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MBMC Supply and Demand: An Introduction Supply and Demand: An Introduction.

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1 MBMC Supply and Demand: An Introduction Supply and Demand: An Introduction

2 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 2 Supply and Demand: An Introduction How do consumers get the goods and services they want in the right quantities and qualities? Some goods and services are allocated by the market forces of supply and demand

3 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 3 Supply and Demand: An Introduction Why do some goods and services have shortages or surpluses and others do not? Some good and supplies services are regulated by government

4 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 4 What, How, and For Whom? Central Planning Versus the Market Three Problems All Economic Systems Must Address What should be produced? How should it be produced? For whom will it be produced?

5 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 5 What, How, and For Whom? Central Planning Versus the Market Centralized Economic Organizations Agrarian society Former Soviet Union Cuba North Korea China Bureaucracy

6 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 6 What, How, and For Whom? Central Planning Versus the Market A small number of individuals address: What Establish production targets for factories and farms How Plan how to achieve the goals For Whom Distribute the goods and services produced

7 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 7 What, How, and For Whom? Central Planning Versus the Market Free-Market or Capitalist Economic System Individual choices determine: Which careers to pursue Which products to produce or buy When to start and shut-down a business Who gets what is decided by individual preferences and purchasing power

8 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 8 Buyers and Sellers In Markets Market Consists of all buyers and sellers of a good or service What do you think? What determines the price of pizza, gasoline, a car wash, or other goods and services?

9 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 9 Buyers and Sellers In Markets The Demand Curve A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price

10 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 10 Buyers and Sellers In Markets A Property of Demand As price of a good or service goes down the quantity consumers wish to buy will increase Therefore, the demand curve is downward- sloping

11 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 11 The Daily Demand Curve for Pizza in Chicago Price ($ per slice) Quantity (1000s of slices per day) Demand

12 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 12 Buyers and Sellers In Markets The Demand Curve Why do buyers purchase a greater quantity at lower prices and vice-versa? The substitution effect The income effect

13 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 13 Buyers and Sellers In Markets The Substitution Effect The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes

14 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 14 Buyers and Sellers In Markets The Income Effect The change in the quantity demanded of a good that results because a change in the price of a good changes the buyers purchasing power

15 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 15 Buyers and Sellers In Markets The Cost-Benefit Principle The reservation price is the benefit the buyer receives from the good The cost of the good is its market price If the reservation price (benefit) exceeds the market price (cost) the consumer will purchase the good At higher prices, benefit will exceed cost for a smaller quantity than at lower prices

16 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 16 Buyers and Sellers In Markets Price ($ per slice) Quantity (1000s of slices per day) Demand The buyers reservation price: The largest dollar amount the buyer would be willing to pay for a good 4 2 3

17 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 17 Buyers and Sellers In Markets Horizontal Interpretation Price determines quantity demanded Price ($ per slice) Demand

18 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 18 Buyers and Sellers In Markets Vertical Interpretation Quantity measures the marginal buyers reservation price Price ($ per slice) Demand

19 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 19 Buyers and Sellers In Markets The Supply Curve A curve or schedule showing the quantity of a good that sellers wish to sell at each price

20 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 20 Buyers and Sellers In Markets Question Will the opportunity cost of producing additional units of pizza increase or decrease? Hint:Low-hanging-fruit principle

21 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 21 Buyers and Sellers In Markets The Supply Curve Sellers must receive a higher price to produce additional units of product to cover the higher opportunity costs of each additional unit

22 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 22 The Daily Supply Curve for Pizza in Chicago Price ($ per slice) Quantity (1000s of slices per day) Supply

23 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 23 The Daily Supply Curve for Pizza in Chicago Price ($ per slice) Quantity (1000s of slices per day) Supply Horizontal Interpretation Shows the quantity produced for each price

24 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 24 The Daily Supply Curve for Pizza in Chicago Price ($ per slice) Quantity (1000s of slices per day) Supply Vertical Interpretation Shows the marginal cost (reservation price) for producing each additional unit

25 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 25 Sellers Reservation Price The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost The Daily Supply Curve for Pizza in Chicago

26 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 26 Market Equilibrium Equilibrium A system is in equilibrium when there is no tendency for it to change Market Equilibrium Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price

27 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 27 The Equilibrium Price and Quantity of Pizza In Chicago Price ($ per slice) Quantity (1000s of slices per day) Supply Demand Equilibrium at $3 Quantity Demanded = Quantity Supplied

28 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 28 Market Equilibrium Equilibrium Price and Equilibrium Quantity The values of price and quantity for which quantity supplied and quantity demanded are equal

29 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 29 What Do You Think? Would buyers prefer a lower price than the equilibrium price? Would sellers prefer a higher price than the equilibrium price? Market Equilibrium

30 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 30 Excess Supply Price ($ per slice) Quantity (1000s of slices per day) Supply Demand Excess supply = 8,000 slices per day

31 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 31 Excess Demand Price ($ per slice) Quantity (1000s of slices per day) Excess demand = 8,000 slices per day Supply Demand

32 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 32 Points Along the Demand and Supply Curves of a Pizza Market Demand for pizzaSupply of pizza Price ($/slice) Quantity demanded (1000s of slices/day) Price ($/slice) Quantity supplied (1000s of slices/day)

33 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 33 Graphing Supply and Demand and Finding the Equilibrium Price and Quantity Price ($per slice) Quantity (1000s of slices per day) Demand 0 68 Supply The Equilibrium Price = $2.50 The Equilibrium Quantity = 5

34 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 34 Market Equilibrium What Do You Think? Is the market equilibrium always an ideal outcome for all market participants?

35 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 35 An Unregulated Housing Market Monthly Rent ($/apartment) Quantity (Millions of apartments/day) 1,600 2 Supply Demand What Do You Think? Is $1600 more than some people can afford?

36 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 36 Rent Controls Monthly Rent ($/apartment) Quantity (Millions of apartments/day) 1,600 2 Supply Demand 2,400 Controlled = Excess demand = 2 million apartments per month

37 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 37 Market Equilibrium Rent Controls Reconsidered Other consequences of rent controls Maintenance will decline and housing quality will fall Illegal payments Creation of co-ops and conversion to condominiums Reduction in household mobility Discrimination

38 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 38 Market Equilibrium What do you think? How can we make housing affordable for poor people without using rent ceilings?

39 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 39 Rent Controls Monthly Rent ($/apartment) Quantity (Millions of apartments/day) Supply Demand 1, What is the impact of a rent control set at $1,200/month?

40 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 40 Price Controls In The Pizza Market Price ($ per slice) Quantity (1000s of slices per day) Supply Demand Excess demand = 8,000 slices per day 4 Price ceiling =

41 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 41 Market Equilibrium Pizza Price Controls? Market responses to a pizza price ceiling Long lines Preferential treatment to selected customers Alternative pricing strategies Poorer quality ingredients Black-market pizzas

42 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 42 Predicting and Explaining Changes In Prices and Quantities Distinguishing Between: A change in the quantity demanded A movement along the demand curve that occurs in response to a change in price A change in demand A shift of the entire demand curve

43 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 43 An Increase In Quantity Demanded vs. An Increase In Demand Price ($/can) Quantity (1000s of cans/day) Increase in quantity demanded D

44 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 44 An Increase In Quantity Demanded vs. An Increase In Demand Price ($/can) Quantity (1000s of cans/day) Increase in demand D D D D

45 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 45 Predicting and Explaining Changes In Prices and Quantities Change in the quantity supplied A movement along the supply curve that occurs in response to a change in price Change in supply A shift of the entire supply curve

46 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 46 An Increase In Quantity Supplied vs. An Increase In Supplied Price ($/can) Quantity (1000s of cans/day) S S Increase in quantity supplied

47 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 47 An Increase In Quantity Supplied vs. An Increase In Supplied Price ($/can) Quantity (1000s of cans/day) S 068 S S S Increase in supply

48 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 48 The Effect on the Market for Tennis Balls of a Decline in Court-Rental Fees Price ($/ball) Quantity (letters/month) 1.00 S D 40 D

49 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 49 Predicting and Explaining Changes In Prices and Quantities Shifts in Demand Complements Two goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other

50 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 50 The Effect on the Market for Overnight Letter Delivery of a Decline in the Price of Internet Access Price ($/letter) Quantity (letters/month) P Q S D P Q D

51 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 51 Predicting and Explaining Changes In Prices and Quantities Shifts in Demand Substitutes Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other

52 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 52 Predicting and Explaining Changes In Prices and Quantities What do you think? How will a decline in airfares affect inter- city bus fares and the price of hotel rooms in resort communities?

53 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 53 Predicting and Explaining Changes In Prices and Quantities Economic Naturalist When the Federal Government implements a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?

54 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 54 The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C. Rent (dollars per month) Conveniently located apartments (units per month) D P Q S P Q D

55 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 55 Predicting and Explaining Changes In Prices and Quantities Shifts in Demand Changes In Demand An increase (decrease) in the demand for a good will shift the demand curve to the right (left)

56 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 56 Predicting and Explaining Changes In Prices and Quantities A Change In Income Normal Good One whose demand increases (decreases) when the incomes of buyers increase (decrease)

57 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 57 Predicting and Explaining Changes In Prices and Quantities A Change In Income Inferior Good One whose demand decreases (increases) when the incomes of buyers increase (decrease)

58 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 58 The Effect of the Release of Jurassic Park on the Market for Toy Dinosaurs Price Toy Dinosaurs (units per month) P Q D S D P Q D = demand after release of movie

59 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 59 The Effect of a Credible Rumor on the Market for Apple Macintosh Computers Price Apple Computers (units per month) P Q S D P Q D D = demand after rumor of cheaper model soon to be released

60 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 60 The Effect of the Increase in the Population of Potential Buyers Price Housing NY City (units per month) P Q S D P Q D D = demand after increase in population

61 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 61 Predicting and Explaining Changes In Prices and Quantities Factors that Shift Demand Price of complements Price of substitutes Income Preferences Population of potential buyers Expectations

62 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 62 The Effect on the Skateboard Market of an Increase in the Price of Fiberglass Price ($/skateboard) Quantity (skateboards/month) S D S

63 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 63 Predicting and Explaining Changes In Prices and Quantities What Do You Think? Does the increase in the cost of fiberglass have any effect on the demand curve for skateboards?

64 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 64 The Effect on the Market for New Houses of a Decline in Carpenters Wage Rates Price ($1000/house) Quantity (houses/month) D S S

65 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 65 The Effect of Technical Change on the Market for the Term Paper Revisions Price ($/revision) Quantity (millions of revisions per year) D S S

66 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 66 Predicting and Explaining Changes In Prices and Quantities Factors that Shift Supply Costs of production Technology Weather Number of suppliers Expectations

67 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 67 Price Quantity P P QQ S D D An increase in demand will lead to an increase in both the equilibrium price and quantity Four Rules Governing the Effects of Supply And Demand Shifts

68 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 68 Price Quantity P P QQ S D D A decrease in demand will lead to a decrease in both the equilibrium price and quantity Four Rules Governing the Effects of Supply And Demand Shifts

69 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 69 P P QQ S D S Price Quantity An increase in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity Four Rules Governing the Effects of Supply And Demand Shifts

70 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 70 P P QQ S D S Price Quantity An decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity Four Rules Governing the Effects of Supply And Demand Shifts

71 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 71 Predicting and Explaining Changes In Prices and Demand Factors That Cause an Increase (rightward or upward shift) in Demand 1.A decrease in the price of complements to the good or service 2.An increase in the price of substitutes for the good or service 3.An increase in income (for a normal good)

72 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 72 Predicting and Explaining Changes In Prices and Demand Factors That Cause an Increase (rightward or upward shift) in Demand 4.An increased preference by demanders for the good or service 5.An increase in the population of potential buyers 6.An expectation of higher prices in the future

73 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 73 Predicting and Explaining Changes In Prices and Demand Factors That Cause an Increase (rightward or upward shift) in Supply 1.A decrease in the cost of materials, labor, or other inputs used in the production of the good or service 2.An improvement in technology that reduces the cost of producing the good or service

74 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 74 Predicting and Explaining Changes In Prices and Demand Factors That Cause an Increase (rightward or upward shift) in Supply 3.An improvement in the weather, especially for agricultural products 4.An increase in the number of suppliers 5.An expectation of lower prices in the future

75 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 75 The Effects Of Simultaneous Shifts In Supply And Demand Price ($/bag) Millions of bags per month P Q S D P Q D S S after reduction in price of corn harvesting equipment D after discovery that oils are harmful to peoples health The Market for Corn Tortilla Chips

76 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 76 The Effects Of Simultaneous Shifts In Supply And Demand Price ($/bag) Millions of bags per month P Q S D P Q D S D after discovery that oils are harmful to peoples health S after reduction in price of corn harvesting equipment The Market for Corn Tortilla Chips

77 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 77 Predicting and Explaining Changes In Prices and Demand Assume A vitamin found in corn chips helps protect against cancer and heart diseases Swarm of locusts destroys part of the corn crop What Do You Think? What will happen to the equilibrium price and quantity of corn chips?

78 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 78 Predicting and Explaining Changes In Prices and Demand Economic Naturalist Why do the prices of some goods, like airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down?

79 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 79 Seasonal Variation in Air Travel Price ($/ticket) 1000s of tickets S DSDS DWDW QWQW QSQS PWPW PSPS High Consumption and Prices Due to High Demand

80 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 80 Seasonal Variation in Corn Markets Price ($/bushel) Millions of bushels SWSW D QWQW QSQS PWPW PSPS S High Consumption and Low Prices due to High Supply

81 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 81 Markets And Social Welfare What Do You Think? When are the prices and quantities determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?

82 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 82 Markets And Social Welfare Cash On The Table Assume: All exchange is purely voluntary If so: The buyers reservation price exceeds the sellers reservation price and both the buyer and seller receive an economic surplus

83 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 83 Markets And Social Welfare Cash On The Table Buyers surplus The difference between the buyers reservation price and the price he or she actually pays

84 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 84 Markets And Social Welfare Cash On The Table Sellers surplus The difference between the price received by the seller and his or her reservation price

85 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 85 Markets And Social Welfare Cash On The Table Total surplus The difference between the buyers reservation price and the sellers reservation price

86 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 86 Markets And Social Welfare Cash On The Table Economic metaphor for unexploited gains from exchange

87 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 87 Price Controls In The Pizza Market Price ($ per slice) Quantity (1000s of slices per day) S D Assume: Buyers reservation P = $4 Sellers reservation P = $2 Pizza sells for $3 Buyers surplus: $4 - $3 = $1 Sellers surplus: $3 - $2 = $1 Total surplus: $4 - $2 = $2

88 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 88 Price Controls In The Pizza Market Price ($ per slice) Quantity (1000s of slices per day) Excess demand = $8,000 slices/day D Assume price controls = $2 Quantity supplied falls to 8,000 Buyers reservation price ($4) is greater than sellers ($2) Both would benefit from additional production There is CASH ON THE TABLE S

89 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 89 Markets And Social Welfare Smart For One, Dumb For All Socially optimal quantity The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good The socially optimal quantity occurs when MC = MB

90 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 90 Markets And Social Welfare Smart For One, Dumb For All Economic efficiency occurs when all goods and services are produced and consumed at their respective socially optimal levels

91 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 91 Markets And Social Welfare Smart For One, Dumb For All The Efficiency Principle Maximize the economic surplus Increases the economic pie

92 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 92 Markets And Social Welfare Smart For One, Dumb For All When is the market equilibrium efficient? When all cost of producing the good or service are borne directly by the seller When all benefits from the good or service accrue directly to buyers

93 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 93 Markets And Social Welfare Smart For One, Dumb For All Inefficient market equilibrium When some costs of production fall on people other than those who sell the good or service

94 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 94 Markets And Social Welfare Example: Pollution The market is in equilibrium: MC = MB MC however underestimates the cost to society of producing the good Therefore, the market produces more than the efficient amount and there is no incentive for producers and consumers to alter their behavior

95 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 95 Markets And Social Welfare Smart For One, Dumb For All Inefficient market equilibrium When some benefits from the good or service accrue to people who did not buy the good or service

96 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 96 Markets And Social Welfare Example: Vaccinations The market is in equilibrium: MC = MB MB underestimates the benefits to society of consuming the vaccinations The market produces less than the efficient amount of vaccinations and there is no incentive for producers and consumers to alter their behavior

97 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 97 Markets And Social Welfare Smart For One, Dumb For All In these markets Buyers and sellers are behaving rationally Market equilibrium exists There are no unexploited opportunities for individuals Economic surplus is not maximized

98 MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An IntroductionSlide 98 Markets And Social Welfare The Equilibrium Principle A market in equilibrium leaves no unexploited opportunities for individuals, but may not exploit all gains achievable through collective action.

99 MBMC End of Chapter End of Chapter


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