Demand, Supply, and EquilibriumMicroeconomics – Unit 2: Nature and Function of Product Markets

The Relationship Between Demand and Total/Marginal Utility Total Utility Marginal Utility The Law of Diminishing Marginal Utility

Demand

Amounts of a product consumers are willing and able to buy

Law of Demand = inverse or negative relationship between price and quantity demanded

Pric

e

Quantity

D

D

Law of Demand

Why?◦ Price is an obstacle to buying◦ Diminishing marginal utility

Determinants of Demand

Consumer tastes/preferences # of buyers in the market Consumers’ incomes◦ Income Effect

Prices of related goods◦ Substitute goods Substitution Effect

◦ Complementary goods

Consumer expectations

Supply

Amounts of a product that producers are willing and able to make available for sale

Law of Supply = positive relationship between price and quantity supplied

Pric

e

Quantity

S

S

Law of Supply

Why?◦ Price = incentive to sell more product◦ Increases in marginal cost

Determinants of Supply

Resource prices Technology Taxes and subsidies Prices of other goods◦ Substitution in production

Producer expectations # of sellers in the market

Market Equilibrium

Equilibrium price = “market clearing price”

Equilibrium price (Po) = ◦ A. Productive Efficiency◦ B. Allocative Efficiency

Market ensures MB ≥ MC Any price above equilibrium = surplus Any price below equilibrium = shortage

Producer and Consumer Surplus

Consumer Surplus = the sum of the products of the prices and quantities consumers would have been willing to buy ABOVE the equilibrium price

Producer Surplus = the sum of the products of the prices and quantities suppliers would have been willing to sell BELOW the equilibrium price

Producer and Consumer Surplus

Calculating Producer and Consumer Surplus Calculating Producer and Consumer

Surplus

Price Ceilings

Gov’t sets a maximum price sellers may charge consumers

EX: rent controls, usury lawsPr

ice

Quantity

S

SD

D

Po

Pc

QoQs Qd

Shortage

Price Floors

Gov’t sets a minimum price buyers may pay sellers

EX: crop price supports, minimum wagesPr

ice

Quantity

S

SD

D

Po

Pf

QoQd Qs

Surplus

Maximum and Minimum Price Controls Complete the Worksheet on Maximum

and Minimum Price Controls

Equilibrium Price and Quantity

Complete the Worksheet on Equilibrium Price and Quantity

Greebies

Changes in Supply/Demand/Equilibrium ∆’s in Demand◦ Raises or reduces both equilibrium price (Po)

and equilibrium quantity (Qo) ∆’s in Supply◦ Increase in S = lower Po, higher Qo

◦ Decrease in S = higher Po, lower Qo

Graph Shift

Changes in Supply/Demand/Equilibrium S increases, D decreases◦ Qo depends on relative increase in S vs. D

S decreases, D increases◦ Qo depends on relative increase in S vs. D

S decreases, D decreases◦ If decrease in S > decrease in D = Po will

increase, Qo will decrease◦ If decrease in S < decrease in D = Po will

decrease, Qo will decrease

Changes in Supply/Demand/Equilibrium S increases, D increases◦ If increase in S > increase in D = Po will

decrease Qo will increase◦ If increase in S < increase in D = Po will

increase, Qo will increase

Graph Shift

Changes in Demand/Supply/Equilibrium If increase in S EQUALs the increase in D

then Po will stay the same. If decrease in S EQUALs the decrease in

D then Po will stay the same

Closure: Exit Ticket Activity

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