DEMAND AND SUPPLY Dr Alka Chadha IIM Trichy

Demand • Quantity of a good or service that buyer will purchase at

every possible price • Demand Curve shows the amount of a good that

consumers are willing to buy at each possible price during a given time period, holding other things constant.

• Demand for a good or a service is determined by the willingness and ability to pay for that good or service at a given point of time.

Willingness to pay Utility (Benefit) : total satisfaction received from consuming a good or service

Utility depends on a consumer’s Tastes & Preferences

Everything else remaining same, if WTP Demand

Marketing strategies are designed to WTP

Ability to pay Ability to consume depends on: • Price of the good • Income • Price of other related goods Everything else remaining same: If Ability Demand

Law of demand The law of demand states that, ceteris paribus or other things being equal, the quantity demanded of a good increases when its price decreases.

Qd= f(P, T, M, P’) Quantity demanded varies inversely with price. Demand curve slopes downward. Substitution effect and income effect.

Demand schedule Price (Rs/kg) Quantity demanded (thousand kgs)

A 150 8

B 120 14

C 90 20

D 60 26

E 30 32

Quantity Demanded, Demand, Market Demand

• “My demand for apples is five kilograms” • Five kilograms is the quantity demanded at a certain price

instead of demand. Demand refers to the entire demand schedule or demand curve for the individual, not any specific quantity.

• Change in quantity demanded refers to movement along the demand curve when own price changes, while change in demand refers to shift of the demand curve when other factors change.

• Market Demand: sum of individual demands of all consumers in the market. We will generally refer to market demand when we talk about demand.

Factors that shift the demand curve • Changes in consumer income: Normal good: Demand increases as income increases. Inferior good: Demand decreases as income increases. • Changes in the price of related goods: Substitutes: Goods that can serve as alternatives to a given good. Complements: Goods that are used in conjunction with each other. • Changes in tastes and preferences • Changes in consumer expectation • Changes in the number or composition of consumers

Supply • Quantity of a good or service that producer will sell at

every possible price • Supply Curve shows the amount of a good that producers

are willing to offer for sale at each possible price during a given time period, holding other things constant.

• Supply for a good or a service is determined by the willingness and ability to offer for sale that good or service at a given point of time.

Willingness and Ability to sell • As price rises, producers are willing to offer more for sale. • As price rises, willingness to sell increases because it

becomes more profitable to produce the given good than other uses of the resources available.

• As price rises, ability to sell also increases because the higher price covers the higher marginal cost that results from producing more output.

Law of supply The law of supply states that, ceteris paribus or other things being equal, the quantity supplied of a good increases when its price increases.

Qs= f(P, T, R, P’) Quantity supplied varies directly with price. Supply curve is upward-sloping.

Supply schedule Price (Rs/kg) Quantity supplied (thousand kgs)

A 150 28

B 120 24

C 90 20

D 60 16

E 30 12

Quantity Supplied, Supply, Market Supply • Quantity supplied refers to at a particular amount offered

for sale at a particular price as reflected by a point on the given supply curve.

• Supply refers to the entire supply schedule or supply curve for the individual, not any specific quantity.

• Change in quantity supplied refers to movement along the supply curve when own price changes, while change in supply refers to shift of the supply curve when other factors change.

• Market Supply: sum of individual supplies of all producers in the market. We will generally refer to market supply when we talk about supply.

Factors that shift the supply curve • Changes in technology • Changes in the price of resources/inputs • Changes in the price of alternative goods • Changes in producer expectation • Changes in the number of producers • Changes in government regulations

Market equilibrium Price (Rs/kg)

Quantity demanded (thousand kgs)

Quantity supplied (thousand kgs)

150 8 28

120 14 24

90 20 20

60 26 16

30 32 12

Equilibrium Price and Quantity At price P*, the quantity demanded is equal to the quantity supplied. P S P* D Q* Q

If price is too high… This results in excess supply or surplus for the good equal to 24-14=10 thousand kgs

P 120 S 90 D 14 20 24 Q

If price is too low… This results in excess demand or shortage for the good equal to 12-2=10

P S 90 60 D 16 20 26 Q

Inverse Demand Function • Price as a function of quantity demanded. • Example: Demand Function Qx = 50 – 2Px Inverse Demand Function: 2Px = 50 – Qx Px = 25 – 0.5Qx

Inverse Supply Function • Price as a function of quantity supplied. • Example: Supply Function • Qx = 10 + 2Px Inverse Supply Function: • Px = -5 + 0.5Qx

Market Equilibrium • Find the price that clears the market Qs = Qd • Steady-state: When the market is in equilibrium, the

quantity demanded is the same as the quantity supplied for the prevailing market price.

• This price at which demand is equal to supply is called market clearing price.

Comparative Static Analysis • Comparative static analysis examines how a change in an

exogenous variable will affect the level of an endogenous variable in the model.

• Use this graphical tool to show how the equilibrium price and quantity will change when a determinant of supply or demand changes.

Demand Shift • There is an increase in the price of pears due to an attack

by locusts. • What would happen to the apple market? ♦Demand increases • What happens to the equilibrium price and quantity?

Increase in Demand Equilibrium is at a higher price and higher quantity. P S P2 E2 P1 E1 E D’ D Q1 Q2 Q

Supply Shift • The benign weather brought a bumper crop. • What would happen to the market? ♦ Supply increases • What happens to the equilibrium price and quantity?

Increase in Supply Equilibrium is at a lower price and higher quantity. P S S’ P1 E E1 P2 E2 D Q1 Q2 Q

Simultaneous Shifts in Demand and Supply • Managers may encounter events that lead to

simultaneous shifts in both demand and supply. • A tragic example: ♦In late 1990s, an earthquake hit Kobe, Japan. ♦The earthquake damaged Japan’s sake wine industry. ♦People drank to relieve the stress caused by the earthquake. • What happened to the market?

Demand Increase and Supply Decrease Equilibrium is at a higher price but effect on quantity is uncertain. P S’ S P2 P1 D D’ Q1 Q