Supply and Demand

K2 – PENGANTAR ILMU EKONOMI

TEKNIK INDUSTRI – UNJANI 2018

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SUPPLY – DEMAND - MARKET
• What are supply and demand?
• What is the market mechanism?
• What are the effects of changes in market equilibrium?
• What are elasticities of supply and demand?

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The Supply Curve
Price S
($ per unit)
The Supply
Curve Graphically

P2
The supply curve slopes
P1 upward demonstrating that
at higher prices firms
will increase output
Q S = Q S (P)

Q1 Q2 Quantity
3
 Change in Supply
• The cost of raw P
S S’
• OTHER VARIABLES materials falls
AFFECTING SUPPLY
• COSTS OF
• Produced Q1 at P1 and
PRODUCTION Q0 at P2
•
•
LABOR
CAPITAL
• Now produce Q2 at P1
and Q1 at P2
• RAW MATERIALS
P1
• LOWER COSTS OF • Supply curve shifts right
PRODUCTION ALLOW A
FIRM TO PRODUCE to S’
MORE AT EACH PRICE P2
AND VICE VERSA

Q0 Q1 Q2 Q
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 The Demand Curve
Price
($ per unit) The demand curve slopes
downward demonstrating
that consumers are willing
to buy more at a lower price
as the product becomes
relatively cheaper.
P2

P1

Q1 Q2 Quantity
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 Change in Demand
D
• Income Increases P D’
• Purchased Q0, at P2 and
• OTHER VARIABLES AFFECTING Q1 at P1
DEMAND P2
• INCOME • Now purchased Q1 at P2
• INCREASES IN INCOME and Q2 at P1
ALLOW CONSUMERS
TO PURCHASE MORE • Same for all prices
AT ALL PRICES P1
• CONSUMER TASTES • Demand Curve shifts
• PRICE OF RELATED GOODS right
• SUBSTITUTES
• COMPLEMENTS

Q0 Q1 Q2 Q
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 The Market Mechanism
Price S
($ per unit)

• THE MARKET MECHANISM IS THE

The curves intersect at
TENDENCY IN A FREE MARKET FOR
equilibrium, or market-
PRICE TO CHANGE UNTIL THE
clearing, price.
MARKET CLEARS Quantity demanded
P0 equals quantity
• MARKETS CLEAR WHEN QUANTITY
DEMANDED EQUALS QUANTITY supplied at P0
SUPPLIED AT THE PREVAILING
PRICE

• MARKET CLEARING PRICE – PRICE

D
AT WHICH MARKETS CLEAR

Q0 Quantity
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 The Market Mechanism
• THE MARKET PRICE IS
Price
ABOVE EQUILIBRIUM
($ per unit) S
• THERE IS EXCESS
1. Price is above
SUPPLY - SURPLUS Surplus
the market
• DOWNWARD
P1 clearing price –
PRESSURE ON PRICE
P1
• QUANTITY DEMANDED 2. Qs > QD
INCREASES AND P0 3. Price falls to
QUANTITY SUPPLIED
the market-
DECREASES
clearing price
• THE MARKET ADJUSTS 4. Market adjusts
UNTIL NEW
to equilibrium
EQUILIBRIUM IS D
REACHED

Q Q0 QS Quantity
D
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 The Market Mechanism
• THE MARKET PRICE IS BELOW Price
EQUILIBRIUM:
($ per unit)
• THERE IS A EXCESS 1. Price is below
DEMAND - SHORTAGE the market
• UPWARD PRESSURE ON clearing price
PRICES – P2
• QUANTITY DEMANDED
2. QD > QS
DECREASES AND QUANTITY 3. Price rises to
SUPPLIED INCREASES
P3 the market-
• THE MARKET ADJUSTS
clearing price
UNTIL THE NEW 4. Market adjusts
EQUILIBRIUM IS REACHED. P2 to equilibrium

Shortage D
QS Q QD Quantity
3
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Changes In Market Equilibrium
• Raw material prices fall P D
S
• S shifts to S’ S’
• Surplus at P1 between
Q1, Q2
• Price adjusts to
equilibrium at P3, Q3
P1
P3

Q1 Q3Q2 Q
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Changes In Market Equilibrium
D D’
P
• Income Increases S
• Demand increases to D1
• Shortage at P1 of Q1, Q2
• Equilibrium at P3, Q3 P3
P1

Q1 Q3 Q Q
2
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Changes In Market Equilibrium
P D
• Income Increases & raw D’ S S’
material prices fall
• Quantity increases
• If the increase in D is
greater than the
increase in S price also P2
increases P1

Q1 Q2 Q
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 Market for a College Education
P S2002
(annual cost
in 1970 New
dollars)
equilibrium
• The real price of a was reached
college education rose $3,917 at $4,573 and
55 percent from 1970 S1970 a quantity of
to 2002. 12.3 million
• Increases in costs of students
modern classrooms
and wages increased
costs of production – $2,530
decrease in supply
• Due to a larger
percentage of high D1970 D2002
school graduates
attending college,
Q (millions enrolled))
demand increased 8.6 13.2
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 The Long-Run
Behavior
Resource Market Equilibrium of Natural
Resource Prices

S1900
Price S1950
S2002

• Consumption of copper
has increased about a
hundred fold from 1880
through 2002.
• The long term real price
for copper has remained
relatively constant.
• Increased demand as
world economy grew
• Decreased production
costs increased supply
Long-Run Path of
Price and Consumption
• Conclusion
• Decreases in the costs of
production have increased
D1900 the supply by more than
D1950 D2002 enough to offset the
increase in demand.
Quantity
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 Elasticities of Supply and Demand • The percentage change in a variable is the
• Not only are we concerned with what direction price absolute change in the variable divided by
and quantity will move when the market changes, but the original level of the variable.
we are concerned about how much they change. • Therefore, elasticity can also be written as:
• Elasticity gives a way to measure by how much a
variable will change with the change in another Q Q P Q
EPD = =
variable. P P Q P
• Specifically, it gives the percentage change in one
variable resulting from a one percent change in
another.

• Usually a negative number

• Measures the sensitivity of quantity demanded to price • As price increases, quantity decreases
changes. • As price decreases, quantity increases
• It measures the percentage change in the quantity • When EP > 1, the good is price elastic
demanded of a good that results from a one percent
• %Q > % P
change in price.
%Q D
• When EP < 1, the good is price inelastic
E D
=
%P
P
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• %Q < % P
Price Elasticity of Demand
Price EP = -
Demand Curve
4
Q = 8 – 2P
Elastic

2 Ep = -1

Inelastic

Ep = 0
4 8 Q
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 Infinitely Elastic Demand
Price

• The steeper the demand curve

becomes, the more inelastic the
EP = 
good.
• The flatter the demand curve
becomes, the more elastic the
good P* D
• Two extreme cases of demand
curves
• Completely inelastic demand –
vertical
• Infinitely elastic demand -
horizontal

Quantity
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Completely Inelastic Demand

Price
D

EP = 0

Q* Quantity
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• Income Elasticity of Demand
• Measures how much quantity demanded changes Q/Q I Q
with a change in income. EI = =
I/I Q I

• Cross-Price Elasticity of Demand

• Measures the percentage change in the quantity Qb Qb Pm Qb
demanded of one good that results from a one EQb Pm = =
Pm Pm Qb Pm
percent change in the price of another good.

• Complements: Cars and Tires

• Cross-price elasticity of demand is negative
• Price of cars increases, quantity demanded of tired decreases
• Substitutes: Butter and Margarine
• Cross-price elasticity of demand is positive
• Price of butter increases, quantity of margarine demanded increases
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 Elasticity: An Application
• During 1980’s and 1990’s, market for wheat went QD = QS
through changes that had great implications for 1800 + 240P = 3550 – 266P
American farmers and US agricultural policy
506P = 1750
• Using the supply and demand curves for wheat, P = $3.46 per bushel
we can analyze what occurred in this market
• Supply: QS = 1800 + 240P Q = 1800 + (240)(3.46) = 2,630 million bushels
• Demand: QD = 3550 – 266P
• We can find the elasticities of
demand and supply at these points

• Assume the price of wheat is $4.00/bushel P QD 3.46

due to decrease in supply EPD = = (−266) = −.035
Q P 2,630
QD = 3,550 − (266)(4.00) − 2,486
P QS 3.46
D
=
4.00
( −266) = −0.43
EPS = = (240) = .032
E P
2,486 Q P 2,630

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