The Demand Curve And Supply Curve

Published Date: 02 Nov 2017

Lets take an example of commodities wine and cotton to explain Production Possibility Frontier. Imagine an economy that can only produce wine and cotton and there are different production possibilities. The graph shows three most efficient use of resources points i.e A,B and C by an economy and they are all on the production possibility frontier curve. Point X shows that the resources are being used inefficiently while point Y represents those goals that can not be achieved because the economy does not have sufficient resources to achieve those goals. If economy wants to produce at point Y then it has to use extra resources. If the economy has to produce more wine then it has to giveup some cotton and move from point C to A and if economy has to make more cotton then it has to giveup some wine and move to point C from A and use more resources.

The economy can make the most of its resources if it is making products at point B.

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Positive Vs Normative Statements

Positive Statements

Positive statements are those statements which are objective and are based on facts and these statements are used by economists. These statements are based on available evidence. The statement ‘the unemployment rate is currently at 12%’ is an example of a positive economic statement because it is based on facts and is testable.  "A bad coffee harvest will give rise to coffee prices and people will drink more tea," is also an example of positive economic statement.

Normative Statements

Normative Statements are those statements which are subjective rather than objective and it deals with the values. In these statements, factual evidences are used as support but they are not factual and are based on opinions. These statements are used to recommend possible actions. The statement ‘the employment rate is too high’ is an example of a normative economic statement.

"To reduce poverty, government should increase the minimum wage to $10 per hour" is an example of normative economic statement because possible actions are recommended in this statement.

Absolute Advantage

Absolute advantage means the competency of a party or a country to produce more products than its competitors at lower cost per unit and using same resources.

Example:

In this example, assume that party A is able to produce 5 widgets in an hour with 3 workers while the party B is able to produce 10 widgets in an hour with 3 employees .

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In this example, assume that the workers are being paid equally. Table shows that party B has a comparative advantage over party A because party B is producing double the widgets as party A can with same number of employees.

Opportunity Cost

Opportunity cost is the cost of an alternative that must be forgone to select next best alternative. For example, if some capital or money is used for one purpose, so the opportunity cost is the value (money) of next better purpose the asset would have been used for and it is an important part of company’s decision making process.

Take example of an MBA student who studies in a private institution and pays $30,000 as tution fees and for a 2 year MBA program the total fees will be $60,000, however he could have continued his job. If the student is earning $50,000 an year and the salary is expected to increase by 10% in one year then $105000 would be forgone and adding the amount of expenses for education results in a cost of $165,000 for the MBA degree.

Comparative Advantage

Comparative advantage refers to the capability of a party to produce a specific product or service at a cost that is lower than other party and that party has a comparative advantage. Comparative advantage gives a firm the ability to sell goods at lower price and gain high profits.

Forces that shift the Demand Curve and Supply Curve

There are many reasons for the shift in the Demand curve. Main reasons for the shift in Demand curve is a change in the income, change in the price of substitutes and a change in the taste.

Let us take an example for the shift of Demand curve. In the figure shown below, the demand curve have shifted to right. This means that consumers are demanding greater number of commodities at every price increase. The quantity supplied would increase from 200 to 300 with a price increase from £4 to £5

Same as demand curve, supply curve also shifts for some reasons. Main reasons for the shift in Supply curve is the change in price of the commodity.

Let us take an example for the shift of Supply curve

In the figure shown below, the supply curve have shifted to right. This means that the products supply has increased because price of the commodity has decreased. The quantity supplied would increase from 50 to 60 but at a lower price from £20 to £15.

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Surplus

Surplus occurs when quantity supplied is greater than quantity demanded and in this situation goods would go unsold and this will force sellers to reduce their prices.

Figure below will help us explain surplus. If the price of selling one commodity is at P1, then because of high price only Q1 will be sold and the difference Q2-Q1 is the surplus.

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Shortage

Shortage occurs when quantity supplied is less than quantity demanded. In this situation sufficient goods will not be available for buyers and sellers will increase price of goods and their production.

Figure below will help us explain shortage. At price P1 only Q1 will be sold whereas the demand is Q2. The difference Q2-Q1 is the shortage.

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Price Elasticity of Demand

It is the relationship between a change in the demand of quantity of a particular product and a change in its price and is represented by PEoD. The formula for price elasticity of demand :

PEoD= (percentage change in quantity demanded)/(Percentage change in price)

For example: If the demand in quantity of a good increases 20% responding to an increase in price by 10%, then the price elasticity of demand will be 20%/10%=2.0

Price Elasticity of Supply

It is the relationship of a change in the quantity supplied of a particular product and a change in its price and is represented by PEoS. The formula for price elasticity of supply:

PEoS= (percentage change in quantity supplied)/(Percentage change in price)

For example: If the quantity supplied for a good increases 10% in response to an increase in price by 5%, then the price elasticity of demand will be 10%/5%=2.0

Income Elasticity

In economics, income elasticity of demand is the measure of the relationship of a change in the demand in quantity for a particular good and a change in the income of the buyers. It calculates the response rate of quantity demanded because of an increase or decrease in buyers income and it is denoted by IEoD.

The formula for IEoD is:

IEoD = (Percentage Change in Quantity Demanded)/(Percentage Change in Income)

For example: Let us find out the IEoD with a rise in consumer’s income from $40,000 to $50,000 and a rise in quantity demanded from 150 to 180. So here the percentage change is quantity demanded is 0.2 calculated by the formula: [QDemand(NEW) - QDemand(OLD)] / QDemand(OLD).

The percentage change in income is 0.25 calculated by the formula: [Income(NEW) - Income(OLD)] / Income(OLD)

Now puting the values in IEoD formula we get IEod=0.8

i.e: IEoD = (0.20)/(0.25) = 0.8

Cross price Elasticity of Demand

In economics, cross price elasticity of demand measures the response rate of quantity demanded of one good because of a change in price of other good and is denoted by CPEoD.

The formula for calculating Cross-Price Elasticity of Demand (CPEoD) is: (% Change in Quantity Demand for Good A)/(% Change in Price for Good B)

 For example, if the price of fuel increases by 10%, then in response the fuel inefficient cars’ demand is decreased by 20%, the cross price elasticity of demand would be: -20%/10%=-2. A negative cross elasticity means that the two products are complements, whereas a positive cross price elasticity means that the two products are substitute of each other.

Monopoly Vs Competition

Monopoly is a situation when there is only one producer or seller of the products and there is no substitute of that product. In this situation the seller controlls the whole market and sells at high price. Monopoly means lack of economic competition and the buyers have to buy product on high prices. A monopolist sets price based on profit maximization. In monopoly there are high barriers to entry and price discrimination.

Competition is a situation when there are more than one producers and sellers of the product which means the substitutes are available. In this situation there is a competition is between the sellers and they sell at lower pprice to capture the market. If one seller is selling at high price then the buyers can switch to substitute and buy at lower price.

Monopoly Vs Competitive Market

Marginal Revenue and Price: In a market with perfect competition, the price is equal to marginal cost while in a monopolistic market the price is set above marginal cost.

Number of Competitors: In a competitive market there are a number of competitors while in monopolistic market there is only one seller of the product.

Barriers to Entry: In perfectly cempetitive market there is not any high barrier to entry and the seller can easily enter and leave the market while in monopolistic market the barriers to entry are very high to discourage any competitor.

Product Differentiation: In perfectly cempetitive market there is zero product differentiation because there is a perfect substitute for every product while in monopolistic market there is a great product differentiation because of the lack of product substitutes.

http://economics.about.com/od/economics-basics/a/Positive-Versus-Normative-Analysis-In-Economics.htm

http://www.unc.edu/depts/econ/byrns_web/Economicae/Figures/Positive-Normative.htm

http://www.investopedia.com/terms/p/productionpossibilityfrontier.asp

http://www.netmba.com/econ/micro/cost/opportunity/

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