Demand

Supply

Market Mechanism refers to a process through which market forces of demand and supply interact to determine price and output of each product and service System of economic organization featured by private ownership and the use of private profit of man made and nature made capital Eg factories , farms owned by private individual or firms

Right to private property Freedom of enterprise Freedom of choice by consumers Profit motive Inequalities of incomes

Demand curve The law of demand The law of supply Supply curve Equilibrium Disequilibrium Conditions of demand Conditions of supply

A market consists of:

Buyers (demand) Sellers (supply) Exchange

Market is a place or area where goods and services are bought and sold. A Market is a mechanism by which buyers and sellers interact to determine the price and quantity of a good and service.

Demand is : 1. Desire for good 2. Backed by ability 3. And willingness to pay

Effective demand = the quantity of a commodity which consumers will purchase at a given price per time period

Individual demand can be defined as quantity of a commodity that an individual is willing to buy at a given price over a specified period of time say per day , per week etc Market demand is total quantity that all the users of a commodity are willing to buy at a given price over a specified period of time.(sum of individual demands)

The detailed analysis of demand and supply demonstrates how market forces solve the problem of what,how and whom to produce. It illustrated how prices and quantities of various goods and services are determined

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As price increases the quantity demanded decreases Conversely: As price decreases the quantity demanded increases (Applicable in short run all other things remaining constant (consumers tastes and preferences , income ,substitutes and (cont.) complements etc)

Reflects an inverse relationship, i.e. as price , quantity demanded as price , quantity demanded The law of demand is caused by:
The income effect The substitution effect

A demand schedule shows relationship between the price and quantity demanded of a good . Demand curve for almost all the commodities slope downwards owing to inverse relationship between price and quantity supplied. A table showing the quantity demanded of a product at various prices Example: Demand schedule of good X Price Qty demanded Re 1 500 Rs 2 400 Rs 3 300 Rs 4 200 Rs 5 100

Graphical representation of demand schedule Example: Demand curve

Price 5 Rs 4 3 2 1
100 200 300 400 Quantity 500

Income effect Substitution effect

As prices increase, consumers will purchase fewer goods and services. Their purchasing power (or real income) decreases Quantity demanded decreases As prices decrease, the purchasing power of consumers increases Quantity demanded increases

As prices increase, consumers generally purchase more of a substitute product whose price is lower A substitute product is a product that performs a similar function and satisfies the same consumer need/want e.g.: If the price of butter increases, the quantity demanded will fall as consumers will substitute butter with jam
Tea/coffee Butter/jam

Expectations regarding the future prices Prestigious goods Giffen goods

Price of a commodity Price of related good (a) Substitute goods (b) Complementary goods Income of consumer (a) Normal goods (b)Inferior goods Necessities of life Tastes and preferences Expectations Size and composition of population Distribution of income

Extension in Demand - Rise in quantity demanded due to fall in price

Contraction in demand Fall in quantity demanded due to increase in price

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The entire demand curve shifts to the right

P
Pe1
Pe

E1
E D
EQ EQ1

S
D1

The entire demand curve shifts to the left P by a factor other than price S Caused
E Pe Pe1 E1 D1 D Q

Qe1

Qe

Increase in demand means rise in demand due to change in taste, price of substitutes, income of consumer (forward shift) and backward shift is vice versa Thus demand function = f( Px+ Y + Ps+ Pc+T+A)

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Definition: the quantity of a product which producers offer to the market at a certain price per unit of time

As price increases the quantity supplied increases conversely as price decreases the quantity supplied decreases The law of supply is a direct relationship between price and quantity supplied As price , quantity supplied As price , quantity supplied

The logic of the law of supply:

Producers will seek to maximise their profits i.e.: supplying more at higher prices and less at lower prices. Free market or capitalist economy, producers will produce only that good for which price is more so that they can increase profits

A table showing the quantity supplied at various prices Example: Supply schedule of Good X Price Qty supplied $1 200 $2 300 $3 400 $4 500 $5 600

A graphic representation of the supply schedule Example: Supply curve for good X
Supply curve

5 Price 4 $ 3 2 1

200 300 400

500

600

Quantity

When supply of a commodity changes due to change in factors other than price such as technology, capital, input prices etc it is called increase or decrease in supply

Downward shift to the right of supply curve More supply at same price or same supply at less price is called increase in supply

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Supply curve shifts to the right

P Pe Pe1 S S1

E
E1 D Qe Qe1

Refers to the upward shift to the left of supply curve Less supply at same price or same supply at more price is called decrease in supply

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Supply curve shifts to the left

P

S1
Pe 1 Pe E1 E

D
Q Qe1 Qe

Goal of the firm Price of the good Price of the inputs Technology Price of the related goods (a) Substitutes (b) Complements Expectations of the producer Government Policy

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Supply and demand can now be brought P S together to form the price mechanism
Surplus

Pe
shortage

Equilibrium point (Pe)

D Q
(cont.)

Qe

Market equilibrium (E) is where: Quantity demanded = quantity supplied (intersection of demand and supply curves) The market is cleared (no shortages or surpluses) Price (Pe) is stable State of rest No unsold stock, no unsupplied demand)

In real world price keeps on changing due to change in determinants of demand and supply

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If supply remains constant increase in demand raises and decrease in demand lowers the prices Prices change directly with the change in demand Supply constant , Demand increases, equilibrium price and quantity increases and vice versa

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Increase in supply A rightward shift in supply curve results in a new equilibrium where price is lower and quantity is higher

Decrease in supply A leftward shift in demand curve results in new equilibrium where price is higher and quantity is lower. Reduces quantity raises prices.

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= where quantity demanded is NOT EQUAL to quantity supplied Types: 1. Market shortage: where quantity demanded > quantity supplied 2. Market surplus (oversupply): where quantity supplied > quantity demanded