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Economics for
management
Seminar 6: Demand, Supply
and Equilibrium Prices
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???)
10
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.