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Demand, Supply and

Prices

Week 2
The Market System

Market consists of:


Consumers - create a
demand for a product
Producers supply the
products
A space where both groups
can get together (doesnt
have to be a physical space)
Market demand
consists of the sum of
all individual demand
schedules in the market
Represented by a
demand curve
At higher prices,
consumers generally
willing and able to
purchase less than at
lower prices
Incomes effect
Substitution effect
Demand curve
negative slope (inverse
relationship),
downward sloping from
left to right
Demand

Market demand is the total amount of the product


that consumers are willing and able to purchase at a
particular price over a given period of time.
Factors influencing demand include:
Price of the product
Price of other products
Household income
Tastes
Advertising.

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Expansion/contraction in demand

The demand curve shows the relationship between the quantity demanded of a
Figure 1.
good or service over a particular period of time and its price, assuming ceteris paribus.
The quantity demanded is measured on the horizontal axis and the price on the vertical
axis 5
Movement along the demand curve is the result of a
rise or fall in the price of the product itself.

The terminology we use to describe this movement


along the demand curve is to say that there has been
either an expansion or contraction in demand for the
product.

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Shift in demand

The demand curve will shift to the right (increase) or left


(decrease) if there is a change in the conditions of
demand.

These conditions of demand include:


Price of other products
Household/national income
Tastes of consumers
Etc.
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Increase/decrease in demand

Fig. 2

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Increase in demand

Shift upwards and to the right


Change in conditions of demand:
Rise in price of substitute
Fall in price of complement
Rise in real income (normal product)
Fall in real income (inferior product)
Change of tastes in favour of product
Rise in advertising expenditure.

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Decrease in demand

Shift downwards and to the left as a result of


change in conditions of demand.

Any suggestions?

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The Demand Function
Dx = f (Px , Po , Y, T, P, A,)
Where:
Px = own price of good X
Po = Prices of other goods substitutes and complements
Y = Incomes the level and distribution of income
T = Tastes and fashions
P = The level and structure of the population
A = Advertising
Plus many others
Market demand curve is the total amount that
consumers demand at a particular price over a given
period of time.

The market demand curve is derived from summing


the individual demand curves horizontally.

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The market demand curve is obtained by summing the individual demand curves
Figure 3.
horizontally. The quantities demanded by each individual at each price are added
together, so at a price of, say, 20 pence, individual A demands 20 units and individual B
demands 15 units. The overall market demand is therefore 35 units at a price of 20
pence 13
Market Supply
consists of the sum of
all individual supply
schedules in the
market
Represented by a
Supply curve
At higher prices, Supply
producers generally
willing to sell more
than at lower prices
supply curve positive
slope, upward sloping
from left to right

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The supply
Price curve slopes
Supply upwards from
left to right
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positive
relationship
between supply
and price. As
price rises, it
3 encourages
producers to
offer more for
sale whereas a
fall in price
would lead to
200 800 the quantity
Quantity Bought and supplied to fall.
Sold (000s)
Fig. 4 15
The Supply Function;
S = f (Pn, Po , H, N,
Fn, E, Sp)
Where:
Pn = Price
Po = Profitability of other
goods in production
and prices of goods in
joint supply
H = Technology
N = Natural shocks
Fn = Costs of production
E = Expectations of
producers
Sp = Social factors

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Changes in any of the
factors OTHER than price
cause a shift in the supply
curve
A shift in supply to the
left the amount
producers offer for sale at
every price will be less
A shift in supply to the
The Supply Curve
right the amount
producers wish to sell at
every price increases
HINT: Be careful to not
confuse supply going up
and down with the
direction of the shift!
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Price ()
S

D
450 Quantity Bought
Fig. 5 and Sold (000s)
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What would happen if
the price was above or Exercise
below this point?

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The responsiveness of one
variable to changes in
another
When price rises, what
happens
to demand?
Demand falls
BUT! - how much does
demand fall?

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This refers to attempts to
measure the
responsiveness of the
demand for product X to
changes in the following
factors:
The price of X itself:
price elasticity of
Elasticity
demand Concept
The price of other
products: cross elasticity
of demand
The real income of
households: income
elasticity of demand
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Measures the responsiveness
of the quantity demanded
(QD) of a product to a change
in its own price
PED = % change in QD of X
% change in price of X

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Relatively elastic demand
if PED >I
(ignoring sign)
Fall in price: Total
revenue rises
Rise in price: Total
revenue falls Price Elasticity of
Relatively inelastic Demand (PED) (2
demand if PED < I
(ignoring sign)
Rise in price: Total
revenue rises
Fall in price: Total
revenue falls

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If the PED of a good is
between
-1 and infinity
We describe the good as
being relatively elastic
We expect the demand
curve to be relatively
flatter

If the PED of a good is


between
0 and -1
We describe the good as
being relatively inelastic
We expect the demand
curve to be relatively
steeper

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Elasticity: Why is it
important and who
cares about it?

If demand is price inelastic:


If demand is price elastic:
Increasing price would
Increasing price would increase TR
reduce TR (% Qd > % P)
(% Qd < % P)
Reducing price would
increase TR (% Qd > % P) Reducing price would reduce
TR (% Qd < % P)

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If the PED of a good is -1
Unitary elasticity
If the PED of a good is
zero
Perfectly Inelastic
Vertical demand curve
If the PED of a good is
infinity
Perfectly Elastic
Horizontal Demand
Curve

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Measures the
responsiveness of the
quantity demanded (QD)
of X to a change in
household or national
income.

IED = % change in QD of X
% change in real income

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Some goods and
especially services
(e.g. education,
health, leisure) have
high positive IEDs
IED may be negative
over certain ranges of
income for inferior
goods and services
IED is useful in
forecasting shifts in
demand when GDP is
rising/falling

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An Engle curve is a diagram
relating changes in the quantity
demanded of X to a change in
real income
Curve 1 relates to normal
products (positive IED
throughout)
Curve 2 relates to a product
which becomes inferior for
incomes above Y2
Curve 3 relates to products
for which demand is
saturated for incomes above
Y1

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Fig. 6
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Measures the
responsiveness of the
quantity demanded (QD)
of X to a change in the
price of Y
CED = % change in QD of X
% change in price of Y

Where X and Y are


substitutes in
consumption,
CED is positive
Where X and Y are
complements in
consumption,
CED is negative

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Time period the longer
the time under
consideration the more
elastic a good is likely to
be
Number and closeness of
substitutes the greater
the number of substitutes,
the more elastic
The proportion of income
taken up by the product
the smaller the proportion
the more inelastic
Luxury or Necessity This
refers to how consumers
view a product for
example, addictive drugs

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