1. Chapter 4 Demand, Supply, and Equilibrium

2. Chapter 4 Outline 4 Demand, Supply, and Equilibrium
4.1 Markets 4.2 How Do Buyers Behave? 4.3 How Do Sellers Behave? 4.4 Supply and Demand in Equilibrium 4.5 What Would Happen if the Government Tried to Dictate the Price of Gasoline?
Key Ideas
In a perfectly competitive market, (1) sellers all sell an identical good or service, and (2) any individual buyer or any individual seller isn’t powerful enough on his or her own to affect the market price of that good or service.
The demand curve plots the relationship between the market price and the quantity of a good demanded by buyers.
The supply curve plots the relationship between the market price and the quantity of a good supplied by sellers.
The competitive equilibrium price equates the quantity demanded and the quantity supplied.
When prices are not free to fluctuate, markets fail to equate quantity demanded and quantity supplied.
Chapter 4 Outline

3. Why do brown eggs cost more than white eggs?
4 Demand, Supply, and Equilibrium
Why do brown eggs cost more than white eggs?
Answer: Hold on until the end of the chapter
The market price is the price at which buyers and sellers conduct transactions.
The market allocates to those who can afford to pay, not those who need, deserve, or want it but who cannot pay for it.
Before jumping into demand and supply, position the material as having the ability to answer a lot of questions that we see in the real world. For example, why do brown eggs cost more than white eggs? Give students an opportunity to suggest answers. A popular answer is that they are healthier or organic. Pursue that—why would that make them cost more? Invite other answers. Some students may say that consumers want them more. Again, pursue that—ask why? Don’t respond as to whether the answers are correct or incorrect; just make note of what their answers are so you can refer to them later. In the meantime, you can smile knowingly, and tell them the answer will be revealed by the end of the chapter.
In a perfectly competitive market every buyer pays and every seller charges the same market price, no buyer or seller is big enough to influence that market price, and all sellers sell an identical good or service

4. How much would you be willing to pay for an “A” in this course?
4.2 How Do Buyers Behave?
How much would you be willing to pay for an “A” in this course?
Depending on the size of the class, ask for a show of hands at various price points, or with a larger class one can estimate or ask them write it down on a piece of paper and turn it in. By the next class period, you could construct a demand schedule.
4.2 How Do Buyers Behave?
Quantity Demanded = The amount of a good that buyers are willing to purchase at a given price.
Demand Schedule = A table that reports the quantity demanded at different prices, holding all else equal.
Demand Curve = Plots the quantity demanded at different prices.

5. How much are you willing to pay for an “A”?
4.2 How Do Buyers Behave?
How much are you willing to pay for an “A”?
Demand Schedule
Price
Quantity Demanded
$20 20
$30 16
$50 12
$100 7
$150 2
The demand curve slopes down, illustrating that different students have different levels of willingness to pay.
4.2 How Do Buyers Behave? Willingness to Pay
Why are some students willing to pay more for an “A” than others? That is, why isn’t the price the same for everyone?
Answers: some students are satisfied with less than an A; because an A might be earned more easily by some than others. The answers indicate that the benefits of an A are different for different students, and that the demand curve reflects the benefit of the good.

6. Market Demand for an “A”
4.2 How Do Buyers Behave? From Individual Demand Curves to Aggregated Demand Curves
Market Demand Curve ---The sum of the individual demand curves of all the potential buyers. The market demand curve plots the relationship between the total quantity demanded and the market price, holding all else equal.
4.2 How Do Buyers Behave? From Individual Demand Curves to Aggregated Demand Curves
Market Demand for an “A”

7. 4.2 How Do Buyers Behave? Shifting the Demand Curve
Remember your willingness to pay for an “A”?
What if you had copies of each one of the tests?
Would you be willing to pay more or less than before?
Comment: they are unwilling to pay as much for an “A” because now they have higher “wealth”.
4.2 How Do Buyers Behave? Shifting the Demand Curve
Shifts of the Demand Curve --- occur when one of the following changes:
1. tastes and preferences
2. income and wealth
3. availability and prices of related goods
4. number and scale of buyers
5. buyers’ expectations about the future

8. Demand Schedule Demand Schedule
Price
Quantity Demanded
$20 20
$30 16
$50 12
$100 7
$150 2
Demand Schedule
Price
Quantity Demanded
$20 10
$30 8
$50 5
$100 2
$150
With access to the tests, students would pay less for an A than before. This could also demonstrate what would happen if the Biology professor was also selling grades and announced that he/she was cutting the price of those grades. The effect on the demand for an A (if they are substitutes) would be a decrease.

9. 4.2 How Do Buyers Behave? Shifting the Demand Curve
Showing the shift of the demand curve in the opposite direction—if graduate schools suddenly announced that they were weighing the grades in economics class much more heavily than other courses.

10. 4.2 How Do Buyers Behave? Shifting the Demand Curve
Exhibit 4.4 Shifts of the Demand Curve vs. Movement Along the Demand Curve
There is a difference between changes in a good’s price and changes in the other factors that determine demand. When anything other than price changes, it shifts the curve = change in demand. When the price changes, it’s a movement along = change in quantity demanded.
Point out the difference between changes in a good’s price and changes in the other factors that determine demand. When anything other than price changes, it shifts the curve = change in demand. When the price changes, it’s a movement along = change in quantity demanded.

11. Exhibit 4.3 Market Demand Curve for Oil
4.2 How Do Buyers Behave?
Shifting the Demand Curve
Starting off with an example that is very personal to students (like willingness to pay for an “A”) is helpful in making the concepts relevant. Once this foundation is established, it is easier to then revisit the example presented in the book, the market for oil (and gasoline). Make the point that the same concepts are at work here, and that the reasons for the existence of demand are identical to the earlier example.
Exhibit 4.3 Market Demand Curve for Oil

12. Evidence-Based Economics Example:
4 What Would Happen If the Government Tried to Dictate the Price of Gasoline
Evidence-Based Economics Example:
How much more gasoline would people buy if its price were lower?
Return to the opening, evidence-based example.

13. A table that reports the quantity supplied at different prices.
4.3 How Do Sellers Behave?
Quantity Supplied
The amount of a good that sellers are willing to sell at a given price.
Supply Schedule
A table that reports the quantity supplied at different prices.
Supply Curve
Plots the quantity supplied at different prices.
As with constructing the demand schedule, call off prices, recording the quantity supplied at each price, developing a supply schedule.

14. Why is the price not the same for everybody?
4.3 How Do Sellers Behave?
Why are more of you willing to take off your clothes, the higher the price?
Why is the price not the same for everybody?
The positive slope - why it is the case that the higher the price, the more students are willing to take off their clothes. That is, why is the price not the same for everybody?
Answers: some are more willing to take risk, because some might be closet exhibitionists, because some don’t care what other people think, etc. All of these answers deal with the cost of taking off their clothes—for some the cost is low (those who have been waiting for just such a chance, for example), so they would require little payment. Others (more risk-averse, more shy) would require a higher price to cover the cost (embarrassment, etc.).

15. Market Supply for Classroom Nudity
4.3 How Do Sellers Behave?
Market Supply Curve -- Plots the relationship between the total quantity supplied and the market price, holding all else equal.
4.3 How Do Sellers Behave? From the Individual Supply to the Market Supply Curve
Market Supply for Classroom Nudity

16. Remember what price you required to take off your clothes in class?
4.3 How Do Sellers Behave? From the Individual Supply Curve to the Market Supply Curve
Remember what price you required to take off your clothes in class?
What if you were at a nudist beach?
Would you require more or less to take off your clothes at the beach?
Question: why your prices would be lower in the nudist beach situation. After all, naked is naked. Typical answers are since everyone else is naked, don’t feel so conspicuous, less risk, etc. Point them in the direction of cost—the cost of being naked has fallen in this situation.
Shifts of the Supply Curve = Occur when one of the following changes:
1. input prices
2. technology
3. number and scale of sellers
4. sellers’ expectations about the future

17. 4.3 How Do Sellers Behave? Shifting the Supply Curve
Shift of Supply Curve for Nudity
A reduction in cost graphically-- a decrease in input price, defined broadly. The shift could also reflect a change in technology—for example, if glasses were invented that could see through clothes.
Show this reduction in cost graphically--this shift could be an example of a decrease in input price, defined broadly. The shift could also reflect a change in technology—for example, if glasses were invented that could see through clothes.
When the market price changes, it’s a movement along the curve = change in quantity supplied; when one of the other factors change, it’s a shift in supply = change in supply.

18. 4.4 Supply and Demand in Equilibrium
Competitive Equilibrium ---The point at which the market comes to an agreement about what the price will be (competitive equilibrium price) and how much will be exchanged (competitive equilibrium quantity) at that price.
Excess Demand --- Occurs when consumers want more than suppliers provide at a given price. This situation results in a shortage.
Excess Supply -- Occurs when suppliers provide more than consumers want at a given price. This situation results in a surplus.

19. Exhibit 4.10 Demand Curve and Supply Curve for Oil
4.4 Supply and Demand in Equilibrium
Exhibit 4.10 Demand Curve and Supply Curve for Oil

20. 4.4 Supply and Demand in Equilibrium
Using the concept of incentive to change, point out that if price is at $140, producers have an incentive to produce 38 billion barrels of oil. But market exchanges are voluntary—suppliers can’t force consumers to buy. At $140, consumers only want 29 billion barrels. Since the short side of the market always prevails, the market quantity will only be 29, meaning that 9 billion barrels will have to be stockpiled. As oil inventories start building up, producers realize that they need to lower the price to encourage consumers to buy—they have an incentive to change (lower) price.
Exhibit 4.11 Excess Supply

21. 4.4 Supply and Demand in Equilibrium
In this case, if price is $60, consumers would like to purchase 44 billion barrels, but producers only want to produce 30 billion. Again, exchanges are voluntary, so the short side of the market will prevail, and only 30 billion will be exchanged on this market in the short run. But consumers will start competing with each other, bidding the price up until there is no longer any incentive to do so—i.e., until the excess demand is eliminated.
Exhibit 4.12 Excess Demand

22. It’s time to revisit the question:
4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
It’s time to revisit the question:
Why do brown eggs cost more than white eggs?
Why would brown eggs be more expensive to produce than white eggs?
Might suggest that a different kind of chicken lays them (which is correct)—if so, ask what difference that would make, remembering the factors that shift supply.
Reveal the complete answer—brown eggs are laid by Rhode Island Red chickens, which are larger (and therefore more expensive to feed) than regular chickens.
Remind students of the answers they gave when you first posed the question: that they are healthier or organic; that consumers want them more. Most of the answer will be about some aspect of demand, so explore that graphically.

23. 4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
The cost of producing brown eggs is higher. Which is correct—show that graphically.

24. Both the Demand Curve and Supply Curve Shift Right
4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
Both the Demand Curve and Supply Curve Shift Right
Think of each shift separately and ask yourself a series of questions:
--what shifts, demand or supply?
--does it shift to the right or to the left?
--what is the effect on price? On quantity?

25. The Demand Curve Shifts Right and the Supply Curve Shifts Left
4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
The Demand Curve Shifts Right and the Supply Curve Shifts Left
If demand shifts right (ignoring supply), price and quantity both increase
If supply shifts left (ignoring demand), price increases, but quantity decreases
Therefore, the effect of both shifts is unambiguous with respect to price, but indeterminate with respect to quantity

26. The Demand Curve Shifts Left and the Supply Curve Shifts Right
4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
The Demand Curve Shifts Left and the Supply Curve Shifts Right
In this case, if demand shifts left (ignoring supply), price will increase and quantity will decrease
If supply shifts right (ignoring demand), both price and quantity will increase.
Therefore, the effect of both shifts is that price will increase, but the effect on quantity depends upon the relative size of the shifts.
In this case, if demand shifts left (ignoring supply), price will increase and quantity will decrease
If supply shifts right (ignoring demand), both price and quantity will increase.
Therefore, the effect of both shifts is that price will increase, but the effect on quantity depends upon the relative size of the shifts.

27. Both the Demand Curve and the Supply Curve Shift Left
4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
Both the Demand Curve and the Supply Curve Shift Left
Finally, if demand shifts left (ignoring supply), both price and quantity decrease.
If supply shifts left (ignoring demand), price increases, but quantity decreases.
Therefore, the effect of both shifts is that price may increase or decrease, but quantity will definitely decrease.

28. Effects of Shifts of Demand and Supply
4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium
Effects of Shifts of Demand and Supply
Change in Supply
Change in Demand
Increase Demand
Decrease Demand
Increase Supply
Equil. P ?
Equil. Q
Equil. P
Equil. Q ?
Decrease Supply
Equil. Q ?

29. 4.5Alternative Example: “One more question: Why is there a parking problem on campus?”
Demand is greater than supply. Then ask what the market mechanism is for addressing situations where demand is greater than supply.
Then ask why that is not occurring in this case.
Answer: The price should increase to eliminate the excess demand.
There’s a parking problem is because they aren’t charged enough for parking—that if price were allowed to increase, it would—to equilibrium. They understand this conceptually, but are still rather grumpy about the outcome.