Download - CHAPTER 2 DEMAND CHAPTER 3 SUPPLY Zoubida SAMLAL - MBA, CFA Member, PHD candidate for HBS program
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CHAPTER 2 DEMAND CHAPTER 3 SUPPLY
Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program
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OUTLINE
• Demand• Supply• Market Equilibrium• Examples• Price ceiling/floor
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BUILD A MODEL
• buyers• sellers• & their interaction
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USE THE MODEL
• to predict–the impact of changes
• to explain –changes that occur
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DEMAND
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DEMAND
• behaviour of buyers• relationship between– quantity demanded of a good– price– holding other factors constant
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QUANTITY DEMANDED (QD)
• amount of good or service– unit of measure
• per unit of time• “2 bottles of water per day”
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LAW OF DEMAND
If the price of a good
then the Qd
holding other things constant!!!
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WHY?
• higher price makes you feel poorer– income effect
• higher price on one good,substitute other goods.
– substitution effect
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EXAMPLE: BOTTLES OF WATER PER DAY
Describe demand in 2 ways:• Demand schedule– a list of Qd
at each price• Demand curve– a graph of demand schedule
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DEMAND SCHEDULE
P QdPrice = $/bottle
Qd = bottles/day
$2.00 0$1.50 1
$1.00 2$.50 3
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DEMAND CURVEP
Qd
0 1 2 3 4
2
1.5
1
.5D
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• individual demand• demand curve for 1 buyer
• market demand**• demand curve for all buyers• add up individual Qd for each price
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CHANGES IN DEMAND
• recall our assumption– hold other things constant– allow only price to change
• but what if other factors do change?– change in demand– shift to a new demand curve
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INCREASE IN DEMAND
• increase in Qd at every price• demand curve shifts to the right
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P
Qd0 1 2 3 4
2
1.5
1
.5 DD’
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DECREASE IN DEMAND
• decrease in Qd at every price• demand curve shifts to the left
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P
Qd
DD’’
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FACTORS AFFECTING DEMAND
• income• prices of related goods• buyer expectations• # of buyers• preferences
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INCOME
• for normal goods,an increase in income will increase demand
• examples:CDs, bottled water,eating out,
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• for inferior goods,• an increase in income will• decrease the demand• examples:– ramen noodles,– check-cashing service
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PRICES OF RELATED GOODS
• what are related goods?– substitutes
e.g. Snapple, Coke– complements
goods consumed with watere.g. pretzels
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SUBSTITUTES
• if price of Snapple rises,– people switch to water– increase in demand for water
• if price of Snapple falls,– people switch from water
to Snapple– decrease in demand for water
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COMPLEMENTS• if price of pretzels rises– eat fewer pretzels,
so drink less water,– demand for water falls
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BUYER EXPECTATIONS
• buyers can expect change in– future income– future prices
and act to change demand today
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• expect price of water to rise next month,• buy a case today,• increase demand today
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# OF BUYERS
• size of population• demographics– age– gender– race
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• if there are more buyers• increase market demand for water• could be due to– more people overall – more people who like
water
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PREFERENCES
• what do we want to buy?• change in our likes/dislikes– acid washed jeans?– tattoos?
• change in technology– 5 1/4” floppies?– DVDs?
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• if drinking more water• beneficial to health,
• increase in demand for bottled water
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IMPORTANT!!• Change in demand
-- occurs when other factors change-- shift to a new demand curve
• change in demand– NOT caused by change in price of
the good
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• Change in quantity demanded• -- occurs when prices change• -- movement along existing demand
curve
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CHANGE IN QDP
Qd
D
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CHANGE IN DEMANDP
Qd
DD
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SUPPLY
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SUPPLY
• behavior of sellers• relationship between– quantity supplied of a good– price– holding other factors constant
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LAW OF SUPPLY
If the price of a good
then the Qs
holding other things constant!!!
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WHY?
• Holding costs constant• higher price means higher profit margin
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SUPPLY SCHEDULE
P QsPrice = $/bottle
Qs = bottles/day
$2.00 3$1.50 2
$1.00 1$.50 0
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S
SUPPLY CURVEP
Qs0 1 2 3 4
2
1.5
1
.5
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• Individual supply• supply curve for 1 supply
• market supply**• supply curve for all sellers• add up individual Qs for each price
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CHANGES IN SUPPLY
• if other factors do change,– change in supply– shift to a new supply curve
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INCREASE IN SUPPLY
• increase in Qs at every price• supply curve shifts to the right
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P
Qs
S
S’
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DECREASE IN SUPPLY
• decrease in Qs at every price• supply curve shifts to the left
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P
Qs
S
S’’
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FACTORS AFFECTING SUPPLY
• Cost of inputs• prices of related goods• seller expectations• # of seller• productivity
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COST OF INPUTS
• As input prices get higher,supply decreases
• example: increase in cost of– bottles– labor– electricity
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PRICES OF RELATED GOODS• Substitutes in production– a good that can be made instead
of bottled watere.g. bottled tea
• If price of bottled tea increases,switch to tea production,supply of bottled water falls
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• Complements in production• good that is produced with other good– e.g. Beef & leather• if price of beef rises,– Qs of beef rises,– & supply of leather rises–
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SELLER EXPECTATIONS
• Expect input prices to rise in future– increase supply today
• expect price of good to rise in future– decrease supply today
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# of sellers
• As more sellers supply good,– market supply increases
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PRODUCTIVITY
• Amount of output per unit of input– bottles of water per hour of labor
• Increase in productivity lowers cost– increases supply
• what makes productivity increase?– Technology– human capital
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IMPORTANT!!• Change in supply
-- occurs when other factors change-- shift to a new supply curve
(right or left)• change in supply
-- NOT caused by change in price ofthe good
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• Change in quantity supplied• -- occurs when prices change• -- movement along existing supply curve
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CHANGE IN QSP
Qs
S
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P
Qs
S
S’’
CHANGE IN SUPPLY
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MARKET EQUILIBRIUM
• What will be the price of bottled water? – Price at which Qs = Qd
-- equilibrium price-- equilibrium quantities
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MARKET FOR BOTTLED WATER
P
(millions bottles per day)
Q
D
S
$10
10
Equilibrium
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WHY IS THIS AN EQUILIBRIUM?
• If Qs > Qd– surplus– price falls until Qs = Qd
• If Qs < Qd– shortage– price rises until Qs = Qd
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CHANGES IN EQUILIBRIUM
• If supply and/or demand changes(shifts left or right),then equilibrium will change too.
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EXAMPLE 1
• Market for bottled water• price of plastic bottles rises• what happens to equilibrium?
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WHICH CURVE IS AFFECTED?
• buyers or sellers?• Supply curve– bottles are an input
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INCREASE OR DECREASE IN SUPPLY?
• Increase in cost of input• supply decreases– shift LEFT
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P
(millions bottles per day)
S
Q
D
$10
10
S’
Equilibrium:
P
Q
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NOTE
• Change in supply causeschange in equilibrium price
BUT• Change in price does NOT cause a
change in supply
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EXAMPLE 2
• Market for bottled water• sugar is found to be harmful to health• what happens to equilibrium?
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WHICH CURVE IS AFFECTED?
• Demand curve– health concerns increase
preferences for water
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INCREASE OR DECREASE IN DEMAND?
• Increase in preference for water• demand increases– shift RIGHT
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P
(millions bottles per day)
S
Q
D
$10
10
D’
Equilibrium:
P
Q
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EXAMPLE 3
• Market for bottled water• incomes fall &
sellers expect utilities to rise
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WHICH CURVE IS AFFECTED?
• Demand curve– income falls
• Supply curve– seller expectations change– expect costs to rise
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INCREASE OR DECREASE?
• Demand decreases (left)– income falls &
bottled water is normal good• Supply increases (right)– make more water today before
costs go up
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P
(millions bottles per day)
S
Q
DD’
Equilibrium:
P
Q ?
S’
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EXAMPLE 4: LEATHER SANDALS
Market for leather sandalsA. Mad cow disease
-- must destroy 20% of herds
• what happens to equilibrium
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P
Q
S
D
S’
Supply decreases
Q decreases
P increases
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PETA• campaign against leather products• what happens to equilibrium?
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P
Q
S
DD’
demand decreases
Q decreases
P decreases
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EXAMPLE 5: NATURAL GAS PRICES
• Winter 2000-2001prices increased over 100%• why?
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• 3 possible causes:• 1. Supply decreases• or• 2. Demand increases• or• 3. both
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P
Q
S
D
S’
Decrease in Supply
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WHY WOULD S FALL?
• regulation-- tougher to drill-- increase costs
• hot summer (2000)-- depletes inventories
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P
Q
S
D
D’
Increase in Demand
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• Why would D rise?• booming economy (2000)• EPA rules• -- fewer coal plants, more gas
plants• cold winter
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WHY DID P RISE?
• both falling supply & rising demand-- but demand was most
important
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PRICE CEILING
• gov’t regulation sets maximum price• example: rent control in NYC• what happens?
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Rent
Q
S
D
$2500
500
$1200
250 750
rent ceiling = $1200
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Rent
Q
S
D
$2500
500
$1200
250 750
Qd = 750 units
Qs = 250 units
at P = $1200:
SHORTAGE
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WHO GETS HOUSING?• those willing to pay more – bogus fees:“key money”
• those who look harder– loss of time
• those who get lucky– Monica on Friends
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RESULT
• Price does not ration scarce good• too few apt. units• lost resources in searching• price ceiling is inefficient
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WHY HAVE RENT CONTROL?
• intended to help make housing affordable• secondary effect– shortage– run-down buildings– rent-controlled apts. go to the “connected”