Presentation on theme: "AP Macroeconomics Demand and Supply. Price and Quantity Price – the amount of money paid for an economic good/service – Ex. A gallon of gasoline has a."— Presentation transcript:
AP Macroeconomics Demand and Supply
Price and Quantity Price – the amount of money paid for an economic good/service – Ex. A gallon of gasoline has a price of $3.35 Quantity – the amount of items – Ex. If I buy four loaves of bread the quantity is four
Demand Consumers willingness and ability to buy an item at a given price – Willingness means that buyers must want the item – Ability means that buyers must have the financial resources to afford the item
The Law of Demand The price of an item determines the quantity demanded The lower the price the higher the quantity demanded – When goods/services are cheap, I tend to buy more The higher the price the lower the quantity demanded – When goods/services are expensive, I tend to buy less Therefore, the price of a good/service is inversely related with the quantity demanded
2 Reasons Why the Law of Demand Exists Substitution Effect When apples are expensive and their substitutes (pears) are relatively cheap, I buy fewer apples and more pears Diminishing Marginal Utility Each additional unit of an item purchased gives less marginal utility (happy points) than the previous unit. Therefore, the only way I will buy more is if the price is lower.
2 Reasons Why the Law of Demand Exists (cont.) Example relating to diminishing marginal utility Ex. When Im hungry, I typically will buy 2 breakfast tacos. The reason I dont buy a third taco is because the marginal utility of the third taco is less than the price of the taco. But, if the marginal utility of the third taco is more than the price of the taco I will buy the third taco
A Third Reason why the Law of Demand Exists (cont.) Income Effect When things are expensive, money buys less When things are cheap, money buys more
Demand Schedule Mr. Bharuchas Demand for Breakfast Tacos PriceQuantity $2.000 $1.501 $1.002 $0.503 Notice that Mr. Bharucha is obeying the law of demand. Now thats making a good choice!!!!
Mr. Bharuchas Demand for Breakfast Tacos P Q D Demand Curve PriceQuantity $2.000 $1.501 $1.002 $ $2.00 $0.50 $1.00 $
Changes in Demand Price changes QUANTITY demanded and we will see a shift ON (or along) the demand curve Increase in Demand – More quantity demanded at all prices – Demand Curve shifts Decrease in Demand – Less quantity demanded at all prices – Demand Curve shifts Know that Price does not change Demand!
P Q D D1D1 Increase in Demand
P Q D1D1 D Decrease in Demand
Changes in Demand T.R.I.P.E. The following cause the entire demand curve to shift – Tastes and Preferences – Related Goods (Complements & Substitutes) – Income – Population – Expectations of future price changes
Changes in Demand T.R.I.P.E. Tastes and Preferences – Preferences and tastes are affected by advertising, trends, health considerations, etc. Ex. Demand for yogurt with probiotics has increased because many people believe there are health benefits to probiotics (increased immunity, healthier digestion) Ex. Demand for cigarettes/smokeless tobacco has decreased because they cause cancer.
Changes in Demand T.R.I.P.E. Related Goods – Complements – goods/services used in conjunction Ex. When the price of gasoline increases the demand for its complement, Suburbans, decreases. Ex. When the price of movie tickets decreases, the demand for theatre popcorn increases. (When the price of movie tickets go down, we go to the movies more; when we go to the movies more we demand more popcorn)
T.R.I.P.E Related Goods (cont.) Related Goods – Substitutes – goods/services used in lieu of other goods/services Ex. When the price of gasoline increases, the demand for ethanol increases. Ex. When the price of movie tickets increases, the demand for DVDs increases.
Changes in Demand T.R.I.P.E. Income of consumers – When consumers income increases: Demand for normal goods/services increases – Ex. More income means more demand for steak Demand for inferior goods/services decreases – Ex. More income means less demand for Ramen noodles, generic food, and used cars
Changes in Demand T.R.I.P.E. Income of consumers – When consumers income decreases Demand for normal goods/services decreases – Ex. Less income means less demand for steak Demand for inferior goods/services increases – Ex. Less income means more demand for generic food, Ramen noodles, used cars
Changes in Demand T.R.I.P.E. Population – More population = more demand Ex. As Americas population grows so does the demand for housing – Less population = less demand Ex. As Japans population declines so does the demand for education (fewer Japanese schools)
Changes in Demand T.R.I.P.E. Expectations of future price changes – If consumers expect prices to rise in the future, then demand increases now Ex. Prior to Hurricanes Katrina and Rita, consumers expected higher fuel prices and this caused demand for fuel to increase. – If consumers expect prices to fall in the future, then demand decreases now Ex. If investors believe a companies stock price is going to decline, then demand for that stock decreases.
Supply Producers willingness and ability to sell a good/service
The Law of Supply The price of an item determines the quantity supplied The lower the price the lower the quantity supplied – When goods/services command a low price, suppliers tend to produce less of them The higher the price the higher the quantity supplied – When goods/services command a high price, suppliers tend to produce more of them Therefore, the price of a good/service is directly related with the quantity supplied
Reason for Law of Supply The profit motive : When the market price rises (for example after an increase in consumer demand), it becomes more profitable for businesses to increase their output. Higher prices send signals to firms that they can increase their profits by satisfying demand in the market.
P Q S Supply Curve PriceQuantity $2.004 $1.503 $1.002 $0.501 $1.00 $1.50 $ Supply of Breakfast Tacos
Changes in Supply Increase in Supply – More quantity supplied at all prices – Supply Curve shifts Decrease in Supply – Less quantity supplied at all prices – Supply Curve shifts Know that Price does not change Supply! Price changes QUANTITY supplied
P Q S Increase in Supply S1S1
P Q S Decrease in Supply S1S1
Changes in Supply Things that cause the whole supply curve to shift Input costs Competitors (number of) Expectation of future price Government action
Changes in Supply I.C.E.G. Input Costs – Prices of raw materials or other factors of production (Land, labor, capital) – Changes in productivity (efficiency gains/losses)
Changes in Supply I.C.E.G. Competition – Number of producers in the market Ex. Fewer producers = less supply More Producers = more supply
ICEG Expected Prices – If producers expect prices to rise in the future, then they supply less now, so that they can sell their good/service at the future higher price Ex. If ExxonMobil expects the price of oil to rise in the future, they may not release as much oil to the market and may instead wait for the price to go up before they sell the oil.
ICEG – If producers expect prices to fall in the future then they supply more now while prices are still relatively high Ex. If a corn farmer expects the price of corn to decrease in value, he would be inclined to sell it now before there is a decrease in price.
Changes in Supply I.C.E.G. Government action – Business taxes – Regulation – Subsidies (money from govt)
Equilibrium When supply = demand, there is equilibrium in the market Equilibrium creates a single price and quantity for a good/service
P Q S D p q Market Equilibrium
Changes in equilibrium When supply or demand changes, the equilibrium price and quantity change If demand increases then price increases and quantity increases If demand decreases then price decreases and quantity decreases
Changes in equilibrium If supply increases then price decreases and quantity increases If supply decreases then price increases and quantity decreases
P Q S D p q D1D1 p1p1 q 1 Increase in Demand D.: P & Q
P Q S D1D1 p1p1 q1q1 D p q Decrease in Demand D.: P & Q
P Q S D p q Increase in Supply S.: P & Q S1S1 p1p1 q1q1
P Q S D p q Decrease in Supply S.: P & Q S1S1 p1p1 q1q1
Disequilibrium If price occurs at some point where supply and demand are not equal, then disequilibrium exists. If the price is higher than the equilibrium price, then a surplus (Q s >Q D ) occurs – Suppliers will churn out more than we want to buy If the price is lower than the equilibrium price, then a shortage occurs (Q s
P Q S D pepe qeqe Market Disequilibrium (Price, p x, above Equilibrium Price, p e ) pxpx qsqs qdqd If price is p x, then q d < q s.: surplus exists (surplus = q s – q d )
P Q S D pepe qeqe qdqd qsqs If price is p x, then q s < q d.: shortage exists (shortage = q d – q s ) pxpx Market Disequilibrium (Price, p x, below Equilibrium Price, p e )
Causes of Disequilibrium Price floor – a minimum price for a good/service or resource determined outside of the market (floors are set above equilibrium) – Artificially raises minimum price – Ex. Minimum wage (price for labor)
P Q S D pepe qeqe Effective Price Floor (ex. Minimum wage in competitive unskilled labor market) p mw qsqs qdqd If price floor is effective, then q d < q s.: surplus labor exists
Causes of Disequilibrium (cont.) Price ceiling – a maximum price for a good/service or resource determined outside of the market – Ceilings are set BELOW equilibrium – MAX price that can be charged – Ex. Rent control of some apartments in NYC – Does NOT work
P Q S D pepe qeqe qdqd qsqs If price ceiling is effective then q s < q d.: apartment shortage exists ptpt Effective Price Ceiling (ex. Rent for some apartments in NYC)
Conclusion Markets work best when supply and demand determine the price of goods/services or resources. When forces other than supply and demand determine the price of goods/services or resources, surpluses and shortages result. Over time, the forces of supply and demand undermine artificial price controls – Ex. Underground markets to get around rent control