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Demand
Introduction
Want of goods & services accompanied by willingness and ability to purchase The amount of goods and services that consumers in a market are willing and able to purchase during a given period of time (e.g., week, month) is called Quantity Demanded
Generalized.
Relation between quantity demanded and these 6 factors is referred to as Generalized Demand Function and is expressed as follows: Qd= f (P, M, PR, T, Pe, N)
Qd : quantity demanded of the product P : price of the product M : consumers income PR : price of related product T : taste & preference patterns of consumers Pe : expected price of the product in some future period N : number of consumers in the market
Relation
Quantity demanded Consumers income
When income rises, Qd may rise or fall Qd rises normal goods Qd falls inferior goods
When income falls, Qd may fall or rise Qd falls normal goods Qd rises inferior goods Direct relation for normal goods Inverse relation for inferior goods
Relation
Quantity demanded Price of related goods
Commodities may be related in consumption in either of two ways:
Substitute goods (one good can be used in place of other) Complement goods (they are used in conjunction with each other) Independent goods
Relation
Substitute goods Increase in price of good Y will lead to increase in demand for good X Decrease in price of good Y will lead to decrease in demand for good X => Direct relation in case of substitute goods Complement goods Increase in price of good Y will lead to decrease in demand for good X Decrease in price of good Y will lead to increase in demand for good X => Inverse relation in case of complementary goods
Relation
Quantity demanded Expected Future price of goods
If price is expected to rise in future, current demand may rise If price is expected to fall in future, current demand may fall => Direct relation
Relation
Quantity demanded Consumer taste pattern
Increase in taste/preference for the good, demand will increase Decrease in taste/preference for the good, demand will decrease => Direct relation
Relation
Quantity demanded Number of consumers
Increase in number of consumers for the good, demand will increase Decrease in number of consumers for the good, demand will decrease => Direct relation
Summary of relationships
Vari Relation to Qd able P Inverse M Sign of slope parameter
b = Qd/P is negative
PR
Inverse for inferior good Direct for substitute goods Inverse for complementary goods
c = Qd/M is negative
d = Qd/PR is positive d = Qd/PR is negative
Summary
Variable Relation to Qd Sign of slope parameter
T Pe N
Demand Function The relation between price and quantity demanded per period of time, when all other factors that affect consumer demand are held constant, is called a demand function or simply demand. Demand gives, for various prices of a good, the corresponding quantities that consumers are willing and able to purchase at each of those prices, all other things held constant.
Demand Function. A demand function can be expressed as an equation, a schedule/table, or a graph. A demand function can be expressed in the most general form as the equation Qd = f(P) which means that the quantity demanded is a function of (depends on) the price of the good, holding all other variables constant
Demand Function. Such demand function is obtained by holding all the variables in the generalized demand function constant except price Qd = f(P, M, PR) = f(P)
To derive a demand function, Qd = f(P), the variables M and PR must be assigned fixed values.
Derivation .. Suppose M (consumer income) is Rs. 20000 and PR (price of related good) is Rs. 250. To find the demand function, fixed values of M and PR are substituted into the generalized demand function: Qd = 1800 20P + 0.6(20000) 50(250) = 1800 20P + 12000 12500 = 1300 20P
Derivation .. Thus, the demand function is expressed in the form of a linear demand equation. Intercept parameter (1300) is the amount of the good consumers will demand if price is zero. Slope (-20) indicates that a Re. 1 increase in price causes quantity demanded to decrease by 20 units.
Derivation ..
Demand equation can be converted into demand schedule by changing values of P in the equation, Qd = 1300 20P.
Price 65 60 50 40 30 20 10 0 Qd 0 100 300 500 700 900 1100 1300
Demand Curve
Demand schedule can be converted into a graph. A graphical demand function is called a demand curve.
70 60 50 0, 65 100, 60 300, 50 500, 40 700, 30 900, 20 1100, 10 0 200 400 600 800 1000 1200 1300, 0 1400
Price
40 30 20 10 0
Quantity demanded
Demand..
Note that in the graph of the demand function, Qd = 1300 20P, the independent variable P is plotted along the vertical axis and the dependent variable Qd is plotted along the horizontal axis. Thus the equation plotted in the figure is the inverse of the demand equation and is called inverse demand function since price is expressed as a function of quantity demanded: P = 65 1/20Qd.
Demand..
The vertical intercept is 65, indicating that at a price of 65, consumers will demand zero units of the good. The horizontal intercept is 1300, which is the maximum amount of the good buyers will take when the good is given away (P = 0) Slope of the graphed inverse demand function is -1/20, indicating that if quantity demanded rises by one unit, price must fall 1/20 of a Re.
Demand..
A point on a demand curve can be interpreted as in either of two ways:
(1) The maximum amount of a good that will be purchased if a given price is charged (2) The maximum price that consumers will pay for specific amount of a good.
Law of demand
Quantity demanded increases when price falls and quantity demanded decreases when price rises, other things held constant. (Law of demand) Once a demand function, Qd = f(P), is derived from a generalized demand function, a change in quantity demanded can be caused only by a change in price.
Dynamics
Change in quantity demanded Increase (caused by fall in price) Decrease (caused by rise in price)
Change in demand (Shift in demand) Increase (caused by change in non-price variables) Decrease (caused by change in non-price variables)
Shifts/Change in Demand
When any one of the five variables held constant while deriving a demand function from the generalized demand relation changes value, a new demand function results, causing the entire demand curve to shift to a new location
Change in demand can be understood from simplified version of generalized demand function
Change
Now, suppose income decreases by 500 Qd = 1800 20P + 0.6(19500) 50(250) Qd = 1800 20P + 11700 12500 Qd = 1000 20P (D2)
Price
65 60 50 40 30 20 10
1300
1600
1000
D0
1 Qd= :[
20 00-
P]
1:
[Qd =16
D2 :[
002
Qd =1
0P]
000
- 20
P]
Change
Now, suppose PR decreases by 10 Qd = 1800 20P + 0.6(20000) 50(240) Qd = 1800 20P + 12000 12000 Qd = 1800 20P (D4)
Price
65 60 50 40 30 20 10
1300
800
1800
D0 : D3 : Qd =
Qd =
D4 : 13 00 -2 0P
Qd =
Price
40 30 20 10 0 0
18
00
-2
0P
80
0-
20
200
400
600
800
1000
1200
1400
1600
1800
Quantity demanded
Substitute goods
Complement goods
PR rises
PR falls
PR falls
PR rises
d>0
d<0
Pe rises
N rises
Pe falls
N falls
f>0
g>0
Supply
Introduction
The amount of goods and services offered for sale in a market during a given period of time (e.g., week, month) is called Quantity Supplied
Generalized.
Relation between quantity supplied and these 6 factors is referred to as Generalized Supply Function and is expressed as follows: Qs= g (P, PI, Pr, Tech, Pe, F)
Qs quantity of a good or service offered for sale P price of the good or service PI Prices of inputs used in production Pr price of goods or service related in production Tech level of available technology Pe expectations of producers concerning future price of the good F number of firms or amount of productive capacity in the industry
Relation
Quantity supplied Price of inputs
When input price rises, Qs falls When input price falls, Qs rises Inverse relation
Relation
Quantity supplied Price of goods related in production
Depends on whether goods are substitutes or complements in production:
Substitutes in production Two goods X and Y are substitutes in production if an increase in the price of good X relative to good Y causes producers to increase production of good X and decrease production of good Y => Inverse relation
Relation
Complements in production Two goods X and Y are complements in production if an increase in the price of good X relative to good Y causes producers to increase production of good Y also => Direct relation
Relation
Quantity supplied Level of Technology
When technology improves, Qs increases When technology deteriorates, Qs decreases => Direct relation
Relation
Quantity supplied Future price expectations
If price is expected to rise in future, current supply may fall If price is expected to fall in future, current supply may rise => Inverse relation
Relation
Quantity supplied Number of firms or productive capacity of industry
Increase in number of firms or productive capacity, Qs will increase Decrease in number of firms or productive capacity, Qs will decrease => Direct relation
Summary
Vari Relation to Qs able P Direct PI Inverse Sign of slope parameter
k = Qs/P is positive
l = Qs/PI is negative
Pr
m = Qs/Pr is negative
m = Qs/Pr is positive
Summary
Vari Relation to Qs able Tech Direct Pe Inverse Sign of slope parameter
n = Qs/Tech is positive
r = Qs/Pe is negative
Direct
s = Qs/F is positive
Supply Function The relation between price and quantity supplied per period of time, when all other factors that affect supply are held constant, is called a supply function or simply supply. Supply gives, for various prices of a good, the corresponding quantities that producers are willing to supply at each of those prices, all other things held constant.
Supply Function. A supply function can be expressed as an equation, a schedule or table, or a graph. A supply function can be expressed in the most general form as the equation Qs = f(P) which means that the quantity supplied is a function of (depends on) the price of the good, holding all other variables constant
Supply Function. A supply function is obtained by holding all the variables in the generalized supply function constant except price Qs = f(P, PI, F) = f(P)
To derive a supply function, Qs = f(P), the variables PI and F must be assigned fixed values.
Derivation .. Suppose PI (Input price) is Rs. 50 and F (number of firms) is 90. To find the supply function, fixed values of PI and F are substituted into the generalized supply function: Qs = 50 + 10P - 8(50) + 5(90) = 50 + 10P - 400 + 450 = 100 + 10P
Derivation .. Linear supply function gives the quantity supplied for various product prices, holding constant the other variables that affect supply.
Derivation ..
Supply equation can be converted into supply schedule by changing values of P in the equation, Qs = 100 + 10P.
Price 65 60 50 40 30 20 10 Qs 750 700 600 500 400 300 200
Derivation .. Supply schedule can be converted into a graph. A graphical supply function is called a supply curve.
Supply curve
70 60 50
Price
40 30 20 10 0 0 100 200 300 400 500 600 700 800 Quantity supplied
Supply..
Note that in the graph of the supply function, Qs = 100 + 10P, the independent variable P is plotted along the vertical axis and the dependent variable Qs is plotted along the horizontal axis. Thus the equation plotted in the figure is the inverse of the supply equation and is called inverse supply function since price is expressed as a function of quantity supplied: P = - 10 + 1/10Qs.
Supply..
A point on a supply curve can be interpreted as in either of two ways:
(1) The maximum amount of a good that will be offered for sale at a specific price (2) The minimum price necessary to induce producers to offer a given quantity for sale.
Supply.
Once a supply function, Qs = f(P), is derived from a generalized supply function, a change in quantity supplied can be caused only by a change in price.
Dynamics
Change in quantity supplied Increase (caused by rise in price) Decrease (caused by fall in price)
Change in supply (Shift in supply) Increase (caused by change in non-price variables) Decrease (caused by change in non-price variables)
Shifts/Change in supply
When any one of the five variables held constant while deriving a supply function from the generalized supply relation changes value, a new supply function results, causing the entire supply curve to shift to a new location
Change in supply can be understood from simplified version of generalized supply function
Change
Suppose, number of firms decreases to 30 Qs = 50 + 10P - 8(50) + 5(30) = 50 + 10P - 400 + 150 = - 200 + 10P (S2)
Price
65 60 50 40 30 20 10
100
250
Price
40 30 20 10 0 0
S2
Qs :
-2 0 =
0 +1
S0
= Qs :
0 10
0 +1
P
s :Q 1 5 =2 0
0 +1
200
400
600
800
1000
Quantity supplied
Pr falls
Pr rises
m<0
Complement goods
Pr rises
Pr falls
m>0
Summary of Supply ..
Determinants of Supply State of Technology (Tech) Supply increases Tech rises Supply decreases Tech falls Sign of slope parameter n>0
Pe falls
F rises
Pe rises
F falls
r<0
s>0
Market Equilibrium
Defined
Market equilibrium is a situation in which, at the prevailing price, consumers can buy all of a good they wish and producers can sell all of the good they wish. In other words, equilibrium occurs when price is at a level for which quantity demand demanded equals quantity supplied. In equilibrium, the price is called equilibrium price and the quantity sold is called equilibrium quantity
Qd
[Qd = 1300 + 20P]
Qs - Qd +750
750
60 50
40 30 20 10
700 600
500 400 300 200
100 300
500 700 900 1100
+600 +300
0 -300 -600 -900
i.e., 1300 20P = 100 + 10P Solving this equation for equilibrium price, 1300 100 = 10P + 20P 1200 = 30P P = 1200/30 = 40
Supply
Price
Demand
Market equilibrium
When the current price is above the equilibrium price, quantity supplied exceeds quantity demanded. The resultant excess supply induces sellers to reduce price in order to sell the surplus. If the current price is below equilibrium price, quantity demanded exceeds quantity supplied. Resultant excess demand causes the unsatisfied consumers to bid up price.
Since prices below equilibrium are bid up by consumers and prices above equilibrium are lowered by producers, the market will converge to the equilibrium price-quantity combination.
S0
Supply
Price
50 40 30 20 10 0 0
Y
C
X D1 D0 D2 Demand
200
400
600
800
1000
1200
1400
1600
Quantity demanded/supplied
D0 T Y
S2
S0 S1
Price
R S
Demand
800
1000
1200
1400
Quantity demanded/supplied
Q0
Q1 Q2 Q3
B
P1 P3 C
P0 A
D1 Q3 Q2 Q0/Q1 D0
S3
P0 P3 A
P2 P1
D B
D0 D1 Q2 Q0/Q1 Q3
Q1
P2
D0 D1 Q3 Q1 Q2 Q0