Copyright 2002, Pearson Education Canada1 Demand, Supply and Market Equilibrium Chapter 4

Copyright 2002, Pearson Education Canada2 The Basic Decision-Making Units in the Economy: zFirms and Households

Copyright 2002, Pearson Education Canada3 Firms and Households zA firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. zHouseholds are the consuming unit in the economy.

Copyright 2002, Pearson Education Canada4 The Entrepreneur zThe entrepreneur is the person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

Copyright 2002, Pearson Education Canada5 Markets zProduct or output markets are the markets in which goods and services are exchanged. zInput or factor markets are the markets in which resources used to produce products are exchanged

Copyright 2002, Pearson Education Canada6 Labour Markets zLabour markets are the input/factor markets in which households supply work for wages to firms that demand labour.

Copyright 2002, Pearson Education Canada7 Capital Markets zCapital markets are the input/factor markets in which households supply their savings, for interest or for claims to future profits, to firms that demand funds in order to buy capital goods.

Copyright 2002, Pearson Education Canada8 Land Markets zLand markets are the input/factor markets in which households supply land or other real property in exchange for rent.

Copyright 2002, Pearson Education Canada9 Factors of Production zThe inputs into the production process. Land, labour, and capital are the three key factors of production.

Copyright 2002, Pearson Education Canada10 The Circular Flow zA circular flow diagram describes the interaction of firms and households in markets for outputs and inputs.

Copyright 2002, Pearson Education Canada11 The Circular Flow of Economic Activity (Figure 4.1)

Copyright 2002, Pearson Education Canada12 Determinants of Household Demand: zThe price of the product in question zThe income available to the household zThe households amount of accumulated wealth zThe prices of other products available zTastes and preferences zExpectations about future income, wealth, and prices

Copyright 2002, Pearson Education Canada13 Quantity Demanded zThe quantity demanded represents the amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price.

Copyright 2002, Pearson Education Canada14 Changes in Quantity Demanded vs. Changes in Demand zChanges in the price of a product affect the quantity demanded per period. Changes in any other factor, such as income or preferences, affect demand. An increase in income, for instance, tends to increase demand. While a drop in prices will increase the quantity demanded.

Copyright 2002, Pearson Education Canada15 The Demand Schedule zA demand schedule is a table or chart showing how much of a given product a household would be willing to buy at different prices.

Copyright 2002, Pearson Education Canada16 The Demand Curve zThe demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. zDemand curves are usually derived from demand schedules.

Copyright 2002, Pearson Education Canada17 D P Q 0 The Demand Curve

Copyright 2002, Pearson Education Canada18 The Law of Demand zThe negative relationship between price and quantity demanded. As price rises, quantity demanded decreases. As price falls, quantity demanded increases zThis is why we observe a negative slope in demand curves.

Copyright 2002, Pearson Education Canada19 Anna’s Demand Schedule for Telephone Calls (Table 4.1)

Copyright 2002, Pearson Education Canada20 Anna’s Demand Curve $ $10.00 $7.50 $3.50 $ Quantity demanded Price

Copyright 2002, Pearson Education Canada21 Other Determinants of Household Demand z Income and Wealth yIncome: The total of all earnings received by a household in a given period of time yWealth: The total value of what a household owns less what it owes

Copyright 2002, Pearson Education Canada22 Income as a Determinant of Demand zNormal Goods: Goods for which demand goes up when income is higher and for which demand goes down when income is lower. zInferior Goods: Goods for which demand falls when income rises.

Copyright 2002, Pearson Education Canada23 Prices of Other Goods and Services as Determinants of Demand zSubstitutes: Goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. yPerfect substitutes are identical products. zComplements: Goods that “go together”; when the price of one increases, demand for the other goes down, and vice versa.

Copyright 2002, Pearson Education Canada24 Other Determinants of Household Demand: zTastes and Preferences - These are quite subjective and tend to change over time. zExpectations - With respect to future income, wealth, prices, and availability.

Copyright 2002, Pearson Education Canada25 Shift of Demand vs. Movement Along Demand Curve zShift of a demand curve is the change that takes place in a demand curve when a new relationship between the quantity demanded of a good and the price of that good is brought about by a change in the original conditions. zMovement along the demand curve is what happens when a change in price causes quantity demanded to change.

Copyright 2002, Pearson Education Canada26 Anna’s Demand for Telephone Calls - A Change in Quantity Demanded zThe graph shows a shift in quantity demanded from 3 to 7 caused by a change in price from $7.50 to $3.50. $ $10.00 $7.50 $3.50 $ Quantity demanded Price

Copyright 2002, Pearson Education Canada27 Anna’s Demand for Telephone Calls - A Change in Demand zWhen any factor except price changes the relationship between price and quantity is different; there is a shift of the demand curve, in this case from D 1 to D 2. $15.00 $10.00 $7.50 $3.50 $ D1 D2

Copyright 2002, Pearson Education Canada28 Changes in Demand Income Changes Income Rises P Q P Q Demand for normal good shifts right D1D1 D1D1 D2D2 Demand for inferior good shifts left D2D2

Copyright 2002, Pearson Education Canada29 Price of hamburger rises P Q P D1D1 D2D2 Q P D1D1 D2D2 Quantity of hamburger demanded falls Demand for complement good (ketchup) shifts left Demand for substitute good (chicken) shifts right Q Changes in Demand Prices of Related Goods

Copyright 2002, Pearson Education Canada30 From Household to Market Demand zDemand for a good or service can be defined for an individual household, or for a group of households that make up a market.

Copyright 2002, Pearson Education Canada31 Market Demand Defined zMarket demand may be defined as the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

Copyright 2002, Pearson Education Canada32 DADA P 0 48QdQd 3 0 $1.50 $3.50 DBDB QdQd 0 P $1.50 $3.50 DCDC 94 QdQd 0 Price $3.50 $ QdQd Market Demand Deriving market demand from the individual demand curves: P $3.50 $1.50

Copyright 2002, Pearson Education Canada33 Supply zA firm’s decision about what quantity of product to supply depends on: yThe price of the good or service yThe cost of producing the product which depends on: xThe price of required inputs (land, labour, capital) xThe technologies to be used to produce the product yThe prices of related products

Copyright 2002, Pearson Education Canada34 Quantity Supplied zThe amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period.

Copyright 2002, Pearson Education Canada35 The Law of Supply zThe positive relationship between price and quantity of a good supplied. An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied.

Copyright 2002, Pearson Education Canada36 The Supply Schedule and Supply Curve zA supply schedule is a table, or chart, showing how much of a product firms will supply at different prices. zA supply curve is a graph illustrating how much of a product a firm will supply at different prices.

Copyright 2002, Pearson Education Canada37 Clarence Brown’s Supply Schedule for Soybeans (Table 4.3)

Copyright 2002, Pearson Education Canada38 Clarence Brown’s Soybean Supply Curve (Figure 4.6)

Copyright 2002, Pearson Education Canada39 Changes in Quantity Supplied vs. Changes in Supply: zChanges in quantity supplied imply movement along a supply curve. zChanges in supply imply a shift in the entire supply curve.

Copyright 2002, Pearson Education Canada40 zChange in quantity supplied from 600 to 800 tonnes per year due to an increase in price from $115 to $150 per tonne. zCauses movement along supply curve. A Change in the Quantity Supplied of Clarence Brown’s Soybeans (Figure 4.6)

Copyright 2002, Pearson Education Canada41 Shift Of Supply Curve for Soybeans Following Development of New Strain (Figure 4.7)

Copyright 2002, Pearson Education Canada42 Q P S S1S1 S2S2 P Q An increase in the quantity supplied An increase in supply Changes in Quantity Supplied vs. Changes in Supply:

Copyright 2002, Pearson Education Canada43 From Individual Firm to Market Supply zThe supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry.

Copyright 2002, Pearson Education Canada44 Market Supply zThe sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service. zAs with market demand, market supply is the horizontal summation of the individual firms’ supply curves.

Copyright 2002, Pearson Education Canada45 From Individual Firm to Market Supply (Figure 4.8)

Copyright 2002, Pearson Education Canada46 Market Equilibrium zThe operation of the market depends on the interaction between suppliers and demanders. zAn equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. zAt equilibrium, there is no tendency for the price to change.

Copyright 2002, Pearson Education Canada47 Market Equilibrium P Q PEPE QEQE E S D

Copyright 2002, Pearson Education Canada48 0 Tonnes of Soybeans D S P $ per tonne The market for soybeans in equilibrium:

Copyright 2002, Pearson Education Canada49 Excess Demand zExcess Demand is the condition that exists when quantity demanded exceeds quantity supplied at the current price.

Copyright 2002, Pearson Education Canada50 Excess Demand (Figure 4.9c) zAt $85 per tonne quantity demanded exceeds quantity supplied by 2500 tonnes. zExcess demand tends to lead to an increase in prices.

Copyright 2002, Pearson Education Canada51 Excess Supply zExcess supply is the condition that exists when quantity supplied exceeds quantity demanded at the current price.

Copyright 2002, Pearson Education Canada52 Excess Supply (Figure 4.10) zAt $150, quantity supplied exceeds the quantity demanded by 2000 tonnes. zThis causes prices to fall

Copyright 2002, Pearson Education Canada53 D1D1 D2D2 S Q P Q 1 Q 2 P2P2 P1P1 D2D2 S P Q Q 2 Q 1 P1P1 P2P2 Increase in Demand Decrease in Demand D1D1 Changes in Equilibrium Demand Shifts/Supply is Constant

Copyright 2002, Pearson Education Canada54 D D S1S1 Q P Q 1 Q 2 P2P2 P1P1 S1S1 P Q Q 2 Q 1 P1P1 P2P2 Increase in Supply Decrease in Supply S2S2 S2S2 Changes in Equilibrium Supply Shifts/Demand is Constant

Copyright 2002, Pearson Education Canada55 D1D1 S1S1 Q P Q 1 Q 2 P?P? Increase in Demand & Supply Decrease in Demand & Supply S2S2 D2D2 D2D2 S2S2 Q P Q 2 Q 1 S1S1 D1D1 P=? Changes in Equilibrium Supply & Demand both Increase (or Decrease )

Copyright 2002, Pearson Education Canada56 D1D1 S1S1 Q P Q= ? Demand Increases & Supply Decreases Demand Decreases & Supply Increases S2S2 D2D2 D2D2 S2S2 Q P Q=? S1S1 D1D1 P1P1 P2P2 P1P1 P2P2 Changes in Equilibrium Demand & Supply Move Opposite

Copyright 2002, Pearson Education Canada57 Review Terms & Concepts zcapital Market zcomplements, complementary Goods zdemand curve zdemand schedule zentrepreneur zequilibrium zexcess demand zexcess supply zfactors of production zfirm zhouseholds zincome zinferior goods zinput or factor markets zlabour market zland market

Copyright 2002, Pearson Education Canada58 Review Terms & Concepts (continued) zlaw of demand zlaw of supply zmarket demand zmarket supply zmovement along a demand curve znormal goods zperfect substitutes zproduct or output markets zprofit zquantity demanded zquantity supplied zshift of a demand curve zsubstitutes zsupply curve zsupply schedule zwealth or net worth