chapter 4: demand and supply analysis chapter checklist 1.distinguish between quantity demanded and...
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CHAPTER 4:
Demand and Supply Analysis
CHAPTER 4:
Demand and Supply Analysis
CHAPTER CHECKLIST
1. Distinguish between quantity demanded and demand and explain what determines demand.
2. Distinguish between quantity supplied and supply and explain what determines supply.
3. Explain how demand and supply determine price and quantity in a market and explain the effects of changes in demand and supply.
4. Explain how price ceilings, price floors, and sticky prices cause shortages, surpluses, and unemployment.
LECTURE TOPICS
Demand
Supply
Market Equilibrium
Price Rigidities
MARKETS
A market is any arrangement that bring buyers and sellers together.
In this chapter, we study a simple model of a market: a market that has so many buyers, all small relative to the size of the market, and so many sellers, all small relative to the size of the market, that no individual buyer or seller can influence the price by their individual actions.
This is called a “perfectly competitive market.”
MARKETS
4.1 DEMAND
Quantity demanded
The amount of a good, service, or resource that people are willing and able to buy during a specified period at a specified price.
The quantity demanded is an amount per unit of time. For example, the amount per day or per month.
How much people want to buy, given the price.
4.1 DEMAND
The Law of Demand
Other things remaining the same, [“ceteris paribus”]• If the price of a good rises, the quantity
demanded of that good decreases.• If the price of a good falls, the quantity
demanded of that good increases.• I.e., if something becomes more expensive,
people want to buy less of it; if it becomes cheaper, people want to buy more of it.
4.1 DEMAND
Demand Schedule and Demand Curve
Demand
The relationship between the quantity demanded and the price of a good when all other influences on buying plans remain the same.
Demand is a list of quantities at different prices and is illustrated by the demand curve.
“Demand” means all the amounts people will want to buy at all possible different prices, everything else unchanged; it is the relationship between price and how much people want to buy.
4.1 DEMAND
Demand scheduleA list of the quantities demanded at each different price when all the other influences on buying plans remain the same.
Demand curveA graph of the relationship between the quantity demanded of a good and its price when all other influences on buying plans remain the same; i.e. the graph of the good’s own-price and how much people want to buy at each own-price.
4.1 DEMAND
Economists have their own traditions ….
It is usual to draw graphs with the dependent variable on the y (vertical) axis and the independent variable on the x (horizontal) axis
Economics does it the other way round in demand and supply diagrams -- own-price determines the amount buyers want to buy, but own-price is on the vertical [y] axis.
Why?
Economists started drawing [and publishing in books] supply and demand diagrams in the 19th century, before the standard y = f(x) convention was strongly established
The standard supply and demand diagrams are so firmly established, nobody dares try to change them to conform to what is standard in math, science, and engineering
4.1 DEMAND
Changes in Demand
Change in the quantity demanded
A change in the quantity of a good that people plan to buy that results from a change in the price of the good.
Change in demand
A change in the quantities that people plan to buy [at various prices] when any influence other than the own-price of the good changes. In other words, a shift or change in the relationship between the price of the good and how much of it people want to buy.
4.1 DEMAND
1. When demand decreases, the demand curve shifts leftward from D0 to D1.
2. When demand increases, the demand curve shifts rightward from D0 to D2.
When demandchanges, thedemand curve shifts.
4.1 DEMAND
The main influences on buying plans that change demand are:
• Prices of related goods
• Income
• Expectations
• Number of buyers
• Preferences
Make a Mnemonic to remember:
Economists use “Y” for income a lot; so Prices of related goods Y -- income of [potential] buyers Number of [potential] buyers Tastes [preferences] of [potential] buyers Expectations about the future
4.1 DEMAND
Prices of Related Goods
SubstituteA good that can be consumed in place of another good. For example, apples and oranges.
The demand for a good increases, if the price of one of its substitutes rises.
The demand for a good decreases, if the price of one of its substitutes falls.
4.1 DEMAND
ComplementA good that is consumed with another good. For
example, ice cream and fudge sauce.
The demand for a good increases, if the price of
one of its complements falls.
The demand for a good decreases, if the price of
one of its complements rises.
4.1 DEMAND
Income
The demand for a normal good increases if income increases.
The demand for an inferior good decreases if income increases.
4.1 DEMAND
Expectations
Expected future income and expected future prices influence demand today.
For example, if the price of a computer is expected to fall next month, the demand for computers today decreases.
Number of Buyers
The greater the number of buyers in a market, the larger is the demand for any good.
4.1 DEMAND
Preferences
When preferences change, the demand for one item increases and the demand for another item (or items) decreases.
Preferences change when:• People become better informed, or new information becomes available.• New goods become available.• Fashions [opinions] shift for some reason.• Advertisers succeed in influencing tastes.
4.1 DEMAND
Demand: A Summary
4.2 SUPPLY
Quantity suppliedThe amount of a good, service, or resource that people are willing and able to sell during a specified period at a specified price – how much people want to sell at the given price.
The Law of Supply Other things remaining the same,
•If the price of a good rises, the quantity supplied of that good increases. When price rises,
people will want to sell more.
•If the price of a good falls, the quantity supplied of that good decreases. If the good’s price falls,
people will want to sell less.
4.2 SUPPLY
Supply Schedule and Supply Curve
Supply
The relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same.
Supply is a list of quantities at different prices and is illustrated by the supply curve, just like demand and the demand curve.
4.2 SUPPLY
Supply scheduleA list of the quantities supplied at each different price
when all other influences on selling plans remains the same.
Supply curve
A graph of the relationship between the quantity supplied and the good’s own-price when all
other influences on selling plans remain the same. As with demand, this is the relationship between the amounts sellers will want to sell and the price of the good, other things constant.
4.2 SUPPLY
4.2 SUPPLY
Changes in Supply
Change in quantity supplied
A change in the quantity of a good that suppliers plan to sell that results from a change in the price of the good.
Change in supply
A change in the quantities that suppliers plan to sell at all different prices when any influence on selling plans other than the own-price of the good changes; i.e. a change in the relationship between own-price and how much sellers want to sell caused by some change in something other than the good’s price.
4.2 SUPPLY
2. When supply increases, the supply curve shifts rightward from S0 to S2.
1. When supply decreases, the supply curve shifts leftward from S0 to S1.
When supply changes, the supply curve shifts.
4.2 SUPPLY
4.2 SUPPLY
The main influences on selling plans that change supply are:
• Prices of related goods
• Prices of resources and other Inputs
• Expectations
• Number of sellers
• Productivity
Things that shift supply ..
Prices of inputs used to make the good and of related outputs;
Expectations about future prices Supplier numbers Technology
4.2 SUPPLY
Prices of Related Goods
A change in the price of one good can bring a change in the supply of another good.
Substitute in production
A good that can be produced in place of another good. For example, a truck and an SUV in an auto factory.
• The supply of a good increases if the price of one of its substitutes in production falls.
• The supply a good decreases if the price of one of its substitutes in production rises.
4.2 SUPPLY
Complement in production
A good that is produced along with another good. For example, straw is a complement in production of wheat. Manufacturing examples are hard to find except in things like metal-refining.
• The supply of a good increases if the price of one of its complements in production rises.
• The supply a good decreases if the price of one of its complements in production falls.
4.2 SUPPLY
Prices of Resources and Other Inputs
Resource and input prices influence the cost of production. And the more it costs to produce a good, the smaller will be supply of that good.
Expectations
• Expectations about future prices influence supply.
• Expectations of future input prices also influence supply.
4.2 SUPPLY
Number of Sellers
The greater the number of sellers in a market, the larger is supply.
Productivity
Productivity is output per unit of input.
An increase in productivity lowers costs and increases supply.
4.2 SUPPLY
Supply: A Summary
Supply and Market Structure
Remember, we ONLY talked about markets where there are many suppliers, all small compared to the market
With other market structures, there may not be a ‘supply curve’ in a meaningful sense; ECO 2023 will deal with those cases
4.3 MARKET EQUILIBRIUM
Market equilibriumWhen the quantity demanded equals the quantity supplied—when buyers’ and sellers’ plans are consistent.
Equilibrium priceThe price at which the quantity demanded equals the quantity supplied.
Equilibrium quantityThe quantity bought and sold at the equilibrium price.
4.3 MARKET EQUILIBRIUM
Figure 4.5 shows theequilibrium price andequilibrium quantity.
1. Market equilibrium is at the intersection of the demand curve and the supply curve.
2. The equilibrium price is $1 a bottle.
3. The equilibrium quantity is 10 million bottles a day.
4.3 MARKET EQUILIBRIUM
Price: A Market’s Automatic Regulator
Law of market forces• When there is a shortage, the price tends to rise.• When there is a surplus, the price tends to fall.
Surplus or Excess Supply
The quantity supplied exceeds the quantity demanded.
Shortage or Excess Demand
The quantity demanded exceeds the quantity supplied.
4.3 MARKET EQUILIBRIUM
Figure 4.6(a) marketachieves equilibrium.
At $1.50 a bottle:
1. Quantity supplied is 11 bottles.
3. There is a surplus.
4. Price falls until the market is in equilibrium.
2. Quantity demanded is 9 bottles.
4.3 MARKET EQUILIBRIUM
Figure 4.6(b) marketachieves equilibrium.
At 75 cents a bottle:
5. Quantity demanded is 11 bottles.
7. There is a shortage.
8. Price rises until the market is in equilibrium.
6. Quantity supplied is 9 bottles.
4.3 MARKET EQUILIBRIUM
Figure 4.7(a) shows theeffects of an increase indemand.
1. An increase in demand shifts the demand curve rightward.
2. The price rises to restore market equilibrium.
3. Quantity supplied increases along the supply curve.
4. Equilibrium quantity increases.
4.3 MARKET EQUILIBRIUM
Figure 4.7(b) shows theeffects of a decrease indemand.
1. A decrease in demand shifts the demand curve leftward.
2. The price falls to restore market equilibrium.
3. Quantity supplied decreases along the supply curve.
4. Equilibrium quantity decreases.
4.3 MARKET EQUILIBRIUM
Effects of Changes in Demand
When demand changes:
• The supply curve does not shift.
• But there is a change in the quantity supplied – sellers change how much they want to sell, because price changes.
• Price and quantity change in the same direction as the change in demand.
4.3 MARKET EQUILIBRIUM
Figure 4.8(a) shows theeffects of an increase insupply.1. An increase in supply shifts
the supply curve rightward.
2. The price falls to restore market equilibrium.
3. Quantity demanded increases along the supply curve.
4. Equilibrium quantity increases.
4.3 MARKET EQUILIBRIUM
Figure 4.8(b) shows theeffects of a decrease in supply.
1. A decrease in supply shifts the supply curve leftward.
2. The price rises to restore market equilibrium.
3. Quantity demanded decreases along the supply curve.
4. Equilibrium quantity decreases.
4.3 MARKET EQUILIBRIUM
Effects of Changes in Supply
When supply changes:
• The demand curve does not shift.
• But there is a change in the quantity demanded – buyers change how much they want to buy, because the price changes.
• Price changes in the same direction as the change in supply.
• Quantity changes in the opposite direction to the change in supply.
4.3 MARKET EQUILIBRIUM
Figure 4.9(a) shows theeffects of an increase inboth demand and supply.
An increase in demandshifts the demand curverightward and an increasein supply shifts the supplycurve rightward.
1. Quantity increases.
2. Price might rise or fall.
4.3 MARKET EQUILIBRIUM
Increase in Both Demand and Supply
• Increases the equilibrium quantity.
• The change in the equilibrium price is ambiguous because the:
Increase in demand raises the price.
Increase in supply lowers the price.
4.3 MARKET EQUILIBRIUM
Figure 4.9(b) shows theeffects of a decrease inboth demand and supply.
A decrease in demandshifts the demand curveleftward and a decrease insupply shifts the supplycurve leftward.
3. Quantity decreases.
4. Price might rise or fall.
4.3 MARKET EQUILIBRIUM
Decrease in Both Demand and Supply
• Decreases the equilibrium quantity.
• The change in the equilibrium price is ambiguous because the:
Decrease in demand lowers the price
Decrease in supply raises the price.
4.3 MARKET EQUILIBRIUM
Figure 4.10(a) shows theeffects of an increase indemand and a decrease insupply.
An increase in demandshifts the demand curverightward, and a decreasein supply shifts the supplycurve leftward.
1. Price rises.
2. Quantity might increase, decrease, or not change.
4.3 MARKET EQUILIBRIUM
Increase in Demand and Decrease in Supply
• Raises the equilibrium price.
• The change in the equilibrium quantity is ambiguous because the:
Increase in demand increases the quantity.
Decrease in supply decreases the quantity.
4.3 MARKET EQUILIBRIUM
Figure 4.10(b) shows theeffects of a decrease indemand and an increasein supply.
A decrease in demandshifts the demand curveleftward, and an increasein supply shifts the supplycurve rightward.
3. Price falls.
2. Quantity might increase, decrease, or not change.
4.3 MARKET EQUILIBRIUM
Decrease in Demand and Increase in Supply
• Lowers the equilibrium price.
• The change in the equilibrium quantity is ambiguous because the:
Decrease in demand decreases the quantity.
Increase in supply increases the quantity.
Kinds of Equilibrium Unstable
Neutral Stable
Market Equilibrium
One of the neat things about the market is that the Demand and Supply model shows that market equilibrium is generally stable
I.e., it is like
If the ball moves a little, it will go back where it started; if conditions don’t change, but price is perturbed [moved] a little from equilibrium, it will go back where it started.
4.4 PRICE RIGIDITIES
Price adjustments bring market equilibrium.
But sometimes prices do not adjust. What happens then?
Three reasons why price adjustment might not occur are:
• Price ceiling• Price floor• Sticky price
4.4 PRICE RIGIDITIES
Price Ceiling
Price Ceiling
The highest price at which it is legal to trade a particular good, service, or factor of production.
Rent Ceiling
A law that makes it illegal for landlords to charge a rent that exceeds a set limit.
Figure 4.11 shows a rental apartment market.
1. Market equilibrium is determined by demand and supply.
2. The equilibrium rent is $550 a month.
3. The equilibrium quantity is 4,000 apartments.
4.4 PRICE RIGIDITIES
Figure 4.12 shows a rental apartment market.
The rent ceiling is introduced below the equilibrium rent at $400 a month.
The quantity for apartments demanded increases to 6,000.
The quantity of apartments supplied decreases to 3,000.
There is a shortage of 4,000 apartments.
4.4 PRICE RIDIGITIES
4.4 PRICE RIGIDITIES
Price Floor
Price floor
The lowest price at which it is legal to trade a particular good, service, or factor of production.
Minimum wage law
A government regulation that makes hiring labor for less than a specified wage illegal.
Figure 4.13 shows a market for fast food servers.
1. Market equilibrium is determined by demand and supply.
2. The equilibrium wage rate is $5 an hour.
3. The equilibrium quantity is 5,000 servers.
4.4 PRICE RIGIDITIES
Figure 4.14 shows how a minimum wage creates unemployment.
The minimum wage rate is set at $7 an hour.
1. The quantity demanded decreases to 3,000 workers.
2. The quantity supplied increases to 7,000 workers.
3. A surplus of workers occurs and 4,000 are unemployed.
4.4 PRICE RIGIDITIES
4.4 PRICE RIGIDITIES
Sticky Price
In most markets, a law does not restrict the price.
But in some markets, either the buyer and seller agree on a price for a fixed period or the seller sets a price that changes infrequently.
In these markets, prices adjust slowly and not quickly enough to avoid shortages and surpluses.
Methodology
How to use Demand and Supply:
Identify the Ceteris Paribus variable(s) that changed.
Shift the Demand and/or Supply curve. Find the new Equilibrium. Make your prediction. It will be qualitative – direction of
change, not how much.