Lecture 2

1. Lecture 2

2. Supply Curve • It shows the relationship between price and quantity supplied. If the price of a product increases then the supply of that product will increase. So there is a positive relationship between price and quantity supplied. • Why does it slope upward? Or why do we have a positive relationship between price and quantity supplied ? - Higher prices embody greater incentives for firms to produce more output because profit opportunities are enhanced and that why when price increases quantity supplied increases.

3. Changes in Demand and Supply Movement along the curve • If there is change in price of a product then there will be a movement along its demand curve and supply curve Shift of the curve • If there is a change in any factor/variable other than price (such as: income, taste, price of other goods like substitute or complementary good etc.) then there will be a shift in the curve.

4. Determination of Equilibrium • The point at which demand curve cuts supply curve is the equilibrium. Equilibrium price and quantity are determined from equilibrium point. • It shows stability. • Any price greater than equilibrium price will create excess supply which is a unstable situation. In this case price needs to fall to attain equilibrium. • Any price lower than equilibrium price will create excess demand. In this case price needs to increase to attain equilibrium.

5. Excess Supply • If price is higher than equilibrium price then quantity supplied will be greater than quantity demanded. So in this case there will an excess supply in the market that is producers can’t sell their products. • Competition among producers to increase sales leads to a downward pressure on price and so they need to lower the price to sell out their product. • If the price decreases then the quantity demanded increases and quantity supplied decreases. So the excess supply decreases ( the gap between supply and demand curve decreases). This process will continue until equilibrium price is reached where quantity demanded is equal to quantity supplied.

6. Excess Demand • If price is lower than equilibrium price then quantity demanded will be greater than quantity supplied. So in this case there will an excess demand in the market. • To meet the excess demand, producer will increase the supply but they will do this if they get a higher price. So there is an upward pressure on price. • When the price increases the quantity demanded decreases and quantity supplied increases. So the excess demand decreases. This process will continue until equilibrium price is reached where quantity demanded is equal to quantity supplied.

7. Change in equilibrium due to shift in demand • If there is a rightward shift in demand ( say for an increase in income) then a new equilibrium will restore at a higher price and higher quantity.

8. Change in equilibrium due to shift in Supply • If there is a rightward shift in Supply ( say for an increase in production due to good weather) then a new equilibrium will restore at a lower price and higher quantity.

9. Change in equilibrium due to shift in both demand and supply • Suppose there is a shift in demand which leads to a new equilibrium at E2. This leads to a higher price P2 and a higher quantity Q2. To stabilize the price we can increase the supply which will change the equilibrium to E3 where the price has got back to its initial value of P1 and quantity is increased further to Q3.

10. Opportunity Cost • Opportunity cost of a choice is the value of the best alternative forgone. • It isthe cost expressed in terms of the next best alternative sacrificed • It helps us view the true cost of a decision. • Example: The opportunity cost of labour/ work is leisure. For example if you are working then you cannot watch movie. So here the opportunity cost of working is watching movie.

11. Production Possibility Frontiers If the economy reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra X1 – Xo consumer goods is Yo – Y1 capital goods. Capital Goods Ym A Yo B Y1 Consumer Goods Xo X1 Xm

12. Demand and Supply Equation and Determination of Equilibrium Price and Quantity • Demand: Qd= 286 − 20p • Supply: Qs = 88 + 40p • In Equilibrium: Qd = Qs 286 − 20p = 88 + 40p 60p = 198 P = 3.30 So Equilibrium Price = 3.30 And Q = 286 – 20(3.3) = 220 So Equilibrium Quantity=220