Basic Concepts in Economics: Theory of Demand and Supply
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Basic Concepts in Economics: Theory of Demand and Supply. Discussant : Md. Alamgir Assistant Professor, BIBM. Definition of economics. Economics, the Science of Scarcity

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Basic concepts in economics theory of demand and supply

Basic Concepts in Economics: Theory of Demand and Supply

Discussant :

Md. Alamgir

Assistant Professor, BIBM


Definition of economics

Definition of economics

  • Economics, the Science of Scarcity

  • The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.

  • The study of how individuals and societies use limited resources to satisfy unlimited wants.


Fundamental economic problem

Fundamental economic problem

  • Scarcity.

  • The condition in which our wants are greater than the limited resources available to satisfy those wants.

  • Individuals and societies must choose among available alternatives.


Opportunity costs

Opportunity Costs

  • The most highly valued opportunity or alternative forfeited when a choice is made.

  • Economists believe that a change in opportunity cost can change a person’s behavior.

  • The higher the opportunity cost of doing something, the less likely it will be done.


Marginal benefits

Marginal Benefits

  • Is additional benefits.

  • The benefits connected to consuming an additional unit of a good or undertaking one more unit of an activity.


Marginal costs

Marginal Costs

  • Is additional costs.

  • The costs connected to consuming an additional unit of a good or undertaking one more unit of an activity.


Building a definition of economics goods and bads

Good - Anything from which individuals receive utility or satisfaction.

Utility - The satisfaction one receives from a good.

Bad - Anything from which individuals receive disutility or dissatisfaction.

Disutility - The dissatisfaction one receives from a bad.

Building A Definition of Economics~ Goods and Bads ~


Economic goods free goods and economic bads

Economic goods, free goods, and economic bads

  • economic good (scarce good) - the quantity demanded exceeds the quantity supplied at a zero price.

  • free good - the quantity supplied exceeds the quantity demanded at a zero price.

  • economic bad - people are willing to pay to avoid the item


Positive vs normative economics

Positive vs. Normative Economics

  • Positive- The study of “what is” in economic matters.

    Cause Effect

  • Normative - The study of “what should be” in economic matters

    Judgment and Opinion

    Examples?


Microeconomics

Microeconomics

  • Microeconomics deals with human behavior and choices as they relate to relatively small units—an individual, a business firm, an industry, a single market.


Macroeconomics

Macroeconomics

  • Macroeconomics deals with human behavior and choices as they relate to highly aggregate markets (e.g., the goods and services market) or the entire economy.


Barter vs monetary economy

Barter vs. monetary economy

  • Barter – goods are traded directly for other goods

  • Problems:

    • requires double coincidence of wants

    • high information costs

  • Monetary economy has lower transaction and information costs


Relative and nominal prices

Relative and nominal prices

  • Relative price = price of a good in terms of another good

  • Nominal price = price expressed in terms of the monetary unit

  • Relative price is a more direct measure of opportunity cost


Markets

Markets

  • In a market economy, the price of a good is determined by the interaction of demand and supply


Demand

Demand

The willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period.

  • A relationship between price and quantity demanded in a given time period, ceteris paribus.

  • Demand Schedule:The numerical tabulation of the quantity demandedof a good at different prices.

  • A demand schedule is the numerical representation of the law of demand.


Downward slopping demand curve

Downward Slopping Demand Curve

  • The graphical representation of the demand schedule and law of demand.


Demand schedule

Demand schedule


Demand schedule and graph

Demand - Schedule and Graph


Law of demand

Law of demand

  • An inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus.


Law of demand1

As the price of a good rises, the quantity demanded of the good falls, and as the price of a good falls, the quantity demanded of the good rises,

ceteris paribus.

Law of Demand

Quantity

Price


Ceteris paribus

Ceteris Paribus

  • A Latin term meaning “all other things

    constant” or “nothing else changes.”

  • Ceteris paribusis an assumption used to

    examine the effect of one influence on an outcome while holding all other influences constant.


Change in quantity demanded vs change in demand

Change in quantity demanded vs. change in demand

Change in quantity demanded Change in demand


Market demand curve

Market demand curve

  • Market demand is the horizontal summation of individual consumer demand curves


Determinants of demand

Determinants of demand

  • tastes and preferences

  • prices of related goods and services

  • income

  • number of consumers

  • expectations of future prices and income


Tastes and preferences

Tastes and preferences

  • Effect of fads:


Prices of related goods

Prices of related goods

  • substitute goods – an increase in the price of one results in an increase in the demand for the other.

  • complementary goods – an increase in the price of one results in a decrease in the demand for the other.


Change in the price of a substitute good

Change in the price of a substitute good

  • Price of coffee rises:


Change in the price of a complementary good

Change in the price of a complementary good

  • Price of DVDs rises:


Income and demand normal goods

Income and demand: normal goods

  • A good is a normal good if an increase in income results in an increase in the demand for the good.


Income and demand inferior goods

Income and demand: inferior goods

  • A good is an inferior good if an increase in income results in a reduction in the demand for the good.


Demand and the of buyers

Demand and the # of buyers

  • An increase in the number of buyers results in an increase in demand.


Expectations

Expectations

  • A higher expected future price will increase current demand.

  • A lower expected future price will decrease current demand.

  • A higher expected future income will increase the demand for all normal goods.

  • A lower expected future income will reduce the demand for all normal goods.


International effects

International effects

  • exchange rate – the rate at which one currency is exchanged for another.

  • currency appreciation – an increase in the value of a currency relative to other currencies.

  • currency depreciation – a decrease in the value of a currency relative to other currencies.


International effects continued

International effects (continued)

  • Domestic currency appreciation causes domestically produced goods and services to become more expensive in foreign countries.

  • An increase in the exchange value of the U.S. dollar results in a reduction in the demand for U.S. goods and services.

  • The demand for U.S. goods and services will rise if the U.S. dollar depreciates.


Factors causing a shift in the demand curve

Factors Causing a Shift in the Demand Curve

  • Income

  • Preferences

  • Prices of substitute goods

  • Prices of complementary goods

  • Number of buyers

  • Expectations of future prices


Supply

Supply

  • The relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.

  • The willingness and ability of sellers to produce and offer to sell different quantities of a good at different prices during a specific time period.


Law of supply

Law of Supply

  • As the price of a good rises, the quantity supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus.

Quantity

Price


Supply curve

Supply Curve

  • The graphical representation of the law of

    supply, which states that price and quantity

    supplied are directly related, ceteris paribus.


Supply schedule

Supply Schedule

  • The numerical tabulation of the quantity supplied of a good at different prices.

  • A supply schedule is the numerical representation of the law of supply.


Supply schedule1

Supply schedule


Change in quantity supplied

Change in Quantity Supplied

  • A change in quantity supplied refers to a movement along a supply curve.

  • The only factor that can directly cause a change in the quantity supplied of a good is a change in the price of the good, or own price.


Law of supply1

Law of supply

  • A direct relationship exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.


Reason for law of supply

Reason for law of supply

  • The law of supply is the result of the law of increasing cost.

    • As the quantity of a good produced rises, the marginal opportunity cost rises.

    • Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.


Change in supply vs change in quantity supplied

Change in supply vs. change in quantity supplied

Change in supplyChange in quantity supplied


Individual firm and market supply curves

Individual firm and market supply curves

  • The market supply curve is the horizontal summation of the supply curves of individual firms. (This is equivalent to the relationship between individual and market demand curves.)


Determinants of supply

Determinants of supply

  • the price of resources,

  • technology and productivity,

  • the expectations of producers,

  • the number of producers, and

  • the prices of related goods and services

    • note that this involves a relationship in production, not in consumption


Price of resources

Price of resources

  • As the price of a resource rises, profitability declines, leading to a reduction in the quantity supplied at any price.


Technological improvements

Technological improvements

  • Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability.


Expectations and supply

Expectations and supply

  • An increase in the expected future price of a good or service results in a reduction in current supply.


Increase in of sellers

Increase in # of sellers


Prices of other goods

Prices of other goods

  • Firms produce and sell more than one commodity.

  • Firms respond to the relative profitability of the different items that they sell.

  • The supply decision for a particular good is affected not only by the good’s own price but also by the prices of other goods and services the firm may produce.


International effects1

International effects

  • Firms import raw materials (and often the final product) from foreign countries. The cost of these imports varies with the exchange rate.

  • When the exchange value of a dollar rises, the domestic price of imported inputs will fall and the domestic supply of the final commodity will increase.

  • A decline in the exchange value of the dollar raises the price of imported inputs and reduce the supply of domestic products that rely on these inputs.


Factors that cause the supply curve to shift

Factors that Cause the Supply Curve to Shift

  • Prices of relevant resources

  • Technology

  • Number of sellers

  • Expectation of future prices

  • Taxes and subsidies

  • Government restrictions


Market equilibrium

Market equilibrium


Surplus and shortage

Surplus and Shortage

  • Surplus (Excess Supply) - A condition in which quantity supplied is greater than quantity demanded.

  • Surpluses occur only at prices above equilibrium price.

  • Shortage (Excess Demand) - A condition in which quantity demanded is greater than quantity supplied.

  • Shortages occur only at prices below equilibrium price.


Move to market equilibrium

Move to Market Equilibrium


Moving to market equilibrium

Moving to Market Equilibrium

Equilibrium


Demand and supply as equations

Demand and Supply as Equations

  • Let’s now look at demand and supply as equations. Here is a demand equation: Qd = 1,500 − 32P

  • To see what this equation says, we let price (P ) in the equation equal $10 and then solve for quantity demanded Qd. We get Qd = 1,180.

    Qd = 1,500 - 32(10) = 1,180

  • So this equation says that if price is $10, it follows that quantity demanded is 1,180 units.

  • We could find other quantities demanded by plugging in different dollar amounts for price (P).


Demand and supply as equations cont

Demand and Supply as Equations (Cont.)

  • Now here is a supply equation: QS = 1,200 + 43P

  • To find what quantity supplied (QS) equals at a particular price, we let $5 equal price (P ) and solve for quantity supplied. We get 1,415.

    QS = 1,200 + 43(5) = 1,415

  • Now suppose we want to find equilibrium price and quantity given our demand and supply equations. How would we do it?


Demand and supply as equations cont1

Demand and Supply as Equations (Cont.)

  • First, we know that in equilibrium the quantity demanded (Qd ) of a good is equal to the quantity supplied (Qs ), so let’s set the two equations equal to each other this way:

    1,500 -32P = 1,200 + 43P

  • Now we can solve for P. We add 32P to both sides of the equal sign and subtract 1,200 from both sides. We are left with: 75P = 300 ; It follows then that P = 300/75 or $4.00.


Demand and supply as equations cont2

Demand and Supply as Equations (Cont.)

  • Once we know equilibrium price is $4.00, we can place this value in either the demand or supply equation to find the equilibrium quantity. Let’s place it in the demand equation: Qd = 1,500 - 32(4.00) = 1,372

  • Just to make sure that 1,372 is also the quantity supplied, we put the equilibrium price of $4.00 into the supply equation: QS = 1,200 43(4.00) = 1,372

  • In summary, given our demand and supply equations, equilibrium price is $4.00 and equilibrium quantity is 1,372.


Consumer surplus

Consumer Surplus

  • CS = Maximum buying price - Price paid

  • CS = the difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid.


Producer surplus

Producer Surplus

  • PS = Price received - Minimum Selling Price

  • PS = the difference between the price sellers receive for a good and the minimum or lowest price for which they would have sold the good.


Consumer and producer surplus

Consumer and Producer Surplus


Total surplus ts

Total Surplus (TS)

TS = CS + PS

  • Total Surplus (TS) is the sum of consumers’ surplus and producers’ surplus.


Total surplus

Total Surplus

Equilibrium


Utility

Utility

  • Utility = level of happiness or satisfaction associated with alternative choices

  • utility maximization


Total and marginal utility

Total and marginal utility

  • total utility - the level of happiness derived from consuming the good

  • marginal utility - the additional utility that is received when an additional unit of a good is consumed


Marginal utility

Marginal utility

# of slices of pizza total utilitymarginal utility

0 0

1 70

2 110

3 130

4 140

5 145

6 140

-

70

40

20

10

5

-5


Law of diminishing mu

Law of diminishing MU

  • law of diminishing marginal utility - marginal utility declines as more of a particular good is consumed in a given time period, ceteris paribus

  • even though marginal utility declines, total utility still increases as long as marginal utility is positive. Total utility will decline only if marginal utility is negative


Demand rises

Demand rises


Demand falls

Demand falls


Supply rises

Supply rises


Supply falls

Supply falls


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