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Chapter 3Demand, Supply, and Market
EquilibriumCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3-2
Markets
• Interaction between buyers and sellers• Markets may be• Local• National• International
• Price is discovered in the interactions of buyers and sellers
LO1
3-3
Demand
• Demand• Demand schedule or demand curve• Amount consumers are willing and able to
purchase at a given price• Other things equal• Individual demand• Market demand
LO2
3-4
Law of Demand
• Law of demand• Other things equal, as price falls, the
quantity demanded rises, and as price rises, the quantity demanded falls
• Explanations • Price acts as an obstacle to buyers• Law of diminishing marginal utility• Income effect and substitution effect
LO2
3-5
The Demand Curve
LO2
6
5
4
3
2
1
0 10 20 30 40 50 60 70 80
Quantity demanded (bushels per week)
Pric
e (p
er b
ushe
l)P Qd
$5
4
3
2
1
10
20
35
55
80
P
Q
D
3-6
Market Demand
LO2
Market Demand for Corn, Three Buyers
Priceper bushel
Quantity Demanded Total Qd
per weekJoe Jen Jay
$5 10 12 8 30
4 20 23 17 60
3 35 39 26 100
2 55 60 39 154
1 80 87 54 221
3-7
Changes in Demand
6
5
4
3
2
1
0
Quantity demanded (thousands of bushels per week)
Pric
e (p
er b
ushe
l)
P
Q
D1
2 4 6 8 10 12 14 16 18
D2
D3
LO2
P Qd
$5
4
3
2
1
2000
4000
7000
11,000
16,000
Decreasein demand
Increasein demand
3-8
Changes in Demand
LO2
6
5
4
3
2
1
0
Quantity demanded (thousands of bushels per week)
Pric
e (p
er b
ushe
l)P
Q
D1
2 4 6 8 10 12 14 16 18
D2
D3
Change in demand
Change in quantity demanded
3-9
Determinants of Demand
• Determinants of demand• Change in consumer tastes and preferences• Change in the number of buyers• Change in income• Normal goods• Inferior goods
LO2
3-10
Determinants of Demand
• Change in prices of related goods• Complementary good• Substitute good
• Change in consumer expectations• Future prices• Future income
LO2
3-11
Determinants of DemandDeterminants of Demand: Factors That Shift the Demand Curve
Determinant Examples
Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones.
Change in the number of buyers A decline in the birthrate reduces the demand for children’s toys.
Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine.
Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods).
Change in consumer expectations Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans.
3-12
Supply
• Supply• Supply schedule or a supply curve• Amount producers are willing and able to sell
at a given price• Individual supply• Market supply
LO3
3-13
Law of Supply
• Law of supply• Other things equal, as the price rises, the
quantity supplied rises and as the price falls, the quantity supplied falls
• Explanation• Price acts as an incentive to producers• At some point, costs will rise
LO3
3-14
The Supply Curve
LO3
5
4
3
2
1
0
Pric
e (p
er b
ushe
l)
Quantity supplied (bushels per week)
S1
10 20 30 40 50 60 70
P
Q
P Qs
$5
4
3
2
1
60
50
35
20
5
3-15
Changes in Supply
LO3
$6
5
4
3
2
1
0
Pric
e (p
er b
ushe
l)
S1
Quantity supplied (thousands of bushels per week)
2 4 6 8 10 12 14 16
P
Q
S2
S3
Increasein supply
Decrease in supplyP Qs
$5
4
3
2
1
12,000
10,000
7000
4000
1000
3-16
Changes in Supply
$6
5
4
3
2
1
0
Pric
e (p
er b
ushe
l)
S1
Quantity supplied (thousands of bushels per week)2 4 6 8 10 12 14 16
P
Q
S2
S3
Change in quantity supplied
Change in supply
LO3
3-17
Determinants of Supply
• Determinants of supply• A change in resource prices• A change in technology• A change in the number of sellers• A change in taxes and subsidies• A change in prices of other goods• A change in producer expectations
LO3
3-18
Determinants of SupplyDeterminants of Supply: Factors That Shift the Supply Curve
Determinant Examples
Change in resource prices A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline.
Change in technology The development of more effective wireless technology increases the supply of cell phones.
Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education.
Change in prices of other goods An increase in the price of cucumbers decreases the supply of watermelons.
Change in producer expectations An expectation of a substantial rise in future log prices decreases the supply of logs today.
Change in the number of suppliers An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games.
3-19
Market Equil ibrium
• Equilibrium occurs where the demand curve and supply curve intersect
• Equilibrium price and equilibrium quantity• Surplus and shortage• Rationing function of prices• Efficient allocation
LO4
3-20
Efficient Allocation
• Productive efficiency• Producing goods in the least costly way• Using the best technology• Using the right mix of resources
• Allocative efficiency• Producing the right mix of goods• The combination of goods most highly
valued by society
LO4
3-21
Market Equil ibrium
6
5
4
3
2
1
0 2 4 6 8 10 12 14 16 18
Bushels of corn (thousands per week)
Pric
e (p
er b
ushe
l)
P Qd
$5
4
3
2
1
2000
4000
7000
11,000
16,000
P Qs
$5
4
3
2
1
12,000
10,000
7000
4000
1000
7
D
S6,000 bushelsurplus
7,000 bushelshortage
LO4
3
3-22
Rationing Function of Prices
• The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent
LO4
3-23
Changes in Demand and Equil ibrium
LO5
0
P
D4
D3
0
P
D1
D2
S
Increase in demand
D increase:P↑ , Q↑
D decrease:P↓ , Q↓
Decrease in demand
S
3-24
Changes in Supply and Equil ibrium
0
P
D
S4 S3
0
P
D
S2S1
Increase in supply
S increase:P↓ , Q↑
S decrease:P↑ , Q↓
Decrease in supply
LO5
3-25
Complex Cases
LO5
Effects of Changes in Both Supply and Demand
Change in Supply Change in DemandEffect on Equilibrium
PriceEffect on Equilibrium
Quantity
1. Increase Decrease Decrease Indeterminate
2. Decrease Increase Increase Indeterminate
3. Increase Increase Indeterminate Increase
4. Decrease Decrease Indeterminate Decrease
3-26
Government Set Prices
• Price ceiling• Set below equilibrium price• Rationing problem• Black markets
• Example is rent control
LO6
3-27
Government Set Prices
SP
Q
D
P0
PC
Q0
Shortage
QdQs
Ceiling$3.50
3.00
LO6
3-28
Government Set Prices
• Price floor• Prices are set above the market price• Chronic surpluses
• Example is the minimum wage law
LO6
3-29
Government Set Prices
LO6
S
P
Q
D
P0
Pf
Q0
Surplus
QsQd
Floor
2.00
$3.00
3-30
Legal Market for Human Organs
• What if we created a legal market for human organs?
• Positive effects• Increase the incentive to donate• Eliminate the persistent shortage of eyes,
livers, hearts, kidneys, etc.
3-31
Legal Market for Human Organs
• Negative effects• Diminishes the special nature of life by
commercializing it• The market would leave out the poor and
uninsured• Increases the cost of medical care
• Prohibition on market solution has resulted in a $1 billion illegal market
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