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The Market Forces of
Supply and Demand
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The Market Forces of
Supply and DemandxSupplyanddemandare the two words
that economists use most often.
xSupplyanddemandare the forces that
make market economies work.
xModern microeconomics is aboutsupply, demand, and market
equilibrium.
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Markets
x Buyersdeterminedemand.
xSellersdeterminesupply.
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Demand
Quantity demanded
is the amountof a good that buyers are
willing and able
to purchase.
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Law of Demand
The law of demand states that,
ceteris paribus, there is aninverse relationship between price
and quantity demanded.
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Demand Schedule
The demand schedule is a table
that shows the relationshipbetween thepriceof the good
and thequantitydemanded.
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Demand Schedule
Pr
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Demand Curve
Thedemand curveisthe downward-
sloping line relating price to quantitydemanded.
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Demand Curve
Rs.32.5
02.001.50
1.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of
Ice-CreamCone
Quantity
of Ice-Cream
0
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Ceteris Paribus
Ceteris paribusis a Latin phrase thatmeans all variables other than the
ones being studied are assumed to be
constant. Literally,ceteris paribus
means other things being equal.
The demand curve slopes downward
because, ceteris paribus, lower prices
imply a greater quantity demanded!
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Ceteris Paribus
s Ceteris Paribus means other things being
equal. What other things?
s Consumer income.s Consumer preferences.
s Fashion.
s
Price of related goods.s Government policies.
s Weather conditions.
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Market Demand
xMarket demand refers to the
sum of all individual demandsfor a particular good or service.
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Determinants of Demand
x
Market price : A larger quantity is demanded ata lower price & vice versa.
x Tastes, habits and preferences : Demand depends
upon a persons tastes, habits and preferences.Demand for ice creams, bhel puri etc depends
upon an individuals tastes. Tea, betal leafs,
tobacco etc is a matter of habits. People with
different tastes & habits have different
preferences. A strict veg. will have no demand
for fish and a person who likes non veg will
purchase fish even at a high price.
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sExpectations : If a consumer expects that the
prices of a product are going to rise in future, the
demand may increase and vice versa.xConsumer income : A rich consumer demands
more goods than a poor consumer.
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s Prices of related goods ( substitutes andcomplementary ) : When a desire or a want canbe satisfied by alternative similar goods, theyare called as substitutes. Eg. Peas and beans,groundnut oil and mustard oil, tea or coffee,
jowar or bajra etc.
s Demand for a commodity depends on therelative prices of the substitutes. There will bemore demand for a commodity if itssubstitutes are highly priced.
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s Complementary products : When, in order to
satisfy a given want, two or more goods are
needed in combination, these goods arereferred to as complementary goods. Eg. car
and petrol, pen and ink, shoes and socks, guns
and bullets. Complementary goods are always
in Joint Demand. Thus, when the price of acomplementary product will fall, the demand
for its complementary product will increase.
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Change in Quantity Demanded
versus Change in Demand
Change inQuantity Demandedx Movement along the demand curve.
x Caused by a change in theprice of
the product.
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Changes in Quantity
Demanded
0
D1
Price of
Cigarettesper Pack
Number ofCigarettes Smoked
A tax that raises theprice of cigarettes
results in a
movement along thedemand curve.
A
C
20
2.00
Rs.4.
00
12
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Change in Quantity Demanded
versus Change in Demand
Change in Demandx A shift in the demand curve, either
to the left or right.
x
Caused by a change in adeterminant other than the price.
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Changes in Demand
0
D1
Price of
Ice-CreamCone
Quantity
of Ice-Cream
D3
D2
Increase in
demand
Decrease indemand
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Change in Quantity Demanded
versus Change in Demand
Variables thatAffect Quantity
Demanded
A Change inThis Variable . . .
Price Represents a movement
along the demand curve
Income Shifts the demand curve
Prices of relatedgoods
Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of
buyers
Shifts the demand curve
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Two Simple Rules for
Movements vs. Shiftss Rule One
When an independent variable changes and
that variable does not appear on the graph,the curve on the graph will shift.
s Rule Two
When an independent variable does appear
on the graph, the curve on the graph will notshift, instead a movement along the existingcurve will occur.
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Consumer IncomeNormal Good
Rs.3.00
2.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10 1211
Price of
Ice-CreamCone
Quantity
of Ice-Cream0
Increasein demand
Anincrease
inincome...
D1
D2
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Consumer IncomeInferior Good
Rs.3.00
2.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10 1211
Price of
Ice-CreamCone
Quantity
of Ice-Cream0
Decreasein demand
An
increasein
income...
D1D2
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Exceptions to the law of
Demands Law of Demand is a universal
phenomenon. Very rarely, it is so
observed that with a fall in price,demand also falls and a increase in price
increases demand.
s The demand curve in such cases isupward sloping.
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Exceptions to the law of
Demands A few such exceptions are seen in case of:
s Giffen Goods : In cases of some inferior goods,
as observed by Robert Giffen, when price falls,there is a fall in the demand for these products.
s Eg. This was observed by Giffen in Italy when
consumers purchased less of cheap potatoes
when the price went down and purchased meat
from the savings.
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Exceptions to the law of
Demands Snob Appeal : Goods that are used as Status
Symbol eg. Rolls Royce cars, Johney Walker
Scotch Whisky, Diamonds etc.s The demand for these goods increases even if
the price is increased because these goods are
purchased for their exclusiveness which
increases with an increase in price.
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Exceptions to the law of
Demands Speculation : When the consumers understand
that there is a increase in price of a product
and they are expecting a further rise, they willnot mind purchasing more of that product even
if its price is increased.
s Consumers psychology : Many consumers do
not purchase products at the time of discountsales etc assuming that the quality of the
products may have been compromised.
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Law of Supply
Thelaw of supplystates that, ceteris
paribus, there is a direct (positive)relationship between price and
quantitysupplied.
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Supply
Quantity suppliedis the amount of a
good that sellers are willing and ableto sell.
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Supply Schedule
Thesupply scheduleisa table that
shows the relationship between theprice of the good and the quantity
supplied.
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Supply Schedule
P
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Supply Curve
Thesupply curveis the upward-sloping line relating price to quantity
supplied.
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Supply Curve
Rs.3.002.502.00
1.501.00
0.50
21 3 4 5 6 7 8 9 10 1211
Price of
Ice-CreamCone
Quantity
of Ice-Cream0
P
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Market Supply
xMarket supply refers to the sum
of all individual supplies for all
sellers of a particular good or
service.
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Determinants of Supply
x Market price : The single largest factor that
affects supply is the price. More commodities
will be supplied at a higher price and vice
versa.x Input prices : When the factors of production
are available at low price, more investment is
encouraged. This increases supply.x Technology : The improvement in the
technique of production leads to increased
supply.
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x Natural conditions : The supply ofagricultural commodities depends uponthe natural conditions. Whenever there isgood monsoon, conductive temperature,the supply of such products increases.
x Transport conditions : Difficulties intransport may cause a temporarydecrease in supply. So, even at risingprice, quantity supplied may decrease.
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x Expectations : When a seller expects a further risein the price, he may withhold the supply and hencethe supply may decrease.
x Prices of other products : The prices of substitutes
or related products can influence the supply. If theprices of wheat are increasing, farmers may growmore of wheat and less of rice. If the price of sugarrises, the price of jaggary will also rise.
x Govt. policy : If the policies of the govt. areliberalized, more firms may tend to enter themarket and hence supply may rise.
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Change in Quantity Supplied
versus Change in Supply
Change in Quantity Suppliedx Movement along the supply curve.
x Caused by a change in the market price
of the product.
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Change in Quantity Supplied
1 5
Price of
Ice-CreamCone
Quantity
of Ice-Cream0
S
1.00
A
CRs.3.00
A rise in the price
of ice cream conesresults in a
movement along
the supply curve.
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Change in Quantity Supplied
versus Change in Supply
Change in Supply
x A shift in the supply curve, either to the
left or right.
x Caused by a change in a determinant
other than price.
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Change in Supply
Price of
Ice-CreamCone
Quantity
of Ice-Cream0
S1 S2
S3
Increasein Supply
Decreasein Supply
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Change in Quantity Supplied
versus Change in SupplyVariables thatAffect Quantity Supplied A Change in This Variable . . .
Price Represents a movement alongthe supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
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Shifts in Curves versus
Movements along Curves
x A shift in the supply curve is called a
change in supply.
x A movement along a fixed supply curve iscalled achange in quantity supplied.
x A shift in the demand curve is called a
change in demand.x A movement along a fixed demand curve is
called achange in quantity demanded.
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Supply and Demand Together
Equilibrium Pricex The price that balances supply and
demand. On a graph, it is the price at which
the supply and demand curves intersect.Equilibrium Quantity
x The quantity that balances supply and
demand. On a graph it is the quantity atwhich the supply and demand curves
intersect.
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Supply and Demand Together
Price
Demand
Schedule
Supply
Schedule
At Rs.2.00, the quantity demanded is
equal to the quantity supplied!
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Supply
Demand
Price of
Ice-CreamCone
Quantity
of Ice-Cream
Equilibrium of
Supply and Demand
21 3 4 5 6 7 8 9 10 12110
Rs.3.00
2.502.00
1.5
01.00
0.50
Equilibrium
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Price of
Ice-CreamCone
Quantity
of Ice-Cream21 3 4 5 6 7 8 9 10 12110
Rs.3.002.50
2.00
1.5
01.00
0.50
Supply
Demand
Surplus
Excess Supply
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Surplus
When the price is above the equilibrium
price, the quantity supplied exceeds the
quantity demanded. There isexcess supply
or asurplus. Suppliers will lower the price
to increase sales, thereby moving toward
equilibrium.
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Excess Demand
Quantity ofIce-Cream Cones
Price ofIce-Cream
Cone
Rs.2.00
0 1 2 3 4 5 6 7 8 9 10111213
Supply
Demand
Rs.1.50
Shortage
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Shortage
When the price is belowthe equilibrium
price, the quantity demanded exceeds the
quantity supplied. There isexcess demand
or ashortage. Suppliers will raise the price
due to too many buyers chasing too few
goods, thereby moving toward equilibrium.
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Three Steps To Analyzing
Changes in Equilibriumx Decide whether the event shifts the
supply or demand curve (or both).
x Decide whether the curve(s) shift(s) to
the left or to the right.
x Examine how the shift affects
equilibrium price and quantity.
H I i D d
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How an Increase in Demand
Affects the EquilibriumPrice of
Ice-CreamCone
2.00
0 7 Quantity of
Ice-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
2. ...resulting
in a higherprice...
Rs.2.50
10
3. ...and a higherquantity sold.
New equilibrium
H D i S l Aff t
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S2
How a Decrease in Supply Affects
the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 7 8 9 11 12 Quantity of13
Demand
Initial equilibrium
S1
10
1. Shortage of milk reducesthe supply of ice cream...
Newequilibrium
2. ...resulting
in a higherprice...
Rs.2.50
3 and a lower