Chapter 4 Supply and Demand – An Initial Look The free enterprise system is absolutely too important to be left to the voluntary action of the marketplace. RICHARD KELLY

The Invisible Hand Invisible hand –Adam Smith –People pursue own self-interests –“Led by an invisible hand” –Promote wellbeing of community 2

Demand and Quantity Demanded Quantity demanded –Number of units –Consumers Willing Can afford to buy –Specified period of time 3

Demand and Quantity Demanded Quantity demanded –Depends on price –Also depends on Population size Consumer incomes Tastes Prices of other products 4

Demand and Quantity Demanded Demand schedule - Table –Period of time –Quantity demanded changes As price changes All other determinants – constant All other determinants constant –As price rises Quantity demanded falls –As price falls Quantity demanded rises 5

Demand schedule for beef Table 1 6 Price per poundQuantity demandedLabel in Figure 1 $7.5045A B C E F G H

Demand and Quantity Demanded Demand curve –Graphical depiction of demand schedule –Quantity demanded – changes Price – changes –Period of time –All other determinants – constant 7

Demand curve for beef Figure 1 8 D D Price per Pound $ Quantity Demanded in Millions of Pounds per Year G A B C E F H

Demand and Quantity Demanded Change in price –Movement along demand curve Change in other determinants –Shifts entire demand curve –Consumers - buy more (any & all prices) Demand curve – shifts right/outward –Consumers – buy less (any & all prices) Demand curve – shifts left/inward 9

Movement along versus shift of a demand curve Figure 2 10 D0D0 D0D $7.30 Price per Pound 0 Quantity Demanded in Millions of Pounds per Year C F D1D1 D1D1

Demand and Quantity Demanded Consumer income - increase –Demand – increase Outward shift Population – increase –Demand – increase Outward shift Consumer preferences – in favor –Demand – increase Outward shift 11

Shifts of the demand curve Figure 3 12 (a) Price Quantity demanded D0D0 D0D0 D1D1 D1D1 (b) Price Quantity D0D0 D0D0 D2D2 D2D2 S S E M

Demand and Quantity Demanded Prices & availability of related goods –Price of substitutes – increase Demand – increase –Shift right –Price of complements – increase Demand – decrease –Shift left 13

Supply and Quantity Supplied Quantity supplied –Number of units –Sellers - want to sell –Specified period of time All other determinants constant –As price rises Quantity supplied rises –As price falls Quantity supplied falls 14

Supply and Quantity Supplied Supply schedule - Table –Period of time –Quantity supplied changes As price changes All other determinants – constant 15

Supply schedule for beef Table 2 16 Price per poundQuantity suppliedLabel in Figure 4 $7.5090a b c e f g h

Supply and Quantity Supplied Supply curve –Graphical depiction of supply schedule –Quantity supplied – changes Price – changes –Period of time –All other determinants – constant 17

Supply curve for beef Figure 4 18 S S Price per Pound $ Quantity Supplied in Millions of Pounds per Year a b e f h g c

Supply and Quantity Supplied Change in price –Movement along supply curve Change in other determinants –Shifts entire supply curve Size of industry Technological progress Prices of inputs Prices of related outputs 19

Movement along versus shift of a supply curve Figure 5 20 S0S0 S0S $7.30 Price per Pound 0 Quantity Supplied in Millions of Pounds per Year c f S1S1 S1S1

Supply and Quantity Supplied Size of industry –Increase New firms - enter Existing firms - expand –Supply – increase Outward shift Technological progress –Reduces costs –Supply – increase Outward shift 21

Shifts of the supply curve Figure 6 22 (a) Price Quantity (b) Price Quantity D D S0S0 S0S0 S1S1 S1S1 S0S0 S0S0 S2S2 S2S2 V E U

Supply and Quantity Supplied Prices of inputs – increase –Supply – decrease Inward shift Prices of related outputs - change –Supply – shift 23

Supply and Demand Equilibrium Supply-demand diagram –Graph: Supply & Demand curves –Determines Equilibrium price Equilibrium quantity Shortage –Excess quantity demanded Over quantity supplied 24

Supply and Demand Equilibrium Surplus –Excess quantity supplied Over quantity demanded Equilibrium –No inherent forces that produce change Equilibrium change –“Outside events” 25

Determination of equilibrium price & quantity of beef Table 3 26 Price per pound Quantity Demanded Quantity Supplied Surplus or Shortage Price Direction $ SurplusFall SurplusFall SurplusFall NeitherUnchanged ShortageRise ShortageRise ShortageRise

Demand curve for beef Figure Price per Pound $ Quantity in Millions of Pounds per Year S S a g D D G A E

Supply and Demand Equilibrium Law of Supply and Demand –Free market –Forces: supply & demand Push the price - equilibrium level –Quantity supplied = quantity demanded –May be disobeyed Long term –Shortages –Surpluses –Prices - fail to move toward equilibrium 28

Demand shifts & supply-demand equilibrium Demand curve - shift outward / right –Supply curve – no change –Equilibrium price – rise –Equilibrium quantity – rise Demand curve - shift inward / left –Supply curve – no change –Equilibrium price – fall –Equilibrium quantity – fall 29

The effects of shifts of the demand curve Figure 8 30 (a) D0D0 D0D0 S S Quantity Price per pound D1D1 D1D1 T $7.30 (b) D0D0 D0D0 S S Quantity Price per pound $ E D2D2 D2D2 M 7.10 L R E

Supply shifts & supply-demand equilibrium Supply curve - shift outward / right –Demand curve – no change –Equilibrium price – fall –Equilibrium quantity – rise Supply curve - shift inward / left –Demand curve – no change –Equilibrium price – rise –Equilibrium quantity – fall 31

The effects of shifts of the supply curve Figure 9 32 (a) D D S0S0 S0S0 Quantity Price per pound $ (b) S1S1 S1S1 J D D S0S0 S0S0 Quantity Price per pound E $7.40 S2S2 S2S2 U V I E

Application: Who really pays that tax? New tax on product: 10 cents gasoline tax per gallon –Firms Decrease supply Pay part of tax –Consumers Pay part of tax What if consumers have an inelastic demand for gasoline? 33

Who pays for a new tax on products? Figure D D S0S0 S0S0 Millions of gallons per year Price per gallon $ S1S1 S1S1 50 Q1Q1 30 Q2Q2 E1E1 M E0E0

The Market Fights Back Battling the invisible hand Legally imposed constraints on prices –Price ceilings Legal maximum Equilibrium price – above it –Price floors Legal minimum Equilibrium price – below it 35

Price Ceilings Keep price – below free-market level Consequences –Shortage –Shortage – persistent Quantity demanded > quantity supplied –Illegal or “black” market –Black market prices – higher –Portion of revenues – illicit supplier –Investment – dries up 36

Case study: Rent controls in New-York city Rent control –To protect consumers –Long run - worse off –Shortage – long waiting list, high search cost –Poor maintenance –Black market – bribes –Only some benefit, and they defend the rent control 37

Supply-demand diagram for rental housing Figure D D S S Rent per month 1,200 $2, Millions of dwellings rented per month 3.5 E Market rent Rent ceiling C B

Price Floors Keep price – above free-market level Symptoms –Surplus –Problem of disposal for regulated goods –Motivate sellers provide disguised and unwanted discounts –Overinvestment in industry 39

Case study: Farm price supports; Sugar prices Farm price supports –Introduced “temporary” –Prices – inflated –Surplus – unsellable Purchases by government Taxpayer pays –Higher prices –Taxes 40

Case study: Farm price supports; Sugar prices Sugar industry –Producers Low-interest loans Enforced price floor –Limit domestic production –Limit foreign imports –Supply curve – left shift Industry – benefits Consumers – pay 41

Supporting the price of sugar Figure Price Quantity D D S0S0 S0S0 S1S1 S1S1 25¢ 50¢

Summary Movement along the D or S curve vs. shift of the whole curve Supply meets demand → equilibrium Price control is a bad idea 43