Determining Price - Demand and Supply

1
Determining Price Demand and Supply
2
Outline

• What do we mean by supply and demand
• What determines demand
• What determines supply
• How do demand and supply interact to determine
  price.

3
Definitions

• Effective Demand The quantity consumers are
  willing and able to buy at any given price
• Supply The quantity firms are willing and able
  to sell at any given price
• Shortage An excess of demand over supply
• Surplus An excess of supply over demand

4
Demand
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64
20 50 57
30 45 50
40 40 43
50 35 36
60 30 29
70 25 22
80 20 15
90 15 8
100 10 1
Quantity
5
Demand
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64 119
20 50 57 107
30 45 50 95
40 40 43 83
50 35 36 71
60 30 29 59
70 25 22 47
80 20 15 35
90 15 8 23
100 10 1 11
Demand
Quantity
6
Demand
Show on the diagram the quantity that would be
demanded if the price were 45
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64 119
20 50 57 107
30 45 50 95
40 40 43 83
50 35 36 71
60 30 29 59
70 25 22 47
80 20 15 35
90 15 8 23
100 10 1 11
100
80
60
40
20
Demand
120
20
40
60
80
100
Quantity
7
Demand
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64 119
20 50 57 107
30 45 50 95
40 40 43 83
50 35 36 71
60 30 29 59
70 25 22 47
80 20 15 35
90 15 8 23
100 10 1 11
100
80
60
40
20
Demand
120
20
40
60
80
100
Quantity
8
Extensions and Contractions

• If price increases, there is a contraction in
  demand
• If price falls, there is an extension in demand

Price
Contraction
Extension
Demand
Quantity
9
Demand

• The law of demand states that the demand curve
  always slopes down (i.e. as price falls, demand
  rises, as long as everything else remains
  constant).

10
Demand
Exercise Utility Monster

• The law of demand states that the demand curve
  always slopes down (i.e. as price falls, demand
  rises, as long as everything else remains
  constant).

11
Why does the demand curve slope down?

• Income Effect
• As the price rises it is as though income falls
• Substitution Effect
• As the price rises other goods get relatively
  cheaper so consumers substitute away to other
  things.
• Diminishing Marginal Utility
• Generally the amount of extra benefit people gain
  falls with each unit they consume and so they are
  not prepared to pay quite as much for the next
  unit.

12
Why does the demand curve slope down?

• Income Effect
• As the price rises it is as though income falls
• Substitution Effect
• As the price rises other goods get relatively
  cheaper so consumers substitute away to other
  things.
• Diminishing Marginal Utility
• Generally the amount of extra benefit people gain
  falls with each unit they consume and so they are
  not prepared to pay quite as much for the next
  unit.

Does the demand for all goods go down as income
falls? Can you think of any exceptions?
13
Why does the demand curve slope down?

• Extension Exceptions to the law of demand-
  http//en.wikipedia.org/wiki/Law_of_demandExcepti
  ons_to_the_law_of_demand
• Extension Indifference curves and budget
  constraints video -http//www.youtube.com/watch?v
  P_N2hr9aMow
• Extension Drawing income and substitution
  effects video- http//www.youtube.com/watch?vYZxI
  mVH5gKM

14
Shifts in Demand

• To draw a demand curve we have to assume that
  everything except price remains constant.
• If anything other than price changes then one of
  the curves will shift.
• A shift left means at the same price less would
  be demanded

Price
Shift Right
D2
Shift Left
Demand
D1
Quantity
15
List as many things as possible which will affect
demand for wellies.
Start
16
Causes of Shift in Demand

• Lots of things cause the demand curve to shift
• Price of other goods. Some goods are consumed
  together, some goods instead of each other.
• Incomes. Some goods people buy more of when
  incomes increase, some less.
• Demographics average age, gender, population
  size etc. will affect demand for certain goods

17
Causes of Shift in Demand

• Advertising successful advertising can increase
  demand for a product
• Fashions and tastes. Some goods go in or out of
  fashion, some are more desirable depending on the
  season, weather etc.
• Expectations if people expect the price to
  rise, or incomes to fall they may change their
  behaviour early.

18
Causes of Shift in Demand

• Advertising successful advertising can increase
  demand for a product
• Fashions and tastes. Some goods go in or out of
  fashion, some are more desirable depending on the
  season, weather etc.
• Expectations if people expect the price to
  rise, or incomes to fall they may change their
  behaviour early.

Exercise Shifts in Demand
19
Supply
Price
Supply(000,000) Supply(000,000) Supply(000,000)
Price Microsoft Apple total
100 77 45
90 69 40
80 61 35
70 53 30
60 45 25
50 37 20
40 29 15
30 21 10
20 13 5
10 5 0
Quantity
20
Supply
Price
Supply(000,000) Supply(000,000) Supply(000,000)
Price Microsoft Apple total
100 77 45 122
90 69 40 109
80 61 35 96
70 53 30 83
60 45 25 70
50 37 20 57
40 29 15 44
30 21 10 31
20 13 5 18
10 5 0 5
Supply
Quantity
21
Supply

• The law of Supply states that the supply curve
  always slopes up (i.e. as price falls, supply
  also falls).

Price
Supply
Quantity
22
Why does the supply curve slope up?

• Supply is driven by costs
• The higher the profit per unit the greater then
  incentive for firms to produce more
• Costs rise with output
• In the short run, firms face diminishing marginal
  returns - it costs firms more to make each extra
  unit.
• This means that to persuade firms to supply an
  extra unit they must be compensated with a higher
  price.

23
Diminishing Marginal Returns

• The Law of Diminishing Marginal Returns states
  that if more units of a variable factor are used
  with a fixed quantity of another factor of
  production then each additional worker will add
  less to total output than the previous worker.
• In English
• Factors of production are not perfect substitutes
  for one another.
• You cant solve the problem of not enough capital
  by adding more labour.
• Think about a bin lorry, I can add more people
  and each extra person will add a little more to
  output, but less and less as they will start to
  get in each others way.
• If workers are paid the same but produce less
  output then the marginal cost (cost of the next
  unit) rises

24
Diminishing Marginal Returns
Exercise Diminishing Marginal Returns

• The Law of Diminishing Marginal Returns states
  that if more units of a variable factor are used
  with a fixed quantity of another factor of
  production then each additional worker will add
  less to total output than the previous worker.
• In English
• Factors of production are not perfect substitutes
  for one another.
• You cant solve the problem of not enough capital
  by adding more labour.
• Think about a bin lorry, I can add more people
  and each extra person will add a little more to
  output, but less and less as they will start to
  get in each others way.
• If workers are paid the same but produce less
  output then the marginal cost (cost of the next
  unit) rises

25
Extensions and Contractions

• If price increases, there is an extension in
  supply
• If price falls, there is a contraction in supply

Price
Supply
Extension
Contraction
Quantity
26
Shifts in supply

• Shifts in supply are the same as shifts in
  demand- any non-price factor affecting supply
  will cause a shift right or left.

S1
Price
Supply
Shift Left
S2
Shift Right
Quantity
27
Causes of Shift in Supply

• Lots of things cause the supply curve to shift
• Price of other goods. Some goods are consumed
  together, some goods instead of each other.
• Incomes. Some goods people buy more of when
  incomes increase, some less.
• Demographics average age, gender, population
  size etc. will affect demand for certain goods

28
Causes of Shift in Supply

• Indirect Taxes remember, only indirect taxes
  affect the costs of production. Direct taxes
  change income.
• Number of firms. The more firms in the market the
  greater supply at each price

29
Causes of Shift in Supply

• Indirect Taxes remember, only indirect taxes
  affect the costs of production. Direct taxes
  change income.
• Number of firms. The more firms in the market the
  greater supply at each price

Exercise Shifts in supply
30
Shifts in Supply and Demand

• When deciding what shifts, think What would
  happen if the price remained the same?
• e.g. If there were a wet summer what would happen
  to the market for umbrellas (if price remained
  the same would people demand/supply more/less)

31
Price

• The market will settle at the market clearing (or
  equilibrium ) price.
• This will occur where demand crosses supply.
• Here there is no shortage or surplus.

Price
Supply
P
Demand
Q
Quantity
32
Price
Exercise Fast foods and text books equilibriums

• The market will settle at the market clearing (or
  equilibrium ) price.
• This will occur where demand crosses supply.
• Here there is no shortage or surplus.

Price
Supply
P
Demand
Q
Quantity