The Market EconomySupply and demand

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The Market Economy-Supply and demand

• Chapter 4, pages 82-99 Chapter 5, pages 103-109

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Outline

• Introduction
• Demand
• Supply
• Equilibrium
• Disequilibrium
• Comparative static analysis

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Bidding!

• How much will you pay for a brand new iPhone?
• How much will you get paid to shave your head?

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The U.S. Economy
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Supply and Demand

• Supply and demand is an economic model
• Designed to explain how prices and quantities are
  determined in certain types of markets

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Figure 7 Market Equilibrium
S
E
P
D
Q
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Markets

• Paris Flea Market
• Some buyers
• Some sellers
• A place to trade

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Buyers and Sellers

• Buyers and sellers in a market can be
• Households
• Business firms
• Government agencies
• All three can be both buyers and sellers in the
  same market, but are not always

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• For purposes of simplification this text will
  usually follow these guidelines
• In markets for consumer goods, well view
  business firms as the only sellers, and
  households as only buyers
• In most of our discussions, well be leaving out
  the middleman

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Competition in the market

• Chevron vs Shell
• How do you choose?
• - price
• - brand (quality)
• - distance
• - service

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Competition in Markets

• In imperfectly competitive markets, individual
  buyers or sellers can influence the price of the
  product
• In perfectly competitive markets (or just
  competitive markets), each buyer and seller takes
  the market price as a given

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• 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

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Using Supply and Demand

• Supply and demand model is designed to explain
  how prices are determined in perfectly
  competitive markets
• Perfect competition is rare but many markets come
  reasonably close
• Perfect competition is a matter of degree rather
  than an all or nothing characteristic
• Supply and demand is one of the most versatile
  and widely used models in the economists tool kit

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Supply and Demand

• DEMAND - from consumer's point of view
• SUPPLY - from producer's point of view

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Demand

• Quantity demanded the amount of a good that
  households want to consume given their income and
  prices in a given time period

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Question

• How does what we "demand" differ from what we
  "want"?
• demand is what you are willing and able to buy
  given your income and the price of the good
  (limited)
• a want is a desire, but not necessarily something
  you have the resources to buy (unlimited)

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Quantity Demanded

• Implies a choice
• Is hypothetical
• Stresses price

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Questions in the packet

• Supplemental course packet p52

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The Law of Demand

• As the price of a good increases, the quantity
  demanded falls, holding all else constant,
  (ceteris paribus)
• Ceteris Paribus - holding all else constant
• in real world many variables change
  simultaneously
• However, in order to understand the economy we
  must first understand each variable separately.

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Relative price

• If the price of this text book doubles, some of
  you may decide not to take this class. The
  quantity of this text book demanded will fall.
  However, if the prices of all textbooks double,
  the relative price hasn't changed.
• Do questions on packet p53

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Relative price

• The relative price - the price of a good compared
  to the price of other goods.
• example hats at bookstore cost 10,t-shirts
  cost 20. (money prices)
• 1 t-shirt 2 hats and 1 hat 1/2 of a t-shirt
  (relative prices)
• If the price of a t-shirt is cut to 10, has the
  relative price changed?
• Yes
• If the price of hats and t-shirts are both cut in
  half, has the relative price changed?
• No

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Relative price

• When we look at the demand curve we are looking
  at relative price changes holding all else
  constant.
• Since we are holding other things constant we are
  engaging in partial equilibrium analysis We find
  the amount of a good sold given the price, but we
  hold other things constant.

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The Demand Schedule and The Demand Curve

• 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

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Other Things Constant

• Other things constant places a limitation on the
  application of the law of demand.
• All other factors, such as changing tastes,
  prices of other goods, income, and even the
  weather, are assumed to remain constant, whether
  they actually remain constant or not.

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Quantity Demanded Versus Demand

• Quantity demanded refers to a specific amount
  that will be demanded per unit of time at a
  specific price.
• it refers to a specific point on the demand
  curve.
• A change in quantity demanded, caused only by a
  change in the price of the good itself, is shown
  by a movement along a demand curve.

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Quantity Demanded Versus Demand

• Demand refers to a schedule of quantities of a
  good that will be bought per unit of time at
  various prices, other things constant.
• It refers to the entire demand curve.
• A change in demand, caused by anything other than
  the goods own price, is shown by a shift in the
  demand curve.

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Figure 1 The Demand Curve
A
4.00
B
2.00
D
40,000
60,000
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Figure 2 A Shift of The Demand Curve
B
C
2.00
60,000
80,000
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Dangerous Curves Change in Quantity Demanded
vs. Change in Demand

• Language is important when discussing demand
• Quantity demanded means
• A particular amount that buyers would choose to
  buy at a specific price
• It is a number represented by a single point on a
  demand curve
• When a change in the price of a good moves us
  along a demand curve, it is a change in quantity
  demand
• demand means
• The entire relationship between price and
  quantity demandedand represented by the entire
  demand curve
• When something other than price changes, causing
  the entire demand curve to shift, it is a change
  in demand

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Income Factors That Shift The Demand Curve

• An increase in income has effect of shifting
  demand for normal goods to the right
• However, a rise in income shifts demand for
  inferior goods to the left
• A rise in income will increase the demand for a
  normal good, and decrease the demand for an
  inferior good
• E.g. ground sirloin vs. ground chuck

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Wealth Factors That Shift The Demand Curve

• Your wealthat any point in timeis the total
  value of everything you own minus the total
  dollar amount you owe
• An increase in wealth will
• Increase demand (shift the curve rightward) for a
  normal good
• Decrease demand (shift the curve leftward) for an
  inferior good

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Prices of Related Goods Factors that Shift the
Demand Curve

• Substitutegood that can be used in place of some
  other good and that fulfills more or less the
  same purpose
• A rise in the price of a substitute increases the
  demand for a good, shifting the demand curve to
  the right
• Complementused together with the good we are
  interested in
• A rise in the price of a complement decreases the
  demand for a good, shifting the demand curve to
  the left

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Examples of substitute
V.S.
V.S.
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Complements
V.S.
V.S.
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Other Factors That Shift the Demand Curve

• Population
• As the population increases in an area
• Number of buyers will ordinarily increase
• Demand for a good will increase
• Tastes
• Combination of all the personal factors that go
  into determining how a buyer feels about a good
• When tastes change toward a good, demand
  increases, and the demand curve shifts to the
  right
• When tastes change away from a good, demand
  decreases, and the demand curve shifts to the left

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• Expected Price
• An expectation that price will rise (fall) in the
  future shifts the current demand curve rightward
  (leftward)
• E.g. gas price
• Taxes and Subsidies
• Taxes increase the cost of goods, thereby
  reducing demand.
• Subsidies have an opposite effect.

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Movements Along and Shifts of The Demand Curve
P2
P1
P3
Q2
Q1
Q3
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Movements Along and Shifts of The Demand Curve

• Entire demand curve shifts rightward when
• income or wealth ?
• price of substitute ?
• price of complement ?
• population ?
• expected price ?
• tastes shift toward good
• Taxes ? or subsidies ?

D2
D1
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Movements Along and Shifts of The Demand Curve

• Entire demand curve shifts leftward when
• income or wealth ?
• price of substitute ?
• price of complement ?
• population ?
• expected price ?
• tastes shift toward good
• Taxes ? or subsidies ?

D1
D2
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Supply

• A firms quantity supplied of a good is the
  specific amount its managers would choose to sell
  over some time period, given
• A particular price for the good
• All other constraints on the firm
• Market quantity supplied (or quantity supplied)
  is the specific amount of a good that all sellers
  in the market would choose to sell over some time
  period, given
• A particular price for the good
• All other constraints on firms

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Quantity Supplied

• Implies a choice
• Quantity that gives firms the highest possible
  profits when they take account of the constraints
  presented to them by the real world
• Is hypothetical
• Does not make assumptions about firms ability to
  sell the good
• How much would firms managers want to sell,
  given the price of the good and all other
  constraints they must consider?
• Stresses price
• The price of the good is just one variable among
  many that influences quantity supplied
• Well assume that all other influences on supply
  are held constant, so we can explore the
  relationship between price and quantity supplied

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The Law of Supply

• States that when the price of a good rises and
  everything else remains the same, the quantity of
  the good supplied will rise
• 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
• We assume everything else remains the same in
  order to understand how supply reacts to price

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The Supply Schedule and The Supply Curve

• Supply scheduleshows quantities of a good or
  service firms would choose to produce and sell at
  different prices, with all other variables held
  constant
• Supply curvegraphical depiction of a supply
  schedule
• Shows quantity of a good or service supplied at
  various prices, with all other variables held
  constant

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Figure 4 The Supply Curve
S
4.00
G
2.00
F
40,000
60,000
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Shifts vs. Movements Along the Supply Curve

• A change in the price of a good causes a movement
  along the supply curve
• In Figure 4
• A rise (fall) in price would cause a rightward
  (leftward) movement along the supply curve
• A drop in transportation costs will cause a shift
  in the supply curve itself
• In Figure 5
• Supply curve has shifted to the right of the old
  curve (from Figure 4) as transportation costs
  have dropped
• A change in any variable that affects
  supplyexcept for the goods pricecauses the
  supply curve to shift

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Figure 5 A Shift of The Supply Curve
S2
S1
4.00
J
G
60,000
80,000
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Factors That Shift the Supply Curve

• Input prices
• A fall (rise) in the price of an input causes an
  increase (decrease) in supply, shifting the
  supply curve to the right (left)
• Price of Related Goods
• When the price of an alternate good falls(rises),
  the supply curve for the good in question shifts
  rightward (leftward)
• Technology
• Cost-saving technological advances increase the
  supply of a good, shifting the supply curve to
  the right

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Factors That Shift the Supply Curve

• Number of Firms
• An increase (decrease) in the number of
  sellerswith no other changesshifts the supply
  curve to the right (left)
• Expected Price
• An expectation of a future price increase
  (decrease) shifts the current supply curve to the
  left (right)

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Factors That Shift the Supply Curve

• Changes in weather
• Favorable weather
• Increases crop yields
• Causes a rightward shift of the supply curve for
  that crop
• Unfavorable weather
• Destroys crops
• Shrinks yields
• Shifts the supply curve leftward
• Other unfavorable natural events may effect all
  firms in an area
• Causing a leftward shift in the supply curve

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Figure 6(a) Changes in Supply and in Quantity
Supplied
S
P2
P1
P3
Q3
Q1
Q2
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Figure 6(b) Changes in Supply and in Quantity
Supplied
S1

• Entire supply curve shifts rightward when
• price of input ?
• price of alternate good ?
• number of firms ?
• expected price ?
• technological advance
• favorable weather

S2
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Figure 6(c) Changes in Supply and in Quantity
Supplied
S2

• Entire supply curve shifts rightward when
• price of input ?
• price of alternate good ?
• number of firms ?
• expected price ?
• unfavorable weather

S1