Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Supply and Demand: An Introduction
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Market Coordination How do consumers get the goods and services they want in the right quantities and qualities? Some goods and services are allocated by the market forces of supply and demand Why do some goods and services have shortages or surpluses and others do not? Some goods and services are regulated by government
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Questions All economies must answer the following questions: What should be produced? How should it be produced? For whom will it be produced?
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Central Planning Agrarian society Former Soviet Union Cuba, North Korea China Bureaucracy A small number of of individuals address these concerns: Establish production targets for factories and farms Plan how to achieve the goals Distribute the goods and services produced
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Market Forces Free market Capitalist economies Individuals decide for themselves Which careers to pursue Which products to produce or buy When to start businesses Who gets what is decided by individual preferences and purchasing power
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Markets A market for any good consists of all buyers and sellers of that good Includes individuals who either do sell or might sell Includes individuals who either do buy or might buy
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Prices Why are some goods cheap and others expensive? Through most of history, individuals had no idea Most thought that it was because of the cost of production Others thought only of the value people received from consumption Answer: both are important
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Supply Curve Shows the total quantity of a good or service that sellers wish to sell at each price On a graph In a schedule Positive relationship As price rises, a higher quantity can be sold because more opportunity costs can be covered Application of the “low-hanging fruit principle” Reflects the rising marginal costs of producing additional units
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.1 Daily Supply Curve of Hamburgers in Greenwich Village
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Demand Curve Shows the total quantity of a good or service that buyers wish to buy at each price On a graph In a schedule Negative relationship As price rises, consumers want fewer items People switch to substitutes People cannot afford as much
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.2 Daily Demand Curve for Hamburgers
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Market Equilibrium When all buyers and sellers are satisfied with their respective quantities at the market price There is a stable, balanced, unchanging situation The supply and demand curves intersect This results in the equilibrium price The price the good sells for This results in the equilibrium quantity The quantity that will be sold
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.3 The Equilibrium Price and Quantity of Hamburgers in Greenwich Village
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Disequilibrium Excess supply Surplus Price is higher than equilibrium price Sellers are dissatisfied Excess demand Shortage Price is lower than equilibrium price Buyers are dissatisfied
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.4 Excess Supply
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.5 Excess Demand
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Free Markets and Equilibrium Free markets have an automatic tendency to eliminate excess supply and excess demand Surplus leads producers to decrease the price Shortage leads producers to increase the price
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Legislation and Markets Market equilibrium does not mean that everyone has what they want E.G. a poor person may not be able to afford the item at the equilibrium price Legislators protect consumers by using price ceilings A maximum allowable price specified by law Price signal is too low, so consumers want too much e.g. rent controls, limits on the price of gasoline Result in shortages
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Legislation and Markets Legislators protect producers by using price floors A minimum allowable price specified by law For example, price supports, minimum wage Price signal is too high, so consumers don’t want as much Result in surpluses
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.6 An Unregulated Housing Market
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.7 Rent Controls
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Economists and the Poor Economists realize there are more effective ways of helping the poor than violating the free market system Using rent controls or price ceilings results in inefficiency for everyone Using a direct income transfer to the poor is a more efficient way to help
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.8 Price Controls in the Hamburger Market
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Markets and Social Welfare Social optimal quantity of a good The quantity that results in the maximum possible economic surplus The socially optimal quantity will occur where the marginal cost equals the marginal benefit Economic efficiency Occurs when all goods and services are produced and consumed at their respective socially optimal levels
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Markets and Efficiency Efficiency Principle Efficiency is an important social goal Everyone can have a larger slice of a larger pie Equilibrium Principle A market in equilibrium leaves no unexploited opportunities for individuals No “cash on the table” remains All opportunities for profit have been exploited Efficiency occurs when the market-demand curve captures all the marginal benefits of the good the market-supply curve captures all the marginal costs of the good
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Terminology If the good’s price changes, you have a “change in quantity demanded” A movement along the demand curve “change in quantity supplied” A movement along the supply curve If something else changes, you have a “change in demand” A shift of the entire demand curve change in supply” A shift of the entire supply curve
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig. 4.9 An Increase in the Quantity Demanded Versus an Increase in Demand
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Shifts in Supply Favorable changes to the producer shift supply curve rightward lower equilibrium price higher equilibrium quantity Unfavorable changes to the producer shift supply leftward higher equilibrium price lower equilibrium quantity
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig The Effect on the Skateboard Market of an Increase in the Price of Fiberglass
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Shifts in Supply Changes in the Cost of Production Changes in Technology Changes in Weather Changes in Expectations
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig The Effect on the Market for New Houses of a Decline in Carpenters’ Wage Rates
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig The Effect of Technical Change on the Market for Manuscript Revisions
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Shifts in Demand Complements Substitutes Income Preferences Demand curve shifts rightward higher equilibrium price higher equilibrium quantity Demand curve shifts leftward lower equilibrium price lower equilibrium quantity
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig The Effect on the Market for Tennis Balls of a Decline in Court Rental Fees
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Complements Goods that are more valuable when used in combination--e.g. tennis balls and tennis courts Two goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Substitutes Goods that replace each other--e.g. messages and overnight letters Two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig Effect on the Market for Overnight Letter Delivery of a Decline in the Price of Internet Access
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Income Normal good One whose demand curve shifts right when the incomes of buyers increase Inferior good One whose demand curves shifts left when the incomes of buyers increase
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Simultaneous Shifts If, at the same time, Demand decreases and Supply increases Demand shifts left Lower price, lower quantity Supply shifts right Lower price, higher quantity We can predict that price will fall But, what happens to quantity? We must know the magnitude of the shifts
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig Four Rules Governing the Effects of Supply and Demand Shifts
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig The Effects of Simultaneous Shifts in Supply and Demand
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Slide Fig Seasonal Variation in the Air Travel and Corn Markets