Demand and Supply Analysis

AGENDA OF THE PRESENTATION

Basic

concepts of demand and supply (Mathematically & Graphically). Equilibrium Quantity and Price. Impacts of different factors on equilibrium quantity and

REFERENCES
This lecture has been prepared from the Book Microeconomic Theory by Walter Nicholson & Managerial Economics by Maurice Thomas

ECONOMIC ACTIVITIES

Consumption
Demand

Production
Supply

DEMAND
Amount of a good or service that consumers are willing and able to purchase during a given period of time is called quantity demanded.

Demand Relations

Generalized Demand Function

QD=D(P,) (Where shows other factors)

Ordinary Demand Function

QD=D(P) (Keeping as constant)

The Generalized Demand Function

The relation between quantity demanded and all the factors that affect quantity demanded

QD= D(P,)

D/P=DP<0
D/=D
factors
may have any sign depending upon the

Factors in
QD = D(M, PR, T, Pe, N)
Where

QD M PR T Pe N

the quantity demanded of the good or service the consumes income (generally per capita)

the price of related goods or services,

the taste patterns of consumers, the expected price of the good in some future period,

the number of consumers in the market.

MATHEMATICAL EXPRESSION IN LINEAR FUNCTIONAL FORM

QD = a + bP + cM + d PR + eT + fPe + gN
Where QD, P ,M, PR, T, Pe,and N are as defined above, and a, b, c, d, e, f, and g are parameters.

Intercept Parameter: (a)

It shows the value of Qd, when the variables P ,M, PR, T, Pe,and N are all simultaneously equal to zero

Slope Parameters: (b,c,d,e,f,g)

Parameters in a linear function that measure the effect on the dependent variable (Qd) of changing one of the independent variables (P ,M, PR, T, Pe and N), while holding the rest of these variables constant.

SUMMARY OF THE GENERALIZED A(LINEAR) DEMAND FUNCTION

Variable Relation to Sign of quantity demanded Slope parameter

P M
PR T Pe N

Inverse
Direct for normal goods Inverse for inferior goods Direct for substitute goods

Inverse for complement goods

Direct Direct Direct

b=QD/P is (-)ve c= QD /M is (+)ve c= QD /M is (-)ve d= QD /PR is (+)ve d= QD /PR is (-)ve e= QD /T is (+)ve f= QD / Pe is (+)ve g= QD /N is (+)ve

The Ordinary Demand Function

A demand function can be expressed in the most general form as the equation:

QD = D(P)
It means that the quantity demanded is a function of (depends on) the price of the good, holding all other variables constant.

QD = D(P;M, PR, T, Pe, N)= D(P)

Where the prime on the right of the semicolon means that variables are held constant at some specified amount no matter what value the product price takes.

DERIVATION OF DEMAND FUNCTION FROM

GENERALIZED DEMAND FUNCTION

Suppose the generalized demand function is

QD = 280 - 20P + 60M - 50PR + 20T + 10Pe + 4N
To derive demand function, QD = D(P), the variables M, PR, T, Pe, and N must be assigned fixed values.

QD = 280-20P+60(15)-50(10)+20(8)+10(6) + 4(100) QD = 1300-20P

Where 1300 is the Intercept Parameter -20 is the slope of the demand function (=Qd/P)

LAW OF DEMAND (SCHEDULE & CURVE)

Quantity demanded increases when price falls, other things held constant (vice versa) is called Law of Demand. And a table showing a list of possible product prices and the corresponding quantities demanded.

Demand Schedule

Price Quantity Demanded 65 0 60 100 50 300 40 500 30 700 20 900 10 1100 Qd = 1300-20P

DEMAND CURVE
Qd = 1300-20P
Price D

Quantity Demanded

CHANGES IN DEMAND
Extension/Contraction Change in Demand due to Product Price
Price D Price D

Rise/Fall Change in Demand due to other factors

D1

D1

Movement along the curve

Shift to right or left

DEMAND
Amount of a good or service that consumers are willing and able to purchase during a given period of time is called quantity demanded.

Demand Relations

Generalized Demand Function

QD=D(P,) (Where shows other factors)

Ordinary Demand Function

QD=D(P) (Keeping as constant)

SUPPLY
Amount of a good or service offered for sale in a market at some particular price during a given period of time is called quantity supplied.

Supply Relations

Generalized Supply Function

QS=S(P, ) (Where shows other factors)

Ordinary Supply Function

QS=S(P) (Keeping as constant)

The Generalized Supply Function

The relation between quantity supplied and all the factors that affect quantity demanded

QS= S(P, )

S/P=SP>0
S/ =S may have any sign depending upon the
factors

FACTORS IN

QS = S(Pi, Pr, T, Pe, F)

Where

QS Pi PR T Pe F

the quantity supplied of the good or service the price of the inputs used to produce the good. the price of related in production. the level of available technology. the expected price of the good. the number of firms producing the good

MATHEMATICAL EXPRESSION IN LINEAR FUNCTIONAL FORM

QS = h + kP + lPi + mPr+ nT + rPe + sF

Where QD, P , Pi, Pr, T, Pe,and F are as defined above, and h, k, l, m, n, r, and s are parameters. Intercept Parameter: (h)
It shows the value of QS, when the variables P , Pi, Pr, T, Pe,and F are all simultaneously equal to zero

Slope Parameters: (b,c,d,e,f,g)

Parameters in a linear function that measure the effect on the dependent variable (Qd) of changing one of the independent variables (, Pi, Pr, T, Pe, and F), while holding the rest of these variables constant.

SUMMARY OF THE GENERALIZED A(LINEAR) SUPPLY FUNCTION

Variable Relation to quantity Supplied Sign of Slope parameter

P Pi Pr Pr T Pe F

Direct
Inverse
Direct for complement goods

Inverse for substitute goods

Direct Inverse Direct

k=QS/P is (+)ve l= QS / Pi is (-)ve m= QS /Pr is (+)ve m= QS /PR is (-)ve n= QS /T is (+)ve r= QS / Pe is (-)ve s= QS /F is (+)ve

The Ordinary Supplied Function

A Supply function can be expressed in the most general form as the equation:

QS = S(P)
It means that the quantity supplied is a function of (depends on) the price of the good, holding all other variables constant.

QS = S(P;Pi, Pi, T, Pe, F)= S(P)

Where the prime on the right of the semicolon means that variables are held constant at some specified amount no matter what value the product price takes.

DERIVATION OF SUPPLY FUNCTION FROM

GENERALIZED SUPPLY FUNCTION

Suppose the generalized supply function is

QS = 50 + 10P -8Pi + 5F
To derive demand function, QS = S(P), the variables Pi, and F must be assigned fixed values.

QS = 50+10P-8(50)+5(90) QS = 100+10P Where 100 is the Intercept Parameter +10 is the slope of the supply

LAW OF SUPPLY (SCHEDULE & CURVE)

Quantity supplied increases when price rises, other things held constant (vice versa) is called Law of supply. And a table showing a list of possible product prices and the corresponding quantities supplied.

Supplied Schedule

Price Quantity Supplied 65 750 60 700 50 600 40 500 30 400 20 300 10 200

QS = 100+10P

SUPPLY CURVE
QS = 100+10P
Price
S

Quantity Demanded

CHANGES IN SUPPLY
Extension/Contraction Change in Supply due Price to Product Price
S

Price

Rise/Fall Change in Supply due to other factors

S S1

S S S1

Movement along the curve

Shift to right or left

GRAPHICAL REPRESENTATION
Qd = 1300-20P QS = 100+10P 1300-20P = 100+10P
P* = 40 (Equilibrium price where QD= QS

Q* = 500 at equilibrium Price

Schedule

Price 65 60 50 40 30 20 10

QS QD QS -Q D 750 0 750 700 100 600 600 300 300 500 500 0 400 700 -300 300 900 -600 200 1100 -900

QD = 1300-20P QS = 100+10P

GRAPHICAL REPRESENTATION
QD = 1300-20P QS = 100+10P
Price D Excess Supply E P* S

Excess Demand
D S Q*

Quantity Demanded

Market Equilibrium
It is a situation in which at the prevailing price, consumers can by all of a good they wish and producers can sell all of the good they wish.

QD= QS
to analyze the comparative statics of this simple model, write the total differentials of the demand and supply functions as

dQD= DPdP+Dd dQS= SPdP+Sd

Because maintenance of equilibrium, requires that

dQD= dQS
We can solve these equations for the change in equilibrium price for any combination of shifts in demand () or supply () Suppose demand parameter were to change while remains constant. Then using equilibrium condition

DPdP+Dd = SPdP
or manipulating terms a bit,

P/= D /SP-DP

IMPACT OF SHIFTING FACTORS ON EQUILIBRIUM

Change in () demand parameter & is constant P

D1 D

IMPACT OF SHIFTING FACTORS ON EQUILIBRIUM

Change in () supply parameter & is constant P

S
S1

IMPACT OF SHIFTING FACTORS ON EQUILIBRIUM

Change in () & () simultnously P

S
S1

D1 D