Demand, Supply & Market Equilibrium ECO 2013 Chapter 3 Prof M. Mari Fall 2007 D Q

Demand A relation between the price of a good and the quantity that consumers are willing and able to buy during a given period, other things constant. Willing: you want to buy the product Able: you can afford the buy the product

Demand Schedule and Curve Demand curve: a curve showing the relation between the price of a good and quantity demanded during a given period, other things constant. Suppose we are making pizza. Price of Good Quantity Demanded $3 200 $4 150 $5 100 $6 75 $7 50

Law of Demand States that a quantity of a good demanded during a given period relates inversely to its price, other things constant. Price increases  Quantity Demanded decreases Price decreases  Quantity demanded increases Creates a downward sloping demand curve

Why? Substitution Effect Unlimited wants/scarce resources When the price of a good falls, consumers substitute that good for other goods, which become relatively more expensive. Reverse also holds true

Why? Income Effect Money income: is simply the number of dollars received per period Real income: your income measured in terms of what it can buy. A fall in the price of a good increases consumers’ real income making consumers more able to purchase goods; for a normal good, the quantity demanded increases.

Demand Curve A curve showing the relation between the price of a good and the quantity demanded. Price $6 $5 Point on the line that matches the schedule Every point on the line matches the schedule. It is a price/quantity demanded that consumers are willing and able to buy. $4 $3 Demand Quantity 200 50 75 100 150

Movement Along the Demand Curve Caused by a change in price Only a change in price Move from one point to another on the same graph Called a Change in quantity demanded.

Movement along the Demand Curve Price B $6 $5 A Demand 75 100 Quantity

Demand Individual demand Market demand The demand of an individual consumer Market demand Sum of individual demands of all consumers in the market

Shifts in the Demand Curve A demand curve isolates the relation between prices of a good and quantities demanded when other factors that could affect demand remain unchanged. Factors called assumptions or determinants

Determinants of Demand Changes in consumer income Changes in prices of related goods Changes in consumer expectations Changes in the number or composition of consumers Changes in consumer tastes

Changes in determinants Results in changes to the RELATIONSHIP BETWEEN PRICE AND QUANTITY DEMANDED. At each and every price a DIFFERENT quantity is demanded. Results in a shift in the demand curve New curve must be drawn

Changes in Demand Increase in demand P Qd1 Qd2 $4 150 200 $5 100 $6 75 At each and every price MORE of the good is demanded Shifts to the right Price P Qd1 Qd2 $4 150 200 $5 100 $6 75 A B $5 D2 D1 Quantity 100 150

Causes of Increase in Demand Increase in consumer income Causes consumers to buy more of the product at each and every price. Normal goods Inferior goods

Change in consumer income Normal goods A good for which demand increases as consumer income rise Inferior goods A good which demand increases as consumer income falls

Changes in Price of Related Goods Substitutes Goods that are not consumed jointly Goods that are related in such a way that an increase in the price of one shifts the demand curve for the other rightward. Increase in price of Coke leads to increase in demand for Pepsi

Changes in Price of Related Goods Substitutes Suppose that the price of Coke rises from $1 to $1.50, then the demand for Pepsi will decrease from 75 to 100. $1 D2 D1 75 100

Changes in the price of related goods Complements Goods that are related in a such a way that an increase in the price of one shifts the demand of the other leftward Two goods that are consumed jointly. An decrease in the price of one will increase demand for the other

Changes in Price of Related Goods Complements An decrease in the price of DVD players, increases the demand for DVDs Suppose that DVD players decrease in price from $145 to $100, now the demand for DVDs will decrease from 750 at $20 to 900. $20 D2 D 750 900

Changes in Consumer Expectations Such as expectations in Prices and income Affect how consumers spend their money and their demand If product cheaper today than tomorrow, then increase in demand

Changes in consumer tastes Consumer preferences likes and dislikes in consumption assumed to be constant along a given demand curve assumed constant along a given demand curve Changes in taste will cause a shift in the demand curve as different quantities are demanded at each and every price.

Changes in taste Consumers prefer platform shoes. At $50, demand increases from 100 to 200. $50 D2 D 100 200

Change in the number and composition of consumers The market demand curve is the sum of the individual demand curves. If the number of consumers falls then the sum will be smaller thus shifting the demand curve

Changes in Demand Decrease in demand P Qd1 Qd2 $4 150 110 $5 100 90 $6 At each and every price Less of the good is demanded Shifts to the Left Price P Qd1 Qd2 $4 150 110 $5 100 90 $6 75 60 B $5 A D1 D2 Quantity 90 100

Causes of Decrease in Demand Decrease in consumer income Causes consumers to buy less of the product at each and every price.

Changes in Price of Related Goods Substitutes Goods that are not consumed jointly Goods that are related in such a way that an increase in the price of one shifts the demand curve for the other rightward. Decrease in price of Coke leads to Decrease in demand for Pepsi

Changes in Price of Related Goods Substitutes Suppose that the price of Coke drops from $1 to $0.50, then the demand for Pepsi will decrease from 100 to 75. $1 D D2 75 100

Changes in the price of related goods Complements Goods that are related in a such a way that an increase in the price of one shifts the demand of the other leftward Two goods that are consumed jointly. An increase in the price of one will decrease demand for the other

Changes in Price of Related Goods Complements An decrease in the price of DVD players, increases the demand for DVDs Suppose that DVD players increase in price from $100 to $145, now the demand for DVDs will decrease from 900 at $20 to 750. $20 D1 D2 750 900

Changes in Consumer Expectations Such as expectations in Prices and income Affect how consumers spend their money and their demand If product more expensive today than tomorrow, then decrease in demand

Changes in consumer tastes Consumer preferences likes and dislikes in consumption assumed to be constant along a given demand curve assumed constant along a given demand curve Changes in taste will cause a shift in the demand curve as different quantities are demanded at each and every price.

Change in the number and composition of consumers The market demand curve is the sum of the individual demand curves. If the number of consumers falls then the sum will be smaller thus shifting the demand curve

Review of Demand A change in quantity demanded is not a change in demand Change in quantity demanded is caused by a change in price Change in quantity demanded is a movement along the demand curve Change is demand is caused by a change in the determinants Change in demand shifts the demand curve

Supply Producer’s side A relation between the price of a good and the quantity that the producers are willing and able to offer for sale during a given period, other things constant.

Law of Supply The quantity of a good supplied during a given period is usually directly related to the price of the good Increase in price leads to increase in quantity supplied Decrease in price leads to decrease in quantity supplied. Creates upward sloping supply curve

Supply Curve 5 Price of Good Quantity Demanded $3 50 $4 75 $5 100 $6 150 $7 200 6 Supply 5 Quantity

Movement along the supply curve A change in price and only in price Causes a movement along the supply curve Called a Change in Quantity Supplied Supply $6 B $4 A 100 150

Supply Individual supply Market supply The supply of an individual producer Market supply The sum of individual supplies of all producers in the market

Determinants for the Supply Curve Changes in technology Changes in prices of relevant resources Changes in the prices of alternative goods Changes in Producer Expectations Changes in the number of producers

Changes in Supply Caused by changes in the determinants to the supply curve Results in changes to the relationship between the price and quantity supplied At each and every price a different quantity is supplied New supply curve - shift in supply

Increase in Supply At each and every price more of the good is supplied S1 S2 $6 300 400

Causes of increase in Supply Improvements in Technology Changes in relevant resources Decrease in the price of resources Lowers costs Changes in price of alternative goods If price of alternative good increases, supply of the good increases Changes in producers expectations

Changes in technology Technology is the economy’s stock of knowledge about how to combine resources efficiently

Changes in Technology Improvements in technology Causes an increase in supply More of the product is available at all prices S1 S2 $6 300 400

Changes in Relevant Resources Decrease in resource prices Increases the supply of the good at each and every price. S1 S2 $6 300 400

Changes in prices of Alternative Goods Other goods that use some or all of the same resources as the good in question Beef and leather. If the price of beef increases, producers will supply more beef thus increasing the supply of leather. Price S1 S2 $6 Q Leather 300 400 Above is the market for the supply of leather

Changes in Producers Expectations Expectation of future prices of resources or their own product can cause producers to change what they offer at each individual price

Changes in the Number of Producers As the number of producers change so does the supply of the product A decrease in the number of producers will lead to a decrease in supply

Decrease in Supply At each and every price LESS of the good is supplied 5 S1 S2 400 600

Causes of Decrease in Supply Backward movement in Technology Changes in relevant resources Increase in the price of resources Raises costs Changes in price of alternative goods If price of alternative good decreases, supply of the good decreases Changes in producers expectations

Changes in Relevant Resources Are those employed in the production of the good in question Increase in price of resources Results in decrease in supply Less of the good is available at all prices $9 S1 S2 500 600

Changes in prices of Alternative Goods Other goods that use some or all of the same resources as the good in question Beef and leather. If the price of beef decreases, producers will supply less beef thus decreasing the supply of leather. Price S1 $6 Q Leather 300 400 Above is the market for the supply of leather

Producer’s Expectation Nationalization Expropriation

Supply Review Change in Quantity Supplied Change in Supply Caused by a change in the price of the product Movement along the supply curve Change in Supply Caused by change in the determinants Results in a shift in the supply curve

Market Equilibrium Market Includes all the arrangements used to buy and sell Reduce transaction costs The place where buyers and sellers meet to determine price and quantity

Equilibrium At specific price where: Quantity demanded = Quantity supplied Equilibrium price – market clearing price Equilibrium quantity – D = S

Equilibrium At specific price where: Quantity demanded Equals Quantity Supplied S $5 Equilibrium D Q 150

Reaching Equilibrium If market price is ABOVE equilibrium Qs > QD Economy is at a SURPLUS Market price will fall P Surplus S $6 $5 D Q 100 150 200

Reaching Equilibrium If the market price is BELOW the equilibrium price QD > Qs Shortage exists Market price rises to equilibrium P S $5 $4 D Shortage Q 100 150 200

Shifts in Demand Demand increases Equilibrium price increases Equilibrium quantity increases P S $6 B $4 A D1 D Q 100 150 200

Shifts in Demand Decrease in demand decrease in price decrease in equilibrium S $6 B $5 A D1 D Q 100 200

Shifts in Supply Increase in supply Decrease in equilibrium price Increase in quantity Price S1 S2 $6 $5 Q Leather 300 400

Shifts in Supply Decrease in supply Price increases Quantity decreases

Simultaneous Shifts in Supply and Demand The change in equilibrium price and quantity depends on which curve shifts the most. S S1 5 A B 4 D1 D 200 300

Effect on Equilibrium Price Effect on Equilibrium Quantity Simultaneous Changes Change in Supply Change in Demand Effect on Equilibrium Price Effect on Equilibrium Quantity Increase Decrease Indeterminate

Government Intervention Government enters the economy Price Setting Subsidies Government payments to reduce the cost of product or to limit production.

Price Floors A minimum legal price below which a good or service cannot be sold If above equilibrium causes surplus Surplus S $7 $6 D Q 100 150 200

Price Ceilings A maximum legal price above which a good or service cannot be sold Below equilibrium price Shortage occurs P S $5 D Shortage Q 100 150 200