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CHAPTER 2 Market Forces: Demand and Supply Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior.

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Presentation on theme: "CHAPTER 2 Market Forces: Demand and Supply Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior."— Presentation transcript:

1 CHAPTER 2 Market Forces: Demand and Supply Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2 Chapter Outline Demand – Factors that change quantity demanded and factors that change demand – The demand function – Consumer surplus Supply – Factors that change quantity supplied and factors that change supply – The supply function – Producer surplus Market equilibrium Price restrictions and market equilibrium – Price ceilings – Price floors Comparative statics – Changes in demand – Changes in supply – Simultaneous shifts in supply and demand 2-2 Chapter Overview

3 Market demand curve – Illustrates the relationship between the total quantity and price per unit of a good all consumers are willing and able to purchase, holding other variables constant. Law of demand – The quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises). 2-3 Demand

4 Market Demand Curve 2-4 Quantity (thousands per year) Price ($) Demand $40 0 $30 $ $ Demand

5 Changing only price leads to changes in quantity demanded. – This type of change is graphically represented by a movement along a given demand curve, holding other factors that impact demand constant. Changing factors other than price lead to changes in demand. – These types of changes are graphically represented by a shift of the entire demand curve. 2-5 Demand Changes in Quantity Demanded

6 Changes in Demand 2-6 Quantity 0 Price D1D1 Increase in demand Demand A B D0D0 D2D2 Decrease in demand

7 Demand Shifters Income – Normal good – Inferior good Prices of related goods – Substitute goods – Complement goods Advertising and consumer tastes – Informative advertising – Persuasive advertising Population Consumer expectations Other factors 2-7 Demand

8 Advertising and the Demand for Clothing 2-8 Quantity of high-style clothing 0 $50 $40 50,000 Price of high-style clothing D2D2 60,000 Due to an increase in advertising Demand D1D1

9 The demand function for good X is a mathematical representation describing how many units will be purchased at different prices for good X, different prices of a related good Y, different levels of income, and other factors that affect the demand for good X. 2-9 Demand The Demand Function

10 2-10 Demand The Linear Demand Function

11 2-11 Demand Understanding the Linear Demand Function

12 2-12 Demand The Linear Demand Function in Action

13 Inverse Demand Function 2-13 Demand

14 Graphing the Inverse Demand Function in Action 2-14 Quantity Price $2, ,060 Demand

15 Marketing strategies – like value pricing and price discrimination – rely on understanding consumer value for products. – Total consumer value is the sum of the maximum amount a consumer is willing to pay at different quantities. – Total expenditure is the per-unit market price times the number of units consumed. – Consumer surplus is the extra value that consumers derive from a good but do not pay for Consumer Surplus Demand

16 Quantity in liters Price per liter Demand $5 0 $3 $2 1 2 $ Total Consumer Value: 0.5($5 - $3)x2+(3-0)(2-0) = $8 Expenditures: $(3-0) x (2-0) = $6 Consumer Surplus: 0.5($5 - $3)x(2-0) = $2 Demand Market Demand and Consumer Surplus in Action $4 3 Consumer Surplus

17 Market supply curve – Summarizes the relationship between the total quantity all producers are willing and able to produce at alternative prices, holding other factors affecting supply constant. Law of supply – As the price of a good rises (falls), the quantity supplied of the good rises (falls), holding other factors affecting supply constant Supply

18 Changing only price leads to changes in quantity supplied. – This type of change is graphically represented by a movement along a given supply curve, holding other factors that impact supply constant. Changing factors other than price lead to changes in supply. – These types of changes are graphically represented by a shift of the entire supply curve Supply Changes in Quantity Supplied

19 2-19 Change in Supply in Action Quantity Price S2S2 0 Decrease in supply Supply A B S0S0 S1S1 Increase in supply

20 Input prices Technology or government regulation Number of firms – Entry – Exit Substitutes in production Taxes – Excise tax (Levied on each unite of output sold) – Ad valorem tax (percentage tax: sales tax) Producer expectations 2-20 Supply Supply Shifters

21 2-21 Change in Supply in Action Quantity of gasoline per week Price of gasoline 0 t = per unit tax of 20¢ Supply S0S0 S 0 +t t = 20¢ $1.20 $1.00 t Excise tax

22 2-22 Change in Supply in Action Quantity of backpacks per week Price of backpacks 0 Supply S0S0 S 1 = 1.20 x S 0 $24 $10 Ad valorem tax $12 1,100 $20 2,450

23 The Supply Function The supply function for good X is a mathematical representation describing how many units will be produced at different prices for X, different prices of inputs W, prices of technologically related goods, and other factors that affect the supply for good X Supply

24 The Linear Supply Function 2-24 Supply

25 2-25 Supply Understanding the Linear Supply Function

26 2-26 Supply The Linear Supply Function in Action

27 Inverse Supply Function 2-27 Supply

28 The amount producers receive in excess of the amount necessary to induce them to produce the good Supply Producer Surplus

29 2-29 Producer Surplus in Action Quantity Price Supply $ Supply Producer surplus

30 Competitive market equilibrium – Price of a good is determined by the interactions of the market demand and market supply for the good. – A price and quantity such that there is no shortage or surplus in the market. – Forces that drive market demand and market supply are balanced, and there is no pressure on prices or quantities to change Market Equilibrium

31 2-31 Quantity Price Supply 0 Demand Surplus Shortage Market Equilibrium Market Equilibrium I

32 2-32 Market Equilibrium II Market Equilibrium

33 In a competitive market equilibrium, price and quantity freely adjust to the forces of demand and supply. Sometimes the government restricts how much prices are permitted to rise or fall. – Price ceiling (rental control for tenants) – New York City’s rent control program, which began in 1943, is among the oldest in the country – Price floor (minimum wage) – 7.25 dollar/hour in TX (Jan. 1 st 2014) 2-33 Price Restrictions and Market Equilibrium Price Restrictions

34 2-34 Quantity Price Supply 0 Demand Shortage Price ceiling Nonpecuniary price Lost social welfare Price Restrictions and Market Equilibrium Price Ceiling in Action I

35 2-35 Price Restrictions and Market Equilibrium Price Ceiling in Action II

36 2-36 Quantity Price Supply 0 Demand Surplus Price floor Price Restrictions and Market Equilibrium Price Floor in Action I Cost of purchasing excess supply

37 2-37 Price Restrictions and Market Equilibrium Price Floor in Action II

38 Comparative static analysis – The study of the movement from one equilibrium to another. Competitive markets, operating free of price restraints, will be analyzed when: – Demand changes; – Supply changes; – Demand and supply simultaneously change Comparative Statics

39 Increase in demand only – Increase equilibrium price – Increase equilibrium quantity Decrease in demand only – Decrease equilibrium price – Decrease equilibrium quantity Example of change in demand – Suppose that consumer incomes are projected to increase 2.5% and the number of individuals over 25 years of age will reach an all time high by the end of next year. What is the impact on the rental car market? 2-39 Changes in Demand Comparative Statics

40 2-40 Change in Demand in Action Quantity (thousands rented per day) Price Supply 0 $ Demand for Rental Cars Demand 1 $49 Demand Comparative Statics 108

41 Increase in supply only – Decrease equilibrium price – Increase equilibrium quantity Decrease in supply only – Increase equilibrium price – Decrease equilibrium quantity Example of change in supply – Suppose that a bill before Congress would require all employers to provide health care to their workers. What is the impact on retail markets? 2-41 Changes in Supply Comparative Statics

42 2-42 Quantity Price Supply 0 0 Demand Supply 1 Comparative Statics Change in Supply in Action

43 Suppose that simultaneously the following events occur: – an earthquake hit Kobe, Japan and decreased the supply of fermented rice used to make sake wine. – the stress caused by the earthquake led many to increase their demand for sake, and other alcoholic beverages. What is the combined impact on Japan’s sake market? 2-43 Comparative Statics Simultaneous Shifts in Supply and Demand

44 2-44 Quantity Price Supply 0 0 Demand 1 Supply 1 Demand 0 Comparative Statics Simultaneous Shifts in Supply and Demand in Action Japan’s Sake Market Supply 2 A B C

45 Demand and supply analysis is useful for – Clarifying the “big picture” (the general impact of a current event on equilibrium prices and quantities). – Organizing an action plan (needed changes in production, inventories, raw materials, human resources, marketing plans, etc.) Conclusion

46 Market Demand Curve 2-46 Quantity (Millions of Barrels) Price (Dollars per Barrel) Demand oil $140 0 $100 $ $ International Oil Market Demand

47 Changes in Quantity Demanded 2-47 International Oil Market Quantity (Millions of Barrels) Demand oil $140 0 $100 $ Price (Dollars per Barrel) Increase in quantity demanded Demand

48 Change in Demand 2-48 International Oil Market Quantity (Millions of Barrels) Demand oil1 $140 0 $100 $ Price (Dollars per Barrel) Demand oil Increase in demand $160 Demand

49 2-49 Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil 0 $65 $ $20 International Oil Market Increase in quantity supplied Supply Change in Quantity Supplied

50 2-50 Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil $140 0 $100 $ $ International Oil Market Supply The Market Supply Curve

51 2-51 Change in Supply in Action Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil1 $140 0 $ $ International Oil Market Supply oil $50 Decrease in supply Supply

52 2-52 Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil $140 0 $120 $40 40 Q e = 120 $ International Oil Market Demand oil Surplus 160 million barrels Forces of demand and supply put downward pressure on price. Shortage 160 million barrels Forces of demand and supply put upward pressure on price. P e = $80 Competitive market equilibrium Q d (P e ) = Q s (P e ) Market Equilibrium Competitive Market Equilibrium I

53 2-53 Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil $140 0 P f = $120 P c = $40 40 Q e = 120 $ International Oil Market Demand oil Shortage 160 million barrels P e = $80 Competitive market equilibrium Q d (P e ) = Q s (P e ) Price ceiling Nonpecuniary price Lost social welfare Price Restrictions and Market Equilibrium Price Ceiling in Action I

54 Increase in demand only – Increase equilibrium price – Increase equilibrium quantity Decrease in demand only – Decrease equilibrium price – Decrease equilibrium quantity Example of change in demand – Suppose that worldwide demand for automobiles is projected to decrease by 30% next year. What is the impact on the international crude oil market? 2-54 Changes in Demand Comparative Statics

55 2-55 Change in Demand in Action Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil $140 0 P e2 = $54 Q e1 = 120 $ International Oil Market Demand oil1 P e1 = $80 Demand oil2 Q e2 = 68 Comparative Statics

56 Increase in supply only – Decrease equilibrium price – Increase equilibrium quantity Decrease in supply only – Increase equilibrium price – Decrease equilibrium quantity Example of change in supply – Suppose that war breaks out in a major oil- producing country in the Middle East. What is the impact on the international crude oil market? 2-56 Changes in Supply Comparative Statics

57 2-57 Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil1 $140 0 Q e1 = 120 $ International Oil Market Demand oil P e1 = $80 Supply oil2 P e2 = $100 Q e2 = 80 Comparative Statics Change in Supply in Action

58 Suppose that simultaneously the following two events occur: – worldwide demand for automobiles is projected to decrease by 30% next year. – war breaks out in a major oil-producing country in the Middle East. What is the combined impact on the international crude oil market? 2-58 Comparative Statics Simultaneous Shifts in Supply and Demand

59 2-59 Quantity (Millions of Barrels) Price (Dollars per Barrel) Supply oil1 $140 P e2 = $65 Q e2 = 10 Q e1 = 120 $ International Oil Market Demand oil1 P e1 = $80 Supply oil2 Demand oil2 The equilibrium price increases or decreases depending on the magnitude of the demand and supply changes. Comparative Statics Simultaneous Shifts in Supply and Demand in Action


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