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2. Demand, Supply, & Market Equilibrium

2. Demand, Supply, & Market Equilibrium. What is a Market?. Market is a mechanism through which buyers and sellers (individuals, firms, agents or dealers) of a good (or service) interact to determine price and quantity of a product. Physical or virtual

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2. Demand, Supply, & Market Equilibrium

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  1. 2. Demand, Supply, & Market Equilibrium

  2. What is a Market? Market is a mechanism through which buyers and sellers (individuals, firms, agents or dealers) of a good (or service) interact to determine price and quantity of a product. • Physical or virtual • DD and SS are the 2 major forces that determine market conditions

  3. Demand What is demand? Effective desire Essential for the creation, survival and profitability of a firm Knowing the strength & stability of demand is crucial for expansion of production facilities and entering new market

  4. Demand Attributes of demand: • Price • Point of Time • Market • Quantity

  5. Types of DemandDurable and non durable goods Demand for Non durable Goods - Can be used only once • Utility is exhausted in a single use. • Have a recurring demand - Producers’ Non durables : Raw materials, packing items, fuel, power - Consumers’ Non durables :Food, soap, cooking fuel, cosmetics

  6. Durable goods Durable Goods • Total utility is not exhausted in a single or short term use • Can be used over a long time period • Wear & tear over a period of time; so needs replacement • Generally used by more than 1 person (fridge) • Purchased at irregular intervals

  7. Types of DemandDurable goods • More volatile demand as they can be stored • Strongly dependent on macro economic conditions • Need to consider both new and replacement demand • Style, convenience, technological innovations are important • Producers’ Durables (plants, building, machinery) Consumer Durables (car, fridge)

  8. Individual & Market Demand Market demand is derived by adding up all individual demands at a given price Individual demand refers to a single consumer- Theory of demand is based on Individual demand- Helps in understanding various dimensions of demand analysis But seller is interested in market demand and analysis

  9. Table 3: Market demand curve

  10. Types of Demand Direct and Derived Demand • Direct Demand: Goods demanded as they are. When a commodity is demanded for its own sake by the final consumer ; Satisfaction is derived by the final consumer without any further value addition: Food, clothes, house, medicines.

  11. Types of Demand • Derived Demand: A commodity that is demanded for use either as raw material or as an intermediary for value addition in any other good -Demand for a commodity arising because of demand for some other “parent” commodity: Demand for land, fertilizer, agricultural tools, steel, cement, capital goods. e.g., demand for cement is derived from the demand for new buildings

  12. Types of DemandComplementary & Competing Demand • Complementary Demand: Goods that create joint demand; so demand for one good depends on demand for the other • Competing Demand : Substitutes- Goods that compete with one another to satisfy any particular want.

  13. Demand Curve • Demand curve shows the relationship between the price of a good and quantity demanded, Ceteris paribus • Has negative slope because of the inverse relationship between P and Q

  14. Law of Demand Law of Demand (Marshall) Other things remaining constant, (Ceteris paribus ), when the price of a commodity rises, the demand for the commodity falls and when the price of a commodity falls, the demand for the commodity rises Quantity demanded and price are inversely related.

  15. Demand Schedule and Derivation of DD curve

  16. Demand Curve

  17. Explaining the Negative Relationship Why does demand rise when there is a fall in price ? • New/ more uses of the good • New consumers who could not afford it earlier buy it

  18. Explaining the Law of Demand Substitution Effect: • When price of a commodity falls, the consumer tries to substitute it in the place of other commodities whose price has remained unchanged (as the substitute becomes relatively more expensive)

  19. Explaining the Law of Demand Income Effect: When price of a commodity falls, the consumer’s real income (and purchasing power) increases

  20. Explaining the Law of Demand Law of Diminishing marginal Utility: The utility derived from every additional unit (marginal unit) of a commodity goes on falling as the consumer consumes additional units of a commodity, So, consumer will equate MU with P and stop buying additional units of the commodity when MU=P. Why?

  21. Exceptions to the Law • Giffen goods (Inferior goods) • Veblen goods (snob value) • Demonstration effect • Future expectations regarding prices • Insignificant portion of income spent(Low value and limited use products) • Goods with no substitutes

  22. Sum A fruit seller wants to sell 20 kg of apples. There are 3 customers whose individual demand functions are given below: • D1= 25 - 1.0P • D2= 20 - 0.5P • D3= 15 - 0.5P • Determine the market demand equation for the fruit seller. Find out the price at which he can sell all the apples

  23. Solution • Dm= D1+ D2+D3 = (25-1.0P)+ (20-0.5P)+ (15-0.5P) Dm= 60-2.0P (Market DD Function) As he wants to sell 20 kg, price will be: 20= 60- 2.0P Solving the equation, we get P=20 Respective DD for each consumer will be D1= 5kg; D2= 10 kg; D3= 5kg

  24. Determinants of Demand Price of good X • Price of related good Y • Consumer Income • Tastes and Preferences • Advertising * • Consumer expectations of future price & income • Size and distribution of population • Growth of Economy

  25. Advertising & Buying Behavior • According to a 2006 survey of rural India, 73% of consumers felt promotion had no or moderate effect on their buying behavior. • For edible oils and soft drinks, 54% and 75% said they were influenced by ads. • Purchase of watches and bicycles did not show any impact of ads; but friends, family members and village retailers were the influencers of these purchases.

  26. Demand Function Dx= f (Px, Y, Py, T, A, Ef, N) • Multivariate • Linear- non linear • Coefficients can be positive or negative • In order to assess the effect of one of the variables, we have to assume that all other variables are constant (partial regression coefficient)

  27. Movement and Shift  Change along a curve (Movement) Contraction or Expansion refers to a change along the demand curve. • A movement occurs when a change in the quantity demanded is caused only by a change in price, • Due to a change in price, demand moves along the same demand curve- contraction or expansion in quantity demanded

  28. Shift in Demand Curve • A shift in a demand curve occurs when a good's quantity demanded changes even though price remains the same. E.g., if the price for a bottle of beer was $2 and the quantity of beer demanded increased from Q1 to Q2, then there would be a shift in the demand for beer. • Shifts in the demand curve means that quantity demanded is affected by factors other than price.

  29. Shift in Demand Curve • When factors other than price change, demand curve shifts to its right or left. Indicates that consumers will buy more or less at the same price

  30. Shift in Demand Curve

  31. SUPPLY Supply and Law of Supply • SS is the quantity of a good or service that a producer or seller is willing and able to provide at a price, at a given point of time, ceteris paribus. • DD side is represented by buyers; SS side is represented by sellers • Market supply is the aggregate of individual supplies

  32. Supply and Law of Supply • Supply Function represents the quantity of a commodity that will be provided at a price, levels of technology, input price and all other factors • Sx= f( Px, C, T, G, N)

  33. Determinants of Supply • Price of commodity: Positively related • Cost of production: SS is reduced if Cost of production increases • State of technology: Improved technology reduces cot of production per unit , enhances productivity and increases SS • Number of Firms: If entry is unrestricted, more SS • Government policies: Taxes & subsidies

  34. Supply and Law of Supply Law of Supply: Other things remaining constant, supply of a product increases with increase in price and decreases with decrease in price. • Supply Schedule represents quantity of a product supplied at different prices. • Graphic representation of supply schedule indicates an upward moving curve:

  35. Market Equilibrium • Equilibrium is a state of balance from which there is no tendency to change • Market is at equilibrium when quantity demanded equals quantity supplied. The equilibrium price or clearing price is established here

  36. Market Equilibrium

  37. Equilibrium • When supply and demand are equal (i.e. when the supply curve and demand curve intersect) the economy is said to be at equilibrium. • At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. • Everyone (individuals, firms, or countries) is satisfied with the current economic condition..

  38. Market Equilibrium

  39. Market Equilibrium Imbalance between DD and SS causes either shortage or surplus. 1. Excess SupplyIf the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.

  40. Disequilibrium: S>D

  41. Excess Supply • At price P1, Q2 is the quantity of goods that the producers wish to supply. But consumers want to consume only Q1, (less than Q2). Because Q2 is greater than Q1, too much is being produced and too little is being consumed. Suppliers are producing more goods, in order to sell and increase profits, but consumers  purchase less because the price is too high. 

  42. Disequilibrium: D >S • Excess DemandExcess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it.        

  43. Disequilibrium: D >S

  44. Disequilibrium: D >S • At price P1, the quantity of goods demanded by consumers is Q2 while quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the consumers.

  45. Market Equilibrium • However, as consumers have to compete with one other to buy the good at this price, the demand will push the price up, making suppliers want to supply more and bringing the price closer to its equilibrium. • In a free market economy disequilibrium itself generates conditions of equilibrium

  46. Market Equilibrium Law of One price- • Identical goods sell at virtually identical price in different markets. • Market forces drive price towards equality • Higher prices in one market attract sellers; lower prices attract buyers • The law also holds because of arbitrage: buying where price is low and selling where price is high

  47. Defining the Market • Procter & Gamble: New Product Launch - Debate on common European detergent • Defining the market • Should Europe be defined as one market or should each country be distinctly designated as a separate market? –

  48. P&G executives discussed the following: • Having a single detergent would be less costly but… • Washing temperature preferences • Hand wash • European washing machines are front loading –American, top loading • High penetration of TVs in UK, but only 45% in Portugal and Spain

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