Chapter 3 Supply and Demand

Chapter Objectives Define and explain demand in a product or service market Define and explain supply Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels

Chapter Objectives Understand what causes shifts in demand and supply Understand how price ceilings cause shortages Understand how price floors cause surpluses

The schedule of quantities of a good or service that people are willing and able to buy at different prices –Sometimes a schedule is also called a table Demand

Table 1 Price QD $500 1, , , , , , , , ,000 Figure 1 Price and Quantity Demanded are inversely related Quantity Demanded is a point on the Demand Curve

Supply Is the schedule of quantities of a good or service that people are willing to sell at different prices

Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 Quantity Supplied is a point on the curve

Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price is the price where QD = QS We can find equilibrium price and quantity by seeing where the supply and demand curves cross

Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP MP > EP there is a surplus Surpluses and Shortages 54,000-7,000 = 47,000

Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP Surpluses and Shortages 54,000-7,000 = 44,000 A surplus would force sellers to lower their prices. Eventually, prices would fall back to the equilibrium price

Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP Surpluses and Shortages 57,000-7,000 = 50,000 MP < EP here is a shortage

Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP Surpluses and Shortages 57,000-7,000 = 50,000 A shortage would allow sellers to raise their prices. As prices increased people would buy less. Eventually, prices would move back to the equilibrium price

Table 4 Price QD 1 QD 2 $500 1,000 12, ,000 15, ,000 21, ,000 30, ,000 40, ,000 55, ,000 63, ,000 75, ,000 88,000 The schedule changes from QD 2 to QD 1 The demand curve shifts to the left from D 2 to D 1 This is a decrease in demand

Price Quantity (in thousands) S D Shifts in Supply and Demand If the schedule changes the Supply curve shifts Supply decreases... the curve shifts to the left S

Price Quantity (in thousands) S1S1 D Shifts in Supply and Demand If the Supply curve is S 1 what is the equilibrium price and quantity? The equilibrium price is approximately 262 or 263 S2S2 The equilibrium quantity is approximately 35,000

Price Quantity (in thousands) S1S1 D Shifts in Supply and Demand If the Supply curve changes to S 2 what is the new equilibrium price and quantity? The new equilibrium price is approximately 325 S2S2 The new equilibrium quantity is approximately 26,000

Price Quantity (in thousands) S1S1 D Shifts in Supply and Demand Is a shift from S 1 to S 2 an increase or decrease in Supply? A decrease S2S2

Price Floors and Ceilings The price can go no lower than the floor. A price floor creates a permanent surplus The surplus is the amount by which the quantity supplied is greater than the quantity demanded

Price Floors and Ceilings The price can go no higher than the ceiling. A price ceiling creates a permanent shortage The shortage is the amount by which the quantity demanded is greater than the quantity supplied

Applications of Supply and Demand Interest rates are set by –Supply and demand Wage rates are set by –Supply and demand Rents are determined by –Supply and demand The prices of nearly all goods are determined by –Supply and demand The prices of nearly all services are determined by –Supply and demand

Hypothetical Demand for and Supply of Loanable Funds We can see that $600 billion is lent (or borrowed) at an interest rate of 6 percent What would happen if the supply of loanable funds increased?

Hypothetical Demand for and Supply of Loanable Funds The interest rate would decrease to 4 percent and the amount of money borrowed would increase to $800 billion

Hypothetical Demand for and Supply of Loanable Funds If the demand for loanable funds rises to D 2 the interest rate would rise to 9 percent and the amount of money borrowed would rise to $700 billion

Last Word Government sometimes interferes with the free operation of the markets by –Imposing prices floors and price ceilings –This creates the problems of shortages and surpluses The government may also ensure the smooth operation of the markets by protecting property rights, guaranteeing enforcement of legal contracts, and issuing a supply of money that buyers and sellers readily accept –Property rights are essential to a free and prosperous nation While governmental interference with the market system can have adverse affects, the government does have a substantial supportive role to play in a market economy.