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DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..):Equilibrium

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ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity >>
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Introduction to Economics ­ECO401
VU
Lesson 2.3
DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED........)
Equilibrium:
Equilibrium is a state in which there are no shortages and surpluses; in other words the
quantity demanded is equal to the quantity supplied.
Equilibrium price is the price prevailing at the point of intersection of the demand and supply
curves; in other words, it is the price at which the quantity demanded is equal to the quantity
supplied.
Equilibrium quantity is the quantity that clears the market; in other words, it is it is the quantity
at which the quantity demand is equal to the quantity supplied.
Algebraic Representation of Equilibrium:
If we have following demand and supply functions,
Qd = 100 ­ 10 P
Qs = 40 + 20 P
In equilibrium,
Qd = Qs
Therefore
100 - 10P = 40 + 20P
20P + 10P = 100 - 40
30P = 60
P = 60/30
P=2
Putting the value of price in any of demand and supply equation,
Q = 100 ­ 10x2 (or 40 + 20x2)
Q = 100 ­ 20
Q = 80
The equilibrium price is 2 and the equilibrium quantity is 80.
Equilibrium can shift if:
·  Demand Curve Shifts.
·  Supply Curve Shifts.
·  Both Shift.
This gives rise to eight possibilities. These eight possibilities can be summarized as following:
D
, S ~,
P
Q
D~,S
,
P
Q
D
,S
,
P?
Q
D
,S~,
P
Q
D~,S
,
P
Q
D
,S
,
P
Q?
D
,S
,
P
Q?
D
,S
,
P?
Q
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Introduction to Economics ­ECO401
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The symbol " " or " " shows increase and the symbol " " and " " shows a decrease
while the symbol "~" shows that the particular thing remains same.
Government and Price-Determination:
The government may intervene in the market and mandate a maximum price (price ceiling) or
minimum price (price floor) for a good or service.
A price ceiling is the maximum price limit that the government sets to ensure that prices don't
rise above that limit (medicines for e.g.).
A price floor is the minimum price that a Government sets to support a desired commodity or
service in a society (wages for e.g.).
Social cost is the cost of an economic decision, whether private or public, borne by the society
as a whole.
Marginal social cost is the change in social costs caused by a unit change in output.
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Introduction to Economics ­ECO401
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END OF UNIT 2 - Exercises
Asif and Aasia's "monthly" demand schedules for potatoes are given. Roughly draw
these demand schedules on the same graph. Assume that there are 200 consumers in the
market. Of these, 100 have schedules like Asif's and 100 have schedules like Aasia's.
Complete the Total market demand ("monthly") column in the table below?
Price
Asif
Aasia
Total
market
demand
(pence
(Qd in
(Qd in
(kg)
per kg)
kg)
kg)
20
28
16
4400
40
15
11
2600
60
5
9
1400
80
1
7
800
100
0
6
600
100
90
80
70
60
50
40
Asif's
30
demand
Aasia's
20
demand
10
0
0
5
10
15
20
25
30
Quantity demanded (kg per month)
Assuming that demand does not change from month to month, how would you plot the
annual market demand for potatoes?
The amount demanded would be 12 times higher at each price. If the scale of the horizontal
axis were unaltered, the curve would shift way out to the right. A simple way of showing the new
curve, therefore, would be to compress the scale of the horizontal axis. (If each of the numbers
on the axis were multiplied by 12, the curve would remain in physically the same position.)
At what price is their demand the same?
The two curves cross at a price of Rs50 per kg and at a demand of 10 kg per month.
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Introduction to Economics ­ECO401
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What explanations could there be for the quite different shapes of their two demand
curves?
One explanation could be that Asif is quite happy to eat rice, pasta or bread instead of potatoes.
Thus when the price of potatoes goes up she switches to these other foods, and switches to
potatoes when the price of potatoes comes down. Aasia, by contrast, may not see these other
foods as close substitutes and thus her demand for potatoes will be less price sensitive.
Do all these the determinants of demand affect both an individual's demand and the
market demand for a product?
All except the distribution of income in the economy.
You are given a market demand curve for apples. Assume that the price of apples
increases by 20 per cent at each price ­ due, say, to substantial increases in the prices of
other substitute fruits. Plot the new demand curve for apples. Is the new curve parallel
to the old one?
See below. As you can see, the curves are not parallel. A constant percentage increase in
quantity demanded gives a bigger and bigger absolute increase as quantity increases.
100
90
80
70
60
50
40
New
30
demand
20
Old
demand
10
0
0
100
200
300
400
500
600
700
800
900
Quantity demanded (kg per month)
The price of lamb meat rises and yet it is observed that the sales of lamb meat increase.
Does this mean that the demand curve for lamb meat is upward sloping? Explain.
No not necessarily. For example, the price of substitutes such as beef or chicken may have
risen by a larger amount. In such cases the demand curve for lamb meat will have shifted to the
right. Thus although a rise in the price of lamb meat will cause a movement up along this new
demand curve, more lamb meat will nevertheless be demanded because lamb meat is now
relatively cheaper than the alternatives.
A demand function is given by Qd = 10000 ­ 200P. Draw this in P-Qd space. What is it
about the demand function  equation that makes the demand curve in P- Qd space
(a) downward sloping; (b) a straight line?
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Introduction to Economics ­ECO401
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a) The fact is that the 200P term has a negative sign attached to it. This means that as P
rises, Qd falls.
b) The fact is that there is no P to a power term. The demand curve thus has a constant
slope of ­1/200.
A demand function is given by Qd = a + bY, where Y is total income. If the term "a" has a
value of ­50 000 and the term "b" a value of 0.001, construct a demand schedule with
respect to Y. Do this for incomes between Rs100 million and Rs300 million at Rs50
million intervals.
Y (in Rs
Qd (in
millions)
000s)
100
50
150
100
200
150
250
200
300
250
Now use this schedule to plot a demand curve with respect to income. Comment on its
shape.
The curve will be an upward-sloping straight line, crossing the horizontal axis at ­50 000. It
would rise by 100 000 units for each Rs100 million rise in income.
300
Demand
250
200
150
100
50
0
0
50
100
150
200
250
300
Quantity demanded
Market dem and (with respec t to incom e)
What are the reasons which cause the market supply of potatoes to fall?
Examples include:
· The cost of producing potatoes rises.
· The profitability of alternative crops (e.g. carrots) rises.
· A poor potato harvest.
· Farmers expect the price of potatoes to rise (short-run supply falls).
For what reasons might the supply of leather rise?
Examples include:
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Introduction to Economics ­ECO401
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· The cost of producing leather falls.
· The profitability of producing mutton and chicken decreases.
· The price of beef rises (goods in joint supply).
· A long-running industrial dispute involving leather workers is resolved.
· Producers expect the price of leather to fall (short-run supply increases).
This question is concerned with the supply of gas for home and office heating in winters.
In each case consider whether there is a movement along the supply curve (and in which
direction) or a shift in it (left or right). (a) New gas fields start up in production. (b) The
demand for home heating rises. (c) The price of electric heating falls. (d) The demand for
CNG for cars (produced in joint supply) rises. (e) New technology decreases the costs of
gas production.
(a) Shift right. (b) Movement up along (as a result of a rise in price). (c) Movement down along
(as a result of a fall in price resulting from a fall in demand as people switch to electric heating).
(d) Shift right (more of a good in joint supply is produced). (e) Shift right.
A supply function is given as Qs = c + dP, where "c" is 500 and "d" is 1000. Draw the
schedule (table) and graph for equation for prices from Rs1 to Rs10. What is it in the
equation that determines the slope of the supply `curve'?
10
9
Supply
8
7
6
5
4
3
2
1
0
0
2 000
4 000
6000
8000
100 00
Q u antity supp lie d
P (in
Qs
Rs)
(units)
1
1500
2
2500
3
3500
4
4500
5
5500
6
6500
7
7500
8
8500
9
9500
10
10500
The graph is an upward sloping straight line crossing the horizontal axis at 500 units. The slope
is given by the value of the d term: i.e. the slope is 1/1000 (for every Re1 increase in price,
quantity supplied increases by 1000 units).
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Introduction to Economics ­ECO401
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Explain the process by which the price of houses would rise if there were a shortage.
People with houses to sell would ask a higher price than previous sellers of similar houses
(probably with the advice of an estate agent). Potential purchasers would be prepared to pay a
higher price than previously in order to obtain the type of house they wanted.
With a typical upward sloping market supply curve and downward sloping market
demand curve, what would happen to equilibrium price and quantity if the demand curve
shifted to the left?
Both price and quantity will fall. You should be able to label two demand curves (e.g. D1 and
D2), two equilibrium points (e.g. e1 and e2) corresponding prices Pe2 and Pe1 (Pe2 < Pe1), and
quantities Qe2 and Qe1 (Qe2 > Qe1).
What will happen to the equilibrium price and quantity of butter in each of the following
cases? You should state whether demand or supply (or both) have shifted and in which
direction. (In each case assume ceteris paribus.)
(a) A rise in the price of margarine; (b) A rise in the demand for yoghurt; (c) A rise in the
price of bread; (d) A rise in the demand for bread; (e) An expected rise in the price of
butter in the near future; (f) A tax on butter production; (g) The invention of a new, but
expensive, process for removing all cholesterol from butter plus the passing of a law
which states that all butter producers must use this process.
a) Price rises, quantity rises (demand shifts to the right: butter and margarine are
substitutes).
b) Price falls, quantity rises (supply shifts to the right: butter and yoghurt are in joint supply).
c) Price falls, quantity falls (demand shifts to the left: bread and butter are complementary
goods).
d) Price rises, quantity rises (demand shifts to the right: bread and butter are
complementary goods).
e) Price rises, quantity rises or falls depending on relative sizes of the shifts in demand and
supply (demand shifts to the right as people buy now before the price rises; supply shifts
to the left as producers hold back stocks until the price does rise).
f)Price rises, quantity falls (supply shifts to the left).
g) Price rises, quantity rises or falls depending on the relative size of the shifts in demand
and supply (demand shifts to the right as more health-conscious people start buying
butter; supply shifts to the left as a result of the increased cost of production).
Are there any factors on the supply side that influence house prices?
Yes. Although they are usually less important than demand-side factors, they are, nevertheless
important in determining changes in house prices. The two most important are the expectations
of the construction industry. If house building firms (contractors) are confident that demand will
continue to rise, and with it house prices, they are likely to start building more houses. The
resulting increase in the supply of houses (after the time taken to build them) will help to dampen
the rise in prices.
The other major supply-side factor is the expectations of house owners. If people think that
prices will rise in the near future and are thinking of selling their house, they are likely to delay
selling and wait until prices have risen. This (temporary) reduction in supply will help to push up
prices even further.
Draw a supply and demand diagram with the price of labour (the wage rate) on the
vertical axis and the quantity of labour (the number of workers) on the horizontal axis.
What will happen to employment if the government raises wages from the equilibrium to
some minimum wage above the equilibrium?
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Introduction to Economics ­ECO401
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Firms' demand for labour will shrink at the new higher wage rate. The supply of workers will rise
as more workers would be willing to work (and work more hours) at the higher wage rate. There
will thus be unemployment (a surplus of workers) at the minimum wage set.
All economies have black markets in goods; whether this poses a serious problem is
another matter. What would be the effect on black-market prices of a rise in the official
price?
Other things being equal, there would probably be a fall in the black-market price. A rise in the
official price would cause an increase in the quantity supplied and a reduction in the quantity
demanded and hence less of a shortage. There would therefore be less demand for black-
market products.
Will a system of low official prices plus a black market be more equitable or less
equitable than a system of free markets?
More equitable if the supplies at official prices were distributed fairly (e.g. by some form of
rationing). If, however, supplies were allocated on a first-come, first-served basis, then on
official markets there would still be inequity between those who are lucky enough or queue long
enough to get the product and those who do not get it. Also, the rich will still be able to get the
product on the black market!
Think of some examples where the price of a good or service is kept below the
equilibrium (e.g. rent controls). In each case consider the advantages and disadvantages
of the policy.
Two examples are:
· Rent controls. Advantages: makes cheap housing available to those who would otherwise
have difficulty in affording reasonable accommodation.  Disadvantages: causes a
reduction in the supply of private rented accommodation; causes demand to exceed
supply and thus some people will be unable to find accommodation.
· Tickets for a concert.  Advantages: allows the price to be advertised in advance and
guarantees a full house; makes seats available to those who could not afford the free-
market price. Disadvantages: causes queuing or seats being only available to those
booking well in advance.
Primary and secondary schooling is free in state schools in most countries. If parents
are given a choice of schools for their children, there will be a shortage of places at
popular schools. What methods could be used for dealing with this shortage? What are
their relative merits?
Some form of rationing (selection) will have to be applied. This could be done on the basis of
ability. If the objective is to have schools that cater for the full range of abilities, then this
objective will not be met. If the objective is to recruit the most able children, then selection by
ability is consistent with this goal. An alternative is to select by geographical location, with the
students living nearer to the school being given preference over those living further away. This
is the system used by most state schools. It could well disadvantage children with particular
needs, however, for whom the school would be particularly suitable. Other methods include the
`sibling' rule, whereby children who have older brothers or sisters already at the school are given
preference. This, however, could lead to children living nearer the school being deprived of a
place.
Under what circumstances would making a product illegal (a) cause a fall in its price; (b)
cause the quantity sold to fall to zero.
a) Where the shift in demand was greater than the shift in supply (perhaps because of very
`law abiding' consumers, or where consumers faced harsher penalties than suppliers.
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Introduction to Economics ­ECO401
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b) Where the penalties were very harsh and the law was strictly enforced, and/or where
people were very law abiding.
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Table of Contents:
  1. INTRODUCTION TO ECONOMICS:Economic Systems
  2. INTRODUCTION TO ECONOMICS (CONTINUED………):Opportunity Cost
  3. DEMAND, SUPPLY AND EQUILIBRIUM:Goods Market and Factors Market
  4. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..)
  5. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..):Equilibrium
  6. ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity
  7. ELASTICITIES (CONTINUED………….):Total revenue and Elasticity
  8. ELASTICITIES (CONTINUED………….):Short Run and Long Run, Incidence of Taxation
  9. BACKGROUND TO DEMAND/CONSUMPTION:CONSUMER BEHAVIOR
  10. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)
  11. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)The Indifference Curve Approach
  12. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….):Normal Goods and Giffen Good
  13. BACKGROUND TO SUPPLY/COSTS:PRODUCTIVE THEORY
  14. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):The Scale of Production
  15. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):Isoquant
  16. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):COSTS
  17. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):REVENUES
  18. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):PROFIT MAXIMISATION
  19. MARKET STRUCTURES:PERFECT COMPETITION, Allocative efficiency
  20. MARKET STRUCTURES (CONTINUED………..):MONOPOLY
  21. MARKET STRUCTURES (CONTINUED………..):PRICE DISCRIMINATION
  22. MARKET STRUCTURES (CONTINUED………..):OLIGOPOLY
  23. SELECTED ISSUES IN MICROECONOMICS:WELFARE ECONOMICS
  24. SELECTED ISSUES IN MICROECONOMICS (CONTINUED……………)
  25. INTRODUCTION TO MACROECONOMICS:Price Level and its Effects:
  26. INTRODUCTION TO MACROECONOMICS (CONTINUED………..)
  27. INTRODUCTION TO MACROECONOMICS (CONTINUED………..):The Monetarist School
  28. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME
  29. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUED……………..)
  30. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME
  31. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..)
  32. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..):The Accelerator
  33. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS
  34. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….)
  35. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Causes of Inflation
  36. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):BALANCE OF PAYMENTS
  37. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):GROWTH
  38. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Land
  39. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Growth-inflation
  40. FISCAL POLICY AND TAXATION:Budget Deficit, Budget Surplus and Balanced Budget
  41. MONEY, CENTRAL BANKING AND MONETARY POLICY
  42. MONEY, CENTRAL BANKING AND MONETARY POLICY (CONTINUED…….)
  43. JOINT EQUILIBRIUM IN THE MONEY AND GOODS MARKETS: THE IS-LM FRAMEWORK
  44. AN INTRODUCTION TO INTERNATIONAL TRADE AND FINANCE
  45. PROBLEMS OF LOWER INCOME COUNTRIES:Poverty trap theories: