the market forces of supply and demand - · pdf filesupply and demand qsupply and demand ......

The Market Forces of Supply and Demand

M. En C. Eduardo Bustos Farías

2Análisis Económico de la Empresa


Supply and Demand

Supply and demand is an economic model

Designed to explain how prices are determined in certain types of markets

What you will learn in this lectureHow the model of supply and demand works and how to use itStrengths and limitations of model



The Market Forces of Supply and Demand

Supply 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

A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.



Markets

Specific location where buying and selling takes place, such as

Supermarket or a flea marketIn economics, a market is not a place but rather

A group of buyers and sellers with the potential to trade with each other

Economists think of the economy as a collection of individual marketsFirst step in an economic analysis is to define and characterize the market or collection of markets to analyze



How Broadly Should We Define The Market

Defining the market often requires economists to group things together

Aggregation is the combining of a group of distinct things into a single whole

Markets can be defined broadly or narrowly, depending on our purpose

How broadly or narrowly markets are defined is one of the most important differences between Macroeconomics and Microeconomics



What is a Market?Market Definition - The Extent of a Market

Market Extent• Defines the boundaries of the market

– Geographic– Range of products



What is a Market?Examples

Geographic boundaries• Gasoline: US vs California• Housing: Chicago vs a Chicago neighborhood



What is a Market?Examples

Range of Products• Gasoline: regular, super, & diesel• Cameras: SLR’s, point & shoot, digital



Markets Buyers determine demand.

Sellers determine supply.



Buyers and Sellers

Buyers and sellers in a market can beHouseholdsBusiness firmsGovernment agencies

All three can be both buyers and sellers in the same market, but are not alwaysFor purposes of simplification this class will usually follow these guidelines

In markets for consumer goods, we’ll view business firms as the only sellers, and households as only buyersIn most of our discussions, we’ll be leaving out the “middleman”



Market Type: A Competitive Market

A competitive market is a market. . .

…with many buyers and sellers.

…that is not controlled by any one person.

…in which a narrow range of prices are established that buyers and sellers act upon.



Competition in Markets

In imperfectly competitive markets, individual buyers or sellers can influence the price of the productIn perfectly competitive markets (or just competitive markets), each buyer and seller takes the market price as a givenWhat makes some markets imperfectly competitive and others perfectly competitive?

Perfectly competitive markets have many small buyers and sellers

• Each is a small part of the market, and the product is standardized

Imperfectly competitive markets have just a few large buyers and sellers

• Or else the product of each seller is unique in some way



Competition: Perfect and Otherwise

Perfect Competition

Products are the sameNumerous buyers and sellers so that each has no influence over priceBuyers and Sellers are price takers




MonopolyOne seller, and seller controls price

OligopolyFew sellersNot always aggressive competition




Monopolistic CompetitionMany sellersSlightly differentiated productsEach seller may set price for its own product



Demand

A household’s quantity demanded of a goodSpecific amount household would choose to buy over some time period, given

• A particular price that must be paid for the good• All other constraints on the household

Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period, given

A particular price they must pay for the goodAll other constraints on households



Demand

Quantity demandedis the amount

of a good that buyers are willing and able

to purchase.



Quantity DemandedImplies a choice

How much households would like to buy when they take into account the opportunity cost of their decisions?

Is hypotheticalMakes no assumptions about availability of the goodHow much would households want to buy, at a specific price, given real-world limits on their spending power?

Stresses pricePrice of the good is one variable among many that influences quantity demandedWe’ll assume that all other influences on demand are held constant,so we can explore the relationship between price and quantity demanded



Law of Demand

The law of demand states that there is an inverse

relationship between price and quantity demanded.



The Law of Demand

States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall

The words, “everything else remains the same” are important

• In the real world many variables change simultaneously

• However, in order to understand the economy we must first understand each variable separately

• Thus we assume that, “everything else remains the same,” in order to understand how demand reacts to price



Demand Schedule

The demand schedule is a table that shows the relationship

between the price of the good and the quantity demanded.



Demand Schedule

Price Quantity$0.00 120.50 101.00 81.50 62.00 42.50 23.00 0



The Demand Schedule and The Demand Curve

Demand scheduleA list showing the quantity of a good that consumers would choose to purchase at different prices, with all other variablesheld constant

The market demand curve (or just demand curve) shows the relationship between the price of a good and the quantity demanded , holding constant all other variables that influence demand

Each point on the curve shows the total buyers would choose to buy at a specific price

Law of demand tells us that demand curves virtually always slope downward



Determinants of Demand

Market priceConsumer incomePrices of related goodsTastesExpectations



Demand Curve

The demand curve is the downward-sloping line relating price to

quantity demanded.



Demand Curve

$3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Ice-Cream Cone

0

P r ic e Q u a n t ity$ 0 .0 0 1 2

0 .5 0 1 01 .0 0 81 .5 0 62 .0 0 42 .5 0 23 .0 0 0

Quantity of Ice-Cream Cones



The Demand Curve

Number of Bottles per Month

Price per Bottle

A

B

$4.00

2.00

D

40,000 60,000

At $2.00 per bottle, 60,000 bottles are demanded (point B).

When the price is $4.00 per bottle, 40,000 bottles are demanded (point A).



Ceteris ParibusCeteris paribus is a Latin phrase that

means all variables other than the ones being studied are assumed to be

constant. Literally, ceteris paribusmeans “other things being equal.”

The demand curve slopes downward because, ceteris paribus, lower prices

imply a greater quantity demanded!



Market Demand

Market demand refers to the sum of all individual demands for a particular good or service.Graphically, individual demand curves are summed horizontally to obtain the market demand curve.



Determinants of Demand

Market priceConsumer incomePrices of related goodsTastesExpectations



Change in Quantity Demanded versus Change in Demand

Change in Quantity DemandedMovement along the demand curve.Caused by a change in the price of

the product.



Changes in Quantity DemandedPrice of

Cigarettes per Pack

D1

0Number of Cigarettes Smoked per Day

A tax that raises the price of cigarettes

results in a movement along the demand

curve.

A

C

20

2.00

$4.00

12




Change in DemandA shift in the demand curve, either

to the left or right.Caused by a change in a

determinant other than the price.



Changes in DemandPrice of Ice-Cream Cone

0

D1Quantity of Ice-Cream Cones

D3

Increase in demand

Decrease in demand

D2



A Shift of the Demand Curve

p, $ per kg

220176

Effect of a 60¢ increase in the price of beef

D1

D 2

2320

3.30

Q, Million kg of pork per year



Consumer Income

As income increases the demand for a normal good will increase.As income increases the demand for an inferior good will decrease.



Consumer IncomeNormal Good

$3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211



Increasein demand

An increase in income...

D1

D2

0



Consumer IncomeInferior Good

$3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211



0

Decreasein demand

An increase in income...

D1D2



Prices of Related GoodsSubstitutes & Complements

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.




Variables that Affect Quantity

Demanded

A Change in This Variable . . .

Price Represents a movementalong the demand curve

Income Shifts the demand curve

Prices of relatedgoods

Shifts the demand curve

Tastes Shifts the demand curve

Expectations Shifts the demand curve

Number ofbuyers

Shifts the demand curve



Application Aggregating the Demand for Cling Peaches

p, $ per ton

275

183

Total demand

Demand for canned peaches

Demand for fruit cocktail

Qf = 4 50Q, Tons of peaches per 10,000 people per year

Qc= 18 Q = 220



Demand FunctionsMathematical representations of demand curvesExample:

X and Y are substitutes (coefficient of PY is positive)X is an inferior good (coefficient of M is negative)

MPPQ YXd

X 23210 −+−=



Specific Demand Functions

Linear Demand

HMPPQ HMYYXXd

X ααααα ++++= 0

XMMQ Q

MEX

α=,X

YYPQ Q

PEYX

α=,

X

XXPQ Q

PEXX

α=,

IncomeElasticity

Cross PriceElasticity

Own PriceElasticity



Example of Linear Demand

Qd = 10 - 2POwn-Price Elasticity: (-2)P/QIf P=1, Q=8 (since 10 - 2 = 8)Own price elasticity at P=1, Q=8:(-2)(1)/8= - 0.25



Log-Linear Demand

HMYX HMPPBQ

orHMPPQ

YXd

X

HMYYXXd

X

ββββ

βββββ

0

0 logloglogloglog

=

++++=

M

Y

X

:Elasticity Income:Elasticity Price Cross :Elasticity PriceOwn

βββ



Example of Log-Linear Demand

log Qd = 10 - 2 log POwn Price Elasticity: -2



P

Q

P

D D

QLog Linear Linear



Supply

Quantity supplied is the amount of a good that sellers are willing and able

to sell.



Law of Supply

The law of supply states that there is a direct (positive) relationship between

price and quantity supplied.



Determinants of Supply

Market priceInput pricesTechnologyExpectations Number of producers



Supply Schedule

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

supplied.



Supply Schedule

Price Quantity$0.00 00.50 01.00 11.50 22.00 32.50 43.00 5



Supply Curve

The supply curve is the upward-sloping line relating price to

quantity supplied.



Supply Curve

$3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 11


0Quantity of Ice-Cream Cones

Price Quantity$0.00 00.50 01.00 11.50 22.00 32.50 43.00 5

12



Market Supply

Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.Graphically, individual supply curves are summed horizontally to obtain the market supply curve.



Determinants of Supply

Market priceInput pricesTechnologyExpectations Number of producers



Change in Quantity Supplied versus Change in Supply

Change in Quantity SuppliedMovement along the supply curve.Caused by a change in the market price of the product.



Change in Quantity Supplied

1 50


S

1.00


A

C$3.00 A rise in the price

of ice cream cones results in a

movement along the supply curve.




Change in SupplyA shift in the supply curve, either to the left or right.Caused by a change in a determinant other than price.



Change in SupplyPrice of Ice-Cream Cone


0

S1 S2

S3

Increase in Supply

Decrease in Supply



A Shift of a Supply Curve

p, $ per kg

205176

Effect of a 25¢ increase in the price of hogs

S1S2

2200

3.30





Variables that Affect Quantity Supplied

A Change in This Variable . . .

Price Represents a movement along the supply curve

Input prices Shifts the supply curve Technology Shifts the supply curve Expectations Shifts the supply curve Number of sellers Shifts the supply curve



Total Supply: The Sum of Domestic and Foreign Supply

(a) Japanese Domestic Supply (b) Foreign Supply (c) Total Supply

p, Priceper ton

p, Priceper ton

p, Priceper ton

Qd*

Sd Sf (ban)

Qf* Q = Qd

* Q* = Qd* + Qf

*Qd, Tons per year Qf, Tons per year Q, Tons per year

p * p* p *

S (ban) S (no ban)Sf (no ban)

p p p



Supply and Demand Together

Equilibrium PriceThe price that balances supply and demand. On a graph, it is the price at which the supply and demand curves intersect.

Equilibrium QuantityThe quantity that balances supply and demand. On a graph it is the quantity at which the supply and demand curves intersect.



Supply and Demand TogetherDemand Schedule Supply Schedule

Price Quantity$0.00 00.50 01.00 11.50 42.00 72.50 103.00 13

Price Quantity$0.00 190.50 161.00 131.50 102.00 72.50 43.00 1

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



Equilibrium of Supply and Demand

Supply

Demand


$3.00

QuantiIce-Cream Cones

21 3 4 5 6 7 8 9 10 12110

2.50

2.00

1.50

1.00

0.50ty of

Equilibrium



Excess SupplyPrice of Ice-Cream Cone

21 3 4 5 6 7 8 9 10 12110Quantity of Ice-Cream Cones

Supply

Demand

Surplus$3.00

2.50

2.00

1.50

1.00

0.50



Surplus

When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supplyor a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.



Excess Demand

Quantity ofIce-Cream Cones

Price ofIce-Cream

Cone

$2.00

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Supply

Demand

$1.50

Shortage



Shortage

When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demandor a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.



Market Equilibrium

p, $ per kg

220176

D

S

e

233 246194 2070

3.95

3.30

2.65

Excess supply = 39

Excess demand = 39




Three Steps To Analyzing Changes 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.Examine how the shift affects equilibrium price and quantity.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

How an Increase in Demand Affects the Equilibrium

Price ofIce-Cream

Cone

2.00

0 7 Quantity ofIce-Cream Cones

Supply

Initialequilibrium

D1

1. Hot weather increasesthe demand for ice cream...

D2

2. ...resultingin a higherprice...

$2.50

103. ...and a higherquantity sold.

New equilibrium



Shifts in Curves versus Movements along Curves

A shift in the supply curve is called achange in supply.A movement along a fixed supply curve is called a change in quantity supplied.A shift in the demand curve is called achange in demand.A movement along a fixed demand curve is called a change in quantity demanded.



How a Decrease in Supply Affects the Equilibrium

S2

Price ofIce-Cream

Cone

2.00

0 1 2 3 4 7 8 9 11 12 Quantity ofIce-Cream Cones

13

Demand

Initial equilibrium

S1

10

1. An earthquake reducesthe supply of ice cream...

Newequilibrium

2. ...resultingin a higherprice...

$2.50

3. ...and a lowerquantity sold.



What Happens to Price and Quantity When Supply or Demand Shifts?

No Change In Supply

An Increase In Supply

A Decrease In Supply

No Change In Demand

P same Q same

P down Q up

P up Q down

An Increase In Demand

P up Q up

P ambiguous Q up

P up Q ambiguous

A Decrease In Demand

P down Q down

P down Q ambiguous

P ambiguous Q down



Effects of a Shift of the Demand Curve

(a) Effect of a 60¢ Increase in the Price of Beef

D 1

D2

S

1760 220 228 232

Q, Million kg of pork per yearExcess demand = 12

3.303.50

e2

e1

p, $ per kg



Effects of a Shift of the Demand Curve

(b) Effect of a 25¢ Increase in the Price of Hogs

S1

S2


3.303.55

e1

e2

D

p, $ per kg

1760 220205 215

Excess demand = 15



A Ban on Rice Imports Raises the Price in Japan

p, Price of riceper pound

S (no ban)

D

p2 e2

e1p1

S (ban)

Q, Tons of rice per yearQ1Q2



Price Ceiling on Gasoline

p, $ per gallon

Price ceiling

S1

D

S 2

p2

e2

e1p1 = p

Qs Q2 Q1=Qd

Excess demand Q, Gallons of gasoline per month



Minimum Wage

w, Wageper hour

Minimum wage, price floor

S

D

ew *

w

L, Hours worked per yearLd L* Ls

Unemployment

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