1. Chapter 2: Demand, Supply, and Market Equilibrium McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

2. 2-2 Demand Quantity demanded ( Q d ) Amount of a good or service consumers are willing & able to purchase during a given period of time

3. 2-3 General Demand Function Six variables that influence Q d Price of good or service (P) Incomes of consumers (M) Prices of related goods & services (P R ) Taste patterns of consumers ( T ) Expected future price of product (P e ) Number of consumers in market (N) General demand function Q d = f(P, M, P R, T, P e, N)

4. 2-4 General Demand Function b, c, d, e, f, & g are slope parameters Measure effect on Q d of changing one of the variables while holding the others constant Sign of parameter shows how variable is related to Q d Positive sign indicates direct relationship Negative sign indicates inverse relationship Q d = a + bP + cM + dP R + e T + fP e + gN

5. 2-5 VariableRelation to Q d Sign of Slope Parameter General Demand Function Inverse for complements P PePe N M PRPR Inverse Direct Direct for normal goods Inverse for inferior goods Direct for substitutes b =  Q d /  P is negative c =  Q d /  M is positive c =  Q d /  M is negative d =  Q d /  P R is positive d =  Q d /  P R is negative f =  Q d /  P e is positive g =  Q d /  N is positive e =  Q d /  T is positive T

6. 2-6 Direct Demand Function The direct demand function, or simply demand, shows how quantity demanded, Q d, is related to product price, P, when all other variables are held constant Q d = f(P) Law of Demand Q d increases when P falls, all else constant Q d decreases when P rises, all else constant  Q d /  P must be negative

7. 2-7 Inverse Demand Function Traditionally, price (P) is plotted on the vertical axis & quantity demanded (Q d ) is plotted on the horizontal axis The equation plotted is the inverse demand function, P = f(Q d )

8. 2-8 Graphing Demand Curves A point on a direct demand curve shows either: Maximum amount of a good that will be purchased for a given price Maximum price consumers will pay for a specific amount of the good

9. 2-9 A Demand Curve (Figure 2.1)

10. 2-10 Graphing Demand Curves Change in quantity demanded Occurs when price changes Movement along demand curve Change in demand Occurs when one of the other variables, or determinants of demand, changes Demand curve shifts rightward or leftward

11. 2-11 Shifts in Demand (Figure 2.2)

12. 2-12 Supply Quantity supplied ( Q s ) Amount of a good or service offered for sale during a given period of time

13. 2-13 Six variables that influence Q s Price of good or service (P) Input prices (P I ) Prices of goods related in production (P r ) Technological advances (T) Expected future price of product (P e ) Number of firms producing product (F) General supply function Q s = f(P, P I, P r, T, P e, F) Supply

14. 2-14 General Supply Function k, l, m, n, r, & s are slope parameters Measure effect on Q s of changing one of the variables while holding the others constant Sign of parameter shows how variable is related to Q s Positive sign indicates direct relationship Negative sign indicates inverse relationship Q s = h + kP + lP I + mP r + nT + rP e + sF

15. 2-15 VariableRelation to Q s Sign of Slope Parameter General Supply Function Direct for complements P PePe F PIPI PrPr Direct Inverse Inverse for substitutes k =  Q s /  P is positive l =  Q s /  P I is negative m =  Q s /  P r is negative m =  Q s /  P r is positive r =  Q s /  P e is negative s =  Q s /  F is positive n =  Q s /  T is positive T

16. 2-16 Direct Supply Function The direct supply function, or simply supply, shows how quantity supplied, Q s, is related to product price, P, when all other variables are held constant Q s = f(P)

17. 2-17 Inverse Supply Function Traditionally, price (P) is plotted on the vertical axis & quantity supplied (Q s ) is plotted on the horizontal axis The equation plotted is the inverse supply function, P = f(Q s )

18. 2-18 Graphing Supply Curves A point on a direct supply curve shows either: Maximum amount of a good that will be offered for sale at a given price Minimum price necessary to induce producers to voluntarily offer a particular quantity for sale

19. 2-19 A Supply Curve (Figure 2.3)

20. 2-20 Graphing Supply Curves Change in quantity supplied Occurs when price changes Movement along supply curve Change in supply Occurs when one of the other variables, or determinants of supply, changes Supply curve shifts rightward or leftward

21. 2-21 Shifts in Supply (Figure 2.4)

22. 2-22 Market Equilibrium Equilibrium price & quantity are determined by the intersection of demand & supply curves At the point of intersection, Q d = Q s Consumers can purchase all they want & producers can sell all they want at the “market-clearing” or “equilibrium” price

23. 2-23 Market Equilibrium (Figure 2.5)

24. 2-24 Market Equilibrium Excess demand (shortage) Exists when quantity demanded exceeds quantity supplied Excess supply (surplus) Exists when quantity supplied exceeds quantity demanded

25. 2-25 Value of Market Exchange Typically, consumers value the goods they purchase by an amount that exceeds the purchase price of the goods Economic value Maximum amount any buyer in the market is willing to pay for the unit, which is measured by the demand price for the unit of the good

26. 2-26 Measuring the Value of Market Exchange Consumer surplus Difference between the economic value of a good (its demand price) & the market price the consumer must pay Producer surplus For each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price) Social surplus Sum of consumer & producer surplus Area below demand & above supply over the relevant range of output

27. 2-27 Measuring the Value of Market Exchange (Figure 2.6)

28. 2-28 Changes in Market Equilibrium Qualitative forecast Predicts only the direction in which an economic variable will move Quantitative forecast Predicts both the direction and the magnitude of the change in an economic variable

29. 2-29 Demand Shifts (Supply Constant) (Figure 2.7)

30. 2-30 Supply Shifts (Demand Constant) (Figure 2.8)

31. 2-31 Simultaneous Shifts When demand & supply shift simultaneously Can predict either the direction in which price changes or the direction in which quantity changes, but not both The change in equilibrium price or quantity is said to be indeterminate when the direction of change depends on the relative magnitudes by which demand & supply shift

32. 2-32 S′′ Simultaneous Shifts: (  D,  S) S D′ S′ D Q Price may rise or fall; Quantity rises P A Q P B P′ Q′ Q′′ C P′′

33. 2-33 S′ Simultaneous Shifts: (  D,  S) D S D′ S′ Q Price falls; Quantity may rise or fall P A Q P B P′ Q′ Q′′ C P′′

34. 2-34 Simultaneous Shifts: (  D,  S) S′′ D S D′ S′ Q Price rises; Quantity may rise or fall P A Q P B P′ Q′ Q′′ C P′′

35. 2-35 Simultaneous Shifts: (  D,  S) S′′ D S D′ S′ Q Price may rise or fall; Quantity falls P A Q P B P′ Q′ Q′′ C P′′

36. 2-36 Ceiling & Floor Prices Ceiling price Maximum price government permits sellers to charge for a good When ceiling price is below equilibrium, a shortage occurs Floor price Minimum price government permits sellers to charge for a good When floor price is above equilibrium, a surplus occurs

37. 2-37 Ceiling & Floor Prices (Figure 2.12) QxQx Quantity QxQx PxPx PxPx Price (dollars) SxSx DxDx 2 50 1 62 22 3 32 84 Panel A – Ceiling price SxSx DxDx 2 50 Panel B – Floor price