UTS CRICOS 00099F
Economics for
management
Seminar 6: Demand, Supply
and Equilibrium Prices
UTS CRICOS 00099F
The supply-demand model
01
Linking life and economics
Earlier this year you bought 3 kgs of bananas every week from the super market at $4.00 per kg. These
bananas are from far North Queensland. Last week the same super market increased the price of
bananas to $8.00 per kg.
Will you continue to buy bananas at $8.00 per kg?
If yes, will you buy more or less quantity (Qd) compared to previous purchases?
If not, what may be the reasons for not buying bananas at $8.00?
What may be reasons for the price of bananas to increase?
3
Why Should Managers Study Supply and Demand?
Managers need to understand:
• supply and demand to develop their own competitive strategies and to respond to the actions of their
competitors. (e.g. the concept of “substitutes’ & “complementary goods”, how price are set in a
competitive market?)
• how the structure of the market (e.g. competitive market, monopoly mkt etc) that their firm operates in
impacts supply and demand.
• how public policy will impact supply and demand. (ie the setting of price floor / price ceiling by the
government due to social objectives)
Under a free market (voluntary exchange) , we use the S/D model to see how price (P) are set in the
competitive market - the price mechanism
4
The Features of Demand
02
Demand (D)
The functional relationship between the price (P) of a good or service and the quantity demanded (Qd)
by consumers in a given period of time, all else held constant.
It represents the behaviour of consumers response to a change in price (P).
6
Non-price Factors Influencing ‘Demand’
• Tastes and preferences (e.g., Personal Protective Equipment (ppe; Face masks, gloves, gowns,
sanitizer, protective glasses etc…) ; trendy, health, environmentally products, info fm news, reports)
• Income (concept : Normal Goods vs Inferior goods) e.g., overseas holidays, brand shops, luxurious
items, consumer items)
• Prices of (other) related Goods (concept: substitute vs complement; e.g., Price of banana to
demand for apples)
• Future expectations (e.g., future income, future price)
• Number of potential consumers (e.g., Hospital staff during pandemic time & even an average person;
Demographic factors on property prices)
7
Tastes and Preferences
Tastes and preferences are how potential consumers feel about a good or service and how well a good
or service meets a consumer’s desire.
eg. Personal Protective Equipment (ppe; Face masks, gloves, gowns, sanitizer, protective glasses etc…)
Trendy items, environmentally products – electric cars, info fm news reports – apple & health)
8
Tastes and Preferences in Action
In the aftermath of the September 11, 2001, terrorist attacks on New York and Washington, D.C., the
tastes and preferences of U.S. consumers for airline travel changed dramatically. (e.g. impact on the
airline & the travel industry--- D decreases)
In spring, 2006, the National Chicken Council waged a campaign to prevent fears of the avian bird flu in
Asia from impacting the demand (D) for chicken in the United States.
(e.g. bird flu and demand for farm chickens vs frozen chickens; the mad cow disease impact on the
demand of beef in Europe; the consumption of cigarettes )
9
Income (Y)
The level of a person’s income also affects demand, because demand incorporates both willingness
and ability to pay for the good.
If an increase (decrease) in income causes a person to buy more (less) steak, then for that person,
steak is said to be a normal good. (e.g. brand shops, overseas holidays, expensive restaurants,
expensive cars.).
If an increase (decrease) in income causes a person to buy less (more) hamburger, then for that person,
hamburger is said to be an inferior good. (e.g. $2 shops; generic product vs tailor made product)
Class discussion : How about church??? Education ??? Entertainment???)
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Income in Action
Firms selling normal goods, like, jewelry, automobiles and clothing experience increases in sales when
the general economy is booming, like, in the late 1990’s.
(i.e. demand increase when income (Y) goes up)
Firms selling inferior goods, like, hamburger, used clothing and generic bleach experience increases in
sales when the general economy is in recession, like in the second half of 2008.
(i.e. demand increase when income (Y) goes down)
11
Prices of Related Goods
Prices of related goods will also affect the demand for a good or service.
Products or services are substitute goods for each other if one can be used in place of another. i.e.
consumers view the two goods as being essentially the same and purchase the cheaper of the two goods.
E.g. Coke and Pepsi, ipod download vs CD, McDonald vs Hungry Jack,
Class discussions : Increasing price for bananas to the demand for apples
Complementary goods are products or services that consumers use together. i.e. 2 goods consume
together – “cross-elasticity”
E.g. computers and printers, cars and GPS, frames & lenses etc…
12
Prices of Related Goods in Action
Since 2006 the abundance and relatively low prices of cell phones, iPods, and laptop computers resulted
in many teens and young adults no longer purchasing wristwatches. These all serve as substitutes for
watches (you don’t need the watch if you have a cell phone).
As prices of personal computers have dropped over time, there has been an increased demand for
printers and printer cartridges. Personal computers and printers are complementary products (you need a
PC if you want to use the printer).
13
Future Expectations in Action
In summer, 2004, many consumers responded to high lumber (timber) prices by waiting to purchase until
fall (Autumn) when a normal seasonal decline was expected to occur. One developer in Maryland bought
only as much wood as he needed week-by-week because the high summer prices had increased the cost
of wood for a typical apartment by 50 percent.
14
Number of Potential Consumers
The number of consumers in the marketplace influences the demand for a product.
Examples:
• Age care services (for the ageing population)  impact on the demand of nursing home
• Increasing migrations both from local and overseas impact on the property, rental market
• Growing middle class in China  impact on the demand of food (including milk power) from overseas
15
Number of Potential Consumers in Action
The effect of growing populations on demand (D) and grain, prices can be seen as both increases in the
size of the population in Asian and Latin American economies and growth in the middleclass segments of
these economies had a stimulating effect on the demand for many types of grain from US farmers.
(i.e. increasing number of buyers leading to higher demand, therefore pushing up Price and Quantity
demanded (Qd).
16
Demand (D)
Demand curves are generally portrayed as downward sloping,
suggesting an inverse or negative relationship between the price (P)
of the good and the quantity demanded (Qd), all else equal.
When the price of a good rises the quantity demanded (Qd) falls, all
else equal.
Class discussion: what do you think about consumption of bottled
water if price rises from 1.50 to $2.00? What should you do if you
cannot sell your computer; car; mobile phone, or textbook?
0
1
2
3
4
5
6
7
0 5 10 15
Quantity
P
ri
c
e
17
Demand Curve Shift vs. Movement Along a Demand Curve
The price decreases from P1 to P2, then the quantity
demanded(Qd) increases from Q1 to Q2.
P
Qd
D1
P1
Q1
P2
Q2
A
B
A to B: change (increase)
in quantity demanded (Qd)
i.e. movement along the
demand curve
18
Demand Curve Shift vs. Movement Along a Demand Curve
Income increases, then at the same price P1 the
quantity demanded increases from Q1 to Q2.
Class discussion: what do you think about the
demand for air-tickets in holiday periods?
A to B: change (increase) in demand (i.e. a shift of
the demand) curve
P
Q
D1
D2
P1
Q1 Q2
A B
Marketing is about stimulating demand
19
Individual vs. Market Demand
Market demand is the horizontal sum of individual demand curves.
Example: for P = 10 we have Q1= 5 and Q2 = 8.
Market demand=13
P
Q
D1 D2
D1 + D2
$10
1385
20
Class exercise
“International researchers claiming that the Australian honey producers produce honey are the most
contaminated in the world”
Use the S/D model to forecast the future equilibrium price (Pe) equilibrium level of output (Qe) for
Australian honey market
Australian Honey Market
21
The Features of Supply
03
Supply (S)
The functional relationship between the price (P) of a good or service and the quantity supplied (Qs) by
producers in a given time period, all else held constant.
(represent the behaviour of suppliers when price changes)
23
Non-price Factors Influencing Supply
• Technology (eg flat screen TV, computers, mobile phones )
• Input prices (eg labour costs, costs of raw material e.g. oil price)
• Prices of goods related in production (e.g. beef and hamburger, wheat and flour : input prices)
• Future expectations (i.e. future price, future profit)
• Number of producers (i.e. new firms entry)
24
Technology
The state of technology, or the body of knowledge about how to combine the inputs of production, affects
what output producers will supply because technology influences how the good or service is actually
produced, which, in turn, affects the costs of production. (e.g. factors of production)
What happens to the price of computers; flat screen TV if technology increases productivity, reduces
costs, results in less rejects?
25
Input Prices
Input prices are the prices of all the inputs or factors of production (factor prices) — labor (wage) , capital
(interests), land (rental), and raw materials (eg price of oil) — used to produce the given product. These
input prices affect the costs of production and, therefore, the prices at which producers are willing to
supply different amounts of output.
Wages up: ----- Supply of labour _____ ----- Price _____
26
Input Prices in Action
For broiler chickens, feed costs represent 70 to 75 percent of the costs of growing a chicken to a
marketable size. Thus, changes in feed costs are so important that market analysts often use them as a
proxy to forecast broiler (chicken) prices and returns to broiler processors.
Class discussion: how about the price of fertiliser and transportation costs to farming produce?
27
Prices of Related Goods
The prices of other goods related in production can also affect the supply of a particular good.
Two goods are substitutes in production if the same inputs can be used to produce either of the goods,
such as land for different agricultural crops (e.g. oranges vs mandarins)
Two goods are complementary in production if the production of one is a by-product of the production of
the other. (e.g. bi-product such as meat and cow skin)
28
Future Expectations
If producers expect prices to increase in the future, they may supply less output now than without those
expectations. The opposite could happen if producers expect prices to decrease in the future.
29
Number of Producers
The number of producers influences the total supply of a product at any given price. The number of
producers may increase because of perceived profitability in a given industry or because of changes in
laws or regulations such as trade barriers.
E.g. increase competition; deregulation; removal of import tax, eg telecom industry; ACCC , oil restriction
agreements between oil exporting countries
E.g. allow import of bananas / meat to Australia
30
Number of Producers in Action
For example, the lumber market was reported to be exceedingly strong in January 1999, largely due to
demand from the booming U.S. housing market. However, quotas (restrictions on supply) on the amount of
wood that Canada could ship into the United States also played a role in keeping the price of lumber high
in the United States in January of that year.
31
Supply (S)
Supply curves are generally portrayed as upward
sloping, suggesting a direct or positive relationship
between the price of the good and the quantity
supplied, all else equal.
When the price of a good rises the quantity supplied
rises, all else equal.
Assumption: given the production costs, a higher price
brings a greater profit.
Quantity
P
ri
c
e
32
Supply Curve Shift vs. Movement Along a Supply Curve
The price (P) increases from P1 to P2, then the quantity
supplied (Qs) increases from Q1 to Q2.
(i.e. a movement along the Supply Curve due to price
change)
P
Q
S1
A
B
P1
P2
Q1 Q2
A to B: change
(increase)
in quantity supplied
33
Supply Curve Shift vs. Movement Along
Supply Curve Shift (non-price factors) vs. Movement Along (due to a change in price) a Supply Curve
P
Q
S1 S2
P1
Q1 Q2
A B
A to B: change
(increase)
in supply
Technology improves, then at
the same price P1 the quantity
supplied (Qs) increases from
Q1 to Q2.
E.g. computers, flat screen TV,
mobile phone etc
34
Equilibrium Prices
04
Market Equilibrium
• When the market price of the good is PE, the
quantity supplied is QS which is equal to the
quantity demanded QD.
• We thus have QS = QD = QE.
• PE is thus the equilibrium price.
• The market will tend to be pushed towards
this equilibrium at Point E by the forces of
competition.
• Let’s see how this works.
36
QE
S1
Price
Quantity
PE E
D1

Disequilibrium – Excess Demand
• Now imagine that the price level was P1
instead of PE.
• In this case, demand would be given at point
A with a quantity of QA and supply would be
given at point B with a quantity of QB .
• At this price, there is an excess demand of
QA  QB.
• Consumers would compete for the available
supply which would drive up the price.
• As the price increases, demand would
decline and supply would increase. But at
any price between P1 and PE there will still
be some excess demand and this will keep
pushing the price up.
• Price will keep rising until the excess demand
is eliminated, which requires QD = QS at E.
37
QE
S1
Price
Quantity
PE E
QA
B A
D1
QB
P1

 
Disequilibrium – Excess Supply
• Now imagine that the price level was P2
instead of PE.
• In this case, supply would be given at point C
with a quantity of QC and demand would be
given at point D with a quantity of QD .
• At this price, there is an excess supply of
QD  QC.
• Firms would compete to supply the good to
consumers which would drive the price down.
• As the price falls, demand would increase
and supply would decrease. But at any price
between P2 and PE there will still be some
excess supply and this will keep pushing the
price down.
• Price will keep falling until the excess supply
is eliminated, which requires QD = QS at E.
38
QE
S1
Price
Quantity
PE  E
 
QC
D C
D1
QD
P2
Practice exercise:
Use the S/D Model to describe what happens to the equilibrium price (Pe) and quantity (Qe) traded of oil in
response to each of the following:
“The US government report showed an unexpected rise in petrol inventories and an increase in oil
production amid global oversupply worries”.
P($)
Qty
39
The Effects of Public Policy
05
Public Policy impact on Market equilibrium
At prices where the quantity supplied (Qs) exceeds
the quantity demanded (Qd) there exists a surplus in
that market at that price.
If P1 > Pe, then Qs > Qd (surplus)
E.g. Public policy: the setting of price floor by the
government
E.g. minimum wage to protect workers
P
Q
P1
surplus D
S
Qd Qs
Pe
Qe
41
Public Policy impact on Market equilibrium
At prices where the quantity demanded (Qd) exceeds
the quantity supplied (Qs) there exists a shortage in that
market at that price.
If P2 < Pe, then Qd > Qs (shortage)
e.g. Public policy: the setting of price ceiling by the
government
P
Q
D
S
P2
shortage
Qs Qd
Pe
Qe
42
Changes in Equilibrium – Changes in Demand and Supply
When non-price factors change, the supply
and demand curves may both shift and
produce a change in the equilibrium price
(Pe) and quantity (Qs).
P
Q
D1
D2
S1
S2
P1
P2
Q1 Q2
43
Changes in Equilibrium – Changes in Demand and Supply
When supply and demand move in the same direction, equilibrium quantity changes in the same direction,
but the direction of the change in equilibrium price is uncertain and depends on the magnitude of the
changes in supply and demand. (i.e. an increase in D and an increase in S; Quantity up, P uncertain) and
vice versa
When supply and demand move in the opposite direction, equilibrium price changes in a predictable
manner, but the direction of the change in equilibrium quantity is uncertain and depends on the magnitude
of the changes in supply and demand. (i.e. an increase in D and an decrease in S; Quantity uncertain, P
up) and vice versa
44
Changes in Equilibrium – Changes in Demand and Supply
No Change in S Increase in Supply Decrease in
Supply
No Change in
Demand
P =
Q =
P ↓
Q ↑
P ↑
Q ↓
Increase in
Demand
P ↑
Q ↑
P ?
Q ↑
P ↑
Q ?
Decrease in
Demand
P ↓
Q ↓
P ↓
Q ?
P ?
Q ↓
45
Use the S/D model to demonstrate the following simultaneous shifts
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Self-revision: What you need to know
1. Outline and apply the law of demand and law of supply
2. Explain using a graph how the market adjusts to equilibrium
3. Differentiate between movements along the demand and supply curves and shifts of the demand and
supply curves
4. Show and explain how non-price determinants shift / change the supply and demand curves and
explain how the shifts affect price (P) and quantity (Q)
5. Identify and draw simultaneous shifts of the curves and their effect on price (P) and quantity (Q)
6. Explain how a price ceiling and price floor affects a market with reference to diagrams and outline how
it affects efficiency
7. Apply theoretical principals to real-life case studies
47
Self-practice exercises: Demand (D) and Supply (S) Model
Use the D/S Model, to demonstrate, how the change of the following items will lead to the changes in D or
S; Price (P) & Quantity (Q):
• Positive expectations about future income
• A major health concern
• An increase in production costs
• An improvement in technology
• A decrease in income tax
• An increase in wage rates
• An increase in GST,
• A decrease in income on normal goods
• An increase in price of substitute
• The cost of imported raw materials fall & a decrease in income tax
• An expectations of future inflation to rise & an increase in oil price
Shifts D or Shifts S
48
Demand (D) and Supply (S) Model
Shifts D Shifts S
Positive expectations about future
income
An increase in production costs
A major health concern An improvement in technology,
A decrease in income tax An increase in wage rates
A decrease in income on normal
goods
An increase in GST, Sales tax
An increase in price of substitute
49