DEMAND, SUPPLY, AND MARKET EQUILIBRIUM CHAPTER 3 DEMAND, SUPPLY, AND MARKET EQUILIBRIUM Thanks to Dr. Amy Peng Ryerson University ©2007 McGraw-Hill Ryerson Ltd.

Demand A schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices, during a specified period of time ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

An Individual Buyer’s Demand for Corn Graph Price per bushel Quantity demanded per week $5 10 4 20 3 35 2 55 1 80 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Law of Demand All else equal, as price falls, the quantity demanded rises; as price rises, the quantity demanded falls Supported by: diminishing marginal utility income effect substitution effect ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Market Demand + = 22 43 74 115 167 Price QD–1st Buyer QD–2nd Buyer QD–Market $5 10 12 $4 20 23 $3 35 39 $2 55 60 $1 80 87 + = 22 43 74 115 167 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

35 39 74 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand A change in one or more of the determinants of demand will change the demand data, and therefore there is a shift in the demand curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Demand shifters are changes in: Tastes (preferences) Number of Buyers Income Prices of Related Goods Expectations let’s examine these more closely… ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Changes in tastes (preferences) positive change shifts D curve right more will be demanded at each price D′ D PA QA ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Changes in number of buyers: decrease will shift curve left D’ D PA QA ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Changes in money incomes: when income increases demand for NORMAL goods increases demand for INFERIOR goods decreases ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Changes in prices of related goods: when two products are SUBSTITUTES, price of one and demand for the other move in the same direction ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Changes in prices of related goods: when two products are COMPLEMENTS, price of one and demand for the other move in opposite directions ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Demand Changes in prices of related goods: when products are UNRELATED, there is no effect Changes in expectations: about future prices or incomes ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Change in Quantity Demanded when any other determinant of demand changes, there is a shift in the demand curve when price of the product changes, there is a movement along the demand curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Movement Along Demand Curve PA  Movement along the curve P2 P1 Q1 Q2 QA change in price change in quantity demanded ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.1

Supply A schedule or a curve showing the amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices, during a specified period of time ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Figure 3-4 An Individual Producer’s Supply of Corn 5 1 20 2 35 3 50 4 60 $5 Quantity supplied per week Price per bushel This information can be presented in a supply schedule Quantity Supplied ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

An Individual Producer’s Supply of Corn or graphed Price per bushel Quantity supplied per week $5 60 4 50 3 35 2 20 1 5 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Law of Supply All else being equal, as price rises, the quantity supplied rises; as price falls, the quantity supplied falls Why? price is revenue to suppliers higher prices are necessary to induce higher supplies and to cover higher costs of production ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

The Market Supply Curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Determinants of Supply Supply shifters are changes in: Factor Prices (input costs ie. Resources) Technology Taxes and Subsidies Prices of Other Goods Producer Expectations Number of Sellers let’s examine these more closely… ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Changes in Supply Changes in factor prices: decrease will increase supply and shift curve right more will be supplied at each price S′ S PA QA ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Changes in Supply Changes in taxes and subsidies: increases in taxes will reduce supply S′ S PA QA ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Changes in Supply Changes in technology: new technology will decrease costs and increase supply S′ S PA QA ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Changes in Supply Changes in prices of other goods: higher prices of substitutes in production will reduce supply S′ S PA QA ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Changes in Supply Changes in price expectations: of the future price of a product difficult to generalize Changes in number of sellers: as the number of sellers increases, so does supply ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Changes in Quantity Supplied A change in supply is a shift of the entire curve A change in quantity supplied is a movement from one point to another on a fixed supply curve price quantity S Increase in QS NOT supply! Decrease in QS ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.2

Supply and Demand: Market Equilibrium Equilibrium price will be established where the supply decisions of producers and the demand decisions of buyers are mutually consistent Surpluses drive prices down Shortages drive prices up Let’s look at the process of adjustment to equilibrium graphically ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Figure 3-6 Equilibrium Price and Quantity 6000-bushel surplus S $4 is not the equilibrium price D ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Equilibrium Price and Quantity S $2 is not the equilibrium price 7000-bushel shortage D ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Equilibrium Price and Quantity $3 is the equilibrium price S QD=QS D ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Equilibrium Price and Quantity Rationing Function of Prices: combination of freely made individual decisions results in market-clearing price Efficient Allocation: Productive Efficiency Allocative Efficiency ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Changes in Supply, Demand, and Equilibrium Changes in demand or supply will affect the equilibrium price and quantity ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Increase in Demand D2 P D1 S Q p1 q3 q1 An increase in demand will cause: A shortage at the original price p1 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Increase in Demand D2 P D1 S Q Price has increased from p1 to p2; quantity traded has increased from q1 to q2 D2 P D1 S p2 q2 p1 q3 NOT an increase in supply q1 Q Consumers will bid price up to p2 QS will increase, QD will decrease New equilibrium reached at p2, q2 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Decrease in Demand D1 P D2 S Q p1 q3 q1 A decrease in demand will cause: A surplus at the original price p1 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Decrease in Demand D1 P D2 S Q Price has decreased from p1 to p2; quantity traded has decreased from q1 to q2 P D2 S p1 q3 q2 p2 NOT a decrease in supply q1 Q Producers will drop price to p2 QS will decrease, QD will increase New equilibrium will be reached at p2, q2 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Increase in Supply S1 D P S2 Q p1 q3 q1 An increase in supply will cause: A surplus at the original price p1 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Increase in Supply S1 D P S2 Q Price has decreased from p1 to p2; quantity traded has increased from q1 to q2 P S2 p1 q3 q2 p2 q1 Q Producers will drop price to p2 QD will increase, QS will decrease New equilibrium will be reached at p2, q2 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Decrease in Supply S2 D P S1 Q p1 q3 q1 A decrease in supply will cause: A shortage at the original price p1 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Decrease in Supply S2 D P S1 Q Price has increased from p1 to p2; quantity traded has decreased from q1 to q2 D P S1 p2 q2 p1 q3 q1 Q Consumers will bid price up to p2 QS will increase, QD will decrease New equilibrium will be reached at p1, q2 ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Complex Cases When both supply and demand change, the effect is a combination of the individual effects If both demand and supply shift, one of either price or quantity cannot be predicted—the result is indeterminate ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Table 3-3 Complex Cases Change in supply Change in demand Effect on equilibrium price Effect on equilibrium quantity Increase Decrease Indeterminate ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.3

Figure 3-8 A Price Ceiling Results in a Shortage D P S The result of imposing a legal price ceiling is a... P0 SHORTAGE S D Q Qs Qd ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.4

Price Ceilings and Shortages Rationing Problem Black Markets ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.4

Figure 3-9 A Price Floor Results in a Surplus D P S SURPLUS P0 The result of imposing a legal price floor is a... S D Q Qd Q0 Qs ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.4

Price Floors and Surplus Controversial Tradeoffs Additional Consequences ©2007 McGraw-Hill Ryerson Ltd. Chapter 3.4

Chapter Summary Demand Supply Supply and Demand: Market Equilibrium Demand schedule Market Demand Change in demand Supply Supply schedule Market Supply Change in supply Supply and Demand: Market Equilibrium Application: Government-Set Prices (Ceilings and Floors) ©2007 McGraw-Hill Ryerson Ltd. Chapter 3