Demand, Supply and Price Determination

1
Determining Price Demand and Supply
2
Outline

• What do we mean by supply and demand
• What determines supply
• What determines demand
• How do demand and supply interact to determine
  price.

3
Definitions

• Effective Demand
• Supply
• Shortage
• Surplus

4
Definitions

• Effective Demand The quantity consumers are
  willing and able to buy at any given price
• Supply The quantity firms are willing and able
  to sell at any given price
• Shortage An excess of demand over supply
• Surplus An excess of supply over demand

5
Demand
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64
20 50 57
30 45 50
40 40 43
50 35 36
60 30 29
70 25 22
80 20 15
90 15 8
100 10 1
Quantity
6
Demand
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64 119
20 50 57 107
30 45 50 95
40 40 43 83
50 35 36 71
60 30 29 59
70 25 22 47
80 20 15 35
90 15 8 23
100 10 1 11
Demand
Quantity
7
Demand
Show on the diagram the quantity that would be
demanded if the price were 45
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64 119
20 50 57 107
30 45 50 95
40 40 43 83
50 35 36 71
60 30 29 59
70 25 22 47
80 20 15 35
90 15 8 23
100 10 1 11
100
80
60
40
20
Demand
120
20
40
60
80
100
Quantity
8
Demand
Price
Quantity Demanded Quantity Demanded Quantity Demanded
Price Staff Students total
10 55 64 119
20 50 57 107
30 45 50 95
40 40 43 83
50 35 36 71
60 30 29 59
70 25 22 47
80 20 15 35
90 15 8 23
100 10 1 11
100
80
60
40
20
Demand
120
20
40
60
80
100
Quantity
9
Demand

• The law of demand states that

10
Demand

• The law of demand states that the demand curve
  always slopes down (i.e. as price falls, demand
  rises, as long as everything else remains
  constant).

11
Why does the demand curve slope down?

• There are 3 reasons
• As the price rises other goods get relatively
  ________ so consumers ______________to other
  things.
• e.g. as the price of chocolate rises people buy
  ____ chocolate and more crisps
• As the price rises it is as though
  _____________(the total amount of things that can
  be bought _____)
• Generally people get the most benefit from the
  ______
• ____they consume and so they will be willing to
  pay the ____ for this and then ____ for each
  subsequent unit
• e.g. You will pay a lot for the first ice cold
  Coke, less for the next, less for the next, etc.

12
Why does the demand curve slope down?

• There are 3 reasons
• As the price rises other goods get relatively
  cheaper so consumers substitute away to other
  things.
• e.g. as the price of chocolate rises people buy
  less chocolate and more crisps
• As the price rises it is as though income falls
  (the total amount of things that can be bought
  falls)
• Generally people get the most benefit from the
  first unit they consume and so they will be
  willing to pay the most for this and then less
  for each subsequent unit
• e.g. You will pay a lot for the first ice cold
  Coke, less for the next, less for the next, etc.

13
Why does the demand curve slope down?

• There are 3 reasons
• As the price rises other goods get relatively
  cheaper so consumers substitute away to other
  things.
• e.g. as the price of chocolate rises people buy
  less chocolate and more crisps
• As the price rises it is as though income falls
  (the total amount of things that can be bought
  falls)
• Generally people get the most benefit from the
  first unit they consume and so they will be
  willing to pay the most for this and then less
  for each subsequent unit
• e.g. You will pay a lot for the first ice cold
  Coke, less for the next, less for the next, etc.

Does the demand for all goods go down as income
falls? Can you think of any exceptions?
14
Supply
Price
Supply(000,000) Supply(000,000) Supply(000,000)
Price Microsoft Apple total
10 77 45
20 69 40
30 61 35
40 53 30
50 45 25
60 37 20
70 29 15
80 21 10
90 13 5
100 5 0
Quantity
15
Supply
Price
Supply(000,000) Supply(000,000) Supply(000,000)
Price Microsoft Apple total
10 77 45 5
20 69 40 18
30 61 35 31
40 53 30 44
50 45 25 57
60 37 20 70
70 29 15 83
80 21 10 96
90 13 5 109
100 5 0 122
Supply
Quantity
16
Supply

• The law of supply states that the supply curve
  always slopes up (i.e. as price falls, supply
  also falls, as long as everything else remains
  constant).

Supply
17
Why does the supply curve slope up?

• Supply is driven by costs

18
Why does the supply curve slope up?

• Supply is driven by costs
• The higher the profit per unit the greater then
  incentive for firms to produce more
• Costs rise with output
• In the short run, firms face diminishing marginal
  returns - it costs firms more to make each extra
  unit.
• This means that to persuade firms to supply an
  extra unit they must be compensated with a higher
  price.

19
Diminishing Marginal Returns

• The Law of Diminishing Marginal Returns states
  that if more units of a variable factor are used
  with a fixed quantity of another factor of
  production then each additional worker will add
  less to total output than the previous worker.
• In English
• Factors of production are not perfect substitutes
  for one another.
• I cant solve the problem of not enough capital
  by adding more labour.
• Think about a bin lorry, I can add more people
  and each extra person will add a little more to
  output, but less and less as they will start to
  get in each others way.
• If workers are paid the same but produce less
  output then the marginal cost (cost of the next
  unit) rises

20
Diminishing Marginal Returns
Exercise Diminishing Marginal Returns Sheet

• The Law of Diminishing Marginal Returns states
  that if more units of a variable factor are used
  with a fixed quantity of another factor of
  production then each additional worker will add
  less to total output than the previous worker.
• In English
• Factors of production are not perfect substitutes
  for one another.
• I cant solve the problem of not enough capital
  by adding more labour.
• Think about a bin lorry, I can add more people
  and each extra person will add a little more to
  output, but less and less as they will start to
  get in each others way.
• If workers are paid the same but produce less
  output then the marginal cost (cost of the next
  unit) rises

21
Price

• The market will settle at the
• This is the price at which there is
• This will occur where

Price
Quantity
22
Price

• The market will settle at the market clearing (or
  equilibrium ) price.
• This is the price at which there is neither a
  shortage or a surplus
• This will occur where demand crosses supply

Price
Supply
P
Demand
Q
Quantity
23
Shifts

• Everything we have done so far assumes that
• If anything other than price changes then on of
  the curves will
• A shift can either be
• (away from the origin) or (towards the origin)
• A shift means at the same price would
  be demanded/supplied.

Price
Supply
Quantity
24
Shifts

• Everything we have done so far assumes that
  everything except price remains constant.
• If anything other than price changes then on of
  the curves will shift.
• A shift can either be out (away from the origin)
  or in (towards the origin)
• A shift out means at the same price more would be
  demanded/supplied

S1
Price
Supply
Shift In
S2
Shift Out
Quantity
25
Shifts in Supply and Demand

• When deciding what shifts, think What would
  happen if the price remained the same.
• e.g. If there were a wet summer what would happen
  to the market for umbrellas (if price remained
  the same would people demand/supply more/less