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Demand, Supply, & Demand, Supply, & Market Equilibrium Market Equilibrium Chapter 3 Chapter 3

Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

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Page 1: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Demand, Supply, & Demand, Supply, & Market EquilibriumMarket Equilibrium

Chapter 3Chapter 3

Page 2: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

DemandDemand

A schedule or curve that shows the A schedule or curve that shows the various amounts of a product that various amounts of a product that consumers are willing and able to consumers are willing and able to purchase at each of a series of possible purchase at each of a series of possible prices during a specified period of timeprices during a specified period of time

A statement of a buyer’s plans, or A statement of a buyer’s plans, or intentions, with respect to the purchase of intentions, with respect to the purchase of a producta product

Page 3: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Law of DemandLaw of Demand

Other-Things-Equal AssumptionOther-Things-Equal Assumption

As the Price (P) falls, the Quantity As the Price (P) falls, the Quantity Demanded (QDemanded (QDD) rises. ) rises. (P(P↓ ↓ QQD D ↑)↑)

As the Price (P) rises, the Quantity As the Price (P) rises, the Quantity Demanded (QDemanded (QDD) falls. ) falls. (P(P↑ ↑ QQD D ↓)↓)

Thus, there is an inverse (or negative) Thus, there is an inverse (or negative) relationship between Price and Quantity relationship between Price and Quantity Demanded. Demanded.

Page 4: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Law of Demand Law of Demand

Common SenseCommon Sense– People do buy more at low pricesPeople do buy more at low prices– Sales!!!Sales!!!

Diminishing Marginal UtilityDiminishing Marginal Utility– Each additional unit of the product produces less Each additional unit of the product produces less

satisfaction (or benefit, or utility)satisfaction (or benefit, or utility)

Income EffectIncome Effect– Lower prices increase the purchasing power of a Lower prices increase the purchasing power of a

buyer’s incomebuyer’s income

Substitution EffectSubstitution Effect– Lower prices give buyers the incentive to substitute Lower prices give buyers the incentive to substitute

similar productssimilar products

Page 5: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Individual DemandIndividual Demand 6

5

4

3

2

1

0 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P Qd

$5

4

3

2

1

10

20

35

55

80

IndividualDemand

P

Q

D

Page 6: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Determinants of DemandDeterminants of Demand

TastesTastes– Favorable change in consumer tastes (preferences) = More Demanded Favorable change in consumer tastes (preferences) = More Demanded

at each price at each price Number of BuyersNumber of Buyers– Increase in number of buyers = Increase in DemandIncrease in number of buyers = Increase in Demand

IncomeIncome– Normal (Superior) Goods – Demand Varies Directly with Income Normal (Superior) Goods – Demand Varies Directly with Income – Inferior Goods – Demand Varies Inversely with IncomeInferior Goods – Demand Varies Inversely with Income

Prices of Related GoodsPrices of Related Goods– Substitutes: Used in place of another good Substitutes: Used in place of another good

Example: Leather vs. Cloth CoatsExample: Leather vs. Cloth Coats– Complements: Used together with another good Complements: Used together with another good

Example: Computers & Software Example: Computers & Software – Unrelated Goods: Not related at allUnrelated Goods: Not related at all

Example: Potatoes & AutomobilesExample: Potatoes & Automobiles

Consumer ExpectationsConsumer Expectations

Page 7: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Determinants of DemandDeterminants of Demand

Therefore, an Increase in Demand may be Therefore, an Increase in Demand may be caused by:caused by:– A favorable change in consumer tastes/preferencesA favorable change in consumer tastes/preferences– An increase in the number of buyersAn increase in the number of buyers– Rising incomes if the product is a normal goodRising incomes if the product is a normal good– Falling incomes if the product is an inferior goodFalling incomes if the product is an inferior good– An increase in the price of a substitute goodAn increase in the price of a substitute good– A decrease in the price of a complimentary goodA decrease in the price of a complimentary good– A new consumer expectation that either prices or A new consumer expectation that either prices or

income will be higher in the future income will be higher in the future

Page 8: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Individual DemandIndividual Demand 6

5

4

3

2

1

0

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P Qd

$5

4

3

2

1

10

20

35

55

80

IndividualDemand

P

Q

D1

2 4 6 8 10 12 14 16 18

Demand Can Increase or Decrease

Increase in Demand

Decrease in Demand

D2

D3

Page 9: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Changes in Quantity DemandedChanges in Quantity Demanded

Not to be confused with Change in DemandNot to be confused with Change in Demand– A shift of the demand curve to the right (increase in A shift of the demand curve to the right (increase in

demand) or to the left (decrease in demand)demand) or to the left (decrease in demand)– Cause: A change in one or more determinants of Cause: A change in one or more determinants of

demanddemand

Change in Change in Quantity DemandedQuantity Demanded– A movement from one point to another point – from A movement from one point to another point – from

one price/quantity combination to another– on a fixed one price/quantity combination to another– on a fixed demand schedule/curvedemand schedule/curve

– Cause: An increase or decrease in the price of the Cause: An increase or decrease in the price of the product under considerationproduct under consideration

Page 10: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Individual DemandIndividual Demand

6

5

4

3

2

1

0

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P Qd

$5

4

3

2

1

10

20

35

55

80

IndividualDemand

P

Q

D1

2 4 6 8 10 12 14 16 18

Demand Can Increase or Decrease

Decrease in Demand

D2

D3

An Increase in DemandMeans a Movementof the Line

A Movement BetweenAny Two Points on a

Demand Curve is Called a Change in

QuantityDemanded

Page 11: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

SupplySupply

A schedule or curve showing the various A schedule or curve showing the various amounts of a product that producers are amounts of a product that producers are willing and able to make available for sale willing and able to make available for sale at each of a series of possible prices at each of a series of possible prices during a specific periodduring a specific period

Page 12: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Law of SupplyLaw of Supply

As the Price (P) falls, the Quantity Supplied (QAs the Price (P) falls, the Quantity Supplied (Qss) ) falls. falls. (P(P↓ ↓ QQs s ↓)↓)

As the Price (P) rises, the Quantity Supplied (QAs the Price (P) rises, the Quantity Supplied (Qss) ) rises. rises. (P(P↑ ↑ QQs s ↑)↑)

Thus, there is a direct (or positive) relationship Thus, there is a direct (or positive) relationship between Price and Quantity Supplied. between Price and Quantity Supplied. Remember, the supplier is on the receiving end Remember, the supplier is on the receiving end of the product’s price. Therefore, higher prices of the product’s price. Therefore, higher prices don’t pose the same obstacle on the supply side don’t pose the same obstacle on the supply side as they do on the demand side.as they do on the demand side.

Page 13: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Individual SupplyIndividual Supply 6

5

4

3

2

1

0

Quantity Supplied (bushels per week)

Pri

ce (

per

bu

shel

)

P Qs

$5

4

3

2

1

60

50

35

20

5

IndividualSupply

P

Q

S1

10 20 30 40 50 60 70

Page 14: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Determinants of SupplyDeterminants of Supply

Resource PricesResource Prices– Higher Resource Prices raise production costs & squeeze profitsHigher Resource Prices raise production costs & squeeze profits– Lower Resource Prices reduce production costs & increase Lower Resource Prices reduce production costs & increase

profits profits

TechnologyTechnology– Improvements in technology enable firms to produce units of Improvements in technology enable firms to produce units of

output with fewer resourcesoutput with fewer resources

Taxes & SubsidiesTaxes & Subsidies– Businesses treat most taxes as costs. Businesses treat most taxes as costs. – Increase in sales or property taxes will increase production costs Increase in sales or property taxes will increase production costs

& reduce supply& reduce supply– Subsidies are considered “taxes in reverse”Subsidies are considered “taxes in reverse”– Thus, lower production costs/increase in supply Thus, lower production costs/increase in supply

Page 15: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Determinants of SupplyDeterminants of Supply

Prices of other GoodsPrices of other Goods– Substitution in ProductionSubstitution in Production– Example: Producing basketballs instead of soccer balls results Example: Producing basketballs instead of soccer balls results

in a decline in the supply of soccer balls in a decline in the supply of soccer balls

Producer ExpectationsProducer Expectations– Future Prices of ProductsFuture Prices of Products

Number of Sellers in the MarketNumber of Sellers in the Market– Other things equal, the larger the number of suppliers, the Other things equal, the larger the number of suppliers, the

greater the market supply greater the market supply – As more firms enter the industry, the supply curve shifts to the As more firms enter the industry, the supply curve shifts to the

rightright– The smaller the number of suppliers, the less the market supplyThe smaller the number of suppliers, the less the market supply– As more firms leave the industry, the supply curve shifts to the As more firms leave the industry, the supply curve shifts to the

leftleft

Page 16: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Individual SupplyIndividual Supply 6

5

4

3

2

1

0

Quantity Supplied (bushels per week)

Pri

ce (

per

bu

shel

)

P Qs

$5

4

3

2

1

60

50

35

20

5

IndividualSupply

P

Q

S1

Supply Can Increase or Decrease

S2

S3

2 4 6 8 10 12 14

Page 17: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Changes in Quantity SuppliedChanges in Quantity Supplied

Not to be confused with Change in SupplyNot to be confused with Change in Supply– A change in the schedule & shift of the curveA change in the schedule & shift of the curve– An increase in supply shifts curve to the rightAn increase in supply shifts curve to the right– A decrease in supply shifts curve to the leftA decrease in supply shifts curve to the left– Cause: A change in one or more of the determinants Cause: A change in one or more of the determinants

of supplyof supply

Change in Change in Quantity SuppliedQuantity Supplied – A movement from one point to another on a fixed A movement from one point to another on a fixed

supply curvesupply curve– Cause: A change in the price of the specific product Cause: A change in the price of the specific product

being consideredbeing considered

Page 18: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Individual SupplyIndividual Supply

6

5

4

3

2

1

0

Quantity Supplied (bushels per week)

Pri

ce (

per

bu

shel

)

P Qs

$5

4

3

2

1

60

50

35

20

5

IndividualSupply

P

Q

S1

Supply Can Increase or Decrease

S2

S3

An Increase in SupplyMeans a Movementof the Line

A Movement BetweenAny Two Points on a

Supply Curve is Called a Change in Quantity

Supplied

2 4 6 8 10 12 14

Page 19: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Market EquilibriumMarket Equilibrium

Equilibrium Price (PEquilibrium Price (PEE) ) – Market Clearing PriceMarket Clearing Price– The price where the intentions of buyers & sellers The price where the intentions of buyers & sellers

matchmatch– QQD D = Q= QSS

Equilibrium QuantityEquilibrium Quantity– The quantity demanded & supplied at the equilibrium The quantity demanded & supplied at the equilibrium

price in a competitive marketprice in a competitive market

Competition among buyers & sellers drives the Competition among buyers & sellers drives the price to equilibriumprice to equilibriumSurplus: Excess SupplySurplus: Excess SupplyShortage: Excess DemandShortage: Excess Demand

Page 20: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Market EquilibriumMarket Equilibrium

6

5

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1

0 2 4 6 8 10 12 14 16 18Bushels of Corn (thousands per week)

Pri

ce (

per

bu

shel

)

P Qd

$5

4

3

2

1

2,000

4,000

7,000

11,000

16,000

MarketDemand

200 BuyersP Qs

$5

4

3

2

1

12,000

10,000

7,000

4,000

1,000

MarketSupply

200 Sellers

200 Buyers & 200 Sellers

7

3

D

S

$4 Price Floor

6,000 BushelSurplus

$2 Price Ceiling

7,000 BushelShortage

Page 21: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Government-Set PricesGovernment-Set Prices

Price CeilingsPrice Ceilings– The maximum legal price a seller may charge for a product or The maximum legal price a seller may charge for a product or

serviceservice– Prices at or below the ceiling are legalPrices at or below the ceiling are legal– Prices above are notPrices above are not– Examples: Rent ControlsExamples: Rent Controls– Sometimes leads to black markets & political pressure to lower Sometimes leads to black markets & political pressure to lower

pricesprices

Price FloorsPrice Floors– A minimum price fixed by the government A minimum price fixed by the government – A price at or above the floor are legalA price at or above the floor are legal– Prices below are notPrices below are not– Distort resource allocationDistort resource allocation

Page 22: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Efficient AllocationEfficient Allocation

Productive EfficiencyProductive Efficiency– The production of any particular good in the least costly way The production of any particular good in the least costly way

Example: Have $100 worth of resourcesExample: Have $100 worth of resourcesCan produce a bushel of corn using either $5 or $3 of those Can produce a bushel of corn using either $5 or $3 of those resources, leaving either $95 or $97 remaining for alternative usesresources, leaving either $95 or $97 remaining for alternative usesWhich is better?Which is better?

Allocative EfficiencyAllocative Efficiency– The particular mix of goods & services most highly valued by The particular mix of goods & services most highly valued by

society (minimum cost production assumed)society (minimum cost production assumed)– Society wants iPods instead of cassette tapes Society wants iPods instead of cassette tapes – However, society also wants cell phonesHowever, society also wants cell phones– Competitive markets help assign allocative efficiency Competitive markets help assign allocative efficiency

Page 23: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Equilibrium Price & QuantityEquilibrium Price & Quantity

In competitive markets, produces an assignment In competitive markets, produces an assignment of resources that is “right” from an economic of resources that is “right” from an economic perspectiveperspective

Demand reflects MB based on utility receivedDemand reflects MB based on utility received

Supply reflects MC of producing goodSupply reflects MC of producing good

Remember:Remember:– MB>MC Expand OutputMB>MC Expand Output– MB<MC Reduce OutputMB<MC Reduce Output– MB=MC Optimal OutputMB=MC Optimal Output

Page 24: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Changes in Supply, Demand, Changes in Supply, Demand, & Equilibrium& Equilibrium

Changes in DemandChanges in Demand– Supply Constant, Demand IncreasesSupply Constant, Demand Increases

Raises PRaises PEE and Q and QEE See pg 57, Figure 3.7 aSee pg 57, Figure 3.7 a

– Supply Constant, Demand DecreasesSupply Constant, Demand DecreasesReduces PReduces PEE and Q and QEE See pg 57, Figure 3.7bSee pg 57, Figure 3.7b

Changes in SupplyChanges in Supply– Demand Constant, Supply IncreasesDemand Constant, Supply Increases

Reduces PReduces PEE, Increases Q, Increases QEE See pg 57, Figure 3.7cSee pg 57, Figure 3.7c

– Demand Constant, Supply DecreasesDemand Constant, Supply DecreasesIncreases PIncreases PEE, Reduces Q, Reduces QEE See pg 57, Figure 3,7dSee pg 57, Figure 3,7d

Page 25: Demand, Supply, & Market Equilibrium Chapter 3. Demand A schedule or curve that shows the various amounts of a product that consumers are willing and

Changes in Supply, Demand, Changes in Supply, Demand, & Equilibrium& Equilibrium

Complex Cases: (See pg. 57, Table 3.7)Complex Cases: (See pg. 57, Table 3.7)– Supply Supply ↑ Demand ↓ P↑ Demand ↓ PE E ↓↓ QQE E ??

– Supply ↓ Demand ↑ PSupply ↓ Demand ↑ PE E ↑ Q↑ QE E ? ?

– Supply ↑ Demand ↑ PSupply ↑ Demand ↑ PE E ? Q? QE E ↑ ↑

– Supply ↓ Demand ↓ PSupply ↓ Demand ↓ PE E ? Q? QE E ↓ ↓