1. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 0 Supply and Demand: An Introduction

2. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 1 Market Coordination  How do consumers get the goods and services they want in the right quantities and qualities?  Some goods and services are allocated by the market forces of supply and demand  Why do some goods and services have shortages or surpluses and others do not?  Some goods and services are regulated by government

3. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 2 Questions  All economies must answer the following questions:  What should be produced?  How should it be produced?  For whom will it be produced?

4. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 3 Central Planning  Agrarian society  Former Soviet Union  Cuba, North Korea  China  Bureaucracy  A small number of of individuals address these concerns:  Establish production targets for factories and farms  Plan how to achieve the goals  Distribute the goods and services produced

5. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 4 Market Forces  Free market  Capitalist economies  Individuals decide for themselves  Which careers to pursue  Which products to produce or buy  When to start businesses  Who gets what is decided by individual preferences and purchasing power

6. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 5 Markets  A market for any good consists of all buyers and sellers of that good  Includes individuals who either do sell or might sell  Includes individuals who either do buy or might buy

7. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 6 Prices  Why are some goods cheap and others expensive?  Through most of history, individuals had no idea  Most thought that it was because of the cost of production  Others thought only of the value people received from consumption  Answer: both are important

8. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 7 Supply Curve  Shows the total quantity of a good or service that sellers wish to sell at each price  On a graph  In a schedule  Positive relationship  As price rises, a higher quantity can be sold because more opportunity costs can be covered  Application of the “low-hanging fruit principle”  Reflects the rising marginal costs of producing additional units

9. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 8 Fig. 4.1 Daily Supply Curve of Hamburgers in Greenwich Village

10. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 9 Demand Curve  Shows the total quantity of a good or service that buyers wish to buy at each price  On a graph  In a schedule  Negative relationship  As price rises, consumers want fewer items  People switch to substitutes  People cannot afford as much

11. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 10 Fig. 4.2 Daily Demand Curve for Hamburgers

12. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 11 Market Equilibrium  When all buyers and sellers are satisfied with their respective quantities at the market price  There is a stable, balanced, unchanging situation  The supply and demand curves intersect  This results in the equilibrium price  The price the good sells for  This results in the equilibrium quantity  The quantity that will be sold

13. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 12 Fig. 4.3 The Equilibrium Price and Quantity of Hamburgers in Greenwich Village

14. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 13 Disequilibrium  Excess supply  Surplus  Price is higher than equilibrium price  Sellers are dissatisfied  Excess demand  Shortage  Price is lower than equilibrium price  Buyers are dissatisfied

15. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 14 Fig. 4.4 Excess Supply

16. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 15 Fig. 4.5 Excess Demand

17. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 16 Free Markets and Equilibrium  Free markets have an automatic tendency to eliminate excess supply and excess demand  Surplus leads producers to decrease the price  Shortage leads producers to increase the price

18. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 17 Legislation and Markets  Market equilibrium does not mean that everyone has what they want  E.G. a poor person may not be able to afford the item at the equilibrium price  Legislators protect consumers by using  price ceilings  A maximum allowable price specified by law  Price signal is too low, so consumers want too much  e.g. rent controls, limits on the price of gasoline  Result in shortages

19. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 18 Legislation and Markets  Legislators protect producers by using  price floors  A minimum allowable price specified by law  For example, price supports, minimum wage  Price signal is too high, so consumers don’t want as much  Result in surpluses

20. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 19 Fig. 4.6 An Unregulated Housing Market

21. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 20 Fig. 4.7 Rent Controls

22. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 21 Economists and the Poor  Economists realize there are more effective ways of helping the poor than violating the free market system  Using rent controls or price ceilings results in inefficiency for everyone  Using a direct income transfer to the poor is a more efficient way to help

23. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 22 Fig. 4.8 Price Controls in the Hamburger Market

24. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 23 Markets and Social Welfare  Social optimal quantity of a good  The quantity that results in the maximum possible economic surplus  The socially optimal quantity will occur where the marginal cost equals the marginal benefit  Economic efficiency  Occurs when all goods and services are produced and consumed at their respective socially optimal levels

25. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 24 Markets and Efficiency  Efficiency Principle  Efficiency is an important social goal  Everyone can have a larger slice of a larger pie  Equilibrium Principle  A market in equilibrium leaves no unexploited opportunities for individuals  No “cash on the table” remains  All opportunities for profit have been exploited  Efficiency occurs when  the market-demand curve captures all the marginal benefits of the good  the market-supply curve captures all the marginal costs of the good

26. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 25 Terminology  If the good’s price changes, you have a  “change in quantity demanded”  A movement along the demand curve  “change in quantity supplied”  A movement along the supply curve  If something else changes, you have a  “change in demand”  A shift of the entire demand curve  change in supply”  A shift of the entire supply curve

27. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 26 Fig. 4.9 An Increase in the Quantity Demanded Versus an Increase in Demand

28. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 27 Shifts in Supply  Favorable changes to the producer shift supply curve rightward  lower equilibrium price  higher equilibrium quantity  Unfavorable changes to the producer shift supply leftward  higher equilibrium price  lower equilibrium quantity

29. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 28 Fig. 4.10 The Effect on the Skateboard Market of an Increase in the Price of Fiberglass

30. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 29 Shifts in Supply  Changes in the Cost of Production  Changes in Technology  Changes in Weather  Changes in Expectations

31. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 30 Fig. 4.11 The Effect on the Market for New Houses of a Decline in Carpenters’ Wage Rates

32. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 31 Fig. 4.12 The Effect of Technical Change on the Market for Manuscript Revisions

33. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 32 Shifts in Demand  Complements  Substitutes  Income  Preferences  Demand curve shifts rightward  higher equilibrium price  higher equilibrium quantity  Demand curve shifts leftward  lower equilibrium price  lower equilibrium quantity

34. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 33 Fig. 4.13 The Effect on the Market for Tennis Balls of a Decline in Court Rental Fees

35. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 34 Complements  Goods that are more valuable when used in combination--e.g. tennis balls and tennis courts  Two goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other

36. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 35 Substitutes  Goods that replace each other--e.g. email messages and overnight letters  Two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other

37. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 36 Fig. 4.14 Effect on the Market for Overnight Letter Delivery of a Decline in the Price of Internet Access

38. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 37 Income  Normal good  One whose demand curve shifts right when the incomes of buyers increase  Inferior good  One whose demand curves shifts left when the incomes of buyers increase

39. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 38 Fig. 4.15 The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments

40. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 39 Simultaneous Shifts  If, at the same time,  Demand decreases and Supply increases  Demand shifts left  Lower price, lower quantity  Supply shifts right  Lower price, higher quantity  We can predict that price will fall  But, what happens to quantity?  We must know the magnitude of the shifts

41. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 40 Fig. 4.16 Four Rules Governing the Effects of Supply and Demand Shifts

42. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 41 Fig. 4.17 The Effects of Simultaneous Shifts in Supply and Demand

43. Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 4 - 42 Fig. 4.18 Seasonal Variation in the Air Travel and Corn Markets