Introduction to Supply and Demand

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Introduction to Supply and Demand

S. Folland
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The Law of Demand When price falls, and
if everything else stays the same, then
the quantity demanded will increase.
In latin, everything else stays the same is
stated as ceteris paribus.
Discussion questions Why would families want
more milk just because the price fell?
Would all families buy more milk? Would some?
What happens to you if you break the law of
demand?
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Just for Perspective A Note on Adam Smith
1. The concept of the demand curve was not
developed fully until the 1880s by the
Austrian economists. 2. The father of
economics, Adam Smith, wrote his famous book
The Wealth of Nations in 1776, long before the
concept of demand was fully understood. 3.
Smith thought the price of every good compared to
other goods just depended on the amount of
labor in each. 4. He said if it takes two hours
to catch one beaver, and just one hour to
kill a deer, then one beaver will trade for two
deer. (This turned out to be not so good an
idea). 5. Hundreds of Smiths ideas did turn out
to be good and are still used today.
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Adam Smith, 1723-1790
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Demand Shifters
1. Personal income a. normal goods
(demand increases with income) b. inferior
goods (demand decreases with income) 2. Prices
of related goods a. substitutes (demand for
tea increases when the price of coffee
increases) b. complements (demand for sugar
decreases when the price of tea
increases) 3. Tastes (Can mean ordinary tastes
changing or can refer to something
abstract, like age. 4. Expectations (e.g. if
you believe housing prices will rise
even further, you may buy now. 5. Population.
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Discussion questions on demand shifts Which way
would demand for ___ shift if? 1. Apples, if the
engine plant doubles salaries? 2. Cigarettes, if
the Surgeon General states they are
hazardous to your health? 3. Used clothing, if
the engine plant doubles salaries? 4.
Mustard, if hot dogs double in price? 5. Mercedes
Benzs if BMWs double in price? 6. Exxon stocks,
if an Exxon oil tanker runs aground in
Alaska? 7. Land suitable for residential housing,
if an Interstate Highway is built to the
property.
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Supply Curve
Study questions 1. Would diary farmers offer
every last drop of milk at say 1.00 so
they could not possibly offer more than
45k at 1.50? 2. If not, where would the extra
milk come from?
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Supply Shifters 1. Technological change. E.g.
robots improve productivity on the auto
assembly line. 2. Number of Sellers. E.g. more
firms start up U.S. Loosens up the
immigration laws. 3. Input price changes. E.g.
price of chicken feed affects the supply
of eggs. 4. Expectations 5. Weather. Applies
mainly to agricultural products.
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Study questions regarding equilibrium a.
What if the market price was above PE?
b. Would there be pressures for the price
to fall? c. During the time that the price
is above equilibrium, which would be
greater, quantity supplied or quantity
demanded? d. What do we call the difference
between those two quantities? What if
the good were human labor, then what
would we call the difference between
these two quantities?
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Comparative Static Analysis Compares two
static equilibria. (Static equilbrium a
snapshop of an equilbrium for a given time
period.) Examples Suppose that Brazil, which
grows a large share of the worlds coffee
crop, suffers bad growing weather--a sudden
deep freeze killing many plants, what will
happen to the market for coffee in the
Rochester area?
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You Try It 1. The effect on the market for
rental apartments in Atlanta when the Summer
Olympics came to town. 2. The effect of the Black
Plague on the labor market in a typical
European city back in 1436. 3. The OU faculty
goes on strike and gets double their salarie,
what effect on the market for student credit
hours. 4. What happens to the market for Pentium
III computer chips when the Pentium IV is
invented. 5. The effect of an increase in the
price of flour on the market for bread. 6.
Marijuana is legalized, what happens to the
market for marijuana. 7. The Russian ruble
collapses in value, what effect on our
domestic market for imported Russian furs. 8.
When the price of CDs in general drops, what if
anything happens to the market for CDs.
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Market Intervention When the government
intervenes in the market. 1. Equilibrium can
become unattainable. 2. Disequilibrium can cause
unexpected and unwanted results. 3. There are
two kinds of intervention a. Price floors
e.g. minimum wages, crop price supports. b.
Price ceilings e.g. rent controls, the Irish
potato famine story.
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Points to notice 1. AB is unemployment caused
by the minimum wage, 2. LE- LD is the loss of
jobs 3. WELE is labor income before the MW
4. MWLE is labor income after the MW is in place
(Whether the MW is good for labor or bad for
them depends on whether labor income is larger
before or after the minimum wage is put in place.
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The Card-Krueger study shook up the standard
model it seemed because apparently there was no
real world drop in the average employment level.
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A competing study by David Neumark from our
sister university at MSU, disputed this result
for some pretty good reasons. Also, we have a
history of minimum wage studies, and a good
majority of these agree with the standard
theory. So, economists generally favor the
standard theory. However, this latest challenge
turns out, we economists have been sternly
reminded that the real world data rules, always.
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Question If there were a potato famine, and if
the government were to rule that the price of
potatoes must be frozen at the price of the
previous, good year Who would this favor?
Who would this policy hurt?
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