1. Demand and Supply

2. The Power of Trade Voluntary versus involuntary exchange
An intuitive approach to gains in trade
Using an economic model to demonstrate the gains from trade

3. Voluntary Exchange
All parties to a voluntary exchange must be made better off
Allow for specialization and division of labor
Increase interdependence
Promote cooperation rather than conflict

4. An intuitive Approach to Gains From Trade
Self-sufficiency
Pros: independence
Cons: loss of efficiency, variety in consumption and production
Trade with Yakima?
Trade with other states?
Trade with other nations?

5. History of Trade Tribal to feudal times
Adam Smith (1776) and David Ricardo (1817)
The costs of not trading (e.g. lamb example)
Distribution impacts: consumers win but some producers and workers lose
The cost of protectionism

6. Markets: The power of Demand and Supply
Competitive Markets
identical or homogeneous goods
many sellers and buyers
perfect Information
free entry and exit
Non-Competitive Markets
Monopoly – one seller
Oligopoly – few sellers
Monopolistically Competitive – differentiated products

7. Demand The demand curve Price and the quantity demanded
Rational behavior
Utility maximization MB=MC
Boxes example
Law of Demand – as the price of a product falls, ceteris paribus (all other things equal), the quantity demanded of the good will rise
Law of Diminishing Marginal Utility – Jelly bean example
Income and substitution effects
Substitution effect – consumers will substitute the now relatively cheaper good for other now relatively more expensive goods
Income effect – a decrease in any price, ceteris paribus, increases the purchasing power of the consumer’s income leading. Therefore, consumer will purchase more of a normal good.

8. Demand schedule – is a table of the various prices and the quantities that a consumer will demand at those prices.
Individual demand curve – is a graph relating price and quantity demanded for a consumer.
Market demand curve – is a graph reflecting the sum of individual consumer demands in a market.

9. Catherine’s Demand Schedule17

10. Figure 1 Catherine’s Demand Schedule and Demand Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price
...
2.00
1.50
1.00
0.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of 2.
...
increases quantity
of cones demanded.
Ice-Cream Cones
Copyright © South-Western

11. The demand function – lists all of the determinants of demand and includes:
Price of the Good - law of demand
Price of related goods
Complements – as the Pc goes up QD of the good goes down
Substitutes - as the Ps goes up QD of the good goes up
Income – normal vs. inferior goods
Number of Buyers
Tastes
Expectations – future prices, shortages, other conditions
QD =F ( P(-), PR (Pc(-), Ps(+)) ,I (normal (+), inferior(-)), N(+), T(+), E)

12. Movement along and shifts of the demand curve
Movement – only change in the price of the good
Shifts – changes in any determinant but the prices of the good
Curve versus function
Schedules
Graphs

13. Figure 3 Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand
curve, D 2
Demand
curve, D 1
Demand curve, D 3
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

14. Supply Price and the quantity supplied Supply schedule
Rational behavior an the profit motive
Law of diminishing returns
Supply schedule
Individual supply curve
Market supply curve

15. Ben’s Supply Schedule 29

16. Figure 5 Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
2.50
1. An
increase
in price
...
2.00
1.50
1.00
0.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream Cones 2.
...
increases quantity of cones supplied.
Copyright©2003 Southwestern/Thomson Learning

17. The supply function QS =F ( P, I, N, E, T) Price of the Good
Input prices
technology
number of sellers
expectations
QS =F ( P, I, N, E, T)

18. Figure 7 Shifts in the Supply Curve
Price of
Supply curve, S 3
Ice-Cream
curve,
Supply S 1
Cone
Supply
curve, S 2
Decrease
in supply
Increase
in supply
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

19. Market Equilibrium
Equilibrium price and quantity = market clearing price and quantity
Disequilibrium prices and quantities
Shortage
Surplus
Comparative static analysis: changes in equilibrium prices and quantities
Shifts in curves versus movement along revisited
Changes in demand and supply

20. Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

21. Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Supply
Cone
Surplus
Demand
$2.50 10 4
2.00 7
Quantity of
Quantity
demanded
Quantity
supplied
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

22. Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

23. Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Supply
Cone
Surplus
Demand
$2.50 10 4
2.00 7
Quantity of
Quantity
demanded
Quantity
supplied
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

24. Figure 9 Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Supply
Cone
Demand
$2.00 7
1.50 10 4
Shortage
Quantity of
Quantity
supplied
Quantity
demanded
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

25. Figure 10 How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
1. Hot weather increases
the demand for ice cream . . .
Cone D D
Supply
New equilibrium
$2.50 10
resulting
in a higher
price . . .
2.00 7
Initial
equilibrium
Quantity of 3.
. . .
and a higher
quantity sold.
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

26. Figure 11 How a Decrease in Supply Affects the Equilibrium
Price of
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
Ice-Cream
Cone S2 S1
Demand
New
equilibrium
$2.50 4
resulting
in a higher
price of ice
cream . . .
Initial equilibrium
2.00 7
Quantity of 3.
. . .
and a lower
quantity sold.
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

27. The Invisible Hand Economic Agents are motivated by self-interest
consumers by utility maximization
Producers by profit maximization
Market prices as signals for resource allocation and coordinate consumer and producer behavior
Market or the Price System and Efficiency

28. Demand and Supply Applications
Market for Water
Market for Gas
Shortages and Surplus
Price Controls
Price ceilings
Price floors