1. 1 Chapter 3: Supply and Demand With limited resources and various needs of human being, –Every year, how many acres of wheat should be planted ? How many cars should be made? And how many houses should be built? –Who should decide what and how much to produce? Government or the free ‘market’? Government controlled distribution of scarce resources –Rationing coupons (stamps) of almost everything in P.R.China before 1980 –Rationing of gasoline in 1973 oil crisis in Netherlands –Rent control in New York City and Los Angeles Market force driven allocation of scarce resources

2. 2 What is A Market? A market is a structure where buyers meet sellers to exchange any type of goods, services, and information. –Buyers create demand for a good; –Sellers create supply of a good; –How the price of a good is determined? Cost Value Interaction between supply and demand

3. 3 The Demand Curve A demand curve shows the quantity demanded for a good at a certain level of price. A demand curve is downward sloping. –Substitution effect –Income effect –Marginal buyer’s reservation price $4 $2 8 16 Q P D Demand for Pizzas (1000s of slices/day)

4. 4 The Supply Curve A supply curve shows the quantity supplied of a good at a certain level of price. A supply curve is upward sloping -As the output of a good increases, the opportunity cost of producing the good increases. Therefore, the price to be charged will also increase. -Marginal seller’s reservation price Q P S Supply of Pizzas (1000s of slices/day) $4 $2 816

5. 5 Market Equilibrium P Q 12 $3 S D Market for Pizzas (1000s of slices/day) A market is in equilibrium when a price equates quantity demanded and quantity supplied (market clearing price). At a free market, any deviation from equilibrium tends to automatically revert back to equilibrium. -Excess supply -Excess demand Surplus 816 $4 $2 Equilibrium Deficit

6. 6 An Example: Rent Control A price ceiling is a maximum price specified by law. If the price ceiling is under the equilibrium price, a shortage of apartments results. P Q S D $1,600 $800 123 (millions of apartments/day) Market for NYC Apartments

7. 7 Movements of Demand Curve When the price of a good changes, its quantity demanded changes, which happens along the demand curve – changes in quantity demanded. When any factor other than the price of a good changes, the change shifts the whole demand curve – a change in demand. P Q D D' $2 810 (1000s of cans/day) Demand for Canned Tuna

8. 8 Shifts in Demand What could shift a demand curve? –Price of complementary goods; –Price of substitute goods; –Income: normal or inferior goods; –Preference; –Population of potential buyers; –Expectations on future price changes.

9. 9 Movements of Supply Curve Movements along the supply curve; Shifts of supply curve -Price of an input; -Technological changes; -Weather; -Number of potential sellers; -Expectations on future price changes P (units/month) S’ P’ P Q’ Q Convenient Apartments S D

10. 10 Changes in Supply and Demand Demand changes while supply remains the same DemandEquilibrium PriceEquilibrium Quantity Increase Decrease SupplyEquilibrium PriceEquilibrium Quantity IncreaseDecreaseIncrease DecreaseIncreaseDecrease Supply changes while demand remains the same

11. 11 Changes in Supply and Demand Supply DemandIncreasesDecreases Increases PDepends QIncreases PIncreases QDepends Decreases PDecreases QDepends PDepends QDecreases

12. 12 Efficiency and Equilibrium Does the fact that a market automatically reach its equilibrium also guarantee the achievement of economic efficiency – all goods at their socially optimal levels? –Only if the benefits to buyers and/or the costs to sellers are not shared by others. (Efficiency Principle) –Buyers and sellers are only concerned about their own marginal benefit and marginal cost. –If the production of a good creates benefits or costs to other groups, the market equilibrium would not achieve economic efficiency.

13. 13 Efficiency and Equilibrium Producers sometimes shift costs to others –Pollution is like getting free waste disposal services –Total marginal cost = seller's marginal cost plus marginal cost of pollution –When costs are shifted, supply is greater than socially optimal Buyers may create benefits for others –Marginal benefit is less than the full social benefit –Vaccinations, my neighbor's landscaping –The demand for these goods is less than socially optimal