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Bell Ringer Explain the point that this political cartoon is making.
CHAPTER 3 Demand, Supply, and Market Equilibrium
Supply and Demand 3 Supply and demand is an economic model Designed to explain how prices are determined in certain types of markets The price of a good or service is what must be given in exchange for the good. Price measures the scarcity. Prices provide our economy with incentives to use scarce resources efficiently.
$105,000 $38,000 4 Why is the first car more expensive? 1974 Pontiac Trans AM 2009 Pontiac Solstice
Markets 5 A market is a place (including the internet) where buyers and sellers are brought together to trade goods/services What are some examples of markets?
Buyers and Sellers 6 Buyers and sellers in a market can be Households Business firms Government agencies All three can be both buyers and sellers in the same market, but are not always Usually we simplify our examples by saying: In markets for consumer goods, well view business firms as the only sellers, and households as only buyers In most of our discussions, well be leaving out the middleman
Competition in Markets 7 Perfectly competitive markets have many small buyers and sellers, e.g., farmers market, big city hot dog market Each is a small part of the market, and the product is standardized, and each buyer and seller takes the market price as a given Imperfectly competitive markets have just a few large buyers and sellers, e.g., local electricity company The product of each seller is unique in some way, each buyer or seller has some influence over the price.
Using Supply and Demand 8 Supply and demand model is designed to explain how prices are determined in perfectly competitive markets Perfect competition is rare but many markets come reasonably close Perfect competition is a matter of degree rather than an all or nothing characteristic Supply and demand is one of the most versatile and widely used models in the economists tool kit
Demand 9 Demand is the specific amount of a good that all buyers in the market are willing and able to buy Is there demand if I want a $7000 T.V. but only have $300 to spend? Is there demand if I have $5000 to spend on a fence but I dont need a new fence?
Quantity Demanded 10 Implies a choice How much households would like to buy when they take into account the opportunity cost of their decisions? Is hypothetical Makes no assumptions about availability of the good How much would households want to buy, at a specific price, given real-world limits on their spending power? Stresses price Price of the good is one variable among many that influences quantity demanded Well assume that all other influences on demand are held constant, so we can explore the relationship between price and quantity demanded
The Law of Demand 11 States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall (e.g., air travel, magazines, education, etc) The words, everything else remains the same are important In the real world many variables change simultaneously However, in order to understand the economy we must first understand each variable separately Thus we assume that, everything else remains the same, in order to understand how demand reacts to price
The Demand Schedule and The Demand Curve 12 Demand schedule A list showing the quantity of a good that consumers would choose to purchase at different prices, with all other variables held constant The demand curve shows the relationship between the price of a good and the quantity demanded, holding constant all other variables that influence demand Each point on the curve shows the total buyers would choose to buy at a specific price Law of demand tells us that demand curves virtually always slope downward
Demand Schedule for Maple Syrup in U.S.A. 13 Price (per bottle) Quantity Demanded (Bottles per Month) $1.0075, , , , ,000
Figure 1: The Demand Curve 14 Number of Bottles per Month Price per Bottle A B $ D 40,00060,000 At $2.00 per bottle, 60,000 bottles are demanded (point B). When the price is $4.00 per bottle, 40,000 bottles are demanded (point A).
Shifts vs. Movements Along The Demand Curve 15 A change in the price of a good causes a movement along the demand curve A increase in price would cause a movement to the right along the demand curve A decrease in price will cause a movement to the left along the demand curve
Movements Along The Demand Curve 16 Quantity Price P2P2 Q2Q2 Q1Q1 Q3Q3 P1P1 P3P3 Price increase moves us leftward along demand curve Price decrease moves us rightward along demand curve
Shifts vs. Movements Along The Demand Curve 17 Changes such as more income and population growth lead to the line shifting on the graph Example: Demand curve has shifted to the right of the old curve as income has risen A change in any variable that affects demandexcept for the goods pricecauses the demand curve to shift
A Shift of The Demand Curve 18 BC $ ,00080,000 D1D1 D2D2 An increase in income shifts the demand curve for maple syrup from D 1 to D 2. Number of Bottles per Month Price per Bottle At each price, more bottles are demanded after the shift
Dangerous Curves: Change in Quantity Demanded vs. Change in Demand 19 Language is important when discussing demand Quantity demanded means A particular amount that buyers would choose to buy at a specific price It is a number represented by a single point on a demand curve When a change in the price of a good moves us along a demand curve, it is a change in quantity demand The term demand means The entire relationship between price and quantity demanded and represented by the entire demand curve When something other than price changes, causing the entire demand curve to shift, it is a change in demand
Income: Factors That Shift The Demand Curve 20 An increase in income has effect of shifting demand for normal goods to the right However, a rise in income shifts demand for inferior goods to the left Examples: housing, automobiles, health club memberships, etc. A rise in income will increase the demand for a normal good, and decrease the demand for an inferior good (e.g. instant noodles).
Wealth: Factors That Shift The Demand Curve 21 Your wealthat any point in timeis the total value of everything you own minus the total dollar amount you owe An increase in wealth will Increase demand (shift the curve rightward) for a normal good Decrease demand (shift the curve leftward) for an inferior good
Prices of Related Goods: Factors that Shift the Demand Curve 22 Substitutegood that can be used in place of some other good and that fulfills more or less the same purpose, e.g., different types of meat A rise in the price of a substitute increases the demand for a good, shifting the demand curve to the right Complementused together with the good we are interested in, e.g., pancake mix and maple syrup A rise in the price of a complement decreases the demand for a good, shifting the demand curve to the left
Other Factors That Shift the Demand Curve 23 Population As the population increases in an area Number of buyers will ordinarily increase Demand for a good will increase Expected Price An expectation that price will rise (fall) in the future shifts the current demand curve rightward (leftward) Tastes Combination of all the personal factors that go into determining how a buyer feels about a good When tastes change toward a good, demand increases, and the demand curve shifts to the right When tastes change away from a good, demand decreases, and the demand curve shifts to the left
Shifts of The Demand Curve 24 Quantity Price D2D2 D1D1 Entire demand curve shifts rightward when: income or wealth price of substitute price of complement population expected price tastes shift toward good
Shifts of The Demand Curve 25 Quantity Price D1D1 D2D2 Entire demand curve shifts left when: income or wealth price of substitute price of complement population expected price tastes shift toward good
Supply 26 Supply is the amount of a product that a producer/supplier is willing and able to produce If they want to produce it but dont have the factors of production, then they cant produce If they own the factors of production but dont want to produce then they wont…
The Law of Supply 27 States that when the price of a good rises and everything else remains the same, the quantity of the good supplied will rise The words, everything else remains the same are important In the real world many variables change simultaneously However, in order to understand the economy we must first understand each variable separately We assume everything else remains the same in order to understand how supply reacts to price
The Law of Supply 28 Think about it this way… If you raise the price of jeans and people are knocking down the door to purchase them still…are you going to make more or less of them? If you drop the price whats going to happen? Why? This is why we have clearance racks…
The Supply Schedule and The Supply Curve 29 Supply scheduleshows quantities of a good or service firms would choose to produce and sell at different prices, with all other variables held constant Supply curvegraphical depiction of a supply schedule Shows quantity of a good or service supplied at various prices, with all other variables held constant
The Supply Curve 30 F G 2.00 S 40,00060,000 $4.00 At $4.00 per bottle, quantity supplied is 60,000 bottles (point G). When the price is $2.00 per bottle, 40,000 bottles are supplied (point F). Number of Bottles per Month Price per Bottle
Movements Along the Supply Curve 31 A change in the price of a good causes a movement along the supply curve A rise (fall) in price would cause a rightward (leftward) movement along the supply curve
Changes in Supply and in Quantity Supplied 32 P2P2 Q3Q3 Q1Q1 Q2Q2 P1P1 P3P3 Quantity Price Price increase moves us rightward along supply curve S Price decrease moves us leftward along supply curve
Shift in the Supply Curve 33 A drop in transportation costs will cause a shift in the supply curve itself Supply curve has shifted to the right of the old curve as transportation costs have dropped Input prices A fall (rise) in the price of an input causes an increase (decrease) in supply, shifting the supply curve to the right (left) Price of Related Goods When the price of an alternate good rises (falls), the supply curve for the good in question shifts rightward (leftward) Technology Cost-saving technological advances increase the supply of a good, shifting the supply curve to the right
Factors That Shift the Supply Curve 34 Number of Firms An increase (decrease) in the number of sellerswith no other changesshifts the supply curve to the right (left) Expected Price An expectation of a future price increase (decrease) shifts the current supply curve to the left (right)
Factors That Shift the Supply Curve 35 Changes in weather Favorable weather Increases crop yields Causes a rightward shift of the supply curve for that crop Unfavorable weather Destroys crops Shrinks yields Shifts the supply curve leftward Other unfavorable natural events may effect all firms in an area Causing a leftward shift in the supply curve
A Shift of The Supply Curve 36 S2S2 G J S1S1 60,000 $ ,000 A decrease in transportation costs shifts the supply curve for maple syrup from S 1 to S 2. Number of Bottles per Month Price per Bottle At each price, more bottles are supplied after the shift
Changes in Supply and in Quantity Supplied 37 Quantity Price S2S2 S1S1 Entire supply curve shifts rightward when: price of input price of alternate good number of firms expected price technological advance favorable weather
Changes in Supply and in Quantity Supplied 38 Quantity Price S1S1 S2S2 Entire supply curve shifts rightward when: price of input price of alternate good number of firms expected price unfavorable weather
Equilibrium: Putting Supply and Demand Together 39 When a market is in equilibrium Both price of good and quantity bought and sold have settled into a state of rest The equilibrium price and equilibrium quantity are values for price and quantity in the market but, once achieved, will remain constant Unless and until supply curve or demand curve shifts The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes, respectively At point where supply and demand curves cross
Market Equilibrium 40 E H J 1.00 $3.00 D S 50,00075,00025,000 equilibrium price is $3.00. Number of Bottles per Month Price per Bottle
Excess Demand: Putting Supply and Demand Together 41 Excess demand At a given price, the excess of quantity demanded over quantity supplied Price of the good will rise as buyers compete with each other to get more of the good than is available
Market Equilibrium 42 E H J 1.00 $3.00 D S 50,00075,00025,000 Excess Demand 4.until price reaches its equilibrium value of $ causes the price to rise... 3.shrinking the excess demand At a price of $1.00 per bottle an excess demand of 50,000 bottles... Number of Bottles per Month Price per Bottle
Excess Supply: Putting Supply and Demand Together 43 Excess Supply At a given price, the excess of quantity supplied over quantity demanded Price of the good will fall as sellers compete with each other to sell more of the good than buyers want
Excess Supply and Price Adjustment 44 3.shrinking the excess supply... K L E 3.00 D S $ ,00035,00065,000 Excess Supply at $ causes the price to drop, 4.until price reaches its equilibrium value of $3.00. Number of Bottles per Month Price per Bottle 1.At a price of $5.00 per bottle an excess supply of 30,000 bottles...
Income Rises: What Happens When Things Change 45 Income rises, causing an increase in demand Rightward shift in the demand curve causes rightward movement along the supply curve Equilibrium price and equilibrium quantity both rise Shift of one curve causes a movement along the other curve to new equilibrium point
When One Curve Shifts… 46 1.An increase in demand... E F' 3.00 D1D1 D2D2 S $ ,00060,000 3.to a new equilibrium. 5.and equilibrium quantity increases too. 2.moves us along the supply curve... Number of Bottles of Maple Syrup per Period Price per Bottle 4.Equilibrium price increases
An Ice Storm Hits: What Happens When Things Change 47 An ice storm causes a decrease in supply Weather is a shift variable for supply curve Any change that shifts the supply curve leftward in a market will increase the equilibrium price And decrease the equilibrium quantity in that market
Figure 10: A Shift of Supply and A New Equilibrium 48 E' E3.00 D $ ,00035,000 S2S2 S1S1 Number of Bottles Price per Bottle
Both Curves Shift 49 When just one curve shifts (and we know the direction of the shift) we can determine the direction that both equilibrium price and quantity will move When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantitybut not both Direction of the other will depend on which curve shifts by more
Changes in the Market for Handheld PCs 50 1.An increase in supply... 2.and a decrease in demand and quantity decreased as well. A B $400 D 2003 S 2002 S 2003 D 2002 $ Millions of Handheld PCs per Quarter Price per Handhel d PC 4.Price decreased... 3.moved the market to a new equilibrium.
The Three Step Process 51 Key Step 1Characterize the Market Decide which market or markets best suit problem being analyzed and identify decision makers (buyers and sellers) who interact there Key Step 2Find the Equilibrium Describe conditions necessary for equilibrium in the market, and a method for determining that equilibrium Key Step 3What Happens When Things Change Explore how events or government polices change market equilibrium
Using Supply and Demand: The Invasion of Kuwait 52 Why did Iraqs invasion of Kuwait cause the price of oil to rise? Immediately after the invasion, United States led a worldwide embargo on oil from both Iraq and Kuwait A significant decrease in the oil industrys productive capacity caused a shift in the supply curve to the left Price of oil increased
The Market For Oil 53 P2P2 D E' P1P1 E Q2Q2 Q1Q1 S2S2 S1S1 Barrels of Oil Price per Barrel of Oil
Using Supply and Demand: The Invasion of Kuwait 54 Why did the price of natural gas rise as well? Oil is a substitute for natural gas Rise in the price of a substitute increases demand for a good Rise in price of oil caused demand curve for natural gas to shift to the right Thus, the price of natural gas rose
The Market For Natural Gas 55 Cubic Feet of Natural Gas Price per Cubic Foot of Natural Gas P4P4 P3P3 F Q3Q3 Q4Q4 S D2D2 F' D1D1