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PART 2 THE PRICE MECHANISM Chapter 3 Demand, supply and equilibrium
Demand
Supply
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-1
Lecture Plan
Demand curve The law of demand The law of supply Supply curve Equilibrium Disequilibrium Conditions of demand Conditions of supply
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-2
Demand A market consists of:
Buyers (demand) Sellers (supply) Exchange
Effective demand = the quantity of a commodity
which consumers will purchase at a given price per time period
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-3
The Demand Schedule A table showing the quantity demanded of a
product at various prices Example: Demand schedule for Big Macs Price Qty demanded$1 $2 $3 $4 $5 500 400 300 200 100
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-4
The Demand Curve Graphical representation of demand schedule
Example: Demand curve for Big Macs
Price 5 $ 4 3 2 1 100 200 300 400 Quantity 500
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-5
The Law of Demand As price increases the quantity demanded
decreases Conversely: As price decreases the quantity demanded increases
(cont.)Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-6
The Law of Demand (cont.) Reflects an inverse relationship, i.e.
as price
, quantity demanded
as price , quantity demanded The law of demand is caused by:
The income effect The substitution effect
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-7
The Income Effect As prices increase, consumers will purchase
fewer goods and services. Their purchasing power (or real income) decreases Quantity demanded decreases As prices decrease, the purchasing power of
consumers increases Quantity demanded increases
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-8
The Substitution Effect As prices increase, consumers generally purchase
more of a substitute product whose price is lower A substitute product is a product that performs a similar function and satisfies the same consumer need/want e.g.:
Tea/coffee Butter/margarine
If the price of butter increases, the quantity
demanded will fall as consumers will substitute butter with margarine
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-9
Supply Definition: the quantity of a product which
producers offer to the market at a certain price per unit of time
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-10
The Law of Supply As price increases the quantity supplied increases
conversely as price decreases the quantity supplied decreases The law of supply is a direct relationship between price and quantity supplied As price As price
, quantity supplied , quantity supplied
The logic of the law of supply: Producers will seek to maximise their profits i.e.: supplying more at higher prices and less at lower pricesCopyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-11
The Supply Schedule A table showing the quantity supplied at various
prices Example: Supply schedule for Big Macs Price Qty supplied $1 200 $2 300 $3 400 $4 500 $5 600
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-12
The Supply Curve A graphic representation of the supply schedule
Example: Supply curve for Big Macs
5 Price 4 $ 3 2 1 200 300 400 500 600
Supply curve
Quantity
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-13
Market Equilibrium Supply and demand can now be brought together
to form the price mechanism
P
S
Pe
Equilibrium point (Pe) D Q Qe(cont.)3-14
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
Market Equilibrium (cont.)Market equilibrium (E) is where: Quantity demanded = quantity supplied
(intersection of demand and supply curves) The market is cleared (no shortages or surpluses) Price (Pe) is stable
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-15
Market Disequilibrium= where quantity demanded is NOT EQUAL to quantity supplied Types: 1. Market shortage: where quantity demanded > quantity supplied 2. Market surplus (oversupply): where quantity supplied > quantity demanded
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-16
Market Shortage Caused by setting price BELOW the equilibrium
P
S
Pe
ShortageQs Qd
D Q
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-17
Market Surplus Caused by setting price ABOVE the equilibrium
P
S
D Qd
Surplus
Qs
Q
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-18
Changes in Demand Certain factors (other than price changes) affect the
absolute level of demand These factors are called conditions of demand Changes to the conditions of demand cause changes in demand and this results in shifts of the demand curve
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-19
An Increase in Demand The entire demand curve shifts to the right
PPe1 Pe
E1 E DEQ EQ1
S D1 Q
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-20
A Decrease in Demand The entire demand curve shifts to the left Caused by a factor other than price
P E Pe Pe1 E1 D1 D
S
Q Qe1 Qe
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-21
Conditions of Demand Change in tastes Improvements in technology Real income Change in population Change in the price of substitutes Change in the price of other goods Expectations of the future Advertising
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-22
Changes in Supply Certain factors (other than price changes) affect the
absolute level of supply These factors are called conditions of supply and
they result in shifts of the supply curve (not movements along it)
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-23
An Increase in Supply Supply curve shifts to the right
P Pe Pe1 E
S E1
S1
D Qe Qe1 Q
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-24
A Decrease in Supply Supply curve shifts to the left
P S1 Pe 1 Pe E1 E D Q Qe1 Qe S
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-25
Conditions of Supply Improvements in technology A change in production costs A change in the price of alternative products Weather and seasons
Copyright 2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
3-26