Unit 2

Supply & Demand

and the

Nature and Function of Markets

Demand Basics

• Demand Schedule and Demand Curve

Demand Basics

• Demand versus Quantity Demanded

• Demand- quantities consumers are willing and able to buy at various prices

• Quantity Demanded- quantity consumers are willing and able to buy at a given price

Demand Basics

• Demand versus Quantity Demanded

• Demand- the whole curve

• Quantity Demanded- a point on the curve

Demand Basics

• Demand versus Quantity Demanded

• Change in Demand- the whole curve shifts

• Change in Quantity Demanded- move from one point on the curve to another

Demand Basics

• Changes in Demand– Consumer Income

• Normal v. Inferior Goods

– Population– Preference/Taste– Price of Other Goods

• Compliments• Substitutes

– Expectation of Change in Price

Supply Basics

• Supply Schedule and Supply Curve

Supply Basics

• Supply versus Quantity Supplied

• Supply - quantities producers are willing and able to sell at various prices

• Quantity Supplied- quantity producers are willing and able to sell at a given price

Supply Basics

• Supply versus Quantity Supplied

• Supply - the whole curve

• Quantity Supplied- a point on the curve

Supply Basics

• Change in Supply - the whole curve shifts

• Change in Quantity Supplied- move from one point on the curve to another

Supply Basics- Changes

• # of Producers

• Technology

• Price of Inputs

• Substitutes of Production

• Compliments of Production

• Taxes and Subsidies

• Other Regulations

Individual & Market Demand Curve

• Horizontal sum of individual demand curves

Individual & Market Supply Curve

• Horizontal sum of individual supply curves

What if they both shift?

• Equilibrium Price?

• Equilibrium Quantity?

• One change is certain

• The other is ambiguous

What if they both shift?

• Coffee– New Rebecca Black Song– New Fertilizer

What if they both shift?

• Same Shift- know Q

• Opposite Shift- know P

Equilibrium Price = Market Clearing Price

Let’s Review

• Shifts

• Double Shifts

• Ceilings and Floors

• Shortage and Surplus

• ------------------------------------------

• Quantifying Shortage and Surplus

• Other Effects of Ceilings and Floors

If the market price is above equilibrium price…

If the market price is below equilibrium price…

S & D for Non-Smart Phones (inferior good)

• Decrease in unemployment

• Increase in the price of Smart Phones

S & D for Non-Smart Phones (inferior good)

• Decrease in unemployment

• Increase in the price of Smart Phones

* If the income effect is greater than the substitute effect*

Agenda

• HW and Field Trip

• Beyond Surpluses and Shortages

• Binding v. Non-Binding Price Controls

• A Closer Look at the Downward Slope

• Marginal Utility Activity (HW if incomplete)

Price ControlsEffects beyond Surpluses and

Shortages

Price ControlsEffects beyond Surpluses and

Shortages

• BOTH reduce the quantity of a good bought and sold

Price Ceilings

• Shortages

• Inefficiencies

• Black Markets

Price Ceilings- Inefficiencies

• Misallocation of Resources– Need and willingness to pay

• Wasted Resources– Time and money spent overcoming the

shortage

• Inefficiently Low Quality

Price Ceilings- Black Markets

• Illegal Markets

• Prices ABOVE equilibrium– Prices account for additional cost in the form

of risk

How to stop Canal Street Sales?

Price Ceilings Non-Binding

• Set above equilibrium

• Market prices will remain below the ceiling

Price Floors Non-Binding

• Set below equilibrium

• Market prices will remain above the floor

Price Floors

• Surpluses

• Inefficiencies

• Black Markets

Price Floors- Inefficiencies

• Misallocation of Resources– Those willing to sell at the lowest price do not

always succeed

• Wasted Resources

• Inefficiently High Quality

Price Floors- Black Markets

• Illegal Markets

• Prices below equilibrium– Prices account for the relatively low number of

consumers willing to break the law

Is minimum wage a binding price ceiling?

Now that you are thinking…

• Is minimum wage a binding price floor?

Why Demand Slopes Downward and what’s up with the shape?

• Income Effect

• Substitute Effect

• Diminishing Marginal Utility

Conspicuous Goods

Why Demand Slopes Downward and what’s up with the shape?

• Income Effect

• Substitute Effect

• Diminishing Marginal Utility

Why Demand Slopes Downward?

• Income Effect– Higher price = Lower purchasing power– Lower price = Higher purchasing power– “ability to buy”

Why Demand Slopes Downward?

• Substitute Effect- think opportunity cost– Higher price = Lower relative price of substitutes– Lower price = Higher relative price of substitutes

Why?

• 1st pizza for full price ($10.00), get a 2nd for $5?

Why?

• Buy one pair at regular price and get the second pair half off?

• BOGO Days!

Why Demand Slopes Downward?

• Diminishing Marginal Utility

Why Demand Slopes Downward?

• Diminishing Marginal Utility– MU= satisfaction (quantified in dollars) of an

additional unit of consumption

– Marginal Utility ALWAYS* decreases with additional consumption

– Total Utility increases at a decreasing rate

Why Demand Slopes Downward?

• Diminishing Marginal Utility/Benefit

• Cost-Benefit Analysis– How many slices will you consume?

• OPTIMAL PURCHASE RULE– MU=P

Optimal Purchase Rule?

Optimizing Purchase of 2 or More Goods

• MU per $1

Consumer Equilibrium

• Maximize Total Utility

• MU per $1 (MU/$)

• MUx/Px = MUy/Py

Did you make any consumer equilibrium decisions this

weekend?

Tax Incidence

Tax Incidence

• Nominal (Statutory) versus Economic Incidence

• If “law” doesn’t matter, what does?

PED

PED

• Relationship between % change in price and % change in quantity

PED

Perfectly Inelastic = 0

Unit Elastic = 1

Perfectly Elastic =

PED

Perfectly Inelastic = 0

Unit Elastic = 1

Perfectly Elastic =

• Inelastic <1

• Unit Elastic = 1

• Elastic > 1

PED

PED

*Total Revenue Method*

• Price Decrease – TR Increase– Elastic

• Price Decrease – TR Constant – Unit Elastic

• Price Decrease – TR Decrease– Inelastic

*Total Revenue Method*

• Elastic Demand– Decrease price to Increase TR

• Unit Elastic Demand

• Inelastic Demand– Increase Price to Increase TR

TIP of the DAY

• Remember 2 not 6

Apples

• The price has increased

• The quantity has decreased

• What likely happened?

Reminder and Update and Reminder

• PHILLY TRIP!!!!!!!!!!!!

• FRQs- moved to Tuesday

• Graphs Due Tomorrow

TIP of the DAY

• Remember 2 not 6

1. Inelastic PED- Increase in Price will Increase Total TR

– *Increase P will Increase TR

2. Perfectly Inelastic = 0

Tip of the Day

• Study 2 days before the test as if it were the day before

• The review will expose your weaknesses

PES- Only difference?

Other Elasticities

• Price Elasticity- % Q/ % P

• PED versus PES

• Income Elasticity of Demand– Normal– Inferior goods

• Cross Price Elasticity – Complements and substitutes

Income Elasticity of Demand

• % Q / % Income– Normal

– Inferior

Income Elasticity of Demand

• % Q / % Income– Normal

– Inferior

Income Elasticity of Demand

• % Q / % Income– Necessity

– Luxury (________)

Cross Price Elasticity

• % Qx / % Py

• Substitutes =

• Complements =

• Neither =

Draw TWO S & Ds

• Add a Binding Price Floor to one

• Add a Binding Price Ceiling to the other

• Shade DWL