1 Lecture 2

2 Demand & Supply Mankiw, Chap. 4

3 Lecture Objectives Understand the concepts of the ‘Market’, Market Forces and the Price Mechanism. Explain the laws of demand & and supply Analyze differences between movements along a demand curve and shifts of the curve Identify significance of the conditions of demand & supply Explain the concept of market equilibrium, and the importance of equilibrium in market theory. Describe disequilibrium conditions Examine changes in equilibrium

4 Market Forces - Supply & Demand  What is a market?  Who are main players on a market?  Who determines demand by what?  Who determines supply by what?

5 Market Forces - Supply & Demand  A market is a group of buyers and sellers of a particular good or service.  Through Price Mechanism  Buyers determine demand  Sellers determine supply

6 Demand The amount of a commodity that will be purchased at a given price by consumers at a point in time

7 Demand Schedule A table which shows how much of a product would be purchased over a range of prices at a particular time

8 Individual Demand Schedule Cathy’s Demand: Ice Cream Cones

9 Demand Curve downward-sloping line relating price to quantity demanded. P Q

10 Individual Demand Curve Cathy’s Demand: Ice Cream Cones P $ Per Cone Q # Cones Per Day $2.50 $2.00 $

11 Individual Demand Curve Cathy’s Demand: Ice Cream Cones P $ Per Cone Q # Cones Per Day $2.50 $2.00 $

12 Market Demand  Market demand: sum of all individual demands for a particular good or service.  Market demand curve: individual demand curves summed horizontally

13 Market Demand Schedule  Market demand is the sum of all individual demands at each possible price.  Assume the ice cream market has two buyers as follows: Price Per Cone Cathy Nick Market Demand $ = $ = $ = $ = $ =

14 Market Demand Schedule  Market demand is the sum of all individual demands at each possible price.  Assume the ice cream market has two buyers as follows: Price Per Cone Cathy Nick Market Demand $ = 19 $ = 16 $ = 13 $ = 10 $ = 7

15 Market Demand Curve All Buyers P $ Per Cone Q # Cones Per Day $2.00 $1.50 $ The market demand curve is the summation of all the individual demand curves for a product

16 Law of Demand P Q As P Q

17 Law of Demand There exists an inverse or indirect relationship between Price and Quantity Demanded. As a result, the demand curve slopes downwards from left to right P Q As P Q

18 Ceteris Paribus All the relevant variables (e.g. determinants of demand) are held constant, except the one(s) being studied at the time.

19 Change in Quantity Demanded Price Quantity $ $

20 Change in Quantity Demanded Price Quantity $ $ Caused by a change in Price

21 Change in Quantity Demanded 0 D1D1 Price of Cigarettes per Pack Number of Cigarettes Smoked per Day A tax that raises the price of cigarettes results in a movement along the demand curve. A C $

22 Change in Demand Price $ Quantity 10 Factors causing the demand curve to shift are conditions of demands Rise in quantity demanded at every price

23 Change in Demand Price $ Quantity 10 Caused by Non-Price Factors: Income, Tastes... Factors causing the demand curve to shift are conditions of demands Rise in quantity demanded at every price

24 Change in Demand 0 D1D1 Price of Ice-Cream Cone Quantity of Ice-Cream Cones D3D3 D2D2

25 Change in Demand 0 D1D1 Price of Ice-Cream Cone Quantity of Ice-Cream Cones D3D3 D2D2 Increase in demand Decrease in demand

26 Change in Quantity Demanded vs. Change in Demand  Change in Quantity Demanded –Caused by? –Movement or shift?  Change in Demand –Caused by? –Movement or shift?

27 Change in Quantity Demanded vs. Change in Demand  Change in Quantity Demanded –Caused by a change in the Price of the product. –Movement along the demand curve.  Change in Demand –Caused by changes in Non-Price Factors. –A shift in the demand curve, either to the left or right.

28 Determinants of Demand Market Price & Movement Conditions of Demand and Shift

29 Market Price P Q As P Q

30 Market Price Inverse/ Indirect relationship between Price and Quantity Demanded. P Q As P Q

31 Conditions of Demand Real Income Prices of related goods Technology Tastes Change in population Expectations Advertising Climatic Changes

32 Conditions of Demand Real Income Change in Real Income  Change in demand for a normal good  Change in demand for an inferior good

33 Conditions of Demand Real Income & Normal Good  As income increases...  Examples? P Q

34 Conditions of Demand Real Income & Normal Good  As income increases the demand for a normal good will increase.  Examples? P Q

35 Conditions of Demand Real Income & Normal Good $ Price of Beef Quantity of Beef 0 Increase in demand An increase in income... D1D1 D2D2

36 Conditions of Demand Real Income & Inferior Good  As income increases...  Examples? P Q

37 Conditions of Demand Real Income & Inferior Good  As income increases the demand for an inferior good will decrease.  Examples? P Q

38 Conditions of Demand Real Income & Inferior Good $ Price of Bean Quantity of Bean 0 Decrease in demand An increase in income... D1D1 D2D2

39 Conditions of Demand Prices of Related Goods Related goods Complementary goods –Examples? Substitute goods –Examples?

40 Conditions of Demand Prices of Related Goods Related goods: –Complementary goods/ Complements –Substitute goods/ Substitutes Complementary goods: Two or more goods that are used together. –Examples? Substitute goods: Similar goods that are equally able to satisfy a demand. –Examples?

41 Conditions of Demand Change in Prices of Substitutes  When the fall in price of one good reduces the demand for another good, the two goods are substitutes.  Examples?

42 Conditions of Demand Change in Prices of Complements  When the fall in price of one good increases the demand for another good, the two goods are complements.

43 Concept of Supply Supply: defined as the ability and willingness of producers to offer for sale a good or service. Quantity Supplied: the amount (quantity) of a good that sellers are willing to make available for sale at a certain price for a given period.

44 Supply Schedule The supply schedule shows the amount of a product or service that producers are willing to and able to supply at various prices

45 Individual Supply Schedule Ben’s Store: Ice Cream Cones

46 Supply Curve $ Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 The supply curve is the upward-sloping line relating price to quantity supplied.

47 P (Price Per Cone) Q (# Cones Per Day) $2.50 $2.00 $ Individual Supply Curve Ben’s Store: Ice Cream Cones

48 Market Supply  Market supply: sum of all individual supplies for all sellers of a particular good or service.  The market supply curve obtained by graphically summarizing individual supply curves horizontally.

49 Market Supply Schedule  Market supply is the sum of all individual supplies at each possible price.  Assume the ice cream market has two firms as follows: Price Per Cone Ben’s Jerry’s IceMart Market Supply $ = 0 $ = 0 $ = 1 $ = 4 $ = 7

50 P Price Per Cone Q # Cones Per Day $2.00 $1.50 $ Market Supply Curve All Sellers

51 Change in Quantity Supplied vs. Change in Supply  Change in Quantity Supplied  Caused by a change in the Price of the product.  Movement along the supply curve.  Change in Supply  Caused by changes in Non-Price Factors  A shift in the supply curve, either to the left or right.

52 Determinants of Supply Market Price & Movement Conditions of Supply and Shift

53 Determinants of Supply Market Price Law of Supply There exists a direct (positive) relationship between Price and Quantity Supplied. P Q P  Q 

54 Determinants of Supply Conditions of Supply Improvement of Technology Change in Production Costs Expectations Change in Number of Producers Climatic Changes

55 Market Equilibrium Equilibrium Price The price at which the supply and demand curve intersect. Quantity Supplied and Quantity Demanded are equal. Equilibrium Quantity The quantity at which the supply and demand curve intersect.

Market Equilibrium Demand ScheduleSupply Schedule At $2.00, the quantity demanded is equal to the quantity supplied!

Supply Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones Market Equilibrium $ Equilibrium

58 Disequilibrium Conditions –Excess Supply –Excess Demand Causes of Disequilibrium conditions –Excess Supply: caused by price rise  new price above equilibrium level –Excess Demand: caused by price fall  new price under equilibrium level

7 S P Q o $ PQDQD $ ,000 4,000 7,000 11,000 16,000 $ ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Surplus At a $4 price more is being supplied than demanded Disequilibrium Conditions Excess Supply - Surplus

11 7 S P Q o $ PQDQD $ ,000 4,000 7,000 11,000 16,000 $ ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET At a $2 price more is being demanded than supplied Shortage Disequilibrium Conditions Excess Demand - Shortage

11 7 S P Q o $ PQDQD $ ,000 4,000 7,000 11,000 16,000 $ ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Shortage MARKET DEMAND & SUPPLY Surplus

62 Price Floors and Price Ceilings & Disequilibrium Conditions A Price Ceiling: a legally established maximum price which a seller can charge or a buyer must pay. A Price Floor: a legally established minimum price which a seller can charge or a buyer must pay.

63 A Price Ceiling & Its Effect A price ceiling - a legal maximum on the price at which a good can be sold  two possible outcomes Non-binding price ceiling  No effect Binding price ceiling  Shortage

64 A Non-binding Price Ceiling & No Effect Supply Demand Price Quantity Equilibrium Price Equilibrium Quantity

65 A Non-binding Price Ceiling & No Effect Supply Demand Price Quantity PEPE QEQE Non-binding Price Ceiling PCPC

66 A Binding Price Ceiling & Shortage Supply Demand Price Quantity PEPE QEQE Binding Price Ceiling PCPC

67 A Binding Price Ceiling & Shortage Supply Demand Price Quantity PEPE QEQE PCPC QSQS QDQD Binding Price Ceiling Shortage

68 A Price Floor & Its Effect A price floor - a legal minimum on the price at which a good can be sold  two possible outcomes: Non-binding price floor  No effect Binding price floor  Surplus

69 A Non-Binding Price Floor & No Effect Supply Demand Price Quantity PEPE QEQE Non-binding Price Floor PFPF

70 A Binding Price Floor & Surplus Supply Demand Price Quantity PEPE QEQE Binding Price Floor PFPF

71 A Binding Price Floor & Surplus Supply Demand Price Quantity PEPE QEQE PFPF QdQd QsQs Binding Price Floor

72 Supply Demand Price Quantity PEPE QEQE PFPF QdQd QsQs Surplus A Binding Price Floor & Surplus Binding Price Floor

73 Changes in Equilibrium How to Analyze  Step 1  Step 2  Step 3

74 Changes in Equilibrium How to Analyze  Step 1: –Decide whether the event shifts the supply or demand curve (or both).  Step 2: –Decide whether the curve(s) shift(s) to the left or to the right.  Step 3 –Examine how the shift affects equilibrium price and quantity.

75 Changes in Equilibrium Effects of Increase in Demand Price Quantity P1P1 Q1Q1 P2P2 Q2Q2   As Demand P Q

Changes in Equilibrium Effects of Increase in Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D resulting in a higher price... $ and a higher quantity sold. New equilibrium

S2S2 Changes in Equilibrium Effects of Decrease in Supply Price of Ice-Cream Cone Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S An earthquake reduces the supply of ice cream... New equilibrium 2....resulting in a higher price... $ and a lower quantity sold.

78 Changes in Equilibrium Four Scenarios  An Increase in Demand  A Decrease in Demand  An Increase in Supply  A Decrease in Supply

79 Changes in Equilibrium Four Scenarios  An Increase in Demand will cause: Pe Qe  A Decrease in Demand will cause: Pe Qe  An Increase in Supply will cause: Pe Qe  A Decrease in Supply will cause: Pe Qe

80 Changes in Equilibrium Effects of Change in Demand & Supply

81 Lecture Review Concepts of the ‘Market’, Market Forces and the Price Mechanism. Laws of demand & and supply Movements along a demand curve and shifts of the curve Conditions of demand & supply Market equilibrium Disequilibrium conditions Changes in equilibrium