Last edited 3/00

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Supply, Demand and Market Equilibrium

• By
• Thomas Gruca - University of Iowa
• Mark Pelzer - Kirkwood Community College

2
Demand Raw data
3
Demand Schedule
4
Demand Curve
D
5
Demand Definition

• Relationship between price and quantity demanded
  at a given price

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Demand Curve
D
7
Demand Curve
I
D
8
Change in quantity demanded due to change in
price
I
II
D
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Shifts in the Demand Curve

• income
• related goods
• tastes
• number of consumers
• expectations of future prices

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Demand curve shifts to the right
D
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Demand curve shifts to the left
D
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Demand for an intangible good

• For example, a promise exchanged for money
• Value of the promise depends on future events
• Examples
• loans
• insurance

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Demand for an intangible good

• Application a futures contract
• value based on a future event
• possible events
• price of a bushel of wheat in October
• Microsoft stock price on 3rd Friday of June
• value of the Euro in on February 1st
• price of oil on April 21st

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Assignment

• Political futures contract
• pays 1 if Bradley is the Democratic nominee for
  2000
• pays 0 otherwise
• Price that someone is willing to pay is based on
  their own prediction of a particular outcome
• Assignment graphing a real demand curve

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Graph of Bradley demand data
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The effect of NBA party on demand for Bradley
contracts
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Supply Raw data
18
Supply Schedule
19
Supply Curve
S
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Supply Definition

• Relationship between price and quantity supplied
  at a given price

21
Supply Curve
S
I
22
Change in quantity supplied due to a change in
price
S
II
I
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Shifts in the Supply Curve

• prices of relevant resources
• technology
• taxes
• number of sellers
• expectations of future prices

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Supply curve shifts to the right
S
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Supply curve shifts to the left
S
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Supply for an intangible good

• Simplified insurance example
• Why would anyone supply car insurance?
• Seller expects that you will not have an accident
  during the next year
• If you do, they pay the bills. If not, they still
  keep the premium (price of policy)
• Prices depend on how likely there will be a claim

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Political Futures Contract

• Recall our example political futures contract
• People holding this contract get 1 if Bradley is
  the Democratic nominee for 2000 and 0 otherwise
• They may be willing to sell if they are not 100
  sure that Bradley will be the nominee
• Assignment 4 graphing a real supply curve

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Graph of Bradley supply data
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Effect of internet taxes on supply of Bradley
contracts
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A Market
S
D
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Surplus
S
Surplus
D
Qd
Qs
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Market adjustment to surplus
S
Surplus
D
Qd
Qs
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Shortage
S
D
Shortage
Qd
Qs
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Market adjustment to shortage
S
D
Shortage
Qd
Qs
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Equilibrium
S
Eq.P
D
Eq.Q
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Government interventions Price controls

• The government sets a maximum price
• Example the price of basic commodities in many
  countries (milk, flour, bread, rice)
• what happens to the availability of this good?
• The government sets a minimum price for wages
• Example minimum wage
• what happens to the supply of labor?

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Equilibrium in the Bradley market
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Supply and demand information available in a real
market
Exchanges that already have occurred
S
Offers to sell (ask price)
Market price (observed)
Price
Offers to buy (bid price)
D
Quantity
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Supply and demand information available in a real
market
Price
S
Best Ask
Last Trade
Note Eq.Q. is equilibrium quantity
Best Bid
D
Quantity
Eq.Q
Eq.Q 1
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Iowa Electronic Market

• The market for Bradley contracts is run by the
  Iowa Electronic Market
• real , real time futures market run by the
  Tippie Business School at the University of Iowa
• web site www.biz.uiowa.edu/iem

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IEM Prices 12/10/99

• Market Quotes DCONV00
• (2000 Democratic National Convention Market)
• Quotes current as of 154505 CST, Friday,
  December 10, 1999.
• Symbol Bid Ask Last Low High Average
• BRADLEY 0.310 0.324 0.311 0.311 0.323 0.314
• GORE 0.682 0.694 0.682 0.681 0.698 0.682
• DCROF 0.002 0.003 0.002 0.002 0.002 0.002
• DCROF is a contract for candidates other than
  Gore and Bradley

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Assignment 7

• Choose one of the current markets running at the
  IEM
• Read the prospectus to make sure you understand
  how the contracts work
• Using various news sources, try to determine what
  events will affect prices in the IEM for
  two-weeks
• Using your understanding of supply and demand,
  predict how prices should change
• Determine if your predictions were correct and
  reconcile any discrepancies

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How do bid,ask prices happen?

• The bid and ask prices you see on the IEM trading
  screen are offers to buy and sell posted by
  traders in the market.
• Other information available includes
• last traded price
• volume of trades
• historical prices

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How do you get contracts to sell?

• There are two ways to buy contracts
• Buy a bundle of contracts from the market
• each market has a set of contracts
• only one will pay 1, all others pay 0
• keep the contracts that you think will pay off
  and sell the others
• Buy from another trader

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How do you make in the IEM markets?

• Buy and hold those contracts which eventually pay
  1
• Buy contracts at a low price and sell them when
  the prices rise
• Sell one of each contract when sum of all bid
  prices is greater than 1 (Why?)