4EC508

Business Economics

LECTURE 3: DEMAND &

SUPPLY ANALYSIS
 Demand & Supply recap
Law of Demand
Law of Supply

Demand: downward sloping

Supply: upward sloping

Sensitivity: Internal
 Demand & Supply recap
Changes in the price
of the product • A change in the price of a product leads
cannot shift Demand to movement along Demand or Supply
or Supply of the for that product
product

A change in anything
other than the price • Shift right if demand or supply increase
of the product is a • Shift left if demand or supply decrease
shift factor

Sensitivity: Internal
 Demand & Supply recap
Common demand shift factors:
◦ Income, price of substitutes & complements,
tastes/preferences, advertising,
population,seasons etc.
Common supply shift factors:
◦ Changing cost of inputs in production (transport,
energy, labour, raw materials)
◦ Changing technology leading to lower cost of
production
Sensitivity: Internal
 Explaining Price Changes
Market equilibrium

In equilibrium, market price and quantity will not change

If one of the shift factors change, then either the demand or supply (or
both) could move

Price and quantity will then change, arrive at new equilibrium

Bring all the elements of demand, supply, and equilibrium

together to make predictions

Sensitivity: Internal
 Predicting Changes in Price and
Quantity

All Possible Changes in

Demand and Supply
◦A change in demand
or supply or both
changes the
equilibrium price and
the equilibrium
quantity.

Sensitivity: Internal
 Predicting Changes in Price and
Quantity
Change in Demand
(rightward shift) with No
Change in Supply

When demand
increases, equilibrium
price rises, and the
equilibrium quantity
increases.

Sensitivity: Internal
 Predicting Changes in Price
and Quantity
Change in Demand
(leftward shift) with No
Change in Supply

When demand
decreases, the
equilibrium price
falls, and the
equilibrium quantity
decreases.
Sensitivity: Internal
 Predicting Changes in Price
and Quantity
Change in Supply
(rightward shift) with No
Change in Demand

When supply
increases, the
equilibrium price
falls, and the
equilibrium quantity
increases.
Sensitivity: Internal
 Predicting Changes in Price
and Quantity
Change in Supply
(leftward shift) with No
Change in Demand

When supply
decreases, the
equilibrium price
rises, and the
equilibrium quantity
decreases.
Sensitivity: Internal
 Predicting Changes in Price and
Quantity
Increase in Both Demand
and Supply

An increase in demand and an

increase in supply increase
the equilibrium quantity.

The change in equilibrium

price is uncertain because the
increase in demand raises the
equilibrium price and the
increase in supply lowers it.
Sensitivity: Internal
 Predicting Changes in Price and
Quantity
Decrease in Both Demand
and Supply

A decrease in both demand

and supply decreases the
equilibrium quantity.

The change in equilibrium

price is uncertain because the
decrease in demand lowers
the equilibrium price and the
decrease in supply raises it.

Sensitivity: Internal
 Predicting Changes in Price and
Quantity
Decrease in Demand and
Increase in Supply
A decrease in demand and
an increase in supply lowers
the equilibrium price.

The change in equilibrium

quantity is uncertain because
the decrease in demand
decreases the equilibrium
quantity and the increase in
supply increases it.

Sensitivity: Internal
 Predicting Changes in Price and
Quantity
Increase in Demand and
Decrease in Supply
An increase in demand and a
decrease in supply raises the
equilibrium price.

The change in equilibrium

quantity is uncertain because
the increase in demand
increases the equilibrium
quantity and the decrease in
supply decreases it.
Sensitivity: Internal
Economic Model in Analysis
We can use the economic model of Demand and Supply for
Analysis
◦ Using the D&S model will allow us to:
◦ explain price and quantity movements
◦ critically assess whether the movements are as
predicted by theory
◦ comment on whether movements are a problem to
business/consumers
◦ viewpoint on what will happen in the future to price and
quantities

Sensitivity: Internal
 Class exercise
2. Think about the events that
1.Draw a demand-supply
you are told will occur in
diagram and label the axes
future and decide whether 3. Do the events bring an
with the price and quantity of 1 2
they change demand/supply, increase or a decrease?
the good or service in
both demand and supply, or
question.
neither demand nor supply.

4. Draw the new demand

curve or/and supply curve on
5. Find the new equilibrium
the diagram. Be sure to shift
4 and compare it with the
the curves in the correct
original one.
direction − left for decrease
and right for increase.

Sensitivity: Internal
 Music technology changes
Sony in the 1980s introduce a market changing
product – The Walkman
◦ The portable music player
◦ At first, they are expensive (£125)
◦ Then cheap copies were made, and price fell
(£30), and more people could buy a Walkman
◦ How does this affect Demand&Supply for audio
tapes?

Sensitivity: Internal
Sensitivity: Internal
 An increase in Demand
oThe fall in the Walkman price is a shift factor on
the demand for tapes
oDemand shifts to the right
oMarket price rises from £0.90 to £1.50 and
quantity traded in the market increases from 4 to
6 million tapes a week
oMovement up supply

Sensitivity: Internal
 Computer technology automates production of audio tapes

Computer advances in 1990s led to factory

production automation.

◦ Tapes become cheaper to produce with

automated production

◦ How does this affect D&S for audio tapes?

Sensitivity: Internal
 An increase in Supply
The new technology is a shift factor on supply

Supply shifts to the right

Market price falls from £0.90 to £0.60 and quantity

traded in the market increases from 4 to 6 million tapes a
week

Movement down demand curve

Sensitivity: Internal
 Music technology changes
Apple released the iPod in 2001, at $399, the new
model of iPod touch now sells for about $199

◦ How does this affect Demand & Supply for iPod

products?

Sensitivity: Internal
 First iPod product

Sensitivity: Internal
 iPod Mini

Sensitivity: Internal
 Then came the iPod nanos’

Sensitivity: Internal
DEMAND AND
SUPPLY ANALYSIS

PRICE CHANGES
 Explaining Price Changes

If you know how the Each time price Let’s try it again with
price of a good has changes, some factor some historical analysis
changed over time, has changed to shift of past price
you can explain why it demand and supply movements
changed using demand
and supply analysis

Sensitivity: Internal
 UK CD Player Price Fall 1984-
1999

Sensitivity: Internal
 UK CD Player Price Fall 1984-1999
Over the time period
◦ New low-cost CD producers start up (supply shifts
right) leads to quantity rise and price fall
◦ Incomes increased and demand for music products
rises (demand shifts right) leads to quantity rise and
price rise

For price to fall, supply shift must be much greater than

demand shift
Price is driven by supply in this market
Sensitivity: Internal
 UK CD Player Price Fall 1984-1999

Sensitivity: Internal
 UK House Price Rise 1984 to 1991

Sensitivity: Internal
 UK House Price Rise 1984 to 1991
Over the time period
◦ Incomes increased and demand for houses rises
(demand shifts right) leads to quantity rise and and
price rise
◦ New houses are built (supply shifts right) leads to
quantity rise and price fall
For price to rise, demand shift must be much greater than
supply shift
Price is driven by demand in this market

Sensitivity: Internal
 UK House Price Rise 1984 to
1991

Sensitivity: Internal
Sensitivity: Internal
Sensitivity: Internal
Sensitivity: Internal
 UK Apple Price Movements 1987-
1999

Sensitivity: Internal
 UK Apple Price Movements 1987-
1999
Over the time period
◦ Incomes increased but has little effect on demand for
apples (demand doesn’t shift)
◦ Weather variability (frost/rain/sun) affects harvests
(supply shifts left and right depending) leads to
variable quantity and price changes
Price change unpredictable around a constant level
Price is driven by supply in this market

Sensitivity: Internal
 UK Apple Price Movements
1987-1999

Sensitivity: Internal
 Explaining Quantity
Changes

DEMAND AND SUPPLY LET’S TRY TO EXPLAIN VINYL RECORDS, AUDIO

CAN ALSO EXPLAIN CHANGES IN THE TAPE CASSETTES, CD,
CHANGES IN QUANTITY QUANTITY OF MUSIC DIGITAL DOWNLOAD
TRADED PRODUCTS TRADED

Sensitivity: Internal
 The Music Market

Sensitivity: Internal
 Summarising the Information
Time series data on the previous slide shows rise and
fall in unit quantity traded for each music format

Initially quantity traded increases to a peak and then

falls for each format

How do we explain this repeated pattern?

◦ Use the D&S model to analyse the pattern

Sensitivity: Internal
 What do we know about CD
demand and supply?
At first CDs are scarce, price is high
Over time, economies grow, and incomes rise (people
buy more CD players and CDs), advancement in
technology means it is cheaper to produce
◦ Demand shifts to the right and quantity rises and
price rises (so movement up supply)
◦ Supply shifts to the right and quantity rises and price
falls (so movement down demand)

Sensitivity: Internal
Quantity changes in the market for CDs 1990 to
2000
Price of a CD (£/CD)
S1990

S2000

£20
£15
£10

D2000

D1990

220 700 950 Quantity CDs (mn/year)

 Summary
Economic model of D&S is used to analyse
information on price and quantity changes
in any market
Market information and
Analysis knowledge (internet data/market
reports/news stories)
requires
Model to apply (D&S)

Results in explanation, assessment of

information, commentary and a viewpoint

Sensitivity: Internal