Ch 2

Demand & Supply

Market
Market is a place where transactions take place.
Visible supermarket Invisible - internet (Amazon, Ebay)

Parties in a market
Consumer (Demand) Producer (Supply)
Assumptions: All firms are price-taker

Demand
Demand: a consumer wants and able to buy something. Example: I have $10000
Pen ($10) Book ($200) Computer ($6000) Car ($100000) Flat ($2M)

Demand

Want

Demand
There are many factors affecting consumers decision to buy the goods/services. Functions Example
Own price factors

Pric e

Appearance Income Price of other phones Expectation of future Price Brand name Consumer preference

Non-own price factors

Demand function
A mathematical way to represent the relationship between the Quantity Demanded and the factors affecting it. Qdx = f( Px Py ,I , Pe . ) , Qdx = quantity demanded for good.. x
Px = the own price of good x Py = the price of good y I = Income of the consumer Pe = Expectation of future Price

Example: x = -10Px + 6Py + 12I Qd

Demand Curve
Question: Qdx = -10Px + 6Py + 12I Can we draw the demand function on the following graph?
Px

Yes, but you need an assumption: Ceteris Paribus

Qdx

Demand Curve
Ceteris Paribus: holding other factors constant Qdx = -10Px + 6Py + 12I
Py = 50 I = 100Qdx = -10Px + 6(50) +

12(100) x + Qdx = -10P 1500

Demand Curve
Demand (schedule) Px

Qdx = -10Px + 1500 100 150

0 500

Qdx
Px 150 100 50

50 1000

0 1500

Demand Curve Qdx

500

1000

1500

Demand Curve
The demand curve shows how price change affects the quantity demanded. The demand curve is downward sloping.
Price and Qd are negatively related. Price decreases, Qd increases Price increases, Qd decreases The Law of Demand: the lower the price of a good, the larger the quantity demanded, Ceteris Paribus (and vice versa).

Change in Qd
Q: How to represent a change in own price factor in the graph?
Px Qdx Px 150 100 50 150 0 100 500 50 1000 0 1500

Change in Quantity Demanded Moving along the curve Demand Curve 500 1000

1500

Qdx

Change in Demand
Q: How to represent a change in non-own price factor in the graph, higher income? Qdx = -10Px + 6Py + 12I
Py = 50, I = 100 Increase in Demand

Px Qdx

150 0

100 500

50 1000

0 1500

Py = 50, I = 150 Px Qdx 150 600 100 1100 50 1600 0 2100

Change in Demand
Px Py = 50, I = 150 150 100 50 0

Qdx
Px 150 100 50

600

1100

1600

2100

Shifting of the curve

Dold 500 600 1000 1100 1500 1600

Dnew 2100 Qdx

Change in Demand
Non-Own price factors:
Price of Substitutes (goods replacing each others)
Iphone vs HTC

Price of Complements (goods to be consumed together

Iphone and Monthly Plan

Consumers income Expectation of future price etc

Change in Demand
Question: What happen to the demand for Iphone if the price of HTC drop?
HTC Iphone PHTC Drop, consumers switch from Iphone to HTC Demand for Iphone Drop
p

substitute

Qd

Change in Demand
Question: What happen to the demand for Iphone if the 3G monthly charge reduce?
Monthly charge Iphone Monthly charge Drop, consumers total price drop Demand for Iphone Increase
p

complement

Qd

Qd vs Demand
Changes Own Price Change in Quantity Demanded Moving along the curve
p

Non-Own Price Change in Demand Shifting of the curve

p

Qd

Qd

Market Demand
Market demand is the horizontal summation of the individual demand
p
$10
Consumer A

Consumer B

Market (A+B)

Qd

Qd

Qd

adding up the quantities of all consumers at each price.

Supply
Supply: a producer wants and able to sell something. There are many factors affecting producers decision to sell a good/service.
Own price factor Price Cost Technology Non-Own price Price of related goods factors Expectation of future price etc

Supply function
A mathematical way to represent the relationship between the Quantity Supplied and the factors affecting it. Qsx = f( Px Py ,C , Pe .) , Qsx = quantity supplied of good x ..
Px = the own price of good x Py = the price of good y C = Cost of production Pe = Expectation of future Price

Example: x = 5Px 2C +100 Qs

Supply Curve
Question: Qsx = 5Px 2C +100 Can we draw the supply function on the following graph?
Px

Yes, but you need an assumption: Ceteris Paribus

Qsx

Supply Curve
Ceteris Paribus: holding other factors constant Qsx = 5Px 2C +100
C = 50

Qsx = 5Px 2(50) + 100 Qsx = 5Px

Supply Curve
Qsx = 5Px
Supply (schedule) Px

Qsx
Px 150 100 50

150 750

100 500

50 250

0 0

Supply Curve

250

500

750

Qsx

Supply Curve
The supply curve shows how price change affects the quantity supplied. The supply curve is upward sloping.
Price and Qs are positively related. Price decreases, Qs decreases Price increases, Qs increases The Law of Supply: the lower the price of a good, the smaller the quantity supplied, Ceteris Paribus (and vice versa).

Change in Qs
Q: How to represent a change in own price Change in Quantity Supplied factor in the graph?
Px Qsx Px 150 100 150 750 100 500 50 250 0 0

Supply Curve

50

Moving along the curve

Qsx

250

500

750

Change in Supply
Q: How to represent a change in non-own price factor in the graph, lower Cost? Qsx = 5Px 2C +100
C = 50 Increase in Supply

Px Qsx

150 750

100 500
C = 10

50 250

0 0

Px Qsx

150 830

100 580

50 330

0 80

Change in Supply
Px 150 C = 10 100 50 0

Qsx
Px 150

830

580

330
Sold S new

80

Shifting of the curve 100

50
80 250 330 500580 750 830 Qsx

Change in Supply
Non-Own price factors:
Price of inputs (Cost)
Lunch box and rice

Price of Substitutes in production (goods using the same resources)

Office vs Park (Land)

Price of Joint Supply (goods tend to be produced together)

Leather and Beef (from the same cow)

Expectation of future price etc

Qd vs Demand
Changes Own Price Change in Quantity Supplied Moving along the curve
p

Non-Own Price Change in Suply Shifting of the curve

p

Qs

Qs

Market Supply
Market Supply is the horizontal summation of the individual supply.
p
$10
Producer A

Producer B

Market (A+B)

10

Qd

Qd

15

Qd

adding up the quantities of all produers at each price.

Equilibrium
Equilibrium is a situation that both price and quantity have no tendency to change. Demand and Supply jointly give the equilibrium price and quantity. The equilibrium tells the producers how much they can sell. The equilibrium tells the consumers how much they can buy.

Equilibrium
Which level the price will stay at? A) 50 B) 100 C) 150
Px Excess supply S 150 100 50

Excess demand

0 250 500 750 1000 Qd Qs Qd Qs Qd Qs

D Qx 1500

At $150, Qd<Qs, stock accumulates, P drops to clear the stock. At $100, Qd=Qs, no more competition, P stays. At $50, Qd>Qs, consumers compete for the good, producers raise P make more profit.

Equilibrium
Implication: If the consumers are willing to pay $100, they can buy up to 500 units of x. Total expenditure = P x Qtransacted = $50000 If the sellers are willing to sell at $100, they can sell at most 500 units of x. Total revenue = P x Qtransacted = $50000 If the market is not in equilibrium, the price will adjust to restore back to the equilibrium.

Equilibrium
Question: Will the price remain at $100 forever?

NO, because the Non-Own Price Factors may change.

Comparative Static
Question: What happen to the market of EF3440A if Mr. Ho is replaced by ?
P

S
Students like Mr. Ho more than Andy Lau

$6300 $6000 D 10 14

Remark: compare the two equilibriums to see the change of price and Qd.

D Demand Drops Q

Comparative Static
How do the spread of H1N1 affect the price of face mask? S P
P2 P1 D D Q1 Q2 Q

Comparative Static
The price of memory card dropped drastically. How would this affect the price of digital camera? Complement S Pmemory card P P2 P1 D D Q1 Q2 Q

Ddigital camera

Comparative Static
There is a good harvest of Durian this year. How will this affect the price of ? More durian S Pdurian P

S Cost
P1 P2 D Q1 Q2 Q

Supply

Comparative Static
Since last year, Japanese Yen has been appreciated by more than 10%, how the appreciation of Yen affect the price of tour to Japan? CostTour SupplyTour S P S DTour P2 P1

D Q2 Q1

D Q

Government Intervention
Motivation:
affect the price/quantity of a good

There are five types of interventions:

Price Ceiling Price Floor Quota Tax Subsidy

Direct control on prices Direct control on quantities Indirect control on prices and quantities

Price Ceiling
Maximum price Sellers cannot set a price higher than the Price Ceiling. S P Price ceiling should set below the equilibrium. P1 Result:
Price drops Excess demand D Quantity transacted drops Q Q2 Q1 Excess demand exists Total Revenue of producer drops Pc

Price Ceiling
What happen if the price ceiling is set above the equilibrium?
P Pc P1 D Q1 S

Price and quantity remain at the equilibrium Ineffective price ceiling

Price Floor
Minimum price Sellers cannot set a price lower than the Price Floor. P S Excess supply Price ceiling should set Pf above the equilibrium. P1 Result:
Price rises Quantity transacted drops Q2 Q1 Excess supply exists Total Revenue of producer ??? D Q

Price floor
The government is going to legalise the Minimum wage law. Is everyone benefited from this law? wage S Unemployment Min wage wage1 D Q2 Q1

QLabour

No, only those labours are employed better off. Those low skill labours are worse off as they lost

Price Floor
What happen if the price floor is set below the equilibrium?
P P1 Pf D Q1 Q S

Price and quantity remain at the equilibrium Ineffective price floor

Quota
Maximum quantities Sellers cannot sell more than the Quota. Quota should set below the equilibrium P Quota S quantity. P2 Result:
P1 Price rises Quantity transacted drops Total Revenue of producer ???
Q2 Q1

Quota
What should the new supply curve look like? P Quota S
P1

Snew

P2
P3 P4 Q4Q1 D Q

Tax
Two types of taxes:
Per unit tax Ad valorem tax

Indirect tax: Producers can shift the burden to consumers. Tax likes another cost of production. Adding tax will lower the supply of a good.

Tax
Government set a per unit tax = t Supply shifts up vertically P by t P2 Results: tax
S2
t S1

P1 revenue Price rises Quantity drops Government tax revenue Q2 Q1 = t x Q2

D
Q

Subsidy
The opposition of tax
Per unit subsidy

Subsidy functions to reduce the cost of production. Providing subsidy will increase the supply of a good.

Tax
Government provide a per unit subsidy = s Supply shifts down vertically P S1 by s s S2 Results:
Price drops Quantity increases Government subsidy expenditure = s x Q2
Government P1 subsidy expenditure

P2

D Q1 Q2

Concept Map
Scarcity Make Choice Conflict Competition Price Competition Opportunity Cost

Non-Price Competition
(Order)

Market Economy
P S How market work? P1 D Q1 Q

Command Economy

Mathematical Approach
Market Demand: Qd = 300 10p

Market Supply:
Qs = 100 + 10P What is the equilibrium price and quantity? In equilibrium, Qd = Qs = Qe 300 10Pe = 100 + 10Pe 200 = 20Pe Pe = 10, Qe = 200