MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY

Professor: Prof. Cecilia Flores

Transcribed by: Tyrone Villena

DEMAND - Prices of related goods

o Substitute goods
- Market Demand Curve ▪ A good for which an increase (decrease)
o Illustrates the relationship between the total in the price of one good leads to an
quantity and price per unit of a good all increase (decrease) in the demand for
consumers are willing and able to purchase, the other good.
holding other variables constant. o Complement goods
▪ A good for which an increase (decrease)
- Law of Demand in the price of one good leads to a
o The quantity of a good consumers are willing decrease (increase) in the demand for
and able to purchase increases (decreases) the other good.
as the price falls (rises).
o Price and quantity demanded are inversely - Advertising consumer tastes
related - Population
- Consumer expectations
Shift in Quantity Demanded versus a Shift in Demand - Other factors

- Changing only price leads to changes in quantity

demanded. Changes in Quantity Demanded versus Shift in Demand
o This type of change is graphically - Change in Quantity Demanded
represented by a movement along a given o Change in the price of the good.
demand curve, holding other factors that
impact demand constant. - Shift in Demand
o Change in a factor other than price
- Changing factors other than price led to changes
in demand.
o These types of changes are graphically Note:
represented by a shift of the entire demand
curve - Movement along the same demand curve
between points A and B = change in quantity
demanded
- Going from one demand curve to another like D1
DEMAND SHIFTERS to D2 = a change in demand
- Income
o Normal good
▪ A good for which an increase (decrease)
in income leads to an increase
(decrease) in the demand for that good.
o Inferior good
▪ A good for which an increase (decrease)
in income leads to a decrease (increase)
in the demand for that good.
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

THE DEMAND FUNCTION and Y substitutes or complements? Is good X a

normal or an inferior good?
- The demand function for good X is a - Answer:
mathematical representation describing how
many units will be purchased at different prices 5,460 units. Goods X and Y are substitutes.
for X, the price of a related good Y, income and Good X is an inferior good.
other factors that affect the demand for good X.

Linear Demand Function

Inverse Demand Function
- One simple, but useful, representation of a
demand function is the linear demand function: - By setting 𝑃𝑦 = $15 and 𝑀 = $10,000 and 𝐴 =
2000, the demand function is:

The linear demand function simplifies to

𝑄𝑥 𝑑 = 6060 − 3𝑃𝑥

Solving for 𝑃𝑥 in terms of 𝑄𝑥 𝑑 results in

Understanding the Linear Demand Function 1
𝑃𝑥 = 2020 − 𝑄𝑥 𝑑
- The signs and magnitude of the α coefficients 3
determine the impact of each variable on the Which is called the inverse demand function.
number of units of X demanded. This function is used to construct a market demand
curve.

Consumer Surplus

- Consumer surplus is the extra value that

consumers derive from a good but do not pay
The Linear Demand Function in Action extra for.

- Suppose that an economic consultant for X Corp.

recently provided the firm’s marketing manager
with this estimate of the demand function for the
firm’s product:

- Question: How many of good X will consumers

purchase when 𝑃𝑥 = $200 per unit, 𝑃𝑦 = $15 per
unit, 𝑀 = $10,000, and 𝐴𝑥 = 2000? Are goods X
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

Market Demand and Consumer Surplus in Action - Changing factors other than price leads to
changes in supply.
o These types of changes are graphically
represented by a shift of the entire supply
curve.

SUPPLY SHIFTERS

- Input prices
Note: - Technology or government regulation
- Number of firms
Total Consumer Value is the sum of the maximum o Entry
amount a consumer is willing to pay at different o Exit
quantities - Substitutes in production
- Taxes
Total Expenditure is the per-unit market price times the
o Excise tax: a tax on each unit of output sold,
number of units consumed.
where tax revenue is collected from the
supplier
o Ad valorem tax: percentage tax
SUPPLY - Producer expectations
- Market Supply Curve
o A curve indicating the total quantity of a
good that all producers in a competitive
market would produce at each price, holding
input prices, technology, and other variables
affecting the supply constant.

- Law of Supply
o As the price of a good rises (falls), the
quantity supplied of the good rises (falls),
holding other factors affecting supply
constant.

Changes in Quantity Supplied versus Changes in Supply

- Changing only price leads to changes in quantity

supplies.
o This type of change is graphically
represented by a movement along a given
supply curve, holding other factors that
impact supply constant.
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

The Supply Function - Answer:

𝑄𝑥 𝑠 = 2000 + 3(400) − 4(100) − 1(2000) =
- The supply function for good X is a mathematical 800 television sets.
representation describing how many units will be
produced at alternative prices for X, alternative
input prices W, and alternative values of other
Inverse Supply Function
variables that affect the supply for good X.
- By setting 𝑃𝑊 = $2000 and 𝑃𝑅 = $100 in
The Linear Supply Function
𝑄𝑥 𝑠 = 2000 + 3𝑃𝑋 − 4(100) − 1(2000)
- One simple but useful representation of a supply
The linear supply function simplifies to
function is the linear supply function:’
𝑄𝑥 𝑠 = 3𝑃𝑋 − 400

Solving this for 𝑃𝑋 in terms of 𝑄𝑥 𝑠 results in

400 1 𝑠
𝑃𝑥 = + 𝑄𝑥
3 3

Which is called the inverse supply function. This function

is used to construct a market supply curve.

Understanding the Linear Supply Function

- The signs and magnitude of the β coefficients Producer Surplus

determine the impact of each variable on the - Producer surplus: the amount producers receive
number of units of X produced. in excess of the amount necessary to induce them
to produce the good.

The Linear Supply Function in Action

- Your research department estimates that the

supply function for televisions sets is given by:
𝑄𝑥 𝑠 = 2000 + 3𝑃𝑋 − 4𝑃𝑅 − 1𝑃𝑊

- Question: How many television sets are

produced when 𝑃𝑋 = $400, 𝑃𝑅 = $100 per unit,
and 𝑃𝑊 = $2000?
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

Competitive Market Equilibrium Surplus

- Determined by the intersection of the market

demand and market supply curves.
- A price and quantity such that there is no shortage
or surplus in the market.
- Forces that drive market demand and market
supply are balanced, and there is no pressure on
prices or quantities to change.
- The equilibrium price is the price that equates
quantity demanded with quality supplied

At P1, Q3 units will be offered for sale, while buyers would

purchase only Q1. A higher price discourages many
consumers from buying. The result is a surplus Q3-Q1
units.

Surplus’ drive prices down. Even if P1 exists temporarily,

it will not exist. The large surplus would prompt competing
sellers to lower the price to encourage buyers to take the
Note: The equilibrium price in a competitive market is surplus off their hands. As the price fell, the incentive to
determined by the interactions of all buyers and produce would decline, and the incentive for consumers
sellers in the market. The concepts of market supply to buy would increase. The market would move to its
and market demand make this notion of interaction equilibrium at P2.
more precise. The price of a good in a competitive
market is determined by the interaction of market
supply and market demand for the good. Shortage

Equilibrium Price (Market Hearing Price)

- Is the price where the intentions of buyers and

sellers match. It is the price where quantity
demanded is equal to quantity supplied.

Competition among buyers and sellers drive the price to

the equilibrium price, and once there it will remain there
unless it is disturbed by changes in demand and supply.
At P2, quantity demanded is greater than quantity supplied.
- At any price above equilibrium, quantity supplied,
The result is a shortage or excess demand. P2
exceeds quantity demanded.
discourages sellers from devoting resources to produce a
- At any price below equilibrium, would create a
good and encourages the consumers to desire the good
shortage. Quantity demanded would exceed
more than what is available.
quantity supplied.
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

P2 cannot persist as the equilibrium price. Many

consumers who want to buy the good will not obtain it.
They will express a willingness to pay more than P2,
competition among buyers will drive up the price
eventually to the equilibrium level at P3. Unless disrupted
by the changes of supply or demand, P3 will continue to
prevail.

Thus, Market Equilibrium s a situation in which there are

no excess demand or excess supply. That is equal to
quantity demanded = quantity supplied. At the government regulated price, Qd is greater than Qs.
Represented by the distance from a A to B. There is a
shortage of Qd-Qs units.
Market Equilibrium in Action
What would be the reason for the shortage?
- Consider a market with demand and supply
- Producers are willing to produce less at a lower
functions, respectively, as 𝑄 𝑑 = 10 − 2𝑃 and
price. So quantity is produced from Qe to Qs.
𝑄 𝑠 = 2 + 2𝑃
- Consumers wish to purchase more at a lower
price. Thus, Qd is increased from Qe to Qd. There
- A competitive market equilibrium exists at a price,
is not enough of the good to satisfy all consumers
𝑃𝑒 , such that 𝑄 𝑑 (𝑃𝑒 ) = 𝑄 𝑠 (𝑃𝑒 ). That is,
who are willing and able to buy it at the price
ceiling.
10 − 2𝑃 = 2 + 2𝑃
8 = 4𝑃 Price ceiling typically results in long lines such as those
𝑃𝑒 = $2 created in the 1970s and the price of thus will be nearly
𝑄 = 10 − 2($2) = 6 and 𝑄 𝑒 = 2 + 2($2) = 6
𝑒
tripled.
𝑄 𝑒 = 6 𝑢𝑛𝑖𝑡𝑠
Other than price ceiling, only Qs units of the goods are
available, but consumers are willing to buy Pf. However,
Price Restrictions and Market Equilibrium they can pay more than Pc, the difference between Pf and
Pc reflects the price consumers are willing to pay by
- In a competitive market equilibrium, price and waiting in line.
quantity freely adjust to the forces of demand and
supply. The full economic price is the amount paid to the firm, Pc
- Sometimes government restricts how much + inclusive cost of waiting. Which is paid not in monetary
prices are permitted to rise or fall. units but through opportunity costs and thus is turned
o Price ceiling – maximum legal price that non-linear cost.
can be changed
o Price floor – minimum price set by the
government
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

Price Ceiling in Action Price Floor in Action

- Consider a market with demand and supply - Consider a market with demand and supply
functions, respectively, as 𝑄 𝑑 = 10 − 2𝑃 and functions, respectively, as 𝑄 𝑑 = 10 − 2𝑃 and
𝑄 𝑠 = 2 + 2𝑃. 𝑄 𝑠 = 2 + 2𝑃
- Suppose a $3.50 price floor is imposed on the
- Suppose a $1.50 price ceiling is imposed on the market.
market. o 𝑄 𝑑 = 10 − 2($3.50) = 3 𝑢𝑛𝑖𝑡𝑠
o 𝑄 𝑑 = 10 − 2($1.50) = 7 𝑢𝑛𝑖𝑡𝑠. o 𝑄 𝑠 = 2 + 2($3.50) = 9 𝑢𝑛𝑖𝑡𝑠
o 𝑄 𝑠 = 2 + 2($1.50) = 5 𝑢𝑛𝑖𝑡𝑠 o Since Qs > Qd, a surplus of 9 – 3 = 6 units
o Since 𝑄 𝑑 > 𝑄 𝑠 , a shortage of 7 − 5 = exists
2 𝑢𝑛𝑖𝑡𝑠 exists. o The cost to the government purchasing
o Full economic price of the 5th unit is 5 = the surplus is $3.50 x 6 = $21
10 − 2𝑃𝑓𝑢𝑙𝑙 , 𝑜𝑟 𝑃𝑓𝑢𝑙𝑙 = $2.50.
▪ $1.50 is the dollar price
▪ $1 is the nonpecuniary price Comparative Statistics

- Comparative static analysis

o The study of the movement from one
equilibrium to another.
- Competitive markets, operating free of price
restraints, will be analyzed when:
o Demand changes
o Supply changes
o Demand and supply simultaneously
change

Changes in Demand

- Increase in demand only

When the price floor is set above equilibrium prices shown
o Increase equilibrium price
in the graph, Qs is greater than Qd. More is produced than
o Increase equilibrium quantity
consumers are willing to purchase at that price. Thus, a
- Decrease in demand only
surplus develops.
o Decrease equilibrium price
Let us say that the government imposes a minimum wage o Decrease equilibrium quantity
Pf. More people are looking for work than there are jobs
available. Thus, unemployment results.

In the goods market, the quantity of unsold good is given

by the distance F-G, and this is the amount of product the
government purchases at the price floor.

What is the cost of the government of purchasing the

surplus? This is equal to Pf x (Qs - Qd).
MANECON – MODULE 2: MARKET FORCES: DEMAND AND SUPPLY
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

Changes in Supply Nature of the Increase in Demand Decrease in Demand

Change
- Increase in supply only Increase in Price: Ambiguous Price: Decreases
Supply Quantity: Increases Quantity: Ambiguous
o Decrease equilibrium price
Decrease in Price: Increases Price: Ambiguous
o Increase in equilibrium quantity
Supply Quantity: Ambiguous Quantity: Decreases
- Decrease in supply only
o Increase equilibrium price
o Decrease equilibrium quantity

Simultaneous Shifts in Supply and Demand

- Suppose that simultaneously the following events

occur:
o An earthquake hit Kobe, Japan and
decreased the supply of fermented rice
used to make sake wine.
o The stress caused by the earthquake led
many to increase their demand for sake,
and other alcoholic beverages.
- What is the combined impact on Japan’s sake
market?