Chapter 2 Supply and Demand

Chapter Outline Contents Supply and Demand Curves Equilibrium Quantity and Price Adjustment to Equilibrium Some Welfare Properties of Equilibrium Free Markets and The Poor Price Supports The Rationing and Allocative Function of Prices Determinants of Supply and Demand Predicting and Explaining Changes in Price and Quantity The Algebra of Supply and Demand 2-2

Supply and Demand Curves A Market: consists of the buyers and sellers of a good or service. Law of Demand: the empirical observation that when the price of a product falls, people demand larger quantities of it. Law of Supply: the empirical observation that when the price of a product rises , firms offer more of it for sale. The Demand and Supply Curves for Lobsters in Hyannis, MA., July 20, 2011 2-3

Equilibrium in the Lobster Market Equilibrium Quantity and Price Equilibrium quantity and price: it is the price-quantity pair at which both buyers and sellers are satisfied. 2-4

Excess Supply and Excess Demand Excess supply: the amount by which quantity supplied exceeds quantity demanded. Excess demand: the amount by which quantity demanded exceeds quantity supplied. 2-5

An Opportunity for Improvement in the Lobster Market Some Welfare Properties of Equilibrium If price and quantity take anything other than their equilibrium values, however, it will always be possible to reallocate so as to make at least some people better off without harming others. An Opportunity for Improvement in the Lobster Market 2-6

Rent Controls Rent Controls A price ceiling for rents is a level beyond which rents are not permitted to rise. The price ceiling creates an excess demand of 40,000 units =(80,000 – 40,000) units. 2-7

A Price Support in the Soybean Market Price Supports A price support (or price floor) keep prices above their equilibrium levels. Require the government to become an active buyer in the market. Purpose of farm price supports is to ensure prices high enough to provide adequate incomes for “family farmers.” 2-8

Factors that Shift Demand Curves Factors the Shift the Demand Curve (SHIFT FACTORS) Incomes Normal goods - the quantity demanded at any price rises with income. Inferior goods - the quantity demanded at any price falls with income. Tastes Price of Substitutes and Complements Complements - an increase in the price of one good decreases demand for the other good. Substitutes - an increase in the price of one will tend to increase the demand for the other. Expectations Populations NON_SHIFT FACTOR Price 2-9

Factors that Shift Supply Schedules Factors the Shift the Supply Curve (SHIFT FACTORS) Technology Factor Prices The Number of Suppliers Expectations Weather NON_SHIFT FACTOR Price Factors that Shift Supply Schedules 2-10

Two Sources of Seasonal Variation S= Summer, W =winter Case 1: An increase in supply → a decrease in the equilibrium price and an increase in the equilibrium quantity. Case 2:An increase in demand → an increase in both the equilibrium price and quantity. 2-11

The Effect of Soybean Price Increase on the Equilibrium Price and Quantity of Beef Case III: A decrease in supply → an increase in the equilibrium price and a decrease in the equilibrium quantity. Case IV: A decrease in demand → a decrease in both the equilibrium price and quantity [not shown] 2-12

Graphs of Equations 2.1 and 2.2 2.1: Supply function: P = 2+ 3Qs 2.2: Demand function: P =10 – Qd Let Q* = Qd = Qs Then 2 + 3Q* = 10 – Q* 4Q* =10-2=8 Q* =8/2 = 2 Plug Q* into either demand or supply function. We choose the supply function, so P* = 2+ 3*2 = 8 2-13

A Tax of T=10 Levied on the Seller Shifts the Supply Schedule Upward by T Units Note: A Tax (T) is a shift factor on the S curve. 2-14

Equilibrium Prices and Quantities When a Tax of T = 10 is Levied on the Seller 2-15

The Effect of a Tax of T = 10 Levied on the Buyer Note: A Tax (T) is a shift factor on the D curve. 2-16

Equilibrium Prices and Quantities after Imposition of a Tax of a Tax of T = 10 Paid by the Buyer 2-17

A Tax on the Buyer Leads to the Same Outcome as a Tax on the Seller Assume T =$2 is on the seller Given: p=Qs; P=10-Qd Set Q =10-Q and assume that at equilibrium, Qs=Qd. Thus, 2Qs =10 or Qs=Qd=Q*=5 So P=10-5=$5 Pbuyer =$5+$1=$6; Pseller=$5-$1=$4 Assume T =$2 is on the buyer Given: p=Qs; P=10-Qd Set Q =10-Q and assume that at equilibrium, Qs=Qd. Thus, 2Qs =10 or Qs=Qd=Q*=5 So P=10-5=$5 Pbuyer =$5+$1=$6; Pseller=$5-$1=$4 Summary: It doesn’t matter whether the tax is on buyers or sellers, the result is the same on Pbuyers and Psellers. 2-18

Worked out Problem Problem: Consider a market whose supply and demand curves are given by P= 4Qs and P= 12 - 2Qd respectively. How will the equilibrium price and quantity in this market be affected if a tax of 6 per unit of output is imposed on sellers? If the same is imposed on buyers? Answer: The original price and quantity are given by P*= 8 and Q* = 2 respectively. The supply curve with the tax is given by P = 6+4Qs. Letting P’ and Q’ denote the new equilibrium values of price and quantity, we now have 6 +4Q’ =12 - 2Q’ which yields Q’=1, P’ =10, where P’ is the price paid by buyers and P’-6=4 is the price received by sellers. Alternatively, the demand curve with a tax of 6 levied on buyers is given by P=12 - 6 -2Qd = 6 - 2Qd, and we have 4Q’ =6’ – 2Q’ which yields Q’=1 and P”=4 where P” is the price received by sellers. That is, P”+T = P” + 6 = 10 is the price paid by buyers.

Worked Problem Question: Suppose demand for seats at football games is P = 1900 – (1/50)Q and supply is fixed at Q =90,000 seats. Find the equilibrium price and quantity of seats for a football game (using algebra and a graph). Suppose the government prohibits ticket scalping (selling tickets above their face value), and the face value of tickets is $50 (this policy places a pricing ceiling at $50). How many consumers will be dissatisfied (how large is excess demand)? Suppose the next game is a major rivalry, so demand jumps to P = 2100 – (1/50)Q. How many consumers will be dissatisfied with this game? How do distortions of this price ceiling differ from the more typical case of upward-sloping supply? Answer: a) The equilibrium quantity is Q = 90,000 seats and the equilibrium price is P = 1900 – (1/50)(90,000) = 1900 – 1800 = $100. b) At a price ceiling of P = $50, quantity demanded is found by solving 50 = 1900 – (1/50)Q for Q = 92,500 seats. Since the stadium only holds Q = 90,000 seats, there will be 92,500 – 90,000 = 2,500 dissatisfied fans who want to buy a ticket at P = $50 but cannot find one available. c) Quantity demanded for the higher demand is found by solving 50 = 2100 – (1/50)Q for Q = 102,500 seats. Now there will be 102,500 – 90,000 = 12,500 dissatisfied fans who want to buy a ticket at P = $50 but cannot find one available. The excess demand is12,500 – 2,500 = 10,000 seats more than for the not so big game. d) Normally a price ceiling both raises quantity demanded and lowers quantity supplied. Here, only the first effect is present because the stadium capacity is fixed. S $300 D’ D $100 $50 102.5 90 92.5 105