macro economics_chapter 4_supply demnd

Chapter 4Chapter 4Supply and Demand I:

How Markets Work

© 2002 by Nelson, a division of Thomson Canada Limited© 2002 by Nelson, a division of Thomson Canada Limited

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4:

In this chapter you will…In this chapter you will…

• Learn the nature of a competitive market.• Examine what determines the demand for

a good in a competitive market.• Examine what determines the supply of a

good in a competitive market.• See how supply and demand together set

the price of a good and the quantity sold.• Consider the key role of prices in

allocating scarce resources.


THE MARKET FORCES OF THE MARKET FORCES OF SUPPLY AND DEMANDSUPPLY AND DEMAND

• SupplySupply and Demand are the two words that economists use most often.

• Supply and Demand are the forces that make market economies work!

• Modern microeconomics is about supply, demand, and market equilibrium.


MARKETS AND COMPETITIONMARKETS AND COMPETITION

• The terms supply and demand refer to the behaviour of people. . .

• . . .as they interact with one another in markets.

• A market is a group of buyers and sellers of a particular good or service.– Buyers determine demand...– Sellers determine supply…


Competitive MarketsCompetitive Markets

• A Competitive Market is a market with many buyers and sellers so that each has a negligible impact on the market price.


Competition: Perfect or OtherwiseCompetition: Perfect or Otherwise

Perfectly Competitive: Homogeneous Products Buyers and Sellers are Price Takers

Monopoly: One Seller, controls price

Oligopoly: Few Sellers, not aggressive competition

Monopolistic Competition: Many Sellers, differentiated products


DEMANDDEMAND

• Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at alternative prices for a given period.


Determinants of DemandDeterminants of Demand

• What factors determine how much ice cream you will buy?

• What factors determine how much you will really purchase?

1) Product’s Own Price2) Consumer Income3) Prices of Related Goods4) Tastes5) Expectations6) Number of Consumers


1) Price1) Price

Law of Demand– The law of demand states that,

other things equal, the quantity demanded of a good falls when the price of the good rises.


2) Income2) Income

• As income increases the demand for a normal good will increase.

• As income increases the demand for an inferior good will decrease.


3) Prices of Related Goods3) Prices of Related Goods

Prices of Related Goods– When a fall in the price of one

good reduces the demand for another good, the two goods are called substitutes.

– When a fall in the price of one good increases the demand for another good, the two goods are called complements.


4) Others4) Others

• Tastes• Expectations


The Demand Schedule and the The Demand Schedule and the Demand CurveDemand Curve

The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded.

The demand curve is a graph of the relationship between the price of a good and the quantity demanded.

Ceteris Paribus: “Other thing being equal”


Table 4-1: Catherine’s Demand ScheduleTable 4-1: Catherine’s Demand Schedule

03.0022.5042.0061.5081.00100.50120.00

Quantity of cones Demanded

Price of Ice-cream Cone ($)


Figure 4-1: Catherine’s Demand CurveFigure 4-1: Catherine’s Demand CurvePrice of Ice-Cream Cone

Quantity of Ice-Cream Cones

2 4 6 8 10 120

$3.00

2.50

2.00

1.50

1.00

0.50


Market Demand ScheduleMarket Demand Schedule

• Market demand is the sum of all individual demands at each possible price.

• Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

• Assume the ice cream market has two buyers as follows…


03.00

100.50

120.00

CatherinePrice of Ice-cream Cone ($)

Table 4-2: Market demand as the Sum of Table 4-2: Market demand as the Sum of Individual DemandsIndividual Demands

+

1

6

7

Nicholas

1

22.50

42.00

61.50

81.00

2

3

4

5

4

7

10

13

16

19

Market

=


Price of Ice-Cream Cone


D3

D1

D2

Decrease in demand

Increase in demand

Figure 4-3: Shifts in the Demand CurveFigure 4-3: Shifts in the Demand Curve


Table 4-3: The Determinants of Quantity Table 4-3: The Determinants of Quantity DemandedDemanded


Shifts in the Demand Curve Shifts in the Demand Curve versus versus Movements Along the Demand CurveMovements Along the Demand Curve


Price of Cigarettes,

per Pack.

Number of Cigarettes Smoked per Day

D2

A policy to discourage smoking shifts the demand curve to the left.

0 20

$2.00

D1

A

10

B

Figure 4-4 a): A Shifts in the Demand CurveFigure 4-4 a): A Shifts in the Demand Curve


Price of Cigarettes,

per Pack.

Number of Cigarettes Smoked per Day

0 20

$2.00

D1

A

A tax that raises the price of cigarettes results in a movements along the demand curve.

C

12

$4.00

Figure 4-4 b): A Movement Along the Figure 4-4 b): A Movement Along the Demand CurveDemand Curve


SUPPLYSUPPLY

• Quantity Supplied refers to the amount (quantity) of a good that sellers are willing to make available for sale at alternative prices for a given period.


Determinants of SupplyDeterminants of Supply

• What factors determine how much ice cream you are willing to offer or produce?

1) Product’s Own Price2) Input prices3) Technology4) Expectations5) Number of sellers


1) Price1) Price

Law of Supply– The law of supply states that,

other things equal, the quantity supplied of a good rises when the price of the good rises.


The Supply Schedule and the The Supply Schedule and the Supply CurveSupply Curve

The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied.

The supply curve is a graph of the relationship between the price of a good and the quantity supplied.

Ceteris Paribus: “Other thing being equal”


Table 4-4: Ben’s Supply ScheduleTable 4-4: Ben’s Supply Schedule

53.0042.5032.0021.5011.0000.5000.00

Quantity of cones Supplied

Price of Ice-cream Cone ($)




6 8 10 120 2

1.50

1.00

1

2.00

3 4

$3.00

2.50

5

0.50

Figure 4-5: Ben’s Supply CurveFigure 4-5: Ben’s Supply Curve


Market Supply ScheduleMarket Supply Schedule

• Market supply is the sum of all individual supplies at each possible price.

• Graphically, individual supply curves are summed horizontally to obtain the market demand curve.

• Assume the ice cream market has two suppliers as follows…


53.00

00.50

00.00

BenPrice of Ice-cream Cone ($)

Table 4-5: Market supply as the Sum of Table 4-5: Market supply as the Sum of Individual SuppliesIndividual Supplies

+

8

0

0

Nicholas

13

42.50

32.00

21.50

11.00

6

4

2

0

10

7

4

1

0

0

Market

=




S3

S2S1

Decrease in supply

Increase in supply

Figure 4-7: Shifts in the Supply CurveFigure 4-7: Shifts in the Supply Curve


Table 4-6: The Determinants of Quantity Table 4-6: The Determinants of Quantity SuppliedSupplied


SUPPLY AND DEMAND SUPPLY AND DEMAND TOGETHERTOGETHER

• Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.


EquilibriumEquilibrium

• Equilibrium Price– The price that balances quantity supplied and

quantity demanded. – On a graph, it is the price at which the supply

and demand curves intersect.• Equilibrium Quantity

– The quantity supplied and the quantity demanded at the equilibrium price.

– On a graph it is the quantity at which the supply and demand curves intersect.


At $2.00, the quantity demanded is equal to the quantity supplied!

Demand Schedule

Supply Schedule



Equilibrium price

Demand

Supply

$2.00

6 8 100

Equilibrium

Equilibrium quantity


Price of Ice-Cream

Cone

421 3 5 7 9 11

Figure 4-8: The Equilibrium of Supply and Figure 4-8: The Equilibrium of Supply and DemandDemand



• Surplus– When price > equilibrium price, then quantity

supplied > quantity demanded. • There is excess supply or a surplus. • Suppliers will lower the price to increase sales,

thereby moving toward equilibrium.• Shortage

– When price < equilibrium price, then quantity demanded > the quantity supplied.

• There is excess demand or a shortage. • Suppliers will raise the price due to too many buyers

chasing too few goods, thereby moving toward equilibrium.


Demand

Supply

$2.00

6 8 100 Quantity of Ice-Cream Cones

Price of Ice-Cream

Cone

421 3 5 7 9 11

$2.50

Surplus

Quantity Demanded

Quantity Supplied

Figure 4-9 a): Excess SupplyFigure 4-9 a): Excess Supply


Demand

Supply

$2.00

6 8 100 Quantity of Ice-Cream Cone

Price of Ice-Cream

Cone

421 3 5 7 9 11

$1.50

Shortage

Quantity Supplied

Quantity Demanded

Figure 4-9 b): Excess DemandFigure 4-9 b): Excess Demand


Three Steps To Analyzing Three Steps To Analyzing Changes in EquilibriumChanges in Equilibrium

• Decide whether the event shifts the supply or demand curve (or both).

• Decide whether the curve(s) shift(s) to the left or to the right.

• Use the supply-and-demand diagram to see how the shift affects equilibrium price and quantity.

• Example: A Heat Wave


D1

Supply

$2.00

6 100 Quantity of Ice-Cream Cone

Price of Ice-Cream

Cone

421 3 5 7 11

D2

$2.50

1. Hot weather increases the demand for ice cream…

2. … resulting in a higher price …

3. … and a higher quantity sold.

New equilibrium

Initial equilibrium

Figure 4-10: How an Increase Demand Figure 4-10: How an Increase Demand Affects the EquilibriumAffects the Equilibrium


Demand

S1

$2.00

100 Quantity of Ice-Cream Cones

Price of Ice-Cream

Cone

421 3 7 11

S2

$2.50

1. An earthquake reduces the supply of ice cream…

2. … resulting in a higher price …

3. … and a lower quantity sold.

New equilibrium

Initial equilibrium

Figure 4-11: How a Decrease Demand Figure 4-11: How a Decrease Demand Affects the EquilibriumAffects the Equilibrium


D1

S1

0 Quantity of Ice-Cream Cone

Price of Ice-Cream

Cone

Q1

D2

Large increase in demand

P2

S2

Q2

New equilibrium

Small decrease in supply

Initial equilibriumP1

Figure 4-12 a): A Shift in Both Supply and Figure 4-12 a): A Shift in Both Supply and DemandDemand


D1

S1

0 Quantity of Ice-Cream Cone

Price of Ice-Cream

Cone

Q1

D2

Large decrease in supply

P2

S2

Q2

New equilibrium

Small increase in demand

Initial equilibriumP1

Figure 4-12 b): A Shift in Both Supply and Figure 4-12 b): A Shift in Both Supply and DemandDemand


Table 4-8: What Happens to Price and Table 4-8: What Happens to Price and Quantity when Supply or Demand ShiftsQuantity when Supply or Demand Shifts


Concluding Remarks…Concluding Remarks…

• Market economies harness the forces of supply and demand. . .

• Supply and Demand together determine the prices of the economy’s different goods and services. . .

• Prices in turn are the signals that guide the allocation of resources.


SummarySummary

• Economists use the model of supply and demand to analyze competitive markets.

• In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price.


SummarySummary• The demand curve shows how the

quantity of a good depends upon the price.– According to the law of demand, as the price

of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward.

– In addition to price, other determinants of how much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers.

– If one of these factors changes, the demand curve shifts.


SummarySummary• The supply curve shows how the quantity of a

good supplied depends upon the price.– According to the law of supply, as the price of

a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward.

– In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers.

– If one of these factors changes, the supply curve shifts.


SummarySummary• Market equilibrium is determined by the

intersection of the supply and demand curves.

• At the equilibrium price, the quantity demanded equals the quantity supplied.

• The behavior of buyers and sellers naturally drives markets toward their equilibrium.


The EndThe End

macro economics_chapter 4_supply demnd

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