Business Economics ECO335C1

1
Business Economics ECO335C1

• Week 1 Revision of Demand and Supply Model

2
Making Notes / Learning Objectives

• Explain the law of demand
• Explain the ceteris paribus assumption
• Draw a demand curve
• Make clear the difference between a movement
  along and movement of the demand curve
• Explain and draw a supply curve
• Define equilibrium
• Describe how to use the model to analyse the
  effects of changes in demand and/or supply

3
DEMAND CURVE - Building the model

• Models the relationship between demand and price
• Described as the law of demand
• (1) the income effect
• (2) the substitution effect
• The assumptions
• other things being equal (ceteris paribus)
• a given time period

4
The demand curveThe demand for potatoes
(monthly)
5
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700
Price (pence per kg) 20
Point
A
Price (pence per kg)
A
Demand
Quantity (tonnes 000s)
6
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500
Price (pence per kg) 20 40
Point
A B
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
7
Market demand for potatoes (monthly)
Market demand (tonnes 000s) 700 500 350 200 100
Price (pence per kg) 20 40 60 80 100
Point
E
A B C D E
D
C
Price (pence per kg)
B
A
Demand
Quantity (tonnes 000s)
8
Describing the model in more detail

• Other determinants of demand
• tastes
• number and price of substitute goods
• number and price of complementary goods
• income
• distribution of income
• expectations

9
Showing features of the model on a diagram

• 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

10
An increase in demand
P
Price
D0
O
Q0
Q1
Quantity
11
Describing a model with equations

• Demand functions
• simple demand functions
• Qd a bP
• more complex demand functions
• Qd a bP cY dPs ePc

12
SUPPLY CURVE building the model

• Relationship between supply and price
• - an increase in price causes an increase in the
  quantity supplied and vice versa
• Assumptions
• other things remain equal (ceteris paribus)
• a given time period

13
The supply curveThe supply of potatoes (monthly)
14
Market supply of potatoes (monthly)
Supply
P 20
Q 100
a
Price (pence per kg)
a
Quantity (tonnes 000s)
15
Market supply of potatoes (monthly)
Supply
P 20 40
Q 100 200
a b
Price (pence per kg)
b
a
Quantity (tonnes 000s)
16
Market supply of potatoes (monthly)
e
Supply
d
P 20 40 60 80 100
Q 100 200 350 530 700
a b c d e
c
Price (pence per kg)
b
a
Quantity (tonnes 000s)
17
SUPPLY CURVE

• 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

18
SUPPLY

• Other determinants of supply
• costs of production
• profitability of alternative products
  (substitutes in supply)
• nature and other random shocks
• expectations of producers

19
Describing the model

• 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

20
Shifts in the supply curve
P
S0
Increase
Q
O
21
Shifts in the supply curve
P
S0
S1
Increase
Decrease
Q
O
22
SUPPLY

• Supply functions
• simple supply functions
• Qs a bP
• more complex supply functions
• Qs a bP cC dPs ePj

23
Supply and Demand

• USING THE MODEL Price and output determination

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How does the model work?

• Equilibrium price and output
• response to shortages and surpluses
• shortage (D gt S)
• ? price rises
• surplus (S gt D)
• ? price falls

25
Equilibrium price and outputThe Market Demand
and Supply of Potatoes (Monthly)
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The determination of market equilibrium
(potatoes monthly)
E
e
Supply
d
D
c
C
Price (pence per kg)
b
B
a
A
Demand
Quantity (tonnes 000s)
27
The determination of market equilibrium
(potatoes monthly)
E
e
Supply
d
D
c
C
Price (pence per kg)
b
B
a
A
Demand
Quantity (tonnes 000s)
28
PRICE AND OUTPUT DETERMINATION

• Effects of shifts in the demand curve
• movement along the supply curve and the new
  demand curve

29
Effect of a shift in the demand curve
P
S
g
Pe1
D1
O
Qe1
Q
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Effect of a shift in the demand curve
P
S
g
Pe1
D1
O
Qe1
Q
31
Effect of a shift in the demand curve
P
S
g
Pe1
D2
D1
O
Qe1
Q
32
Effect of a shift in the demand curve
P
S
Pe2
g
Pe1
D2
D1
O
Qe1
Qe2
Q
33
PRICE AND OUTPUT DETERMINATION

• Effects of shifts in the demand curve
• movement along the supply curve and the new
  demand curve
• Effects of shifts in the supply curve
• movement along demand curve and new supply curve

34
Effect of a shift in the supply curve
P
S1
g
Pe1
D
O
Qe1
Q
35
Effect of a shift in the supply curve
P
S1
g
Pe1
D
O
Qe1
Q
36
Effect of a shift in the supply curve
P
S2
S1
g
Pe1
D
O
Qe1
Q
37
Effect of a shift in the supply curve
P
S2
S1
Pe3
g
Pe1
D
O
Qe3
Qe1
Q