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Managerial Economics & DEMAND

Analysis of Demand & Supply & Market Equilibrium

Concept of Market
A market is a mechanism by which buyers and sellers interact to determine the price and quantity of a good or service Demand side of the market for a product refers to all its consumers and the price they are willing to pay for buying a certain quantity of a product during a period of time.

What is Demand???
Demand is the desire or want backed up by money Always related to price and time

Statement of Law of Demand


All other things remaining constant, higher the price of a commodity, smaller is the quantity demanded and lower the price, larger the quantity demanded Dx = f (Px)

Reasons for Inverse Relationship


Income effect- the decline in the price of a commodity leads to an equivalent increase in the income of a consumer because he has to spend less to buy the same quantity of goods. The part of the money left can be used for buying some more units of commodity. For e.g.- suppose the price of mangoes falls from Rs.100/- per dozen to 50/- per dozen. Then with the same amount of 100/- you can buy one more dozen, i.e.,2 dozens at Rs. 50/Substitution effect- When the price of a commodity falls, the consumer tends to substitute that commodity for other commodity which is relatively expensive. For e.g. Suppose the price of the Urad falls, it will be used by some people in place of other pulses. Thus the demand will increase.

Assumptions Underlying the Law


No change in Consumers Income No change in Consumers Preferences No change in Fashion No change in Price of related goods No Expectation of future price changes or shortages

Individual Demand Schedule


Tabular representation of Quantity of a commodity that an individual is willing and able to purchase over a given period of time at each price of the commodity, while holding constant all other relevant economic variables on which demand depends.

Individual Demand Schedule


Price of Com X (Rs per kg) 80 70 Quantity demanded of Com X (Qty in kg) 2 4

60 50

6 10

Market demand Schedule


Tabular representation of Quantity of a commodity that all individuals are willing and able to purchase over a given period of time at each price of the commodity, while holding constant all other relevant economic variables on which demand depends.

Market Demand Schedule


Price in (Rs) Units of Commodity X Market per day Demand by Individuals or Total A B C demanded

4 3 2 1

1 2 3 5

1 3 5 9

3 5 7 10

5 10 15 24

Determinants of Individual Demand


Income Price of Substitute & Complementary products Taste & Preferences Advertisement Expectation regarding future price changes Climatic Conditions

Determinants of Market Demand


Price of Product Distribution of Income & wealth Communitys Common Habits and Scale of Preferences Spending Habits of People Growth of Population Age Structure and Sex ratio of Population Future Expectations Level of Taxation Fashions Climate Conditions Customs Advertisement

Multivariate Demand Function


Dx = D (Px, Py, Pz, B, W, A, E, T, U)
Here Dx, stands for demand for item x (say, a car) Px, its own price (of the car) Py, the price of its substitutes (other brands/models) Pz, the price of its complements (like petrol) B, the income (budget) of the purchaser (user/consumer) W, the wealth of the purchaser A, the advertisement for the product (car) E, the price expectation of the user T, taste or preferences of user U, all other factors.

Demand equation
D= a bP Where a is constant parameter signifying initial demand irrespective of price b represents slope of demand curve functional relationship between price and demand, having minus sign denotes negative function

Exceptions to Law of Demand


Conspicuous consumption The goods which are purchased for Snob appeal are called as the conspicuous consumption. For e.g.- diamonds. They are the prestige goods. They would like to hold it only when they are costly and rare. Speculative market: in this case the higher the price the higher will be the demand. It happens because of the expectation to increase the price in the future. For e.g. shares, lotteries

Contd
Giffens goods: It is a special type of inferior goods where the fall in the price results into the decrease In the quantity demanded. This happens because of peoples preference for superior commodity Consumers Psychological bias: Many a times consumer judges the quality of a good from its price. Such consumers may purchase high price goods because of the feeling of possessing a better quality. The exceptional demand curve shows a positive relation between the price and the quantity demanded.

Shifts in Demand Curve


Extension and Contraction of Demand occurs due to changes in price, other factors remaining constant When more of a commodity is purchased with a fall in price then it is known as extension of Demand and vice versa Refer to movement along same demand curve Increase and Decrease in Demand refers to changes in demand due to factors other than price An increase in demand signifies that more will be purchased at a given price than before . Refer to movement from one demand curve to another

Reasons for shifts (increase or decrease in Demand)


Changes in Income Changes in Taste, habits and Preferences Change in Fashions and Customs Change in Distribution of Wealth Change in Substitutes Change in demand for Complementary goods Advertisement and Publicity Persuasion Change in level of taxation

Nature of Demand
Demand for Consumers goods & Producer's goods Autonomous & Derived Demand Demand for Durables and Non-Durables (Perishables) Joint Demand and Composite Demand

Supply Analysis
Supply during a given period of time means the quantities of goods which are offered for sale at particular prices Supply is what seller is able and willing to offer for sale Supply and Stock are related but distinct terms-Supply comes out of Stock Stock determines potential supply Stock is outcome of production

Determinants of Supply
Cost of factors of production State of Technology Factors outside Economic Sphere such as weather conditions, natural calamities, etc Tax and Subsidy

Law of Supply
Other things remaining same , supply of a commodity rises with a rise in price and falls with a fall in price

Supply schedule

Assumptions :
Cost of production is unchanged Technology is constant Govt policies are unchanged No change in Transport costs No speculation Prices of other goods constant

Positions: Supply Curve


Extension and Contraction : refer to change in supply due to price, other things remaining same.
Movement along the supply curve

Increase and Decrease in Supply: refer to change in supply due to determinants other than price
Shifts in Supply Curve

Causes for change in Supply


Change in Cost of Production Supply also depends on Natural Factors Change in Technique of Production Policies of Government Business Combines

When market is in Equilibrium?


Equilibrium price of a commodity is price at which quantity demanded of commodity equals quantity supplied and market clears Equilibrium is condition which once achieved tends to persist in time.

Equilibrium of Supply and Demand


Price
Excess Supply

Excess Demand

D&S

Effect of Shift in Supply or Demand


Demand & Supply shifts Demand curve shifts to right Demand curve shifts to left Supply curve shifts to right Supply curve shifts to left Effect on price and quantity Both P & Q increases Both P & Q falls P falls but Q increases P increases & Q decreases

If demand rises

If demand falls
If supply rises If supply falls

Simultaneous shifts of Supply and Demand


New equilibrium price and quantity may be greater than, equal or even less than initial equilibrium levels depending on the magnitude and direction of two curves If both D & S shift to right by same amount , the equilibrium point shifts to right by same amount and hence equilibrium price remains same.

Impact of Excise tax on Price and Quantity


An excise is a tax on each unit of commodity If collected from sellers tax causes supply curve to shift upward by the amount of tax Result is that consumers purchase a smaller quantity at a higher price while sellers receive a smaller net price after payment of tax

Impact of Excise tax on Price and Quantity


S1
T S0 E1
Tax

P1 Po

E0

D
Q1 Q0

Impact of Rent Control on Housing Markets


Rent control is a type of price ceiling or maximum rent set below equilibrium price that government use for making rented housing affordable, however the effect has been opposite ie shortage of apartments

Rent Control create shortages


S
$1400

Monthly Rent
$1000 $600

Shortage

1.2 1.6 2 Millions of Apartments

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