PRICE AND QUANTITY

DETERMINATION

Dr MONIKA JAIN
 THE MARKET FORCES OF
SUPPLY AND DEMAND

 Supply and Demand are the forces that make

market economies work!
 In a market economy, the price of a good is
determined by the interaction of demand and
supply
 Modern microeconomics is about supply,
demand, and market equilibrium.

2
 MARKET

 A market is a place group of buyers and sellers of a

particular good or service.
 Buyers determine demand...
 Sellers determine supply...

3
 DEMAND
 Demand indicates how much of a product consumers are
both willing and able to buy at each possible price during
a given period, other things remaining constant.

4
THE CONCEPT OF DEMAND. . .
P
 Quantity Demanded refers
to the amount (quantity) of
a good that buyers are
willing to purchase at
various prices for a given
period.

Q
DEMAND CURVE FOR
PIZZA a
$15
b
12
c
Price

9
d
6
e
3
D
0
8 14 20 26 32
6
Quantity demanded
 DETERMINANTS OF
HOUSEHOLD DEMAND
• The price of the product in question.
• The income available to the household.
• The prices of related products available to the
household.
• The household’s tastes and preferences.
• The household’s expectations about future income,
wealth, and prices.
• The number and composition of consumers

7
LAW OF DEMAND
 An inverse relationship exists between the price of a
good and the quantity demanded in a given time period,
ceteris paribus.
 Reasons:
 substitution
effect
 income effect
DEMAND SCHEDULE
DEMAND CURVE
 DEMAND CURVE

Demand Curves Slopes Downwards :

Traditional Approach was propagated by Alfred Marshall and
is based on the Utility Analysis..
Law of diminishing Marginal Utility states as a
consumer has more of a commodity, the utility derived
from the successive units goes on decreasing.
Consumer will continue consuming a commodity until
the marginal utility of the commodity becomes equal to
it’s price.
 DEMAND CURVE

Modern Approach :

Income Effect Substitution Effect

Income Effect in the price of a commodity affects the purchasing

power (real income) of a household. A fall in the price
causes an increase in the real income and vice versa.
Substitution Effect : When the price of a commodity falls, the
relative price of it’s substitute automatically increases ie
when price of a commodity falls, it becomes relatively
cheaper than other commodities.
DEMAND SCHEDULE
AND DEMAND CURVE
 Individual demand

 Market demand

13
DEMAND SCHEDULE

 A demand schedule is a table showing how much of a given

product a household would be willing to buy at different
prices.
 Demand curves are usually derived from demand schedules.

14
DEMAND SCHEDULE
Price Quantity Demanded
per Pizza per Week (millions)

a $15 8
b 12 14
c 9 20
d 6 26
e 3 32

15
DEMAND CURVE FOR
PIZZA a
$15
b
Price per pizza

12
c
9
d
6
e
3
D
0
8 14 20 26 32
Millions of pizzas per week
16
MARKET DEMAND CURVE

 Market demand is the horizontal summation of

individual consumer demand curves
 EXTENSION AND CONTRACTION OF DEMAND
VS. INCREASE AND DECREASE IN DEMAND
 Extension and contraction of demand
 Movement along the demand curve is caused by a
change in the Price of
the product.
 Increase and decrease in Demand (Shift)
A shift in the demand curve, either to the left or right is caused by
changes in Non-Price Factors.

18
CHANGES IN QUANTITY DEMANDED

Price

$2.00

D
Quantity

7
19
EXTENSION OF DEMAND

Price

$2.00

$1.00
D
Quantity

7 13
20
EXTENSION OF DEMAND
Price
Caused by
a change
$2.00 in Price

$1.00
D
Quantity

7 13
21
 CHANGES IN CONSUMER
INCOME
 If income ↑, consumers willing and able to buy more
which ↑ demand
 Demand curve shifts to the right
 Two categories of goods:
 Normal goods – demand increases as money income increases
 Inferior goods – demand decreases as money income increases
 Examples: used clothing, bus rides, etc.

22
(SHIFT) INCREASE IN DEMAND
Price

$2.00

D’
D

7 10 Quantity
23
(SHIFT) CHANGE IN DEMAND
Price Caused by
Non-Price
Factors:
$2.00 Income,
Tastes...

D’
D

7 10 Quantity
24
THE IMPACT OF A CHANGE IN INCOME
• Higher income decreases the • Higher income increases the
demand for an inferior good demand for a normal good
EXCEPTION TO LAW OF DEMAND
 Veblen Goods- Goods like diamond etc. where
with an increase in price of the good, Quantity
demanded increases.
 Giffen goods
 Conspicuous Necessities
 Future changes in price
 Emergencies
 Change in fashion/Brand loyalty
EXCEPTIONS TO THE LAW OF
DEMAND

► -Veblen goods Veblen goods are also called status-symbol or ostentatious goods

Price of a Veblen good

D

Quantity
Demanded
VEBLEN GOODS
 Goods that some people prefer to buy more of as their
prices increase, as they confer higher status.
 Luxury cars, high-end wines, designer clothes

 Conspicuous consumption is a term used to describe the

lavish spending on goods and services acquired mainly
for the purpose of displaying income or wealth.
APPLE’S IPHONE 3G KING’S BUTTON: “ “THE MOST AMAZING FEATURE OF
THIS PHONE IS ITS HUGE DIAMOND .” PRICE = 2,517,345 EUROS
EXCEPTIONS TO THE LAW OF DEMAND
 Giffen goods-named after Sir Robert Giffen
As price rises, people consume more of it, violating the law
of demand.
Cheaper close substitutes are not available and
It is an inferior good.
 GIFFEN GOODS

A Giffen good is an inferior that constitutes a large percentage of the very poor’s
income. e.g. rice in china.

Price of a Giffen good

D

Quantity
Demanded
 SUPPLY

Quantity supplied is the amount of a good

that sellers are willing and able to sell.
DETERMINANT OF SUPPLY:
MARKET PRICE
Law of Supply P
There exists a direct
(positive)
relationship
between Price and
Quantity Supplied.

Q
DETERMINANTS OF SUPPLY
 Market price
 Input prices
 Technology
 Expectations
 Number of producers
CHANGE IN QUANTITY SUPPLIED
VS. CHANGE IN SUPPLY

 Change in Quantity Supplied

 Movement along the supply curve.
 Caused by a change in the Price of the product.
 Change in Supply (Shift)
 A shift in the supply curve, either to the left or right.
 Caused by changes in Non-Price Factors
CHANGES IN QUANTITY SUPPLIED
S
Price

$2.00

Quantity

3
CHANGES IN QUANTITY SUPPLIED
S
Price

$2.00

$1.00

Quantity

1 3
CHANGES IN QUANTITY SUPPLIED
S
Price
Caused by
a change
$2.00 in Price

$1.00

Quantity

1 3
CHANGE (SHIFT) IN SUPPLY
S S’
Price

$2.00

Quantity

3 6
CHANGE IN SUPPLY
S S’
Price
Caused by
Non-Price
$2.00
Factors:
Technology,
Input Prices

3 6 Quantity
 CHANGE IN SUPPLY
Price of S3
Ice-
Cream
S1 S2
Cone

Decrease
in Supply

Increase
in Supply

Quantity
0 of Ice-
Cream
SUPPLY AND DEMAND TOGETHER

 Equilibrium Price
The price at which the supply and demand curve intersect.
The state in which market supply and demand balance each other and, as
a result, prices become stable.

 Equilibrium Quantity
The quantity at which the supply and demand curve intersect; that is,
Quantity Supplied and Quantity Demanded are equal.
FORCES OF DEMAND. . .
Price

Quantity
FORCES OF DEMAND AND SUPPLY. . .
Price

Quantity
FORCES OF DEMAND AND SUPPLY
AT REST
MARKET EQUILIBRIUM
Price
S

$2.00

D
Quantity

7
EQUILIBRIUM VS. DISEQUILIBRIUM CONT’D..
 Disequilibrium- if the price or supply of the good is anywhere but at
equilibrium.

 What causes disequilibrium?

1. SURPLUS- there is more supplied than demanded, sellers
HAVE to cut prices to sell products

2. SHORTAGE- consumers demand more than what is supplied

Buyers and Sellers will force the market to return to equilibrium

ACTIONS OF BUYERS AND SELLERS
THAT MOVE TOWARD EQUILIBRIUM.
 Excess Supply
Price is above equilibrium price, therefore producers are unable to sell
all they want at the going price.
 Excess Demand
Price is below equilibrium price, therefore consumers are unable to
buy all they want at the going price.
 EQUILIBRIUM OF
SUPPLY AND DEMAND
Price of
Ice-Cream
Cone
Supply
$3.00
Equilibrium
2.50

2.00

1.50

1.00

0.50 Demand
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 EXCESS SUPPLY
Price of
Ice-Cream
Cone
Supply
Surplus
$3.00

2.50

2.00

1.50

1.00

0.50 Demand
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 EXCESS DEMAND
Price of
Ice-Cream
Cone

Supply

$2.00

$1.50

Shortage Demand

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of
Ice-Cream Cones