Laws of market economy

The purpose: Solve and review the basic laws of market economy

Key words: market equilibrium, theory of demand, theory of supply, government intervention, individual demand, prices, sellers, outputs

Questions:

3.1 Theory of Demand

3.2 Theory of Supply

3.3 Market Equilibrium

3.4 Government Intervention in the Market

Theory of Demand

Demand for a commodity

— Depends on size of the market (Industry Demand for the commodity)

— Summation of Individual level Demand

Related to Consumer Choice Theory

Consumer Demand Theory Q_d= f (P_x, I, P_y,T)

Individual Demand

How are price and demand related for a good? (law of demand)

-Normal Goods

-Inferior Goods

Example: Suzuki Mehran

Effect of price of substitute and complementary goods. Effect of Change in Income and Tastes

Market Demand

Horizontal Summation of Individual Demand Curves. Negatively sloped, why? Inverse relation between price and quantity QD= F(Px, I, N, Py, T)

Bandwagon Effect and Snob Effect

Change in demand

Change in quantity Demanded

Demand Faced by A Firm

— Monopolist

ü WAPDA

— Perfect Competition

ü No true example exists (Small scale farmers producing homogeneous wheat in USA)

ü Horizontal demand curve, why?

— Oligopoly

ü Few firms with standardized or differentiated product

— Monopolistic Competition

ü Heterogeneous and differentiated products

— Factors effecting Demand

Advertising, Promotional Policies, Price expectations

— Firms selling durable goods face more volatile & unstable demand. Like automobiles, washing machines, water geezers

— Why? Consumers can wait for Availability of credit, or growth in economy

— Demand function faced by a firm

Q_D= a₀+a₁P_x +a₂I+a₃N+a₄P_y+ a₅T……………

— “a” is coefficient to be estimated with regression analysis

— Implications of estimated demand:

ü Types of inputs

ü Quantity of Inputs

 

Theory of Supply

Supply of a Commodity

— The quantity sellers are willing to sell at a given price level

— Depends on:

ü Price of the commodity

ü Prices of inputs

ü Technology

ü Opportunity cost

ü Future expectations

ü Number of sellers

Individual Supply

The higher the price, greater is the quantity sellers are willing to sell in the market (law of supply)

Effect of prices of inputs and changes in technology

Effect of prices of goods which can be produced with same inputs

Effect of changes in expectations of future

Market Supply

-Horizontal Summation of Individual Supply Curves

-Positively sloped, why?

-Positive relation between price and quantity

-Change in supply

-Change in quantity supplied

Market Equilibrium

Equilibrium exists when quantity sellers are willing to sell is equal to the quantity buyers are willing to buy at a given price.

— Surplus - Results in downward pressure on the price

— Shortage - Results in upward pressure on the price

— Impact of Changes in Demand on Market Equilibrium

— Impact of Changes in Supply on Market Equilibrium