Demand, Supply, and Market Equilibrium Chapter 3 Demand, Supply, and Market Equilibrium

Markets Markets bring together buyers (demanders) and sellers (suppliers) New York Stock Exchange Chicago Board of Trade

Demand Demand is 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 prices Price is the independent variable Quantity is the dependent variable

Law of Demand There is an inverse relationship between price and quantity demanded. Common sense – people buy more at low prices Law of Diminishing Marginal Utility – people need a lower price to entice them to buy more Income Effect – lower price increases purchasing power Substitution Effect – the lower price will entice some to switch from more expensive substitute goods

The Demand Curve Graph Market demand is the sum of all the individual demand schedules in a market.

Change in Demand A change in demand results in a shift of the demand curve. An increase in demand causes the demand curve to shift to the right while a decrease in demand will result in a shift to the left of the demand curve. Note – A change in price causes a change in quantity demanded and does not cause a shift

Determinants of Demand A change in a determinant will cause the demand curve to shift. 1. Tastes and Preferences Technology Medical research Advertising Fads

2. Number of Buyers Globalization Baby Boomers

3. Income Normal Goods (also called superior goods) – people buy more of these goods as their incomes increase Inferior Goods – As incomes increase, consumers buy less of these goods

4. Prices of Related Goods Substitutes – goods that can be used in place of each other An increase in the price of a good will increase the demand for a substitute good

Complementary Goods – goods that are used in conjunction with one another An increase in the price of one good will result in a decrease in demand for it’s complement hhhhhh

5. Consumer Expectations Expectations of higher prices in the future leads to an increase in current demand Real Estate speculation

Supply Supply is a schedule or curve showing the various amounts of a product that producers are willing and able to make available for sale at a series of prices Law of Supply – There is a direct relationship between price and quantity supplied. Thus, the supply curve is up sloping.

As with demand, a change in a determinant will cause the supply curve to shift. Anything that results in a decrease in production costs will cause supply to increase (shift to the right). Anything that results in an increase in production costs will cause supply to decrease (shift to the left) A change in price changes quantity supplied and causes movement on the supply curve.

Determinants of Supply 1. Resource Prices 2. Technology 3. Taxes and Subsidies (payments to produce) 4. Prices of other goods – substitution in production 5. Producer expectations 6. The number of sellers in the market

Market Equilibrium Also known as the market clearing price Quantity demanded = quantity supplied The intersection of demand and supply Graph

The Rationing Function of Prices helps to eliminate shortages (excess demand) and surpluses (excess supply) Graph

Efficient Use of Resources Competitive Markets result in an efficient use of societies resources Productive Efficiency – least cost production Allocative Production – producing the mix of goods and services most desired by society

Changes in Supply, Demand, and Equilibrium Shifts in Demand or Supply – memorize these graphs! D  PQ D  PQ S  PQ S  PQ

Shifts in Both Demand and Supply Hint – When both demand and supply shift, the resulting change in either price or quantity will be indeterminate DS  P?Q DS  P?Q DS  PQ? DS  PQ?

Government Set Prices Price Ceilings – An effective price ceiling is set below equilibrium price. Graph Historic Example – Rent Control Results – Shortages, Black Markets

Price Floors – An effective price floor is set above equilibrium price Graph Historic Example – Agriculture Result – Surplus, Government Purchase of Surplus