Business Economics

Lecture -2

Dr. Muhammad Mehboob

Department of Business Administration

IQRA, Karachi

MBA

(IQRA, KHI) 1
 Outline

• The Market Forces: Demand and Supply

• Law of Demand and Supply

• Demand Schedule and demand Curve

• Supply Schedule and Supply Curve

• Individual and Market Demand Curve

• Individual and Market Supply Curve

• Shift in demand curve
• Shift in Supply curve
• Equilibrium
• Changes in the Equilibrium, Price and Output

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 Markets and Competition
A market is an institutional arrangement under which buyers and sellers can
exchange some quantity of a good and service at a mutually agreeable price.

A market is a group of buyers and sellers of a particular good or service.

The buyers as a group determine the demand for the product, and the sellers
as a group determine the supply of the product

A competitive market is a market that has many buyers and many sellers so
no single buyer or seller can influence the price.

A perfectly competitive market:

-all goods exactly the same
-the buyers & sellers so numerous that no one can affect market price – each
is a “price taker”

In this Lecture, we assume markets are perfectly competitive.

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 Demand

In ordinary language the word demand means desire. However, in economics

demand means;

Willingness and ability of the consumers to purchase a commodity at a given

price ‘that they must pay’ in a given time period.

 Ability to buy it
 Willingness to pay for it
 At a given price
 In a given time period

In simple; If you demand something, then you

1 Want it,
2 Can afford it, and
3 Have made a definite plan to buy it.

Wants or desires are the unlimited. Demand reflects a decision about

which wants to satisfy.

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 Quantity of Demand and Law of Demand

Quantity of Demand
the amount of a good that consumer/buyers are willing and able to buy, at
each possible price over a given period of time.

The Law of Demand

The law of demand states:
“Other things remaining the same, when the price of any commodity increases
its demand falls and when price falls its demand increases”.

According to the law of demand there is inverse relationship between quantity

demanded and price.

Qd = F(P)

The law of demand results from:

 Substitution effect
 Income effect

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 Law of Demand cont.
Substitution effect
When the relative price of a good rises, people seek substitutes for it, so the
quantity demanded of the good decreases.
The substitution effect involves the substitution of good x1 for good x2 or
vice-versa due to a change in relative prices of the two goods.

Income effect
When the price of a good rises relative to income, people cannot afford all
the things they previously bought, so the quantity demanded of the good or
service decreases.

The income effect results from an increase or decrease in the consumer’s

real income or purchasing power as a result of the price change.

The sum of these two effects is called the price effect

Law can not Operate

Precious and Cheap Goods
Cheapest and costly goods demand remain constant. For example salt and
diamond demand can not change due to change in price.
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 Demand Curve and Demand Schedule
Demand schedule:
 Demand schedule is a table showing the Price Quantity
quantity of a commodity that consumers are of of Apples
willing and able to purchase during a given Apple demanded
period of time at each price of the commodity. $0.00 16
 Demand schedule is a table that shows the
relationship between the price of a good and 1.00 14
the quantity demanded 2.00 12

Example: 3.00 10
Asim's demand for Apples. 4.00 8
Notice: that Asim's preferences obey the 5.00 6
law of demand
6.00 4

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 Demand Curve
Demand curve is a graphical representation of the demand schedule
Price of
Apples Quantity
Price
of Apples
$6.00 of Apple
demanded

$0.00 16
$5.00
1.00 14

$4.00 2.00 12

3.00 10
$3.00
4.00 8
$2.00 5.00 6

$1.00 6.00 4

$0.00 Quantity of
Apples
0 5 10 15
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 Demand Curve (cont..)
A demand curve is graph that shows the relationship between the quantity
demanded of a good and its price when all other things equal.

The downward-sloping line relating price and quantity demanded is called

the demand curve

In demand curve, price is shown

on the vertical axis and the quantity is
plotted on the horizontal axis

Demand curve always slope downward

from left to right. Because with
the fall in price demand increase.

A rise in the price, other things

remaining the same, brings a decrease
in the quantity demanded and a
movement along the demand curve.

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 Market Demand versus Individual Demand
Market demand refers to the sum of all individual demands for a particular
good
Market demand is the sum of the quantities demanded by all buyers at each price.
Suppose Asim and Imran are the only two buyers in the apple market. (Qd = quantity
demanded)
Graphically, individual demand curves are summed horizontally to obtain the market
demand curve.

Price Asim's Qd Imran’s Qd Market Qd

$0.00 16 + 8 = 24
1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
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 The Market Demand Curve for Apples

P Qd
P
$6.00
(Market)
$0.00 24
$5.00
1.00 21
$4.00 2.00 18
$3.00 3.00 15

$2.00 4.00 12
5.00 9
$1.00
6.00 6
$0.00
0 5 10 15 20 25 Q

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 Change in Quantity Demanded versus Change in Demand

Change in Quantity Demanded

Caused by a change in the price of the product.

A Movement along the Demand Curve

When the price of the good changes and everything else remains the same, the
quantity demanded changes and there is a movement along the demand curve.

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 Changes in Quantity Demanded

Price of
Cigarettes per
Pack
A tax that raises the
price of cigarettes
C results in a movement
$4.00
along the demand
curve.

2.00 A

D1
0 12 20 Number of Cigarettes Smoked per Day

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 Change in Demand
A shift in the demand curve, either to the left or right.

Caused by a change in a determinant other than the price.

When some influence on buying plans other than the price of the good changes,
there is a change in demand for that good.

The quantity of the good that people plan to buy changes at each and every
price, so there is a new demand curve.

When demand increases, the demand curve shifts rightward.

When demand decreases, the demand curve shifts leftward.

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 Change in Demand
A Shift of the Demand Curve
If the price remains the same but one
of the other influences on buyers’
plans changes, demand changes
and the demand curve shifts.

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 Determinants of Demand/ Shift in the demand
curve

Main factors that change/shift the entire demand curve are:

¨Consumer Income
¨The prices of related goods
¨ Expectations
¨ Expected future income
¨ Population/Number of buyers
¨ Preferences/ taste

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17
 Consumer income

A good for which quantity demanded rises with income is called normal good.

Therefore demand for normal good is positively related to consumer income.

• An increase in income causes increase in quantity demanded at each price,

shifting the D curve to the right.

A good for which quantity demanded falls as income increases is called inferior
good.

Therefore demand for inferior good is negatively related to consumer income

• An increase in income shifts D curves for inferior goods to the left

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 Consumer Income
Normal Good
Price of Ice-
Cream Cone

$3.00 An increase
2.50 in income...
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1
Quantity of Ice-
0 1 2 3 4 5 6 7 8 9 10 11 12 Cream Cones
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 Consumer Income
Inferior Good
Price of Ice-
Cream Cone

$3.00

2.50 An increase
2.00
in income...
Decrease
1.50 in demand
1.00

0.50

D2 D1 Quantity of Ice-Cream
Cones
0 1 2 3 4 5 6 7 8 9 10 11 12
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 Prices of related goods
When a fall in the price of one good reduces the demand for another good, Or an
increase in the price of one good causes an increase in demand for the other, the
two goods are called substitutes.

A substitute is a good that can be used in place of another good.

Example: pizza and burgers. An increase in the price of pizza

increases demand for burgers, shifting burger demand curve to the right.
Other examples: Coke and Pepsi, laptops and desktop computers,

When a fall in the price of one good increases the demand for another good,
or an increase in the price of one causes a fall in demand for the other, the two
goods are called complements.

A complement is a good that is used in conjunction with another good.

Example: computers and software.

If price of computers rises, people buy fewer computers, and therefore less
software. Software demand curve shifts left.
Other Examples: Sugar and milk, Petrol and Car

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 Expectation

Expectations affect consumers’ buying decisions

Expected Future Prices

If the price of a good is expected to rise in the future, current demand for the
good increases and the demand curve shifts rightward.

Example:

Expected Future Income

When income is expected to increase in the future, the demand might increase
now.

Example
If people expect their incomes to rise, their demand for meals at expensive
restaurants may increase now.

If the economy turns bad and people worry about their future job security,
demand for new autos may fall now.

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 Population and Number of buyers

Population
The larger the population, the greater is the demand for all goods.

An increase in the number of buyers causes an increase in quantity

demanded at each price, which shifts the demand curve to the right.

P
$6.00
Suppose the number of buyers
$5.00 increases.
$4.00 Then, at each price, quantity
demanded will increase.
$3.00

$2.00
$1.00

$0.00
0 5 10 15 20 25 30
Q
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 Tastes and Preferences

Tastes
Anything that causes a shift in tastes toward a good will increase demand for
that good and shift its D curve to the right.

Preferences
People with the same income have different demands if they have different
preferences.

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 Own-Price changes

A Movement along the Demand

Curve
When the price of the good
changes and everything else
remains the same, the quantity
demanded changes and there is a
movement along the demand
curve.

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 Summary: Variables That Affect Demand

Variable A change in this variable…

Price …causes a movement

along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve

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 Practice Question: Demand curve

Draw a demand curve for music downloads. What happens to it in each

of the following scenarios? Why?

A. The price of iPods falls

B. The price of music downloads falls
B. The price of compact discs falls

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 A. Price of iPods falls

Music
Music downloads
downloads and and
Price of music iPods
iPods are are complements.
complements.
down-loads
AAfall
fall in
in price
price of
of iPods
iPods shifts
shifts
the
the demand
demand curve curve for
for
music
music downloads
downloads
to
to the
the right.
right.

P1

D1 D2

Q1 Q2 Quantity of
music downloads

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 B. Price of music downloads falls

Price of
music
down-
The
The DD curve
curve
loads
does
does not
not shift.
shift.
Move
Move down
down along
along curve
curve to
to aa

P1 point
point with
with lower
lower P,
P, higher Q..
higher Q

P2

D1

Q1 Q2 Quantity of
music downloads

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 C. Price of CDs falls

Price of
music down-
loads CDs
CDs and and
music
music downloads
downloads areare
substitutes.
substitutes.
AAfall
fall in
in price
price of
of CDs
CDs shifts
shifts
demand
demand for for music
music downloads
downloads
to
to the
the left.
left.
P1

D2 D1

Q2 Q1 Quantity of
music downloads

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 Supply

• Supply comes from the behavior of sellers.

• Willingness and ability of the sellers/producers to produce and sell a

commodity at a given price in a given time period.

• Quantity of Supplied

the amount of goods that producers willing and able to produce and sell during a
given time period at a particular price.

Example:

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 Law of Supply
Other things remaining the same as the price of any commodity rises,
its supply also rises and as price falls, its supply also falls.

The law of supply states that there is a direct (positive) relationship

between price and quantity supplied.

The law of supply results from the general tendency for the marginal
cost of producing a good or service to increase as the quantity
produced increases.

Producers are willing to supply a good only if they can at least cover
their marginal cost of production.

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 Supply Curve and Supply Schedule
Quantity
Supply schedule: Price
of Apples
of lattes
A table that shows the relationship between supplied
the price of a good and the quantity $0.00 0
supplied.
1.00 3
Example: 2.00 6
Starbucks’ supply of apples.
3.00 9
Notice that Starbucks’ supply schedule
4.00 12
obeys the Law of Supply.
5.00 15

6.00 18

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 Supply Curve
The supply curve is the graph that shows the relationship between the quantity
supplied of a good and its price when all other things are equal.

P
$6.00

$5.00

$4.00

$3.00

$2.00

$1.00

$0.00
Q
0 5 10 15

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 Market Supply versus Individual Supply
Market supply refers to the sum of all individual supplies for all sellers of a
particular good or services
The quantity supplied in the market is the sum of the quantities supplied by all
sellers at each price.
Graphically, individual supply curves are summed horizontally to obtain the market
supply curve.
Suppose A and B are the only two sellers in this market. (Qs = quantity supplied)

Price A B Market Qs
$0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30
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 The Market Supply Curve

QS
P
P (Market)
$6.00 $0.00 0
$5.00 1.00 5

$4.00
2.00 10
3.00 15
$3.00
4.00 20
$2.00 5.00 25
$1.00 6.00 30
$0.00 Q
0 5 10 15 20 25 30 35

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 Change in Quantity Supplied

Quantity supplied is the amount of a good that sellers are willing and
able to sell.

Caused by a change in the price of the commodity.

A Movement Along the Supply Curve

When the price of the good changes and other things are equal, the quantity
supplied changes and there is a movement along the supply curve.

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 Change in Quantity Supplied
Price of Ice-
Cream Cone

S
C
$3.00 A rise in the price of ice cream
cones results in a movement
along the supply curve.

A
1.00

Quantity of Ice-
Cream Cones
0 1 5
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 Change in Supply

When some influence on selling plans other than the price of the good
changes, there is a change in supply of that good.

The quantity of the good that producers plan to sell changes at each and
every price, so there is a new supply curve.

When supply increases, the supply curve shifts rightward.

When supply decreases, the supply curve shifts leftward.

(IQRA, KHI) 39
 Change in Supply

Price of Ice-
Cream Cone
S3
S1 S2
Decrease in
Supply

Increase in
Supply

Quantity of Ice-
Cream Cones
0
(IQRA, KHI) 40
 Determinants of Supply and Shift in Supply Curve
Market price
Input prices
Technology
Expectations
Number of producers

(IQRA, KHI) 41
 Changes in input prices
Examples of input prices:
wages, prices of raw materials.

Consider the supply of ice cream, and suppose the price of sugar, an
input into producing ice cream, falls. Ice creams sellers now find that
selling ice cream more profitable than it was before, and they respond
to this by increasing the supply of ice cream. At any given price,
sellers are now willing to produce a larger quantity. The supply curve
for ice cream shifts to the right.

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 Changes in input prices
This is a change in supply. Ice cream sellers want to sell more ice
cream at each price of ice cream cone.

Price of
Ice-cream cone supply @ sugar price of
$10/Kg

Supply @ sugar price

of $6/kg

Quantity of
Ice-cream cones
Ice-Cream Market

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 Change in technology

Technology determines how much inputs are required to produce a

unit of output.

An improvement in technology makes it possible to produce a level of

output with fewer inputs than before. It lowers the cost of production,
profits rise, and firms will try to supply more.

A cost-saving technological improvement has same effect as a fall in

input prices, shifts the supply curve to the right.

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 Change in technology

There is an increase in supply. The supply curve shifts to the

right

Price of
Ice-cream cone Supply @ old
technology

Supply @ improved
technology

Quantity of
Ice-cream cones
Ice-Cream Market

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 Change in Expectation and Number of sellers
Expected Future Prices

If the price of a good is expected to rise in the future, the firm may
reduce supply now, to save some of its inventory to sell later at the
higher price.

This would decrease supply of the good today and shift the supply
curve leftward.

The Number of Suppliers

The larger the number of suppliers of a good, the greater is the supply
of the good. An increase in the number of suppliers shifts the supply
curve rightward.

An increase in the number of sellers increases the quantity supplied at

each price, shifts the supply curve to the right.

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 Summary: Variables That Affect Supply

Variables that
Affect Quantity Supplied A Change in This Variable . . .
Price Represents a movement along
the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve

Dr. S. Irshad (IQRA, KHI) 47

 Demand and supply together or Market Equilibrium
Equilibrium is a situation in which various forces are in balance.

But in economics equilibrium is a situation in which the market price

has reached the level at which quantity supplied equals quantity
demanded

Equilibrium in a market occurs when the price balances the plans of

buyers and sellers.

The point at which the supply and demand curves intersect. This point
is called the market’s equilibrium

A price at which the quantity demanded equals the quantity supplied is

called an equilibrium price.

The equilibrium quantity is the quantity bought and sold at the

equilibrium price.
¨ Price regulates buying and selling plans.
¨ Price adjusts when plans don’t match.
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 Equilibrium of Supply and Demand

Price of Ice- Equilibrium:

Cream Cone P has reached
the level where
quantity supplied equals
quantity demanded Supply
$3.00

2.50 Equilibrium

2.00

1.50

1.00

0.50 Demand
Quantity of Ice-
Cream Cones
0 1 2 3 4 5 6 7 8 9 10 11 12
(IQRA, KHI) 49
 Excess Supply
when quantity supplied is greater than quantity demanded

Price of
Ice-Cream Cone
Supply
Surplus
$3.00 If the price is $2.5, the quantity
supplied exceeds the quantity
2.50 demanded. There is a surplus of
6 ice-cream cones.
At prices above the equilibrium
2.00 price, a surplus forces the price
down. So facing a surplus,
sellers try to increase sales by
1.50 cutting the price
Prices continue to fall until
1.00 market reaches equilibrium

0.50 Demand
Quantity of Ice-
0 1 2 3 4 5 6 7 8 9 10 11 12 Cream Cones
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 Excess Demand
When quantity demanded is greater than quantity supplied

Price of
Ice-Cream If the price is $1.5, the quantity
Cone demanded exceeds the
quantity supplied. There is a
Supply shortage of 6 ice-cream cones
At prices below the equilibrium
price, a shortage forces the
price up so “facing a shortage”
$2.00 sellers raise the price
Prices continue to rise until
$1.50
market reaches equilibrium.

Shortage Demand

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of
Ice-Cream Cones
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 Effects of a shift in demand and supply curve on Equilibrium
Three Steps to Analyzing Changes in Equilibrium

To determine the effects of any event

• Decide whether the event shifts the supply or demand

curve (or both).
• Decide whether the curve(s) shift(s) to the left or to the
right.
• Examine how the shift affects equilibrium price and
quantity by using supply-demand diagram

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 How an Increase in Demand Affects the Equilibrium

1. Hot weather increases

Price of the demand for ice cream...
Ice-Cream
Cone

Supply

$2.50 New equilibrium

2.00
2. ...resulting Initial
in a higher equilibrium
price...
D2

D1
0 3. ...and a higher 7 10 Quantity of
Ice-Cream Cones
quantity sold.
(IQRA, KHI) 53
 How an Increase in Demand Affects the Equilibrium

When demand increases the demand curve shifts rightward.

At the original price, there is now a shortage and this shortage induces firms
to raise the price

When price rises, producers supply a larger quantity of ice-cream, even

though the supply curve has not shifted.

The price rises, and the quantity supplied increases along the supply curve.

Results
• When demand increases, equilibrium price rises and the equilibrium
quantity increases.

• When demand decreases, the equilibrium price falls and the equilibrium
quantity decreases.

(IQRA, KHI) 54
 How a Decrease in Supply Affects the Equilibrium

1. An increase in the price of

Price of
sugar, an input for making ice
Ice-Cream cream, reduces the supply of Ice-
Cone cream
S2
S1

New
$2.50 equilibrium

2.00 Initial equilibrium

2. ...resulting
in a higher
price... Demand

0 1 2 3 4 7 8 9 10 11 12 13 Quantity of
Ice-Cream Cones
3. ...and a lower quantity sold.
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 How a Decrease in Supply Affects the Equilibrium

When supply decreases the supply curve shifts leftward.

At the original price, there is now an excess demand for ice cream and
this shortage causes firms to raise the price.

As Figure shows, the shift in the supply curve raises the equilibrium price from
$2.00 to $2.50 and lowers the equilibrium quantity from 7 to 4 cones.

As a result of the sugar price increase, the price of ice cream rises, and the
quantity of ice cream sold falls

Results

• When supply decreases, the equilibrium price rises and the equilibrium
quantity decreases

• When supply increases, the equilibrium price falls and the equilibrium quantity
increases.

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 A Change in Both Supply and Demand

P
S1
S2

P1
P2
D2
D1
Q
Q1 Q2

(IQRA, KHI) 57
 A Change in Both Supply and Demand

Increase in Both Demand and Supply

• An increase in demand and an increase in supply increase the

equilibrium quantity.

• The change in equilibrium price is uncertain because the increase in

demand raises the equilibrium price and the increase in supply lowers it.

• But effect on Price is ambiguous: If demand increases more than supply,

Price rises. If supply increases more than demand, Price falls.

Decrease in Both Demand and Supply

• A decrease in both demand and supply decreases the equilibrium

quantity.
• The change in equilibrium price is uncertain because the decrease in
demand lowers the equilibrium price and the decrease in supply raises it.

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 A Change in Both Supply and Demand

Decrease in Demand and Increase in Supply

A decrease in demand and an increase in supply lowers the equilibrium

price.

The change in equilibrium quantity is uncertain because the decrease in

demand decreases the equilibrium quantity and the increase in supply
increases it

Increase in Demand and Decrease in Supply

An increase in demand and a decrease in supply raises the equilibrium

price.

The change in equilibrium quantity is uncertain because the increase in

demand increases the equilibrium quantity and the decrease in supply
decreases it.

(IQRA, KHI) 59
 Summary

• Demand is a function of own-price, income, prices of other

goods, and tastes etc.
• The law of demand says that demand curves are negatively
sloped.
• The demand curve shows the relationship between the quantity
of demanded of a good and a good's own price, all else
constant.
Demand curve always slope downward from left to right.
• Changes in own-price show up as movements along a demand
curve.
• Changes in income, prices of substitutes and complements, and
tastes show up as shifts in the demand curve.

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 Summary
• Supply is a function of own price, input prices, technology, future
expectation and number of sellers.

• The curve relating price and quantity supplied is called the supply curve.
• The upward-sloping supply curve reflects the Law of Supply, which
states that the quantity supplied depends positively on the good’s
price.
• Changes in a good’s own price show up as movements along a supply
curve.
• Changes in other determinants of supply include input prices,
technology, expectations, shift the S curve.
• The intersection of S and D curves determine the market equilibrium.
At the equilibrium price, quantity supplied equals quantity demanded.
• If the market price is above equilibrium, a surplus results, which causes
the price to fall. If the market price is below equilibrium, a shortage
results, causing the price to rise.

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