Demand and Supply - Concepts and Applications (2) (1) (Compatibility Mode)

Demand and Supply: Concepts and Applications
Demand and Supply:

Concepts and Applications
Outline
History of Demand and Supply Law of Demand and Demand Curve Derivation Law of Supply and Supply Curve Derivation Equilibrium Shift in Demand and Supply Curve Interaction between Demand and Supply Applications: Interest Rate and Exchange rate. Case Study
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History of Demand and Supply

Adam Smith(1723-1790) Relative price of a good was determined by relative labor costs Demand/supply curve are horizontal This is partly correct explanation During Smiths time, the primary costs of producing goods were associated mainly with labor.
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(continued)
David Ricardo (1772-1823) Law of diminishing returns Upward sloping supply/demand curve
(continued)
Definition of Demand
An economic principle that describes a consumers desire and willingness to pay a price for a specific good or service. Latent Demand Effective Demand
Alfred Marshal (1842-1924) Marginalism Willingness to pay declines: diminishing marginal utility Increasing marginal costs: law of diminishing returns
The Law of Demand

The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls.
The reverse is also true: as the price of a good or service falls, its quantity demanded increases.
Demand Curve
Downward Sloping
The demand curve has a negative slope, consistent with the law of demand.
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Movements Along Demand Curve

Price
Price increase moves us leftward along demand curve Price decrease moves us rightward along demand curve
The Law of Supply

The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. Why do producers produce more output when prices rise?
They seek higher profits They can cover higher marginal costs of production
P2
P1 P3
Q2
Q1
Q3
Quantity 9 10
Supply Curve
Upward Sloping
Equilibrium
In economics, an equilibrium is a situation in which:
there is no inherent tendency to change, quantity demanded equals quantity supplied, and the market just clears.
The supply curve has a positive slope, consistent with the law of supply.
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Equilibrium
Eqm (P,Q)=(3,30)
Shortages and Surpluses

A shortage occurs when quantity demanded exceeds quantity supplied.
A shortage implies the market price is too low.
A surplus occurs when quantity supplied exceeds quantity demanded.

A surplus implies the market price is too high. Equilibrium occurs at a price of $3 and a quantity of 30 units.
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Income: Factors That Shift The Demand Curve An increase in income has effect of shifting demand for normal goods to the right
However, a rise in income shifts demand for inferior goods to the left Examples: Lemon (used Car), health club memberships, etc.
Wealth: Factors That Shift The Demand Curve

Your wealthat any point in timeis the total value of everything you own minus the total dollar amount you owe An increase in wealth will
Increase demand (shift the curve rightward) for a normal good Decrease demand (shift the curve leftward) for an inferior good
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A rise in income will increase the demand for a normal good, and decrease the demand for an inferior good.
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Prices of Related Goods: Factors that Shift the Demand Curve

Substitutegood that can be used in place of some other good and that fulfills more or less the same purpose, e.g., tea and coffee.
A rise in the price of a substitute increases the demand for a good, shifting the demand curve to the right
Other Factors That Shift the Demand Curve

Population
As the population increases in an area
Number of buyers will ordinarily increase Demand for a good will increase
Expected Price
An expectation that price will rise (fall) in the future shifts the current demand curve rightward (leftward)
Complementused together with the good we are interested in, e.g., sugar and tea. A rise in the price of a complement decreases the demand for a good, shifting the demand curve to the left
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Tastes
Combination of all the personal factors that go into determining how a buyer feels about a good When tastes change toward a good, demand increases, and the demand curve shifts to the right When tastes change away from a good, demand decreases, and the demand curve shifts to the left
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Shift in the Demand Curve

Shift Rightward
Equilibrium After a Demand Shift

New Eqm (P,Q)=(4,40)
This demand curve has shifted to the right. Quantity demanded is now higher at any given price.
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The shift in the demand curve moves the market equilibrium from point A to point B, resulting in a higher price and higher quantity.
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Factors That Shift the Supply Curve

Input prices
A fall (rise) in the price of an input causes an increase (decrease) in supply, shifting the supply curve to the right (left)

Number of Firms
An increase (decrease) in the number of sellers with no other changesshifts the supply curve to the right (left)
Price of Related Goods

When the price of an alternate good rises (falls), the supply curve for the good in question shifts rightward (leftward)
Expected Price
An expectation of a future price increase (decrease) shifts the current supply curve to the left (right)
Technology
Cost-saving technological advances increase the supply of a good, shifting the supply curve to the right 21
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Changes in weather
Favorable weather
Increases crop yields Causes a rightward shift of the supply curve for that crop
Shift in the Supply Curve

Shift Upward
Unfavorable weather
Destroys crops Shrinks yields Shifts the supply curve leftward
Other unfavorable natural events may effect all firms in an area

Causing a leftward shift in the supply curve 23
For an given rental price, quantity supplied is now lower than before.
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Equilibrium After a Supply Shift

New Eqm(P,Q)=(4,20)
Price Ceilings & Floors

A price ceiling is a legal maximum that can be charged for a good.
Results in a shortage of a product Common examples include edible oil price.
A price floor is a legal minimum that can be charged for a good.

Results in a surplus of a product Common examples minimum wage for RMG
The shift in the supply curve moves the market equilibrium from point A to point B, resulting in a higher price and lower quantity. 25 26
Price Ceiling
Upward Pressure on Price
Price Floor
Downward Pressure on Price
A price ceiling is set at $2 resulting in a shortage of 20 units.

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A price floor is set at $4 resulting in a surplus of 20 units.

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Interactions Between Demand and Supply Say's law is an economic proposition named after the French businessman and economist Jean-Baptiste Say (17671832). The proposition that "supply creates its own demand The production of goods will generate sufficient demand to ensure that they are sold.
Interactions Between Demand and Supply

Keynesian economics advocates active demand management policies- monetary and fiscal policy to stabilize output. It advocates a mixed economy, predominantly private sector, but with a moderate role of government and public sector. It lost some influence following the stagflation of the 1970s. The advent of the global financial crisis in 2007 has caused a resurgence in Keynesian thought.
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Interest Rate Determination

Interplay between Dd and Ss determines interest rate. Money demand refers to the demand by households, businesses and the government, for highly liquid assets such as currency and checking account deposits. Money demand is affected by the desire to buy things in the near future, but is also affected by the opportunity cost of holding money. The opportunity cost is the interest earnings one gives up on other assets in order to hold money.
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A country's money supply is mostly the amount of coin and currency in circulation and the total value of all checking accounts in banks. If interest rates rises, households and businesses will likely allocate more of their asset holdings into interest bearing accounts (usually not classified as money) and will hold less in the form of money. Money supply and money demand will equalize only at one average interest rate.
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Equilibrium of Money Demand and Money Supply
r MD
Exchange Rate Determination

In the flexible exchange rate, it is the interplay between supply and demand of the foreign exchange Demand of the foreign exchange : Import payments, Foreign debt payment etc. Supply of the foreign exchange : Exports, Remittances, FDI, foreign aid etc.
r0
MS
Money
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Foreign Exchange Market: If Import payment rises, others remain same

Taka per dollar S F' 80 73 F D1 Q3 Q4 Foreign Exchange 35 D2
Case study-1 US-Iraq War: Impact on Oil and Gas Price
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Using Supply and Demand: The Invasion of Kuwait

Why did Iraqs invasion of Kuwait cause the price of oil to rise?
Immediately after the invasion, United States led a worldwide embargo on oil from both Iraq and Kuwait A significant decrease in the oil industrys productive capacity caused a shift in the supply curve to the left
Price of oil increased 37
The Market For Oil: Supply Shock Inflation

Price per Barrel of Oil P2 P1 E D Q2 Q1 Barrels of Oil 38 S2 S1 E'
Using Supply and Demand: The Invasion of Kuwait

Why did the price of natural gas rise as well?
Oil is a substitute for natural gas Rise in the price of a substitute increases demand for a good Rise in price of oil caused demand curve for natural gas to shift to the right
Thus, the price of natural gas rose
The Market For Natural Gas: Demand Pull Inflation

Price per Cubic Foot of Natural Gas F' P4 P3 F D1 Q3 39 Q4 Cubic Feet of Natural Gas 40 D2 S
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Demand Pull Inflation
Case study-2
Price of Cucumber During Ramadan
Price of Cucumber Before Ramadan: 40 Tk. Per KG Price of Cucumber During Ramadan: Upward pressure
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The Market For Cucumber

Price per KG S F' 50 40 F D1 Q3 Q4 Cucumber 43 44 D2
Thank You All
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Demand and Supply - Concepts and Applications (2) (1) (Compatibility Mode)

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