Demand, Supply

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Demand, Supply Market Equilibrium
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Objectives of Discussion

• Identify the basic components of a market demand
  supply
• Identify the factors that affect demand supply
• Describe the market equilibrium process through
  price changes and why markets generate gains from
  trade
• Examine how markets adjust to changes in factors
  that affect demand, supply and prices
• Understanding the market in which a firm competes
  is a way of looking behind the firms current and
  future income statement

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Demand - Some Background

• Market Demand Defined
• Total amount of a good or service that buyers are
  willing able to purchase during a given time
  period
• willing implies desire--may not be able to
  purchase because of availability
• able implies effectiveness-- the means to
  purchase will to carry through if somebody will
  sell
• given time period means that market demand is
  a flow at a point in time

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Factors Affecting Demand

• Market Demand for a given good or service is
  influenced by many factors
• Six primary factors that apply for most goods
  are
• Price (negative relationship)
• Buyers income or financial resources
• Positive relationship for normal goods
• Negative relationship for inferior goods

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Factors Affecting Demand

• Prices of goods related in consumption
• Positive relationship for substitutes
• Negative relationship for complements
• Tastes and Preferences
• Buyer expectations about future price
• Number of consumers in market

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Law of Demand

• Holding all other demand factors constant, price
  of a good is inversely related to the quantity
  demanded (a downward sloping line)
• A change in price causes a change in the
  quantity demanded

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Changes in Quantity Demanded

• Quantity Demanded refers to a single point
  given a particular price on a given demand curve
  (function)
• involves a movement from one point on a demand
  curve to another point on same curve
• Must entail a change in own-price

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A Demand Curve
Figure 2.1
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Reasons for Law of Demand

• Lower price brings new buyers who were unwilling/
  unable to purchase at higher price
• Existing buyers purchase more because
• Good substituted for relatively more expensive
  goods
• Real income increases so buy more of most goods
• Good is used to satisfy less pressing needs that
  had previously been unmet

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Specifying the Demand Function

• The Market Demand Function
• Qd f(P, M, PR, T, Pe, N)
• To define a demand function we need to choose a
  specific form
• e.g. Qd a bP cM dPR eT f Pe gN
• Estimate the parameters (i.e. a,b,c,d,e,f, g)
• Qd 280 - 20P 60M - 50PR 20T 10 Pe 4N

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Changes in Demand

• Demand refers to the whole set of points
  represented by a given demand curve
• involves a shift in the whole demand curve -
  quantity demanded changes for each price of the
  product
• occurs when one of the other demand determinants
  change
• Increase in demand - larger quantity demanded at
  each price
• Decrease in demand - smaller quantity demanded at
  each price

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Changes (Shifts) in Demand
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Demand and Consumer Surplus

• Consumer Surplus is the extra value a consumer
  gets from a good but does not have to pay for it.
  This surplus results from the fact that
  consumers would be willing to pay more for the
  good but dont have to because of the prevailing
  market price.

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Supply - Some Background

• Market Supply Defined
• Total amount of good/ service that sellers are
  willing able to sell during a given time period
• willing implies desire--may not be able to sell
  because buyers arent available
• able implies effectiveness-- seller has means
  to provide will to carry through if somebody
  will buy
• given time period means that market supply is
  a flow not a stock

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Factors Affecting Market Supply

• Market supply for a given good or service is
  influenced by many factors
• Six primary factors are
• Price of the good itself (positive relationship)
• Prices of inputs--labor, raw materials, etc.
  (negative relationship)

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Factors Affecting Market Supply

• Prices of goods related in production
• Negative relationship for substitutes
• gasoline fuel oil compact mid-size cars
• Positive relationship for complements
• e.g. beef leather hides crude oil gas
• Technology/regulatory/tax changes (???
  relationship)
• e.g. robotic production techniques reduced
  average per unit cost of autos
• Number type of firms selling in the market
  market structure regular vs thin markets
• Seller expectations about future prices

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Factors Affecting Market Supply

• Specifying the Supply Relationship
• The Market Supply Function
• Qs g(P, Pi, Pr, T, Pe, F)
• To measure the supply function we need to choose
  a specific functional form
• Qs h kP lPi mPr nT r Pe sF
• Estimate the parameters (i.e. h,k,l,m,n,r s)
• Qs 50 10P - 8Pi 0Pr 0T 0 Pe 5F
• or Qs 50 10P - 8Pi 5F

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Price Quantity Supplied Relationship

• Holding all other supply factors constant, the
  price of a good is positively related to the
  quantity supplied
• Reasons for Direct Relationship
• Existing producers increase output by using more
  costly techniques
• Hire overtime workers, use more expensive sources
  of raw materials, etc.
• Marginal producers who previously were unable to
  survive can now enter the market

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Changes in Quantity Supplied

• Quantity Supplied refers to a single point on a
  given supply function
• Change in quantity supplied involves a move
  from one point on a supply curve to another
  point on same curve
• Must entail a change in own-price

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A Supply Function (Curve)
Figure 2.3
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Changes in Supply

• Supply refers to the whole set of points
  represented by a given supply schedule or curve
• Change in supply occurs when one of the other
  supply determinants change
• Change involves a shift in the whole supply
  curve--the quantity supplied changes for each
  price of the product
• Decrease in supply - smaller quantity supplied at
  each price
• Increase in supply - larger quantity supplied at
  each price

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Shifts in the Supply Curve
Figure 2.4
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Supply and Producer Surplus

• Producer Surplus is the amount producers (firms)
  receive in excess of the amount they would be
  willing to supply the good to the market. The
  concept is equivalent to economic profits.

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Market Equilibrium

• Demand summarizes desires of buyers supply
  summarizes desires of sellers in a market
• Common link between buyers sellers
• is price ? Qd Qs
• Supply Demand depicts the responses of two
  distinct and independent groups of economic
  decision makers each group seeks to maximize
  their gain (surplus) from trade
• A market transaction is an exchange that is
  voluntary and leaves each party no worse off

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Market Equilibrium
Figure 2.5
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Market Equilibrium Process

• In a market with many buyers sellers decision
  makers compete against each other through price
  offers
• When Qd exceeds Qs at a given price, buyers bid
  against each other for the limited quantity
• When Qs exceeds Qd at a given price, sellers
  compete against each other for limited buyers
• In both cases the competition puts pressure on
  market price

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Interfering With the Market Adjustment Process

• When left free to adjust, markets will produce a
  price that eliminates shortages and surpluses
  (timing indeterminate)
• Price ceilings floors are sometimes imposed
  which create conditions of disequilibrium
• Government interference often based on social
  considerations, e.g. equity, regional
  distribution, and political rewards

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Price Ceilings

• Price ceiling is the imposition of a maximum
  price that is lower than the true equilibrium
  price
• Creates condition of excess demand or shortage
• Gasoline prices in 70s
• Electricity prices in California in 2000 - 2001

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Price Floors

• Price floor is imposition of a minimum price that
  is higher than the true equilibrium price
• Creates condition of excess supply or surplus
• Minimum wage is often used as an example, others
  include imports of sugar, tomatoes and steel in
  U.S.

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Price Ceilings Floors
Figure 2.11
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Using Market Equilibrium Analysis (Comparative
Statics)

• Predict the effects of outside events on price
  and quantity movements in a market
• Assess the effects of changes in firm policies on
  sales
• Assess the effects of government policy changes
  on an industry

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Approach

• Identify the avenue through which an exogenous
  event influences the market
• Does it shift the demand curve, the supply
  curve or both?
• Work through the market adjustment process
• Compare the new market equilibrium to the old
  equilibrium (static equilibrium analysis)

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Demand Shifts Outcomes

• Demand shifts with supply constant
• Increase in demand (shift to right) increases
  both price and quantity
• Decrease in demand (shift to left) decreases both
  P Q

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Demand Shifts (supply constant)
Figure 2.6
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Supply Shifts and Outcomes

• Supply shifts with demand constant
• Increase in supply (shift to right) decreases
  price and increases quantity
• Decrease in supply (shift to left) increases
  price and decreases quantity

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Supply Shifts (demand constant)
Figure 2.7
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Simultaneous Shifts in both Demand Supply

• Results vary depending on direction and magnitude
  of shifts
• Without knowledge of magnitude, one variable will
  be indeterminate (ambiguous)
• Consider net effect on price and quantity due to
  shifts of Demand and Supply

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Simultaneous Shifts D S Both Increase
Figure 2.8
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Demand Supply for Air Travel
Figure 2.10
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Discussion QuestionWhat are the factors that
contribute to a well-designed market?
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Features of a Well-Designed Market

• Low transactions costs
• Sufficient information
• Trust/reputation/no collusion
• Enforceable property rights
• Dynamic
• These features are shaped and modified by market
  participants either in the market itself or
  through government rules and regulations

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Summary

• Market equilibrium analysis provides a core tool
  for understanding and analyzing economic
  decisions of managers
• Two groups of independent players (buyers and
  sellers) in most market situations
• Demand represents behavior of buyers, supply
  represents the behavior of sellers
• Common link between buyers and sellers in markets
  is price

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Summary

• Prices in competitive markets will adjust to
  changes in demand and supply through equilibrium
  process
• In addition to own-price, behaviors of buyers
  and sellers are influenced by other demand and
  supply determinants
• Managers can develop a plan for production,
  marketing, etc. by knowing and anticipating
  market conditions
• A well-designed market requires a variety of
  supporting conditions and institutions
• Most of the topics covered in this class are
  extensions and refinements of market equilibrium
  analysis