ModuleSupply and Demand:Introduction and Demand

KRUGMAN'SMACROECONOMICS for AP*

5

Margaret Ray and David Anderson

What you will learn

in this Module:

• What a competitive market is and how it is described by the supply and demand model

• What the demand curve is• The difference between movements along

the demand curve and changes in demand• The factors that shift the demand curve

i

A. Competitive Market- A market is an institution or mechanism which brings together buyers (demanders) and sellers (suppliers) of particular goods and services.

B. Supply and Demand Model

I. Supply and Demand: A Model of a Competitive MarketI. Supply and Demand: A Model of a Competitive Market

A. Demand schedule- shows how much of a product consumers are willing and able to buy at each of a series of possible prices during a specified time period.

B. Law of Demand- 1. Other things being equal, as the price increases, the

corresponding quantity demanded falls.2. Restated, there is an inverse relationship between

price and quantity demanded.

C. Demand curve- The demand schedule graphed

D. Quantity demanded- a point on the line

II. The Demand CurveII. The Demand Curve

Demand Schedule and Demand Curve

Price Quantity

$ 8 3

$ 7 5

$ 6 7

$ 5 10

$ 4 12

$ 3 16

$ 2 22

PricePrice

QuantityQuantity

III. Understanding Shifts of the Demand Curve

A. Increase = right- At any price, consumers wish to buy more.

B. Decrease = left- At any price, consumers wish to buy less.

B. M.E.R.I.T. shifts demand1. market size (number of consumers)2. expectations3. related prices (complements, substitutes)4. income (normal, inferior)5. tastes

ModuleSupply and Demand:Supply and Equilibrium

•KRUGMAN'S•MACROECONOMICS for AP*

6

Margaret Ray and David Anderson

What you will learn

in this Module:

•What the supply curve is•The difference between movements along the supply curve and changes in supply•The factors that shift the supply curve•How supply and demand curves determine a market's equilibrium price and equilibrium quantity•In the case of a shortage or surplus, how price moves the market back to equilibrium

I.The Supply Schedule and the Supply Curve

A.Supply schedule- shows amounts of a product a producer is willing and able to produce and sell at each of a series of possible prices during a specified time period.

B.Supply Curve- a graphical representation of the supply schedule

C.Quantity supplied- a point on the supply curve

D. Law of Supply1. All else equal, as the price rises, quantity supplied

rises. 2. Restated: There is a direct relationship between

price and quantity supplied.

Supply Schedule and Supply Curve

Price Quantity

$ 8 22

$ 7 14

$ 6 8

$ 5 6

$ 4 5

$ 3 4

$ 2 3

Quantity

Price

II. Understanding Shifts of the Supply Curve

A. Increase = right, At any price, firms wish to produce more.

B.decrease = left, At any price, firms with to produce less.

C.T.R.I.C.E. shifts supply1. Technology2. Related prices (complements in production, substitutes in

production)3. Input prices4. Competition (number of producers)5. Expectations

A.Equilibrium- No individual would be better off doing something different

B.Equilibrium price- price where supply meets demand

C.Equilibrium quantity- quantity where supply meets demand

D.Market-clearing price- Equilibrium price. It clears the market. All sellers have buyers, all buyers have sellers

III. Supply, Demand, and EquilibriumIII. Supply, Demand, and Equilibrium

Finding the Equilibrium Price and Quantity

equilibriumEequilibriumprice

equilibriumquantity

IV. Why Does the Market Price Fall If It Is Above the Equilibrium Price?

A. Surplus- When supply is greater than demand

B. Producer's Incentive is to lower the price and clear the market

V. Why Does the Market Price Rise If It is Below the Equilibrium Price?

A. Shortage- When quantity demanded exceeds quantity supplied

B. Consumer's Incentive- pay more and get it first, raising the price to the market clearing price

ModuleSupply and Demand:Changes in Equilibrium

•KRUGMAN'S

•MACROECONOMICS for AP*

7

Margaret Ray and David Anderson

What you will learnin this Module:

• How equilibrium price and quantity are affected when there is a change in either supply or demand

• How equilibrium price and quantity are affected when there is a simultaneous change in both supply and demand

I. Shifting Demand

A. When demand increases, the equilibrium price and quantity both increase

Shifting Demand Continued

B. When demand decreases, the equilibrium price and quantity both decrease

II. Shifting Supply

A. When supply decreases, the equilibrium price increases and the equilibrium quantity decreases

Shifting Supply Cont.

B. When supply increases, the equilibrium price decreases and the equilibrium quantity increases

III. Simultaneous Shifts of Supply and Demand

A. When demand increases and supply decreases the equilibrium price definitely increases, but quantity is ambiguous

Simultaneous Shifts of Supply and Demand

B. When demand decreases and supply increases the equilibrium price definitely decreases, but quantity is ambiguous

Simultaneous Shifts of Supply and Demand

C. When demand and supply increase, the change in equilibrium price is ambiguous, but equilibrium quantity definitely increases

Simultaneous Shifts of Supply and Demand

D. When demand and supply decrease, the change in equilibrium price is ambiguous, but equilibrium quantity definitely decreases

•KRUGMAN'S

•MACROECONOMICS for AP*

8

Margaret Ray and David Anderson

ModuleSupply and Demand: Price Controls (Ceilings and Floors)

What you will learnin this Module:• The meaning of price controls, one

way government intervenes in markets

• How price controls can create problems and make a market inefficient

• Why economists are often deeply skeptical of attempts to intervene in markets

• Who benefits and who loses from price controls, and why they are used despite their well-known problems

A. Sometimes the efficient outcome in the market is judged as unfair to some groups, usually those that are disadvantaged (poor) and struggling to begin with.

B. How will we deal with this?1. A price control is a legal

restriction on how high or low a market price may go.

2. Price controls are enacted by governments in response to political pressures from buyers and sellers.

I. Why Governments Control PricesI. Why Governments Control Prices

A. Legal maximum price

B. If Pe is considered “too high”, then a price ceiling must be set below the equilibrium price.

C. A price ceiling set above the equilibrium price has no effect or non binding.

D. Examples

•Oil Prices in1970s

•California electricity

•New York City apartments

II. Price CeilingsII. Price Ceilings

Modeling a Price Ceiling

III. How a Price Ceiling Causes Inefficiency

A. Inefficient Allocation to Consumers

B. Wasted Resources

C. Inefficiently Low Quality

D. Black Markets-goods and services bought and sold illegally

So Why Are There Price Ceilings?

• Benefit some- consumers may have political clout and persuade government officials that equilibrium is too high. (normative)

• Uncertainty- we’ve always had them

• Lack of understanding

A. Legal minimum price

B. If Pe is considered “too low”, a price floor is set above the equilibrium price.

C. A price floor set below the equilibrium price has no effect or non-binding

D. Examples

• Agricultural products

• Minimum wage

IV. Price FloorsIV. Price Floors

Modeling a Price Floor

V. How a Price Floor Causes Inefficiency

A. Inefficiently Low Quantity

B. Inefficient Allocation of Sales Among Sellers

C. Wasted Resources

D. Inefficiently High Quality

E. Illegal Activity- Black market for labor

So Why Are There Price Floors?

• Benefit some Producers may have the political clout to persuade government that the equilibrium price is unfairly low. This is a normative argument.-

• Disregard

• Lack of understanding

ModuleSupply and Demand:Quantity Controls

•KRUGMAN'S

•MACROECONOMICS for AP*

9

Margaret Ray and David Anderson

What you will learnin this Module:

• The meaning of quantity controls, another way government intervenes in markets

• How quantity controls create problems and can make a market inefficient

• Who benefits and who loses from quantity controls, and why they are used despite their well-known problems

A. Quantity Control or Quota-an upper limit on the quantity of some good that can be bought or sold.

B. Licenses/Permits

• Examples: Fishing, Pollution

I. Controlling QuantitiesI. Controlling Quantities

The Anatomy of Quantity Controls

II. The Anatomy of Quantity Controls

A.Demand Price-Price consumers will pay for that quantityB.Supply Price- Price suppliers will charge for that quantityC.Wedge or Quota Rent-

1. The difference between Demand Price and Supply Price.

2. Earnings that accrue to the license-holder for ownership of the right to sell the good.

3. It is equal to the market price of the license when the licenses are traded.

4. We can also think of the quota rent as the opportunity cost the holder of the license bears for not renting out his license to another producer.

III. The Cost of Quantity Controls

A. Inefficiency

B. Deadweight Loss

C. Illegal Activity