Unit 2 Supply/Demand, Market Structures, Market Failures Chapters 3, 18, 21, 22, 23, and 28

MARKETS AND COMPETITION A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets. 4

MARKETS AND COMPETITION Buyers determine demand. Sellers determine supply 4

DEMAND Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand The law of demand states that, other things equal (ceteris paribus), the quantity demanded of a good falls when the price of the good rises. Substitution Effect Consumers have an incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive Income Effect Lower price raises real income, enabling buyers to buy more of the product 8

The Demand Curve: The Relationship between Price and Quantity Demanded Demand Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. 17

Catherine’s Demand Schedule 17

The Demand Curve: The Relationship between Price and Quantity Demanded The demand curve is a graph of the relationship between the price of a good and the quantity demanded. 17

Catherine’s Demand Schedule and Demand Curve Price of Ice-Cream Cone $3.00 2.50 1. A decrease in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of 2. ... increases quantity of cones demanded. Ice-Cream Cones Copyright © 2004 South-Western

Market Demand versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

Shifts in the Demand Curve Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of the product. 19

Changes in Quantity Demanded Price of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. B $2.00 A 1.00 D 4 8 Quantity of Ice-Cream Cones

Shifts in the Demand Curve Change in Demand A shift in the demand curve, either to the left or right. Caused by any change that alters the quantity demanded at every price. 19

Shifts in the Demand Curve Number of consumers Income of consumers Complement price change Expectations Substitute price change Tastes 11

Shifts in the Demand Curve Price of Ice-Cream Cone Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Shifts and Changes in Demand cont. A closer look at changes in income Normal Good A good that consumers demand more when their incomes increase Inferior Good demand less when their

Consumer Income Normal Good Price of Hamburgers $3.00 An increase in income... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Hamburgers 1 2 3 4 5 6 7 8 9 10 11 12

Consumer Income Inferior Good Price of Spam $3.00 2.50 An increase in income... 2.00 Decrease in demand 1.50 1.00 0.50 D1 Quantity of Spam 1 2 3 4 5 6 7 8 9 10 11 12

SUPPLY Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of Supply The law of supply states that, other things equal (ceteris paribus), the quantity supplied of a good rises when the price of the good rises. 25

The Supply Curve: The Relationship between Price and Quantity Supplied Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. 29

Ben’s Supply Schedule Supplied 29

The Supply Curve: The Relationship between Price and Quantity Supplied The supply curve is the graph of the relationship between the price of a good and the quantity supplied. 29

Ben’s Supply Schedule and Supply Curve Price of Ice-Cream Cone $3.00 2.50 1. An increase in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones 2. ... increases quantity of cones supplied. Copyright©2003 Southwestern/Thomson Learning

Market Supply versus Individual Supply Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

Shifts in the Supply Curve Change in Quantity Supplied Movement along the supply curve. Caused by a change in the price of the product. 30

Change in Quantity Supplied Price of Ice-Cream Cone S C $3.00 A rise in the price of ice cream cones results in a movement along the supply curve. A 1.00 Quantity of Ice-Cream Cones 1 5 30

Shifts in the Supply Curve Change in Supply A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than price. 30

Shifts in the Supply Curve Resource prices Expectations Number of producers Technology changes Government action (taxes, subsidies, and regulations) Other goods prices 27

Shifts in the Supply Curve Price of Supply curve, S 3 Ice-Cream curve, Supply S 1 Cone Supply curve, S 2 Decrease in supply Increase in supply Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

SUPPLY AND DEMAND TOGETHER Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. Equilibrium Price and Quantity On the graph, it is where supply and demand intersect 36

SUPPLY AND DEMAND TOGETHER Demand Schedule Supply Schedule At $2.00, the quantity demanded is equal to the quantity supplied! 36

The Equilibrium of Supply and Demand Price of Ice-Cream Cone Supply Demand Equilibrium Equilibrium price $2.00 Equilibrium quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Equilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

Markets Not in Equilibrium (a) Excess Supply Price of Ice-Cream Supply Cone Surplus Demand $2.50 10 4 2.00 7 Quantity of Quantity demanded Quantity supplied Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Equilibrium Shortage When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cone Demand $2.00 7 1.50 10 4 Shortage Quantity of Quantity supplied Quantity demanded Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Law of supply and demand Equilibrium Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

How an Increase in Demand Affects the Equilibrium Price of Ice-Cream 1. Hot weather increases the demand for ice cream . . . Cone D D Supply New equilibrium $2.50 10 2. . . . resulting in a higher price . . . 2.00 7 Initial equilibrium Quantity of 3. . . . and a higher quantity sold. Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

How a Decrease in Supply Affects the Equilibrium Price of 1. An increase in the price of sugar reduces the supply of ice cream. . . Ice-Cream Cone S2 S1 Demand New equilibrium $2.50 4 2. . . . resulting in a higher price of ice cream . . . Initial equilibrium 2.00 7 Quantity of 3. . . . and a lower quantity sold. Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Supply, Demand, and Government Policies In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. While equilibrium conditions may be efficient, it may be true that not everyone is satisfied. One of the roles of economists is to use their theories to assist in the development of policies. 2 2

CONTROLS ON PRICES Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Result in government-created price ceilings and floors. 3 3

CONTROLS ON PRICES Price Ceiling Price Floor A legal maximum on the price at which a good can be sold. Price Floor A legal minimum on the price at which a good can be sold. 4 4

A Market with a Price Ceiling (b) A Price Ceiling That Is Binding Price of Ice-Cream Cone Supply Demand Equilibrium price $3 2 Price ceiling 75 125 Shortage Quantity of Ice-Cream Quantity supplied Quantity demanded Cones Copyright©2003 Southwestern/Thomson Learning

CASE STUDY: Rent Control in the Short Run and Long Run Rent controls are ceilings placed on the rents that landlords may charge their tenants. The goal of rent control policy is to help the poor by making housing more affordable. One economist called rent control “the best way to destroy a city, other than bombing.” 2

Rent Control in the Short Run and in the Long Run (a) Rent Control in the Short Run (supply and demand are inelastic) Rental Price of Apartment Supply Demand Controlled rent Shortage Quantity of Apartments Copyright©2003 Southwestern/Thomson Learning

Rent Control in the Short Run and in the Long Run (b) Rent Control in the Long Run (supply and demand are elastic) Rental Price of Apartment Supply Demand Controlled rent Shortage Quantity of Apartments Copyright©2003 Southwestern/Thomson Learning

A Market with a Price Floor (b) A Price Floor That Is Binding Price of Ice-Cream Supply Cone Demand Surplus $4 Price floor 80 120 3 Equilibrium price Quantity of Ice-Cream Quantity demanded Quantity supplied Cones Copyright©2003 Southwestern/Thomson Learning

The Minimum Wage An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.

How the Minimum Wage Affects the Labor Market Supply Labor demand Labor surplus (unemployment) Minimum wage Quantity demanded Quantity supplied Quantity of Labor Copyright©2003 Southwestern/Thomson Learning