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Demand & SupplyDemand & Supply

MarketMarket

Market is a “place” where transactions take place.

Visible – supermarketInvisible - internet (Amazon, Ebay)

Parties in a marketConsumer (Demand)Producer (Supply)

Assumptions: All firms are “price-taker”

DemandDemand

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

DemandDemandThere are many factors affecting consumer’s decision to buy the goods/services.Example

Price

FunctionsAppearance IncomePrice of other phonesExpectation of future PriceBrand nameConsumer preference

Non

-ow

n p

rice

facto

rsO

wn

pri

ce

fact

ors

Demand functionDemand functionA mathematical way to represent the relationship between the Quantity Demanded and the factors affecting it.

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

Qdx = f()

Px

,Py ,I ,Pe .

..

Qdx = -10Px + 6Py + 12I

Example:

Demand CurveDemand Curve

Question:Can we draw the demand function on the following graph?

Qdx = -10Px + 6Py + 12I

Yes, but you need an assumption:Ceteris Paribus

Px

Qdx

Demand CurveDemand Curve

Ceteris Paribus: holding other factors constant

Py = 50

I = 100

Qdx = -10Px + 6Py + 12I

Qdx = -10Px + 6(50) + 12(100) Qdx = -10Px + 1500

Demand CurveDemand CurveQdx = -10Px + 1500

Px

Qdx

150

100

500

50

1000 1500

Px 150 100 50 0

Qdx0 500 1000 1500

Demand Curve

Demand (schedule)

Demand CurveDemand 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 increasesPrice increases, Qd decreasesThe Law of Demand: the lower the price of a good, the larger the quantity demanded, Ceteris Paribus (and vice versa).

Change in QdChange in QdQ: How to represent a change in own

price factor in the graph?Px 150 100 50 0

Qdx 0 500 1000 1500

Qdx

100

500

50

1000

Px

150

1500

Demand Curve

Moving along the curve

Change in Quantity Demanded

Change in DemandChange in DemandQ: How to represent a change in non-

own price factor in the graph, higher income?

Py = 50, I = 100

Px 150 100 50 0

Qdx 0 500 1000 1500

Qdx = -10Px + 6Py + 12I

Py = 50, I = 150

Px 150 100 50 0

Qdx 600 1100 1600 2100

Increase in Dem

and

Change in DemandChange in Demand

Qdx

100

500

50

1000

Px

150

1500

Dold

Py = 50, I = 150

Px 150 100 50 0

Qdx 600 1100 1600 2100

2100600 1100 1600

Shifting of the curve

Dnew

Change in DemandChange 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

Consumer’s incomeExpectation of future priceetc

Change in DemandChange in Demand

Question:What happen to the demand for Iphone if the price of HTC drop?

HTC Iphonesubstitute

PHTC Drop, consumers switch from Iphone to HTC

Demand for Iphone Dropp

Qd

Change in DemandChange in Demand

Question:What happen to the demand for Iphone if the 3G monthly charge reduce?Monthly charge Iphonecomplement

Monthly charge Drop, consumers total price drop

Demand for Iphone Increasep

Qd

Qd vs DemandQd vs Demand

Changes

Own Price Non-Own Price

Change in Quantity Demanded

Change in Demand

Moving along the curve Shifting of the curvep

Qd

p

Qd

Market DemandMarket DemandMarket demand is the horizontal summation of the individual demand

adding up the quantities of all consumers at each price.

$10

p

Qd

p

Qd

p

Qd

Consumer A

Consumer B

Market (A+B)

2 1 3

SupplySupplySupply: a producer wants and able to sell something.There are many factors affecting producer’s decision to sell a good/service.

PriceCostTechnologyPrice of related goods Expectation of future priceetc

Own price factor

Non-Own price factors

Supply functionSupply functionA mathematical way to represent the relationship between the Quantity Supplied and the factors affecting it.

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

Qsx = f( )

Px

,Py ,C

,Pe ...

Qsx = 5Px – 2C +100 Example:

Supply CurveSupply Curve

Question:Can we draw the supply function on the following graph?

Yes, but you need an assumption:Ceteris Paribus

Px

Qsx

Qsx = 5Px – 2C +100

Supply CurveSupply Curve

Ceteris Paribus: holding other factors constant

C = 50

Qsx = 5Px – 2C +100

Qsx = 5Px – 2(50) + 100 Qsx = 5Px

Supply CurveSupply CurveQsx = 5Px

Px

Qsx

150

100

250

50

500 750

Px 150 100 50 0

Qsx750 500 250 0

Supply Curve

Supply (schedule)

Supply CurveSupply 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 decreasesPrice increases, Qs increasesThe Law of Supply: the lower the price of a good, the smaller the quantity supplied, Ceteris Paribus (and vice versa).

Change in QsChange in QsQ: How to represent a change in own

price factor in the graph?Px 150 100 50 0

Qsx 750 500 250 0

Moving along the curve

Change in Quantity Supplied

Qsx250 500 750

Px

150

100

50

Supply Curve

Change in SupplyChange in SupplyQ: How to represent a change in non-

own price factor in the graph, lower Cost?

C = 50

Px 150 100 50 0

Qsx 750 500 250 0

Qsx = 5Px – 2C +100

C = 10

Px 150 100 50 0

Qsx 830 580 330 80

Increase in Supply

Change in SupplyChange in SupplyC = 10

Px 150 100 50 0

Qsx 830 580 330 80

Shifting of the curve

Qsx250 500 750

Px

150

100

50

Sold

80 330 580 830

Snew

Change in SupplyChange in SupplyNon-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 priceetc

Qd vs DemandQd vs Demand

Changes

Own Price Non-Own Price

Change in Quantity Supplied

Change in Suply

Moving along the curve Shifting of the curvep

Qs

p

Qs

Market SupplyMarket SupplyMarket Supply is the horizontal summation of the individual supply.

adding up the quantities of all produers at each price.

$10

p

Qd

p

Qd

p

Qd

ProducerA

ProducerB

Market (A+B)

10 5 15

EquilibriumEquilibrium

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.

EquilibriumEquilibriumWhich level the price will stay at?

A) 50 B) 100 C) 150

Qx

100

500

50

1000

Px

150

1500

D

S

250 7500Qd Qs

At $150, Qd<Qs, stock accumulates, P drops to clear the stock.

QdQs

At $50, Qd>Qs, consumers compete for the good, producers raise P make more profit. Qd

Qs

At $100, Qd=Qs, no more competition, P stays.

Excess supply

Excess demand

EquilibriumEquilibriumImplication:

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.

EquilibriumEquilibrium

Question:Will the price remain at $100 forever?

NO, because the Non-Own Price Factors

may change.

Comparative StaticComparative StaticQuestion: What happen to the market of

EF3440A if Mr. Ho is replaced by ?

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

P

QD

S

$6300

14

Students like Mr. Ho more than Andy Lau

Demand DropsD

$6000

10

Comparative StaticComparative StaticHow do the spread of H1N1 affect

the price of face mask?P

QD

S

P1

Q1

D

P2

Q2

Comparative StaticComparative StaticThe price of memory card dropped

drastically. How would this affect the price of digital camera?

P

QD

S

P1

Q1

D

P2

Q2

ComplementPmemory card

Ddigital camera

Comparative StaticComparative Static

There is a good harvest of Durian this year. How will this affect the price of 榴槤飄香 ? Pdurian

Cost 榴槤飄香

More durian

Supply 榴槤飄香

P

QD

S

P1

Q1

S

P2

Q2

Comparative StaticComparative StaticSince last year, Japanese Yen has been appreciated by more than 10%, how the appreciation of Yen affect the price of tour to Japan?

P

QD

S

P1

Q1

S

P2

Q2

DTour

D

CostTour SupplyTour

Government InterventionGovernment Intervention

Motivation:affect the price/quantity of a good

There are five types of interventions:Price CeilingPrice FloorQuotaTaxSubsidy

Direct control on pricesDirect control on quantitiesIndirect control on prices and quantities

Price CeilingPrice CeilingMaximum priceSellers cannot set a price higher than the Price Ceiling.Price ceiling should set below the equilibrium.Result:

Price dropsQuantity transacted dropsExcess demand existsTotal Revenue of producer drops

Pc

Q2

P

QD

S

P1

Q1

Excess demand

Price CeilingPrice CeilingWhat happen if the price ceiling is set above the equilibrium?

Price and quantity remain at the equilibrium

Ineffective price ceiling

Pc

P

QD

S

P1

Q1

Price FloorPrice FloorMinimum priceSellers cannot set a price lower than the Price Floor.Price ceiling should set above the equilibrium.Result:

Price risesQuantity transacted dropsExcess supply existsTotal Revenue of producer ???

Pf

Q2

P

QD

S

P1

Q1

Excess supply

Price floorPrice floorThe government is going to legalise the Minimum wage law. Is everyone benefited from this law?

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

their jobs.

Min wage

Q2

wage

QLabour

D

S

wage1

Q1

Unemployment

Price FloorPrice FloorWhat happen if the price floor is set below the equilibrium?

Price and quantity remain at the equilibrium

Ineffective price floor

Pf

P

QD

S

P1

Q1

QuotaQuotaMaximum quantitiesSellers cannot sell more than the Quota.Quota should set below the equilibrium quantity.Result:

Price risesQuantity transacted dropsTotal Revenue of producer ???

P2

Q2

P

QD

S

P1

Q1

Quota

QuotaQuota

What should the new supply curve look like?

P1

Q1

P

QD

S

P2

Q4

Quota

P3

P4

Snew

TaxTax

Two types of taxes:Per unit taxAd 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.

TaxTax

Government set a per unit tax = tSupply shifts up verticallyby “t”Results:

Price risesQuantity dropsGovernment tax revenue= t x Q2

P

QD

S1

P1

Q1

S2

t

P2

Q2

tax revenue

SubsidySubsidy

The opposition of taxPer unit subsidy

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

TaxTax

Government provide a per unit subsidy = sSupply shifts down verticallyby “s”Results:

Price dropsQuantity increasesGovernment subsidy expenditure = s x Q2

P

QD

S1

P1

Q1

S2s

P2

Q2

Government subsidy

expenditure

Concept MapConcept Map

How market work?

Scarcity

Make ChoiceOpportunity Cost

Conflict

Competition

Price Competition Non-Price Competition

Market EconomyCommand Economy

(Order)

P

QD

S

P1

Q1

Mathematical ApproachMathematical ApproachMarket Demand:

Qd = 300 – 10p Market Supply:

Qs = 100 + 10PWhat is the equilibrium price and quantity?In equilibrium,

Qd = Qs = Qe

300 – 10Pe = 100 + 10Pe

200 = 20Pe

Pe = 10, Qe = 200