs when one of the other variables, or determinants of
demand, changes
Demand curve shifts rightward or leftward
Change in the Demand
Prof. Trupti Mishra, School of Management, IIT Bombay

4. Change in the Demand Curve
Prof. Trupti Mishra, School of Management, IIT Bombay

5. Q
d
0 1,100 700 100
Quantity
Price (Rupees)

900
P

300 500 1,500 1,300
10
20
30
40
50
60
70
80
D
0
D
1
D
2
• •
• •
Demand
increase
Demand
decrease
Shifts in Demand
Prof. Trupti Mishra, School of Management, IIT Bombay

6. 6
Price of
Cigarettes,
per Pack.
Number of Cigarettes
Smoked per Day
D
2
A policy to
discourage smoking
shifts the demand
curve to the left.
0 20
RS 2.00
D
1
A
10
B
A Shifts in the Demand Curve
Prof. Trupti Mishra, School of Management, IIT Bombay

7. 7
Price of
Cigarettes,
per Pack.
Number of Cigarettes
Smoked per Day
0 20
Rs 2.00
D
1
A
A tax that raises
the price of
cigarettes results
in a movements
along the demand
curve.
C
12
Rs 4.00
A Movement Along the Demand Curve
Prof. Trupti Mishra, School of Management, IIT Bombay

8. 8
Prof. Trupti Mishra, School of Management, IIT Bombay
Supply
Supply of a goods refers to the various quantities of the
good which a seller is willing and able to sell at a different
prices in a given market, at a particular point of time.

9. 9
Prof. Trupti Mishra, School of Management, IIT Bombay
Law of Supply

The law of supply states that, other things equal, the quantity
supplied of a good rises when the price of the good rises.
Example: when the price of a good falls from 25 to 10, the
quantity supplied falls from 31 to 16.


10. 10
Prof. Trupti Mishra, School of Management, IIT Bombay
Factors Influencing Supply

Price of good or service (P)
Input prices (PI )
Prices of goods related in production (Pr)
Technological advances (T)
Expected future price of product (Pe)
Number of firms producing product (F)

11. 11
-Supply function

-shows relation between P & Q
s when all other variables are
held constant
 Q
s = g(P)




Supply Function
Prof. Trupti Mishra, School of Management, IIT Bombay

12. 12
Prof. Trupti Mishra, School of Management, IIT Bombay
Supply Function: Example
Qs = 10Px
If Px = 2, Qs = 20
If Px =5,Qs = 50

13. 13

k, l, m, n, r, & s are slope parameters
Measure effect on Qs of changing one of the variables while holding
the others constant
Sign of parameter shows how variable is related to Qs
Positive sign indicates direct relationship
Negative sign indicates inverse relationship
s I r e
Q h kP lP mP nT rP sF
Generalize Supply Function
Prof. Trupti Mishra, School of Management, IIT Bombay

14. 14
Variable Relation to Q
s Sign of Slope Parameter
P
P
e
F
P
I
P
r
Direct
Direct
Direct
Inverse
Inverse
Inverse for substitutes
k = Q
s/P is positive
l = Q
s/P
I is negative
m = Q
s/P
r is negative
m = Q
s/P
r is positive
r = Q
s/P
e is negative
s = Q
s/F is positive
Direct for complements
n = Q
s/T is positive T
Generalize Supply Function
Prof. Trupti Mishra, School of Management, IIT Bombay

15. 15

Supply Schedule
-The supply schedule is a table that shows the relationship
between the price of the good and the quantity supplied.


Prof. Trupti Mishra, School of Management, IIT Bombay

16. 16
Supply Schedule: Example
5 3.00
4 2.50
3 2.00
2 1.50
1 1.00
0 0.50
0 0.00
Quantity of cones Supplied
Price of Ice-cream Cone
(Rs)
Prof. Trupti Mishra, School of Management, IIT Bombay

17. 17
5 3.00
0 0.50
0 0.00
A
Price of Ice-cream Cone
(Rs)
Market supply Schedule
+
8
0
0
B
13
4 2.50
3 2.00
2 1.50
1 1.00
6
4
2
0
10
7
4
1
0
0
Market
=
Prof. Trupti Mishra, School of Management, IIT Bombay

18. 18








Supply Curve

-The supply curve is a graph of the relationship between the
price of a good and the quantity supplied.


Prof. Trupti Mishra, School of Management, IIT Bombay

19. 19
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
6 8 10 12 0 2
1.50
1.00
1
2.00
3 4
Rs 3.00
2.50
5
0.50
Supply Curve: Example
Prof. Trupti Mishra, School of Management, IIT Bombay

20. 20
The Determinants of Quantity Supplied
Prof. Trupti Mishra, School of Management, IIT Bombay

21. 21
S
0
S
2
S
1
Supply
decrease
Q
s
0 700 100 900 300 500
10
20
30
40
50
60
70
80
Quantity
Price (Rupees)

P

• •
• •
Supply
increase
Shifts in Supply
Prof. Trupti Mishra, School of Management, IIT Bombay

22. 22
•Equilibrium refers to a situation in which the price has reached
the level where quantity supplied equals quantity demanded.

Market Equilibrium
Prof. Trupti Mishra, School of Management, IIT Bombay

23. 23


Equilibrium price & quantity are determined by the intersection of demand
& supply curves
At the point of intersection, Q
d = Q
s
Consumers can purchase all they want & producers can sell all they
want at the “market-clearing” price
Market Equilibrium
Prof. Trupti Mishra, School of Management, IIT Bombay

24. 24
At Rs 2.00, the quantity demanded is equal to the
quantity supplied!
Demand Schedule Supply Schedule
Equilibrium
Prof. Trupti Mishra, School of Management, IIT Bombay

25. 25
Equilibrium
price
Demand
Supply
Rs 2.00
6 8 10 0
Equilibrium
Equilibrium
quantity
Quantity of Ice-
Cream Cones
Price of
Ice-Cream
Cone
4 2 1 3 5 7 9 11
The Equilibrium of Supply and Demand
Prof. Trupti Mishra, School of Management, IIT Bombay

26. 26
Equilibrium
•Surplus
–When price > equilibrium price, then quantity supplied >
quantity demanded.
•There is excess supply or a surplus.
•Suppliers will lower the price to increase sales, thereby
moving toward equilibrium.
Prof. Trupti Mishra, School of Management, IIT Bombay

27. 27
Equilibrium
•Shortage
–When price < equilibrium price, then quantity demanded >
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.
Prof. Trupti Mishra, School of Management, IIT Bombay

28. 28
Demand
Supply
2.00
6 8 10 0
Quantity of
Ice-Cream
Cones
Price of
Ice-Cream
Cone
4 2 1 3 5 7 9 11
2.50
Surplus
Quantity
Demanded
Quantity
Supplied
Excess Supply
Prof. Trupti Mishra, School of Management, IIT Bombay

29. 29
Demand
Supply
2.00
6 8 10 0
Quantity of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
4 2 1 3 5 7 9 11
1.50
Shortage
Quantity
Supplied
Quantity
Demanded
Excess Demand
Prof. Trupti Mishra, School of Management, IIT Bombay

30. 30
D
1
Supply
Rs 2.00
6 10 0
Quantity of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
4 2 1 3 5 7 11
D
2
Rs2.50
1. Hot weather increases the
demand for ice cream…
2. …
resulting in
a higher
price …
3. … and a higher quantity
sold.
New equilibrium
Initial
equilibrium
How an Increase Demand Affects the Equilibrium
Prof. Trupti Mishra, School of Management, IIT Bombay

31. 31
Demand
S
1
Rs 2.00
10 0
Quantity of
Ice-Cream
Cones
Price of
Ice-Cream
Cone
4 2 1 3 7 11
S
2
Rs 2.50
1. A technical failure reduces the
supply of ice cream…
2. …
resulting in
a higher
price …
3. … and a lower quantity
sold.
New
equilibrium
Initial
equilibrium
How a Decrease Demand Affects the Equilibrium
Prof. Trupti Mishra, School of Management, IIT Bombay

32. 32
D
1
S
1
0
Quantity of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
Q
1
D
2
Large increase
in demand
P
2
S
2
Q
2
New
equilibrium
Small
decrease in
supply
Initial equilibrium
P
1
A Shift in Both Supply and Demand
Prof. Trupti Mishra, School of Management, IIT Bombay

33. 33
D
1
S
1
0
Quantity of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
Q
1
D
2
Large
decrease in
supply
P
2
S
2
Q
2
New
equilibrium
Small increase
in demand
Initial
equilibrium
P
1
A Shift in Both Supply and Demand
Prof. Trupti Mishra, School of Management, IIT Bombay

34. 34
When demand & supply shift simultaneously

Can predict either the direction in which price changes or
the direction in which quantity changes, but not both

The change in equilibrium price or quantity is said to be
indeterminate when the direction of change depends on
the relative magnitudes by which demand & supply shift
Simultaneous Shifts
Prof. Trupti Mishra, School of Management, IIT Bombay

35. 35
What Happens to Price and Quantity when Supply or
Demand Shifts?
Prof. Trupti Mishra, School of Management, IIT Bombay

36. 36
Session Summary
•The demand curve shows how the quantity of a good depends
upon the price.
–According to the law of demand, as the price of a good falls, the
quantity demanded rises. Therefore, the demand curve slopes
downward.


Prof. Trupti Mishra, School of Management, IIT Bombay

37. 37
Session Summary

–In addition to price, other determinants of how much consumers
want to buy include income, the prices of complements and
substitutes, tastes, expectations, and the number of buyers.

–If one of these factors changes, the demand curve shifts.

Prof. Trupti Mishra, School of Management, IIT Bombay

38. 38
Session Summary
•The supply curve shows how the quantity of a good
supplied depends upon the price.

•According to the law of supply, as the price of a good
rises, the quantity supplied rises. Therefore, the
supply curve slopes upward.

Prof. Trupti Mishra, School of Management, IIT Bombay

39. 39
Session Summary

•In addition to price, other determinants of how much
producers want to sell include input prices, technology,
expectations, and the number of sellers.

•If one of these factors changes, the supply curve shifts.
Prof. Trupti Mishra, School of Management, IIT Bombay

40. 40
Session Summary
•Market equilibrium is determined by the intersection of
the supply and demand curves.

•At the equilibrium price, the quantity demanded equals
the quantity supplied.

•The behavior of buyers and sellers naturally drives
markets toward their equilibrium.
Prof. Trupti Mishra, School of Management, IIT Bombay

41. 41
Prof. Trupti Mishra, School of Management, IIT Bombay
Managerial Economics; D N Dwivedi, 7
th
Edition

Managerial Economics ; Thomas and Maurice, 9
th

Edition

Managerial Economics ; Mark Hirschey
Session References