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Demand, Supply, & Demand, Supply, & Market EquilibriumMarket Equilibrium
Chapter 3Chapter 3
DemandDemand
A schedule or curve that shows the A schedule or curve that shows the various amounts of a product that various amounts of a product that consumers are willing and able to consumers are willing and able to purchase at each of a series of possible purchase at each of a series of possible prices during a specified period of timeprices during a specified period of time
A statement of a buyer’s plans, or A statement of a buyer’s plans, or intentions, with respect to the purchase of intentions, with respect to the purchase of a producta product
Law of DemandLaw of Demand
Other-Things-Equal AssumptionOther-Things-Equal Assumption
As the Price (P) falls, the Quantity As the Price (P) falls, the Quantity Demanded (QDemanded (QDD) rises. ) rises. (P(P↓ ↓ QQD D ↑)↑)
As the Price (P) rises, the Quantity As the Price (P) rises, the Quantity Demanded (QDemanded (QDD) falls. ) falls. (P(P↑ ↑ QQD D ↓)↓)
Thus, there is an inverse (or negative) Thus, there is an inverse (or negative) relationship between Price and Quantity relationship between Price and Quantity Demanded. Demanded.
Law of Demand Law of Demand
Common SenseCommon Sense– People do buy more at low pricesPeople do buy more at low prices– Sales!!!Sales!!!
Diminishing Marginal UtilityDiminishing Marginal Utility– Each additional unit of the product produces less Each additional unit of the product produces less
satisfaction (or benefit, or utility)satisfaction (or benefit, or utility)
Income EffectIncome Effect– Lower prices increase the purchasing power of a Lower prices increase the purchasing power of a
buyer’s incomebuyer’s income
Substitution EffectSubstitution Effect– Lower prices give buyers the incentive to substitute Lower prices give buyers the incentive to substitute
similar productssimilar products
Individual DemandIndividual Demand 6
5
4
3
2
1
0 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week)
Pri
ce (
per
bu
shel
)
P Qd
$5
4
3
2
1
10
20
35
55
80
IndividualDemand
P
Q
D
Determinants of DemandDeterminants of Demand
TastesTastes– Favorable change in consumer tastes (preferences) = More Demanded Favorable change in consumer tastes (preferences) = More Demanded
at each price at each price Number of BuyersNumber of Buyers– Increase in number of buyers = Increase in DemandIncrease in number of buyers = Increase in Demand
IncomeIncome– Normal (Superior) Goods – Demand Varies Directly with Income Normal (Superior) Goods – Demand Varies Directly with Income – Inferior Goods – Demand Varies Inversely with IncomeInferior Goods – Demand Varies Inversely with Income
Prices of Related GoodsPrices of Related Goods– Substitutes: Used in place of another good Substitutes: Used in place of another good
Example: Leather vs. Cloth CoatsExample: Leather vs. Cloth Coats– Complements: Used together with another good Complements: Used together with another good
Example: Computers & Software Example: Computers & Software – Unrelated Goods: Not related at allUnrelated Goods: Not related at all
Example: Potatoes & AutomobilesExample: Potatoes & Automobiles
Consumer ExpectationsConsumer Expectations
Determinants of DemandDeterminants of Demand
Therefore, an Increase in Demand may be Therefore, an Increase in Demand may be caused by:caused by:– A favorable change in consumer tastes/preferencesA favorable change in consumer tastes/preferences– An increase in the number of buyersAn increase in the number of buyers– Rising incomes if the product is a normal goodRising incomes if the product is a normal good– Falling incomes if the product is an inferior goodFalling incomes if the product is an inferior good– An increase in the price of a substitute goodAn increase in the price of a substitute good– A decrease in the price of a complimentary goodA decrease in the price of a complimentary good– A new consumer expectation that either prices or A new consumer expectation that either prices or
income will be higher in the future income will be higher in the future
Individual DemandIndividual Demand 6
5
4
3
2
1
0
Quantity Demanded (bushels per week)
Pri
ce (
per
bu
shel
)
P Qd
$5
4
3
2
1
10
20
35
55
80
IndividualDemand
P
Q
D1
2 4 6 8 10 12 14 16 18
Demand Can Increase or Decrease
Increase in Demand
Decrease in Demand
D2
D3
Changes in Quantity DemandedChanges in Quantity Demanded
Not to be confused with Change in DemandNot to be confused with Change in Demand– A shift of the demand curve to the right (increase in A shift of the demand curve to the right (increase in
demand) or to the left (decrease in demand)demand) or to the left (decrease in demand)– Cause: A change in one or more determinants of Cause: A change in one or more determinants of
demanddemand
Change in Change in Quantity DemandedQuantity Demanded– A movement from one point to another point – from A movement from one point to another point – from
one price/quantity combination to another– on a fixed one price/quantity combination to another– on a fixed demand schedule/curvedemand schedule/curve
– Cause: An increase or decrease in the price of the Cause: An increase or decrease in the price of the product under considerationproduct under consideration
Individual DemandIndividual Demand
6
5
4
3
2
1
0
Quantity Demanded (bushels per week)
Pri
ce (
per
bu
shel
)
P Qd
$5
4
3
2
1
10
20
35
55
80
IndividualDemand
P
Q
D1
2 4 6 8 10 12 14 16 18
Demand Can Increase or Decrease
Decrease in Demand
D2
D3
An Increase in DemandMeans a Movementof the Line
A Movement BetweenAny Two Points on a
Demand Curve is Called a Change in
QuantityDemanded
SupplySupply
A schedule or curve showing the various A schedule or curve showing the various amounts of a product that producers are amounts of a product that producers are willing and able to make available for sale willing and able to make available for sale at each of a series of possible prices at each of a series of possible prices during a specific periodduring a specific period
Law of SupplyLaw of Supply
As the Price (P) falls, the Quantity Supplied (QAs the Price (P) falls, the Quantity Supplied (Qss) ) falls. falls. (P(P↓ ↓ QQs s ↓)↓)
As the Price (P) rises, the Quantity Supplied (QAs the Price (P) rises, the Quantity Supplied (Qss) ) rises. rises. (P(P↑ ↑ QQs s ↑)↑)
Thus, there is a direct (or positive) relationship Thus, there is a direct (or positive) relationship between Price and Quantity Supplied. between Price and Quantity Supplied. Remember, the supplier is on the receiving end Remember, the supplier is on the receiving end of the product’s price. Therefore, higher prices of the product’s price. Therefore, higher prices don’t pose the same obstacle on the supply side don’t pose the same obstacle on the supply side as they do on the demand side.as they do on the demand side.
Individual SupplyIndividual Supply 6
5
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3
2
1
0
Quantity Supplied (bushels per week)
Pri
ce (
per
bu
shel
)
P Qs
$5
4
3
2
1
60
50
35
20
5
IndividualSupply
P
Q
S1
10 20 30 40 50 60 70
Determinants of SupplyDeterminants of Supply
Resource PricesResource Prices– Higher Resource Prices raise production costs & squeeze profitsHigher Resource Prices raise production costs & squeeze profits– Lower Resource Prices reduce production costs & increase Lower Resource Prices reduce production costs & increase
profits profits
TechnologyTechnology– Improvements in technology enable firms to produce units of Improvements in technology enable firms to produce units of
output with fewer resourcesoutput with fewer resources
Taxes & SubsidiesTaxes & Subsidies– Businesses treat most taxes as costs. Businesses treat most taxes as costs. – Increase in sales or property taxes will increase production costs Increase in sales or property taxes will increase production costs
& reduce supply& reduce supply– Subsidies are considered “taxes in reverse”Subsidies are considered “taxes in reverse”– Thus, lower production costs/increase in supply Thus, lower production costs/increase in supply
Determinants of SupplyDeterminants of Supply
Prices of other GoodsPrices of other Goods– Substitution in ProductionSubstitution in Production– Example: Producing basketballs instead of soccer balls results Example: Producing basketballs instead of soccer balls results
in a decline in the supply of soccer balls in a decline in the supply of soccer balls
Producer ExpectationsProducer Expectations– Future Prices of ProductsFuture Prices of Products
Number of Sellers in the MarketNumber of Sellers in the Market– Other things equal, the larger the number of suppliers, the Other things equal, the larger the number of suppliers, the
greater the market supply greater the market supply – As more firms enter the industry, the supply curve shifts to the As more firms enter the industry, the supply curve shifts to the
rightright– The smaller the number of suppliers, the less the market supplyThe smaller the number of suppliers, the less the market supply– As more firms leave the industry, the supply curve shifts to the As more firms leave the industry, the supply curve shifts to the
leftleft
Individual SupplyIndividual Supply 6
5
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3
2
1
0
Quantity Supplied (bushels per week)
Pri
ce (
per
bu
shel
)
P Qs
$5
4
3
2
1
60
50
35
20
5
IndividualSupply
P
Q
S1
Supply Can Increase or Decrease
S2
S3
2 4 6 8 10 12 14
Changes in Quantity SuppliedChanges in Quantity Supplied
Not to be confused with Change in SupplyNot to be confused with Change in Supply– A change in the schedule & shift of the curveA change in the schedule & shift of the curve– An increase in supply shifts curve to the rightAn increase in supply shifts curve to the right– A decrease in supply shifts curve to the leftA decrease in supply shifts curve to the left– Cause: A change in one or more of the determinants Cause: A change in one or more of the determinants
of supplyof supply
Change in Change in Quantity SuppliedQuantity Supplied – A movement from one point to another on a fixed A movement from one point to another on a fixed
supply curvesupply curve– Cause: A change in the price of the specific product Cause: A change in the price of the specific product
being consideredbeing considered
Individual SupplyIndividual Supply
6
5
4
3
2
1
0
Quantity Supplied (bushels per week)
Pri
ce (
per
bu
shel
)
P Qs
$5
4
3
2
1
60
50
35
20
5
IndividualSupply
P
Q
S1
Supply Can Increase or Decrease
S2
S3
An Increase in SupplyMeans a Movementof the Line
A Movement BetweenAny Two Points on a
Supply Curve is Called a Change in Quantity
Supplied
2 4 6 8 10 12 14
Market EquilibriumMarket Equilibrium
Equilibrium Price (PEquilibrium Price (PEE) ) – Market Clearing PriceMarket Clearing Price– The price where the intentions of buyers & sellers The price where the intentions of buyers & sellers
matchmatch– QQD D = Q= QSS
Equilibrium QuantityEquilibrium Quantity– The quantity demanded & supplied at the equilibrium The quantity demanded & supplied at the equilibrium
price in a competitive marketprice in a competitive market
Competition among buyers & sellers drives the Competition among buyers & sellers drives the price to equilibriumprice to equilibriumSurplus: Excess SupplySurplus: Excess SupplyShortage: Excess DemandShortage: Excess Demand
Market EquilibriumMarket Equilibrium
6
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0 2 4 6 8 10 12 14 16 18Bushels of Corn (thousands per week)
Pri
ce (
per
bu
shel
)
P Qd
$5
4
3
2
1
2,000
4,000
7,000
11,000
16,000
MarketDemand
200 BuyersP Qs
$5
4
3
2
1
12,000
10,000
7,000
4,000
1,000
MarketSupply
200 Sellers
200 Buyers & 200 Sellers
7
3
D
S
$4 Price Floor
6,000 BushelSurplus
$2 Price Ceiling
7,000 BushelShortage
Government-Set PricesGovernment-Set Prices
Price CeilingsPrice Ceilings– The maximum legal price a seller may charge for a product or The maximum legal price a seller may charge for a product or
serviceservice– Prices at or below the ceiling are legalPrices at or below the ceiling are legal– Prices above are notPrices above are not– Examples: Rent ControlsExamples: Rent Controls– Sometimes leads to black markets & political pressure to lower Sometimes leads to black markets & political pressure to lower
pricesprices
Price FloorsPrice Floors– A minimum price fixed by the government A minimum price fixed by the government – A price at or above the floor are legalA price at or above the floor are legal– Prices below are notPrices below are not– Distort resource allocationDistort resource allocation
Efficient AllocationEfficient Allocation
Productive EfficiencyProductive Efficiency– The production of any particular good in the least costly way The production of any particular good in the least costly way
Example: Have $100 worth of resourcesExample: Have $100 worth of resourcesCan produce a bushel of corn using either $5 or $3 of those Can produce a bushel of corn using either $5 or $3 of those resources, leaving either $95 or $97 remaining for alternative usesresources, leaving either $95 or $97 remaining for alternative usesWhich is better?Which is better?
Allocative EfficiencyAllocative Efficiency– The particular mix of goods & services most highly valued by The particular mix of goods & services most highly valued by
society (minimum cost production assumed)society (minimum cost production assumed)– Society wants iPods instead of cassette tapes Society wants iPods instead of cassette tapes – However, society also wants cell phonesHowever, society also wants cell phones– Competitive markets help assign allocative efficiency Competitive markets help assign allocative efficiency
Equilibrium Price & QuantityEquilibrium Price & Quantity
In competitive markets, produces an assignment In competitive markets, produces an assignment of resources that is “right” from an economic of resources that is “right” from an economic perspectiveperspective
Demand reflects MB based on utility receivedDemand reflects MB based on utility received
Supply reflects MC of producing goodSupply reflects MC of producing good
Remember:Remember:– MB>MC Expand OutputMB>MC Expand Output– MB<MC Reduce OutputMB<MC Reduce Output– MB=MC Optimal OutputMB=MC Optimal Output
Changes in Supply, Demand, Changes in Supply, Demand, & Equilibrium& Equilibrium
Changes in DemandChanges in Demand– Supply Constant, Demand IncreasesSupply Constant, Demand Increases
Raises PRaises PEE and Q and QEE See pg 57, Figure 3.7 aSee pg 57, Figure 3.7 a
– Supply Constant, Demand DecreasesSupply Constant, Demand DecreasesReduces PReduces PEE and Q and QEE See pg 57, Figure 3.7bSee pg 57, Figure 3.7b
Changes in SupplyChanges in Supply– Demand Constant, Supply IncreasesDemand Constant, Supply Increases
Reduces PReduces PEE, Increases Q, Increases QEE See pg 57, Figure 3.7cSee pg 57, Figure 3.7c
– Demand Constant, Supply DecreasesDemand Constant, Supply DecreasesIncreases PIncreases PEE, Reduces Q, Reduces QEE See pg 57, Figure 3,7dSee pg 57, Figure 3,7d
Changes in Supply, Demand, Changes in Supply, Demand, & Equilibrium& Equilibrium
Complex Cases: (See pg. 57, Table 3.7)Complex Cases: (See pg. 57, Table 3.7)– Supply Supply ↑ Demand ↓ P↑ Demand ↓ PE E ↓↓ QQE E ??
– Supply ↓ Demand ↑ PSupply ↓ Demand ↑ PE E ↑ Q↑ QE E ? ?
– Supply ↑ Demand ↑ PSupply ↑ Demand ↑ PE E ? Q? QE E ↑ ↑
– Supply ↓ Demand ↓ PSupply ↓ Demand ↓ PE E ? Q? QE E ↓ ↓