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Chapter 3 Notes. 3 Demand, Supply, and Market Equilibrium.

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Presentation on theme: "Chapter 3 Notes. 3 Demand, Supply, and Market Equilibrium."— Presentation transcript:

1 Chapter 3 Notes

2 3 Demand, Supply, and Market Equilibrium

3 Chapter Objectives Demand Defined and What Affects It Supply Defined and What Affects It How Supply & Demand Together Determine Market Equilibrium How Changes in Supply and Demand Affect Equilibrium Prices and Quantities Government-Set Prices and their Implications for Surpluses & Shortages

4 Demand Demand Defined Demand Schedule Law of Demand – Diminishing Marginal Utility – Income Effect – Substitution Effect Demand Curve Market Demand

5 Demand – the desire to have a good or service and the ability to pay for it. The 2 factors of desire and ability are both necessary Ex. I have the desire to go on a European vacation, but I can not afford it. Therefore, I do not possess demand for it. What is demand?

6 Demand Defined Expressed on a schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time Show quantities of a product that will be purchased at various psb prices, other things equal

7 Table showing how much of a product an individual is willing & able to each price in the market. Market demand schedule – table showing how much all consumers are willing to each price Demand Schedule

8 Inverse relationship between price and quantity demanded States that when price increases, quantity demanded decreases When P. dec., QD. inc. Ppl buy less at higher prices, more at lower prices Law of Demand

9 Explanations of the Law of Demand Why the inverse relationship b/w P and QD? 1. Common sensethink about it! 2. Diminishing marginal utility – marginal benefit from using each additional unit of a product during a given period will decline. Ex. You get more satisfaction from the first glass of lemonade than the second, third, fourth…and are therefore not willing to pay as much for each additional unit

10 Explanations of the Law of Demand 3. Income and substitution effects income effect – change in the amount that consumers will buy b/c the purchasing power of their income changes, although income itself doesnt change. Ex. You go to the store to buy ground beef, it is on sale, you feel wealthier and buy more.

11 Explanations of the Law of Demand 2. substitution effect – change in the amount that people will buy b.c they substitute goods instead. Ex. You go to the store to buy ground beef but you see ground turkey is on sale for ½ the price so you buy that instead.

12 Graph showing how much of a product an individual will each price Graphic representation of demand schedule and law of demand Slopes downward from left to right Market demand curve – graph showing data from market demand schedule Price on Y-axis, Quantity on X-axis See p.45 Figure 3.1 Demand Curve

13 Individual Demand Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ Individual Demand P Q D

14 -change in the amt. of a product consumers will buy b/c of a change in price Shown by a movement along the demand curve Change in Quantity Demanded

15 Individual Demand Tastes Number of Buyers Income – Normal Goods – Inferior Goods Price of Related Goods – Substitute Good – Complementary Good – Unrelated Goods Consumer Expectations Determinants of Demand

16 Something prompts consumers to buy different every price Represented by shifts of the demand curve Inc. in demand – curve shifts right Dec. in demand – curve shifts left Influenced by 6 factors Change in Demand

17 If consumer income inc., demand inc. If income dec., demand dec. Ex. a factory closes, ppl lose jobs, income falls and demand dec. Factor 1: Income

18 2 types of goods: Normal goods – goods for which demand inc. as income inc. Ex. most goods such as TVs, steaks, IPODS, etc… Inferior goods - goods for which demand dec. as income inc. Ex. Generics, Ramen noodles, etc…

19 # of consumers, population changes, seasonal tourist trends If market size inc., demand inc. Factor 2: Market Size

20 Advertising, trends, styles, popularity, celebrity endorsements If consumer tastes inc., demand inc. Factor 3: Consumer tastes

21 Refers to expectations of future prices If consumers expect a future price inc., current demand inc. Factor 4: Consumer Expectations

22 g/s that can be used in place of each other Ex. Coke and Pepsi, wireless phones and traditional phones If demand for substitute inc., demand for original item dec. Factor 5: Substitute Goods

23 Goods used together so a rise in the demand for one inc. as the demand for another inc. Ex. digital cameras and photo printers, cars and gas Factor 6: Complements

24 Individual Demand Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ Individual Demand P Q D1D Demand Can Increase or Decrease Increase in Demand Decrease in Demand D2D2 D3D3

25 Individual Demand Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ Individual Demand P Q D1D Demand Can Increase or Decrease Decrease in Demand D2D2 D3D3 An Increase in Demand Means a Movement of the Line A Movement Between Any Two Points on a Demand Curve is Called a Change in Quantity Demanded

26 Supply Supply Defined Supply Schedule Law of Supply – Revenue Implications – Marginal Cost Supply Curve Market Supply

27 Willingness and ability of producers to offer a g/s for sale Expressed as a schedule or curve showing the various amounts of a product that producers are willing and able to sell at each of a series of psb prices during a specified period Producer = anyone who is willing to provide a g/s Ex. worker, company, farmers, etc… Profit motivates producers to inc. supply What is supply?

28 Direct (positive) relationship between P and QSS When P. inc., QS inc. When P. dec., QS dec. Law of Supply

29 Table showing how much of a g/s an individual producer is willing and able to each P. Market supply schedule – lists how much of a g/s all producers will each P. See p.51 Figure 3.4 Supply Schedule

30 Supply schedule data in graphic form Shows law of supply in graph form Slopes upward from left to right Market supply curve – market supply schedule in graph form See p.102 Figure 3.4 Supply Curve

31 Individual Supply Quantity Supplied (bushels per week) Price (per bushel) PQsQs $ Individual Supply P Q S1S

32 Changes in quantity supplied – inc. or dec. in the amount of a g/s that producers are willing to sell b/c of a change in P. -shown by movement to different points along the S. curve What Factors Affect Supply?

33 Individual Supply Resource Prices Technology Taxes and Subsidies Prices of Other Goods Producer Expectations Number of Sellers Determinants of Supply

34 Occur when a change in the marketplace causes producers to sell different every price. Inc. in S, curve shifts right Dec. in S, curve shifts left 6 Factors influence supply Changes in Supply

35 Price of resources used to make products Ex. Cost of nuts used to make candy bars Input costs inc., Supply dec. Factor 1: Input Costs

36 Amt of a g/s a person can produce in a given time Ex. More skilled & educated workers, labor strike Inc. productivity, Supply inc. Labor Productivity

37 Excise tax – taxes production/sale of certain goods Tax inc., Supply dec. Subsidy – gov. payment for part of production cost Subsidy inc., supply inc. Regulation – rules/laws controlling business beh. (Ex. Pollution, worker safety) New regulation, Supply dec. Factor 2: Government Action

38 Applying science & innovation to production Ex. Robots on assembly line, computers, etc… Inc. in technology, Supply inc. Factor 3: Technology

39 Factor 4: Prices of Other Goods Substitution in production that may occur when higher prices of other goods a seller produces entice the producer to switch production to those other goods in order to increase profits. See example on page 52.

40 If producers expect a future P. inc, they will withhold current supply. Factor 5: Producer Expectations

41 More producers of a product, Supply inc. Ex. Fast food restaurants, auto manufacturers Factor 6: # of Producers

42 Individual Supply Quantity Supplied (bushels per week) Price (per bushel) PQsQs $ Individual Supply P Q S1S1 Supply Can Increase or Decrease S2S2 S3S

43 Individual Supply Quantity Supplied (bushels per week) Price (per bushel) PQsQs $ Individual Supply P Q S1S1 Supply Can Increase or Decrease S2S2 S3S3 An Increase in Supply Means a Movement of the Line A Movement Between Any Two Points on a Supply Curve is Called a Change in Quantity Supplied

44 Market Equilibrium Equilibrium Price Equilibrium Quantity Surplus Shortage Rationing Function of Prices 3.1

45 Seeking Equilibrium: Demand and Supply Market equilibrium – situation in which the quantity demanded for a service is equal to the quantity supplied Two curves intersect at point of market equilibrium. Equilibrium price(market-clearing price) – price at which QS = QD; equilibrium quantity can also be determined

46 Reaching the Equilibrium Price Trial and error may be necessary for the market to arrive at equilibrium. Market may have a surplus: QS>QD Market may have a shortage: QD>QS

47 Surpluses and Shortages Surpluses happen when prices are too high relative to demand (excess supply) With surplus, prices tend to fall; producers cut back production Shortages happen when prices are too low relative to demand (excess demand) With shortage, prices rise; producers increase quantity supplied

48 Market Equilibrium Bushels of Corn (thousands per week) Price (per bushel) PQdQd $ ,000 4,000 7,000 11,000 16,000 Market Demand 200 Buyers PQsQs $ ,000 10,000 7,000 4,000 1,000 Market Supply 200 Sellers 200 Buyers & 200 Sellers 7 3 D S $4 Price Floor 6,000 Bushel Surplus $2 Price Ceiling 7,000 Bushel Shortage

49 Rationing Function of Prices Ability of the forces of S and D to establish a P at which selling and buying decisions are consistent At equilibrium, there is no shortage and no surplus

50 Efficient Allocation Competitive market also allocate societies resources efficiently Results in productive efficiency – production of any particular good in the least costly way Also results in allocative efficiency – the particular mix of G&S most highly valued by society, assuming minimum-cost production. Demand essentially reflects the MB of a good, while supply reflects MC of producing a good. At the intersection of the S and D curves, MB=MC, resulting in allocative efficiency!

51 Market Equilibrium Changes in S and D affect Equilibrium Changes in Equilibrium Efficient Allocation – Productive Efficiency – Allocative Efficiency

52 Supply Increase; Demand Decrease Supply Decrease; Demand Increase Supply Increase; Demand Increase Supply Decrease; Demand Decrease Market Equilibrium PriceQuantity ? ? ? ?

53 Government-Set Prices Price Ceilings on Gasoline Rationing Problem Black Markets Rent Controls Price Floors on Wheat Optimal Allocation of Resources 3.2

54 Intervention in the Price System: At times the government or other entity will interfere in the price system to keep prices from going too high. Price Ceiling – legal max. price a seller may charge for a product -set below equilibrium price, so a shortage results Ex. Rent control – legal price ceilings on rent, leads to housing shortages Ex. gasoline –See p.58

55 Rationing Resources and Products In periods of national emergency, the gov. may distribute products or resources Rationing – way of allocating products using factors other than price -occurred in U.S. during WWII May lead to black market – illegal buying and selling of products

56 Price Floors Gov. decides to intervene in the price system in order to increase income to certain producers Price Floor –legal minimum price buyers may pay for a product Ex. Minimum wage or price floor on wheat – See p.59

57 A Legal Market for Human Organs Waiting List for Transplants Demand for Organs Vertical Supply of Organs Incentive Role of Market and Up-Sloping Supply Increases Quantity Decreases Price Moral Objections Increase the Cost of Health Care Better to Legalize and Regulate? Last Word

58 A Legal Market for Human Organs Last Word P Q S2S2 S1S1 D1D1 P1P1 P0P0 Q1Q1 Q2Q2 Q3Q3 Supply of Organs Demand for Organs Shortage at Zero Price Q 1 – Q 3 Supply With Price Incentive At Price P 1 the Shortage is Reduced By Q 1 – Q 2


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