PAN African eNetwork Project

Masters of Finance and Control Managerial Economics

Semester - I
Ms. Sonia Singh
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Objective
Analysis of Supply Elasticity of Demand and supply Equilibrium of Supply and Demand

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What Is Supply?
Supply of a commodity refers to the various quantities of the the commodity which a seller is willing and able to sell at different prices in a given market, at a point of time. Supply is related to scarcity. Its only the scarce goods which have a supply price; Goods which are freely available have no supply price.

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The Determinants of Supply

Price of good : since higher money income is necessary to induce producers to produce more, the amount supplied therefore increases when producers get a higher price for their product. Prices of other goods: change in prices of other goods in the market also has influence on the supply of a commodity. E.G: if the price of good Y rises, the producer of X will start considering switching production to Y.

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Factor affecting the supply of

commodity

1. The price of commodity:- The supply of commodity very much depend upon its price. There is direct and positive relationship between price of commodity and supply.

2. The price of the substitutes:-The supply of a particular commodity is inversely related with the price of other commodities,such as the supply of wheat will fall with the rise in price of rice.This is due to the fact that rise in price of rice will encourage the producers to produce more rice.consequently area under wheat will be lesser and the supply will of decline. 3.Change in technology:-If the change in technology or new discoveries bring reduction in price and increase in production,this will increase the level of supply also. 4.Goals of firm:-Generally the aim of firm is maximize the profit. Beside this maximum sales,maximum output or maximum employment is also taken as the goal s of firm..This goals change in them affect the supply of commodity.sometimes the producer may continue to maximize the supply of commodity without profit simply to build the their image and prestige in society.

5.Expected change in price:-In case producer expect an increase in the price ,they will try to withdraw goods from the market.Consequently,supply will reduce .If price is expected to fall in the market ,supply will naturally increase.

6.Natural factors :- Supply of good is a part of good produce.It mean that

more production of good will result its more supply and vice versa..Agricultural production depends upon the natural factors such as rain,fertility,climatic condition etc. production may be adversely affected by drought and heavy rains and flood etc.

7.Means of transportation and communication:-Adequate

supply of commodities is maintained If the means of transportation and communication are developed.Scarcity of good will be less in the domestic market,if the mean of the transportation and communication are properly developed.

8.Taxation policy:-The production of commodity is discouraged ,if heavy

duty in on its products is imposed .In the same way tax concession encourage producer to increase supply.

9.Agreement among producer:-Sometime all the firms producing the

same commodity forms an association, pool or a syndicate and regular supply of the goal in such way ,so that they may get maximum profit.

Law of Supply says, supply of the commodity will increase with increase in price and decrease with decrease in price, other things remaining the same. In other words, price of any commodity is directly related with the quantity supplied .

According to Dooley, the law of supply states that other things remaining the same , higher the price, the greater the quantity supplied or lower the price, the smallest the quantity supplied.

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When we are talking of supply, we are bound to view with the eyes of producers , not the consumers ,because its producers who are the suppliers.
It is quite natural that in case of increase in prices producers will like to multiply their profit. For this they will be required to sell more quantity of goods and thus the supply of goods will increase. Higher price in this way induces the sellers to increase the supply of goods. On the other hand, low prices reduces the margin of profit so the producer reduces the supply.

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RESERVED PRICE
The price cannot fall below a certain point .In case the price falls too much the supply of the product may be stopped .The price below which the producer will not be willing to sell is reserved price.

The amount of reserved price depends upon :->

1.Durability of commodity 2.Estimated price 3.Storage charges 4.Transportation charges etc.
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1.There is no change in price of related commodities. 2.There is no change in technique of production. 3.There is no change in price of factors of production. 4.There is no change in goal of firm. 5.There is no expectation of change in the price of the commodity.

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PRESENTATION OF LAW THROUGH SUPPLY SCHEDULE

Gives a full account of supply of a particular commodity Law of supply can be better be understood with the help of supply schedule Relation between price (x) of good and its supply

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PRESENTATION OF LAW THROUGH SUPPLY CURVE

Graphical representation of supply schedule is supply curve It is an upward sloping curve from left to right Thus both supply schedule and supply curve show law of supply i.e, they show a positive relationship between price and supply

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Presentation of law of supply through supply curve

The graphical representation of the supply schedules supply curve. The relationship between the quantity sellers want to sell during some time period and price is what economists call the supply curve. It is an upward sloping curve from left to right. This shows positive relationship between price and supply. Though usually the relationship is positive, so that when price increases so does quantity supplied, there are exceptions.

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Diagrammatic representation of supply schedule.

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EXCEPTIONS TO THE LAW OF SUPPLY

The law of supply does not apply in following cases:
1.In case of agricultural products whose supply is affected by natural factors. 2.In case of perishable goods like food. In case of these goods seller is willing to sell more units at decaying prices. 3.In case of goods having social distinction. The supply of goods will remain limited even if their prices are high

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Supply curves in very short period (market period):THE SUPPLY CURVE WILL BE A VERTICAL LINE PARALLEL TO Y AXIS, BECAUSE FIRMS CAN NOT ADJUST THEIR PRODUCTION TO ANY CHANGE IN PRICE.

Long Period:SUPPLY OF INPUTS CAN BE CHANGED,THE SUPPLY WILL BE UPWARD SLOPING IN THE LONG PERIOD.

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MOVEMENT ALONG A SUPPLY CURVE AND SHIFT OF THE SUPPLY CURVE :MOVEMENT ALONG A SUPPLY CURVE : If the quantity supplied increases or decreases in response to rise or fall in price of commodity alone assuming other things remaining the same, it is know as the movement along the supply curve. THERE MAY BE TWO FOLLOWING POSSIBILITIES:A) EXTENSION OF SUPPLY :-> When the quantity supplied increases with the rise in price. B) CONTRACTION OF SUPPLY :->when quantity supplied decreases with the fall in price.

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When there is change in supply due to factors other than price of commodity then there is shift in supply curve. Now two cases arises:

1.INCREASE IN SUPPLY: We move from original supply curve to the new rightward supply curve.

2.DECREASE IN SUPPLY: In this case there will be leftward shift in supply curve

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CAUSES FOR THE INCREASE IN SUPPLY

Following causes are responsible for increase in supply:
1. Fall in the price of related (substitutes) goods; 2. Changes in the goals of producers; 3. Fall in the price of factors of production; 4. Improvement in technology; 5. Increase in the number of firms in the market; 6. Subsidies offered by the government; and 7. When the firm expects a fall in the price of the commodity.

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CAUSES FOR DECREASE IN SUPPLY

Following causes are responsible for decrease in supply :
1. Rise in the price of the related (substitute) commodities; 2. Changes in the goals of the producer; 3. Rise in the price of factors of production; 4. Fall in the level of technology; 5. Decrease in the number of firms in the market; 6. When subsidies are withdrawn ; and 7. When the firm expects a rise in the price of the commodity.

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Elasticity and Its Applications

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Elasticity . . .
allows us to analyze supply and demand with greater precision.

is a measure of how much buyers and sellers respond to changes in market conditions

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THE ELASTICITY OF DEMAND

Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

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The Price Elasticity of Demand and Its Determinants

Availability of Close Substitutes Necessities versus Luxuries Definition of the Market Time Horizon

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The Price Elasticity of Demand and Its Determinants

Demand tends to be more elastic :
the larger the number of close substitutes. if the good is a luxury. the more narrowly defined the market. the longer the time period.

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Computing the Price Elasticity of Demand

The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

Percentage change in quantity demanded Price elasticity of demand = Percentage change in price

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Computing the Price Elasticity of Demand

Price elasticity of demand = Percentage change in quantity demanded Percentage change in price

Example: If the price of an ice cream cone increases from 2.00 to 2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:
(10  8) v 100 20% 10 ! !2 (2.20  2.00) v 100 10% 2.00
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The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.
(Q 2  Q1 ) / [( Q2  Q1 ) / 2] Price elasticity of demand = (P2  P1 ) / [(P2  P1 ) / 2]
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The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
Example: If the price of an ice cream cone increases from 2.00 to 2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

(10  8) 22% (10  8) / 2 ! ! 2.32 (2.20  2.00) 9.5% (2.00  2.20) / 2

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The Variety of Demand Curves

Inelastic Demand
Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.

Elastic Demand
Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.

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Computing the Price Elasticity of Demand

(100 - 50)
Price $5 4 Demand

ED !

(100  50)/2 (4.00 - 5.00) (4.00  5.00)/2

67 percent ! ! -3 - 22 percent

50

100 Quantity

Demand is price elastic

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The Variety of Demand Curves

Perfectly Inelastic
Quantity demanded does not respond to price changes.

Perfectly Elastic
Quantity demanded changes infinitely with any change in price.

Unit Elastic
Quantity demanded changes by the same percentage as the price.

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The Variety of Demand Curves

Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.

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Figure 1 The Price Elasticity of Demand

(a) Perfectly Inelastic Demand: Elasticity Equals 0 Price Demand $5 4 1. An increase in price . . .

100

Quantity

2. . . . leaves the quantity demanded unchanged.

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Figure 1 The Price Elasticity of Demand

(b) Inelastic Demand: Elasticity Is Less Than 1 Price

$5 4 1. A 22% increase in price . . . Demand

90

100

Quantity

2. . . . leads to an 11% decrease in quantity demanded.

Figure 1 The Price Elasticity of Demand

(c) Unit Elastic Demand: Elasticity Equals 1 Price

$5 4 1. A 22% increase in price . . . Demand

80

100

Quantity

2. . . . leads to a 22% decrease in quantity demanded.

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Figure 1 The Price Elasticity of Demand

(d) Elastic Demand: Elasticity Is Greater Than 1 Price

$5 4 1. A 22% increase in price . . . Demand

50

100

Quantity

2. . . . leads to a 67% decrease in quantity demanded.

Figure 1 The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity Price 1. At any price above $4, quantity demanded is zero. $4 2. At exactly $4, consumers will buy any quantity. Demand

0 3. At a price below $4, quantity demanded is infinite.

Quantity

Total Revenue and the Price Elasticity of Demand

Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q

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Elasticity and Total Revenue along a Linear Demand Curve

With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.

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Elasticity and Total Revenue along a Linear Demand Curve

With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.

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Elasticity of a Linear Demand Curve

Income Elasticity of Demand

Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

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Computing Income Elasticity

Percentage change in quantity demanded Income elasticity of demand = Percentage change in income

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Income Elasticity
Types of Goods
Normal Goods Inferior Goods

Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

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Income Elasticity
Goods consumers regard as necessities tend to be income inelastic
Examples include food, fuel, clothing, utilities, and medical services.

Goods consumers regard as luxuries tend to be income elastic.

Examples include sports cars, furs, and expensive foods.

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Important Observations
When demand is elastic, a decrease in price will result is an increase in the revenue (sales). When demand is inelastic, a decrease in price will result is a decrease in the revenue (sales). When demand is unit-elastic, an increase (or a decrease) in price will not change the revenue (sales).
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THE ELASTICITY OF SUPPLY

Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price.

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Figure 6 The Price Elasticity of Supply

(a) Perfectly Inelastic Supply: Elasticity Equals 0 Price Supply $5 4 1. An increase in price . . .

100

Quantity

2. . . . leaves the quantity supplied unchanged.

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Figure 6 The Price Elasticity of Supply

(b) Inelastic Supply: Elasticity Is Less Than 1 Price Supply $5 4 1. A 22% increase in price . . .

100

110

Quantity

2. . . . leads to a 10% increase in quantity supplied.

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Figure 6 The Price Elasticity of Supply

(c) Unit Elastic Supply: Elasticity Equals 1 Price Supply $5 4 1. A 22% increase in price . . .

100

125

Quantity

2. . . . leads to a 22% increase in quantity supplied.

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Figure 6 The Price Elasticity of Supply

(d) Elastic Supply: Elasticity Is Greater Than 1 Price Supply $5 4 1. A 22% increase in price . . .

100

200

Quantity

2. . . . leads to a 67% increase in quantity supplied.

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Figure 6 The Price Elasticity of Supply

(e) Perfectly Elastic Supply: Elasticity Equals Infinity Price 1. At any price above $4, quantity supplied is infinite. $4 2. At exactly $4, producers will supply any quantity. Supply

0 3. At a price below $4, quantity supplied is zero.

Quantity

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Determinants of Elasticity of Supply

Ability of sellers to change the amount of the good they produce.
Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.

Time period.
Supply is more elastic in the long run.

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Computing the Price Elasticity of Supply

The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

Percentage change in quantity supplied Price elasticity of supply = Percentage change in price

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DEGREES OF ELASTICITY OF SUPPLY

Es Es=0 Es=inf Es=1 Es>1 Es<1 Types of elasticity Perfectly inelastic Perfectly elastic Unit elastic Elastic(>1) Inelastic(<1) Relationship of supply with price Does not change Limitless change in supply (inc/dec) Changes in same proportion Supply changes in larger percentage Supply changes in lesser percentage

APPLICATION of ELASTICITY
Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties?

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The Farm Example

During bad crop years, prices rise and quantity falls (but not that much) so total revenue to farmers goes up. During good crop years, prices fall and quantity increases (but not that much) so total revenue to farmers goes down. The graphs.

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Figure 8 An Increase in Supply in the Market for Wheat

Price of Wheat 2. . . . leads to a large fall in price . . . $3 2 1. When demand is inelastic, an increase in supply . . . S1 S2

Demand 0 100 110 Quantity of Wheat

3. . . . and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220.
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Summary
The income elasticity of demand measures how much the quantity demanded responds to changes in consumers income. The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good. The price elasticity of supply measures how much the quantity supplied responds to changes in the price. .

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Summary
In most markets, supply is more elastic in the long run than in the short run. The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. The tools of supply and demand can be applied in many different types of markets.

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MARKET EQUILIBRIUM
Market equilibrium
When the quantity demanded equals the quantity suppliedwhen buyers and sellers plans are consistent.

Equilibrium price
The price at which the quantity demanded equals the quantity supplied.

Equilibrium quantity
The quantity bought and sold at the equilibrium price.
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Market Equilibrium


P0: equilibrium price

Only at equilibrium demand intersects supply.

Q0: equilibrium quantity

Market Disequilibria


Excess demand or shortage exists when quantity demanded exceeds quantity supplied at the current price. To eliminate the shortage,
some consumers are willing to raise the current price.

Market Disequilibria


Excess supply or surplus exists when quantity supplied exceeds quantity demanded at the current price. To eliminate the surplus,
some sellers are willing to lower the current price.

Increases in Demand or Supply

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Relative Magnitudes of Change

The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

Relative Magnitudes of Change

When supply and demand both increase, quantity will increase, but price may go up or down.

Decreases in Demand or Supply

Lower demand leads to lower price and lower quantity exchanged.

Lower supply leads to higher price and lower quantity exchanged.

Thank You
Please forward your query To: sonia23singh@gmail.com CC: manoj.amity@panafnet.com

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