The Market Model

Submitted to:

Dr. IKM Mokhtarul Wadud

ECO-134, Sec- 9

Date: 06/12/2007

Submitted by:
Nur Uddin Sabuj
061-476-030

North South University

Dhaka, Bangladesh
Q1 Taking an empirical example, identity the demand and supply functions,
calculate the equilibrium price and quantities.

Answer: In order to simplify the matter, I will take the quantity in the vertical axis as
opposed to price. This is not in accordance with normal economic practices were the
converse is done. Taking the example of Coke as the commodity the demand function of the
good would be:

Q = a – bP
And, the supply function would be

Q = -c + dP

The equilibrium solutions of the price and quantity would be,

P* =
And,
–
Q* =

Now in order to see how the changes of any one of these parameters affect the entire
equilibrium we need to take the partial derivate of each. Concentrating on P* we can get the
following derivatives:

= --

= [= ]

= -- [= ]

Now since all the parameters are confined to positive values, we can conclude that for the
present, model:

= >0

And,

= <0
In order to completely understand this we need to take theoretical values of the parameters
and find out the changes which occur to the market model when any one of these values is
changed.

Q2 Show how the law of demand and supply works.

Answer: The law of demand states that with increasing price, the demand for a particular
good will decrease by a certain amount.

The law of supply, on the other hand, states that with an increase in price the supply for a
particular good will increase.
Q

figure-a
Q*

0 P* P

By these laws, we can find the equilibrium price and quantity for any good. This concept is
represented in the graph figure-a. the point of intersect of the two graphs is known as the
equilibrium point and the values price and quantity at that point are known as the equilibrium
price (P*) and equilibrium quantity (Q*) respectively.

Q3 Graphically represent the market model and show the changes in demand and
supply.

Answer:

Let the demand for coke be represented by the following demand function:

Q = 100 - 2P

The supply function can then be represented as:

Q= -20 + 4P

Thus the equilibrium price and quantity would be

100 – 2P = -20 + 4p,

Or, P* = 20

And

Q = 100 – 2(20)
Or, Q* = 60

The curve would look as shown in figure-b

 Q

Q*

0 P* P

figure-b

Now let the y intercept of the demand curve be changed from 100 to 120 to make a new
function:

Q = 115 – 2P

Let the supply function be the same. The new equilibrium price would then be

115 – 2P = -20 + 4P
Or, P* = 22.5

And

Q = 115 – 22.5(2)
Q* = 70

When represented in a graph, like the one in figure-c, the increased value for the y intersect
causes the entire demand curve to make a parallel upward shift which then gives us an
increased value for both the equilibrium price and quality than it was previously. This is in
accordance to the result we found before, were > 0.
Q

Q*

0 P* P*’ P

figure-c

Now let the y intercept of the supply curve be changed from -20 to -38. The new supply
function would then be:

Q = -38 + 4P
Taking the demand function mentioned first we get the following equilibrium values

100 – 2P = -38 + 4P,

P* = 23

And

Q = -38 + 4(23)
Q* = 54

When seen in figure-d the change has a similar interpretation, but the parallel shift is for the
supply curve this time, and it is downwards because the vertical intercept is negative. The
result that the new P* is greater than the older P* again proves that > 0.
Q Q

S S

Q* Q*

D D

0 P* P*’ P 0 P*’ P* P

figure-d figure-e
Now while keeping the y intercept constant let us increase the gradient of the demand
function from 2 to 4 to make a new function

Q = 100 – 4P

Let the supply function be the same. The new equilibrium price would then be

100 – 4P = -20 + 4P
Or, P* = 15

And

Q = 100 – 15(4)
Q* = 40
Here we get a lower value for the equilibrium price. When seen graphically in figure-e the
slope of the demand function will become steeper as it assumes a larger (absolute) value. The
decrease in P* is in accordance with < 0.

Now let the gradient be changed to 8 while keeping the y intercept the same. We then get the
new supply function:

Q = -20 + 8P
Taking the same demand function we get the new equilibrium values as:

100 – 2P = -20 + 8P
P* = 12

And

Q = -20 + 8(12)
Q* = 76

Figure-f represents this graphically. The increase in the gradient that results in a steeper
supply curve also gives rise to a decreased value for the new P*. This is also according to the
negative sign of the comparative-static derivative <0
Q

Q*

0 P*’ P* P

figure-f

Q4 Clearly distinguish between changes in quantity demanded and changes in

demand.

Answer: Figures-g and figure-h shows the difference between changes in quantity
demanded and change in demand. Change in quantity demand means the moving of the price
along the same demand curve and hence finding the unique demand level for different prices.
Change in demand means a shift in the entire demand curve which results in different price
levels for the same amount of demand.

Q Q

Q*

D D

0 P 0 P* P*’ P

figure-g figure-h