3 Chapter Objectives Demand Defined and What Affects It Supply Defined and What Affects ItHow Supply & Demand Together Determine Market EquilibriumHow Changes in Supply and Demand Affect Equilibrium Prices and QuantitiesGovernment-Set Prices and their Implications for Surpluses & Shortages
4 Demand Demand Defined Demand Schedule Law of Demand Demand Curve Diminishing Marginal UtilityIncome EffectSubstitution EffectDemand CurveMarket Demand184.108.40.206.4
5 What is demand?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 necessaryEx. I have the desire to go on a European vacation, but I can not afford it. Therefore, I do not possess demand for it.
6 Demand DefinedExpressed 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 timeShow quantities of a product that will be purchased at various psb prices, other things equal
7 Demand ScheduleTable 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
8 Law of Demand Inverse relationship between price and quantity demanded States that when price increases, quantity demanded decreasesWhen P. dec., QD. inc.Ppl buy less at higher prices, more at lower prices
9 Explanations of the Law of Demand Why the inverse relationship b/w P and QD?1. Common sense—think 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 effectsincome effect – change in the amount that consumers will buy b/c the purchasing power of their income changes, although income itself doesn’t 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 Demand CurveGraph showing how much of a product an individual will each priceGraphic representation of demand schedule and law of demandSlopes downward from left to rightMarket demand curve – graph showing data from market demand schedulePrice on Y-axis, Quantity on X-axisSee p.45 Figure 3.1
13 Individual Demand Individual Demand P Qd $5 4 3 2 1 10 20 35 55 80 P 654321Quantity Demanded (bushels per week)Price (per bushel)IndividualDemandPQd$543211020355580DQ
14 Change in Quantity Demanded -change in the amt. of a product consumers will buy b/c of a change in priceShown by a movement along the demand curve
15 Individual Demand Determinants of Demand Tastes Number of Buyers IncomeNormal GoodsInferior GoodsPrice of Related GoodsSubstitute GoodComplementary GoodUnrelated GoodsConsumer Expectations
16 Change in DemandSomething prompts consumers to buy different every priceRepresented by shifts of the demand curveInc. in demand – curve shifts rightDec. in demand – curve shifts leftInfluenced by 6 factors
17 Factor 1: Income If consumer income inc., demand inc. If income dec., demand dec.Ex. a factory closes, ppl lose jobs, income falls and demand dec.
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 Factor 2: Market Size# of consumers, population changes, seasonal tourist trendsIf market size inc., demand inc.
21 Factor 4: Consumer Expectations Refers to expectations of future pricesIf consumers expect a future price inc., current demand inc.
22 Factor 5: Substitute Goods g/s that can be used in place of each otherEx. Coke and Pepsi, wireless phones and traditional phonesIf demand for substitute inc., demand for original item dec.
23 Factor 6: ComplementsGoods 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
24 Individual Demand Demand Can Increase or Decrease Individual Demand P 654321IndividualDemandPQdIncrease in Demand$543211020355580Price (per bushel)D2Decrease in DemandD1D3QQuantity Demanded (bushels per week)
25 Demand Curve is Called a Change in Quantity Individual DemandDemand Can Increase or DecreaseAn Increase in DemandMeans a Movementof the LineP654321IndividualDemandA Movement BetweenAny Two Points on aDemand Curve is Called a Change in QuantityDemandedPQd$543211020355580Price (per bushel)D2Decrease in DemandD1D3QQuantity Demanded (bushels per week)
26 Supply Supply Defined Supply Schedule Law of Supply Supply Curve Revenue ImplicationsMarginal CostSupply CurveMarket Supply
27 What is supply?Willingness and ability of producers to offer a g/s for saleExpressed 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 periodProducer = anyone who is willing to provide a g/sEx. worker, company, farmers, etc…Profit motivates producers to inc. supply
28 Law of Supply Direct (positive) relationship between P and QSS When P. inc., QS inc.When P. dec., QS dec.
29 Supply ScheduleTable 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
30 Supply Curve Supply schedule data in graphic form Shows law of supply in graph formSlopes upward from left to rightMarket supply curve – market supply schedule in graph formSee p.102 Figure 3.4
31 Individual Supply Individual Supply P Qs $5 4 3 2 1 60 50 35 20 5 P S1 IndividualSupplyS1PQs$54321605035205Price (per bushel)QQuantity Supplied (bushels per week)
32 What Factors Affect Supply? 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
33 Individual Supply Resource Prices Technology Taxes and Subsidies Determinants of SupplyResource PricesTechnologyTaxes and SubsidiesPrices of Other GoodsProducer ExpectationsNumber of Sellers
34 Changes in SupplyOccur when a change in the marketplace causes producers to sell different every price.Inc. in S, curve shifts rightDec. in S, curve shifts left6 Factors influence supply
35 Factor 1: Input Costs Price of resources used to make products Ex. Cost of nuts used to make candy barsInput costs inc., Supply dec.
36 Labor Productivity Amt of a g/s a person can produce in a given time Ex. More skilled & educated workers, labor strikeInc. productivity, Supply inc.
37 Factor 2: Government Action Excise tax – taxes production/sale of certain goodsTax inc., Supply dec.Subsidy – gov. payment for part of production costSubsidy inc., supply inc.Regulation – rules/laws controlling business beh. (Ex. Pollution, worker safety)New regulation, Supply dec.
38 Factor 3: Technology Applying science & innovation to production Ex. Robots on assembly line, computers, etc…Inc. in technology, Supply inc.
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 Factor 5: Producer Expectations If producers expect a future P. inc, they will withhold current supply.
41 Factor 6: # of Producers More producers of a product, Supply inc. Ex. Fast food restaurants, auto manufacturers
42 Individual Supply Supply Can Increase or Decrease Individual Supply P 654321S3IndividualSupplyS1S2PQs$54321605035205Price (per bushel)QQuantity Supplied (bushels per week)
43 Supply Curve is Called a Change in Quantity Individual SupplySupply Can Increase or DecreaseA Movement BetweenAny Two Points on aSupply Curve is Called a Change in QuantitySuppliedP654321S3IndividualSupplyS1S2PQs$54321605035205Price (per bushel)An Increase in SupplyMeans a Movementof the LineQQuantity Supplied (bushels per week)
44 Market Equilibrium Equilibrium Price Equilibrium Quantity Surplus 3.1Equilibrium PriceEquilibrium QuantitySurplusShortageRationing Function of Prices
45 Seeking Equilibrium: Demand and Supply Market equilibrium – situation in which the quantity demanded for a service is equal to the quantity suppliedTwo 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>QDMarket 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 productionShortages happen when prices are too low relative to demand (excess demand)With shortage, prices rise; producers increase quantity supplied
48 Market Equilibrium 200 Buyers & 200 Sellers P Qd P Qs Market Demand Supply200 Sellers6543216,000 BushelSurplusSPQdPQs$543212,0004,0007,00011,00016,000$5432112,00010,0007,0004,0001,000$4 Price FloorPrice (per bushel)3$2 Price Ceiling7,000 BushelShortageD7Bushels of Corn (thousands per week)
49 Rationing Function of Prices Ability of the forces of S and D to establish a P at which selling and buying decisions are consistentAt equilibrium, there is no shortage and no surplus
50 Efficient Allocation Competitive market also allocate societies’ resources efficientlyResults in productive efficiency – production of any particular good in the least costly wayAlso 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 EquilibriumEfficient AllocationProductive EfficiencyAllocative Efficiency
53 Government-Set Prices Price Ceilings on GasolineRationing ProblemBlack MarketsRent ControlsPrice Floors on WheatOptimal Allocation of Resources3.2
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 resultsEx. Rent control – legal price ceilings on rent, leads to housing shortagesEx. gasoline –See p.58
55 Rationing Resources and Products In periods of national emergency, the gov. may distribute products or resourcesRationing – way of allocating products using factors other than price-occurred in U.S. during WWIIMay lead to black market – illegal buying and selling of products
56 Price FloorsGov. decides to intervene in the price system in order to increase income to certain producersPrice Floor –legal minimum price buyers may pay for a productEx. Minimum wage or price floor on wheat – See p.59
57 A Legal Market for Human Organs LastWordWaiting List for TransplantsDemand for OrgansVertical Supply of OrgansIncentive Role of Market and Up-Sloping SupplyIncreases QuantityDecreases PriceMoral ObjectionsIncrease the Cost of Health CareBetter to Legalize and Regulate?
58 A Legal Market for Human Organs LastWordSupply With Price IncentiveS1S2PSupply of OrgansDemand for OrgansShortage at Zero PriceQ1 – Q3P1At Price P1 theShortage is ReducedBy Q1 – Q2D1P0Q1Q2Q3Q