2.1 Supply and Demand
Supply and demand is an economic model
- Designed to explain how prices are determined in certain types of markets
- Perfect competition is rare but many markets come reasonably close
- Perfect competition is a matter of degree rather than an all or nothing characteristic
- A household’s quantity demanded of a good
1. Specific amount household would choose to buy over some time period, given
- Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period, given
1. A particular price they must pay for the good
2. All other constraints on households
2.3 The Law of Demand
- States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall
2.4 The Demand Schedule and The Demand Curve
- A list (price- quantity combination) showing the quantity of a good that consumers would choose to purchase at different prices, with all other variables held constant
- Each point on the curve shows the total buyers would choose to buy at a specific price
2.5 Shifts of demand vs. Movements Along The Demand Curve
- A change in the price of a good causes a movement along the demand curve
- In Figure 1
1. A fall (rise) in price would cause a movement to the right (left) along the demand curve
- A change in income causes a shift in the demand curve itself
- In Figure 2
1. Demand curve has shifted to the right of the old curve (from Figure 1) as income has risen
2. A change in any variable that affects demand—except for the good’s price—causes the demand curve to shift
2.6 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
- A rise in income will increase the demand for a normal good, and decrease the demand for an inferior good
- Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe
- An increase in wealth will
- Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose
- Complement—used together with the good we are interested in
- As the population increases in an area
- Number of buyers will ordinarily increase
- Demand for a good will increase
- An expectation that price will rise (fall) in the future shifts the current demand curve rightward (leftward)
- 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
- A firm’s quantity supplied of a good is the specific amount its managers would choose to sell over some time period, given
- Market quantity supplied (or quantity supplied) is the specific amount of a good that all sellers in the market would choose to sell over some time period, given
2.8 The Law of Supply
- The words, “everything else remains the same” are important
2.9 The Supply Schedule and The Supply Curve
- Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices, (so again P-Q combination but??)with all other variables held constant
- Supply curve—graphical depiction of a supply schedule
2.10 Shifts of supply vs. Movements Along the Supply Curve
- A change in the price of a good causes a movement along the supply curve
- In Figure 3
A rise (fall) in price would cause a rightward (leftward) movement along the supply curve
A drop in transportation costs will cause a shift in the supply curve itself
- In Figure 4
Supply curve has shifted to the right of the old curve (from Figure 4) as transportation costs have dropped
A change in any variable that affects supply—except for the good’s price—causes the supply curve to shift
2.11 Factors That Shift the Supply Curve
- A fall (rise) in the price of an input causes an increase (decrease) in supply, shifting 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 leftward (rightward)
- Cost-saving technological advances increase the supply of a good, shifting the supply curve to the right
Number of Firms
- An increase (decrease) in the number of sellers—with no other changes—shifts the supply curve to the right (left)
- An expectation of a future price increase (decrease) shifts the current supply curve to the left (right)
Changes in weather
- Favorable weather
Increases crop yields
Causes a rightward shift of the supply curve for that crop
- Unfavorable weather
Shifts the supply curve leftward
Other unfavorable natural events may effect all firms in an area
- Causing a leftward shift in the supply curve
2.12 Market Equilibrium
- The operation of the market depends on the interaction between buyers and sellers.
- An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.
- At equilibrium, there is no tendency for the market price to change.
- When a market is in equilibrium
- The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes, respectively
2.13 Cob-web model
The cob-web model or Theorem analyzes the movements of prices and outputs when supply is wholly determined by prices in the previous period. As prices move up and down in cycles, quantities produced and demanded also seem to move up and down in a counter-cyclical manner (e.g. prices of perishable commodities like vegetables). This is a theory under dynamic equilibrium otherwise called micro dynamics. In order to find out the conditions for the cycles: one has to look at the slope of the demand curve and then of the supply curve.
Example of a Cob-web Model
2.14 Elasticity of Demand
- “Elasticity” is a standard measure of the degree of responsiveness (or sensitivity) of one variable to changes in another variable.
- Elasticity of Demand measures the degree of responsiveness of demand for a commodity to a given change in any of the independent variables that influence demand for that commodity, such as price of the commodity, price of the other commodities, income, taste, preferences of the consumer and other factors.
- Responsiveness implies the proportion by which the quantity demanded of a commodity changes, in response to a given change in any of its determinants .
- Mathematically, it is the percentage change in quantity demanded of a commodity to a percentage change in any of the (independent) variables that determine demand for the commodity.
- Four major types of elasticity:
- In order to assess the impact of one variable on demand, we assume other variables as constant (ceteris paribus)
2.14.1 Price Elasticity of Demand
- Price is most important among all the independent variables that affect the demand for any commodity.
- Hence Price elasticity of demand ( “ep” or “e”) is considered to be the most important of all types of elasticity of demand.
- Price elasticity of demand means the sensitivity of quantity demanded of a commodity to a given change in its own price.
2.14.1.a Degrees of Price Elasticity
2.14.1.b Methods of Measuring Elasticity
2.14.2 Income Elasticity of Demand (ey)
2.14.3 Cross Elasticity of Demand
2.14.4 Promotional Elasticity of Demand
2.15 ELASTICITY OF SUPPLY
- IT IS DEFINED AS THE RESPONSIVENESS OF THE QUANTITY SUPPLIED OF A GOOD TO A CHANGE IN ITS PRICE.
- ELASTICITY OF SUPPLY =
2.15.1 TYPES OF SUPPLY ELASTICITY
PERFECT INELASTIC SUPPLY :- If as a result of a change in price, the quantity supplied of a good remains unchanged, we say that the elasticity of supply is zero.
2.16 Importance of Elasticity
Determination of price
- Elasticity is the basis of determining the price of a product keeping its possible effects on the demand of the product in perspective
Basis of price discrimination
- Products having elastic demand may be sold at lower price, while those having inelastic demand may be sold at high prices
Determination of rewards of factors of production
- Factors having inelastic demand are rewarded more than factors that have relatively elastic demand.
Government policies of taxation
- Goods having relatively elastic demand are taxed less than those having relatively inelastic demand.
2.17 Demand forecasting
- Forecast of demand is an estimation of the future level of demand
- It take steps for the acquisition of the various factors of production like raw materials , labour, capital, land, building etc. at the right time.
- Demand forecasting cannot always give best result because future is uncertain.
- Mainly demand fore casting done at macro level , industry level or firm level.
- Demand forecast necessitates analysis of past trends and present economic conditions.
- Forecast may be done for a Short period or for a Long period
- Period is depend on nature of the business.
- Long run forecasting is connected with major strategic decisions.
2.18 OBJECTIVES OF DEMAND FORECASTING
Short – term Forecasting (Demand estimation)
- To evolve a suitable production policy
- To reduce the cost of purchase
- To determine appropriate price policy
- To set sales targets and establish control
- To forecast short term financial requirements
- Planning of a new unit or expansion of an existing unit.
- Planning of long term financial requirements.
- Planning of man power requirements.
2.19 METHODS OF DEMAND FORECASTING
- The survey method is the most extensively used method in India.
- The survey method is generally used for short-term forecasting.
Survey method include,
- Direct Interview Method
- Collective opinion
- This technique of forecasting is based on the opinions of experts.
- This method is used for demand forecasting and manpower planning.
- It is widely used in the areas of technological and environmental forecasting, defence strategies, futurology, foreign affairs etc.
- Personal income can be used to forecast the demand of consumer goods.
- Agricultural income can be used to forecast the demand of agricultural inputs , implements, fertilizers, etc.
- Automobile registration can be used to forecast the demand of automobile accessories, petrol etc.
- Trend projection method
- Regression method
- Simultaneous equation method
2.20 Concepts of revenue
- The term revenue refers to the income obtained by a firm through the sale of goods at different prices. In the words of Dooley, ‘the revenue of a firm is its sales, receipts or income’.
- The revenue concepts are concerned with Total Revenue, Average Revenue and Marginal Revenue.
1. Total Revenue:
- The income earned by a seller or producer after selling the output is called the total revenue. In fact, total revenue is the multiple of price and output. The behavior of total revenue depends on the market where the firm produces or sells.
- “Total revenue is the sum of all sales, receipts or income of a firm.” Dooley
- Total revenue may be defined as the “product of planned sales (output) and expected selling price.” Clower and Due
- “Total revenue at any output is equal to price per unit multiplied by quantity sold.” Stonier and Hague
2. Average Revenue:
- Average revenue refers to the revenue obtained by the seller by selling the per unit commodity. It is obtained by dividing the total revenue by total output.
- “The average revenue curve shows that the price of the firm’s product is the same at each level of output.” Stonier and Hague
3. Marginal Revenue:
- Marginal revenue is the net revenue obtained by selling an additional unit of the commodity. “Marginal revenue is the change in total revenue which results from the sale of one more or one less unit of output.” Ferguson. Thus, marginal revenue is the addition made to the total revenue by selling one more unit of the good. In algebraic terms, marginal revenue is the net addition to the total revenue by selling n units of a commodity instead of n – 1.