1. Unit Two Demand, Supply, and Market Equilibrium

2. Markets
Markets bring together buyers (demanders) and sellers (suppliers) in search of satisfaction.
A market can exist anywhere at anytime and be global, national or local. It may be face-to-face or digital. It may involve millions of participants or just two (consumer & producer.)
Markets work through a process of voluntary exchange and self-interest.
The law of supply and demand is based on a pure market economy with pure competition (large numbers of independently acting buyers & sellers of standardized products.)

3. Demand
Demand is a schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time.
We say “willing and able” because willingness alone is not effective in the market.
Consumers must be able as well. They must have the necessary dollars or use of credit.

4. The Law of Demand
The law of demand states that if all else is equal (ceteris paribus), as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls.
There is a negative or inverse relationship between the price and quantity demanded (downward slope of the demand curve.)
The law of demand is consistent with common sense. People typically buy more of a product at a low price than at a high price.
If the price changes, causing a change in the quantity demanded, the demand curve does not shift. It simply moves up or down the original demand curve placement.

5. The 3 Price Determinants of Quantity Demand
#1 The Income Effect: indicates that a lower price increases the “purchasing power” of a buyer’s money income (also known as real income.)
If income stays the same and the price level (CPI) increases, then real income or purchasing power goes down, causing a decrease in the quantity demanded (inflation).
If income stays the same and the price level (PL) decreases, then real income or purchasing power goes up, causing an increase in the quantity demanded (deflation or disinflation.)

6. The 3 Price Determinants of Quantity Demanded
#2 The Law of Diminishing Marginal Utilities: Every time an individual purchases a unit of a good or service they begin to move towards 100% total satisfaction.
Each additional (marginal) unit purchased moves them closer to total satisfaction, but brings less satisfaction than the previously purchased unit.
Eventually, the market will get to a place where it stops purchasing additional units (greater satisfaction from saving their income than spending it.)
If the market price goes down the market will get to that place where they stop buying additional units later (QD up.) If, the market price goes up, the market will get to that point sooner (QD down.)

7. The 3 Price Determinants of Quantity Demanded (QD)
#3 The Substitution Effect: suggests that at a lower price, buyers have the incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive.
The product whose price has fallen is now “a better deal” relative to the other products.
For example, a decline in the price of chicken will increase the QD of chicken, but decrease the “demand” for pork, lamb, beef, fish (substitutes.)

8. The Demand Curve
The inverse relationship between price and quantity demanded for any product can be represented on a simple graph.
Quantity demanded (QD) is measured on the horizontal axis and price on the vertical axis.
The downward slope reflects the inverse or negative relationship between the price and quantity demanded.

9. Non Price Determinants of Demand
Economists assume that price is the most important influence on the amount of product purchased.
But they know other non price factors can and do affect purchases.
These factors are known as determinants of demand or “demand shifters” (move the curve right or left.)
They are the “other things equal” in the relationship between price and quantity demanded.

10. 5 Non Price Determinants of Demand (Shifters)
#1 Consumers Tastes: A favorable change in consumer tastes or preferences for a product will increase demand at all prices (The Apple IPHONE) and cause the demand curve to shift to the right.
An unfavorable change in consumer preferences will decrease demand at all prices(HP no longer making PCs), shifting demand curve to the left.
New products may have a large impact on consumer taste. The introduction of digital cameras greatly decreased the demand for film cameras.

11. 5 Non Price Determinants of Demand (Shifters)
#2 Number of Buyers: An increase in the number of buyers in the market is likely to increase product demand and vice versa.
Population growth or decline of various geographic regions (urban flee) directly impacts the demand for products at all prices.
An increase in buyers at all prices will shift the demand curve to the right and a decrease in buyers at all prices, shift the demand curve to the left.

12. 5 Non Price Determinants of Demand (Shifters)
#3 Income: How income affects demand varies depending on the good or service.
Consumers typically buy more products when their income increases - direct relationship. (But there are exceptions).
Products whose demand varies directly with money income are called normal or superior goods (i.e. name brands).
Products whose demand varies inversely with money income are called inferior goods ( i.e. generic brands).

13. 5 Non Price Determinants of Demand (Shifters)
#4 Prices of Related Goods: A change in the price of a related good may either increase or decrease the demand for a product.
A substitute good is one that can be used “in place of” another good. When two products are substitutes, an increase in the price of one will increase the demand for the other. Conversely, a decrease in the price of one will decrease the demand for the other.
Complementary goods are “used together,” they are typically demanded jointly. If the price of a complement goes up, the demand for the related good will decline. Conversely, if the price of a complement falls, the demand for a related good will increase.
The vast majority of goods are unrelated or independent.

14. 5 Non Price Determinants of Demand (Shifters)
#5 Consumer Future Expectations: A newly formed expectation of higher future prices may cause consumers to buy now in order to “beat” the anticipated price rises, thus increasing current demand.
Similarly, a change in expectations concerning future income may prompt consumers to change their current spending. Which may either increase or decrease current demand.

15. Changes in Demand & Quantity Demanded
A change in demand must not be confused with a change in quantity demanded.
A change in demand is a shift of the demand curve to the right (increase) or to the left (decrease.) It occurs, because the consumer’s state of mind about purchasing the product has been altered in response to a change in one or more of the determinants of demand.
In contrast, a change in quantity demanded is a movement from one point to another point. The cause of such a change is an increase or decrease in the price of the product under consideration.

16. Supply
Supply is a schedule or curve showing the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period.
Firms may be willing, but not able to produce a product (time lags, resource availability, patent or copyright infringement.)

17. Law of Supply
The Law of Supply reflects a positive or direct relationship that prevails between price and quantity supplied.
As price rises, the quantity supplied rises; as price falls, the quantity supplied falls.
A supply schedule illustrates that firms will produce and offer for sale more of their product at a high price than at a low price.

18. Price & the Law of Supply
Price is an obstacle from the standpoint of the consumer, who is on the paying end. But the supplier is on the receiving end of the product’s price. Price represents revenue and therefore serves as an incentive.
The higher the price, the greater the incentive to produce, the greater the willingness to risk, and therefore the greater the quantity supplied (original and potential producers.)
Price and quantity supplied are directly related.

19. The Supply Curve
As with demand, it is convenient to represent individual supply graphically.
The upward slope of the supply curve reflects the law of supply.
Producers offer more of a good, service, or resource for sale as its price rises.
The relationship between price and quantity supplied is positive, or direct.

20. Determinants of Supply (Shifters)
In constructing a supply curve, it is assumed that price is the most significant influence on the quantity supplied of any product.
But other factors (“other things equal”) can and do affect supply.
These factors or determinants (other than price,) cause a change in supply and shift the entire supply curve.

21. 6 Non-Price Determinants of Supply (Shifters)
#1 Resource Prices: The prices of the resources or inputs used in the production process help determine the costs of production.
Higher resource prices raise production costs and reduce profits lessening the incentive to take risks, therefore decreasing supply (shift the supply curve to the left.) A “Supply Shock” may substantially drive up an input price.
In contrast, lower resource prices reduce production costs and increase profits, therefore increasing supply (shift to the right.)
Cost of a barrel of crude oil is a good example of this determinant.

22. 6 Non-Price Determinants of Supply (Shifters)
#2 Technology: Improvements in technology enable firms to produce units of output with fewer resources. 90’s “I.T.” boom led to substantial increases in productivity.
Fewer resources equates to a lower cost of production raising profit and increasing the supply of the product (shift right.)
Removing technology (D.D.T. in 1972) is highly unusual, but would increase the cost of production and decreasing supply (shift left.)

23. 6 Non-Price Determinants of Supply (Shifters)
#3 Taxes and Subsidies: Businesses count taxes as a cost of production (Role of Government ? )
An increase in sales, property or corporate taxes will increase production costs and therefore reduce supply.
If the government subsidizes the production of a good (“taxes in reverse”) it lowers the producers’ costs and increases supply (shift left).
Tax cuts are a major component of expansionary fiscal policy and are typically adhered to by conservatives and supply-siders.
Reaganomics (81-89) lowered tax rates significantly and the economy grew by an average GDP of 3.4%.
Believe excessive tax rates can reduce tax revenue.

24. 6 Non-Price determinants of Supply (Shifters)
#4 Prices of Other Goods: Firms that produce a particular product can sometimes use their plant to produce alternative goods.
Firms may shift production to a higher priced good to reap greater profits (substitution in production.)
Corn production up 24% and Soybean production down 18%, “The Ethanol Effect.”

25. 6 Non-Price Determinants of Supply (Shifters)
#5 Future Price Expectations of Producers: Changes in expectations about the future price of a product may affect the producer’s current willingness to supply that product.
It is difficult to generalize how future price expectations may impact current supply.
If wheat farmers expect prices to go up in the near future they may hold back some of their current harvest, decreasing supply.
On the other hand, expectations that a price will increase on a product may induce firms to add another shift of workers or expand their production facilities, causing current supply to increase.

26. 6 Non-Price Determinants of Supply (Shifters)
#6 Number of Sellers: Other things equal, the larger the number of suppliers, the greater the market supply.
As more firms enter an industry, the supply curve shifts to the right.
The smaller the number of firms in the industry, the less the market supply and the curve shifts to the left.
Pure Competition involves numerous independent firms (price takers) while a monopoly involves one firm (price maker).
Many industries are oligopolies, where a few major firms dominate the market ( 3 or 4 firms produce 80%).

27. Difference between Supply & “Quantity” Supplied
Remember, a change in supply means a change in the schedule and a shift of the curve (right or left.)
Changes in supply occur, because of a change in one or more non-price determinants.
In contrast, a change in quantity supplied is a movement from one point to another on a fixed supply curve.
An increase or decrease in the quantity supplied is caused by a change in the price of the specific product being considered.

28. Market Equilibrium Equilibrium Price & Quantity
The equilibrium price (market-clearing price) is the price where quantity demanded equals quantity supplied.
At equilibrium, there is neither a shortage nor a surplus, the market is cleared and everyone is satisfied (buyers and sellers.)
Competition among buyers and among sellers bids (moves) the price to the equilibrium price (balance.)
Non-Price Shifters in demand or supply (shifts to the curves) will change the equilibrium price.

29. Above the Equilibrium Price
At any above-equilibrium price, quantity supplied exceeds quantity demanded and the result is a market surplus.
Surpluses drive prices down by encouraging competing sellers to lower the price to attract buyers to take the surplus off their hands.
As the price falls, the incentive to produce decreases and the incentive to consume increases.
The market is always in search of the equilibrium price.

30. Below the Equilibrium Price
Any price below the equilibrium price will create a shortage (quantity demanded exceeds quantity supplied.)
The market price below the equilibrium price discourages sellers from devoting additional resources to production and encourages consumers to desire more goods than are available.
Consumers desiring to purchase the good at below equilibrium prices will compete for the good and drive up the price to equilibrium (helping to eliminate the shortage.)

31. Rationing Functions of Prices
The ability of the competitive forces of “supply and demand” to establish a price at which buying and selling decisions are made is called the “rationing function of prices.”
Command or centrally planned economies do not enjoy this “natural market force.”
Freely made individual decisions set a market-clearing price. “Laissez-faire” or “let it be.”

32. Efficient Allocation Productive & Allocative Efficiency
A competitive market not only rations goods to consumers, but also allocates society’s resources efficiently to the particular product.
Competition among producers results in “productive efficiency” (lowest cost of production) in an attempt to minimize cost (right mix of resources.)
Competitive markets also produce “allocative efficiency” (desired mix of goods) in search of the elusive “dollar votes” of consumers (consumer sovereignty.)

33. Government Manipulation of Market Prices (Price Controls)
Prices in most markets are free to rise or fall to their equilibrium levels, no matter how high or low those levels might be.
However, the government sometimes concludes that supply and demand will produce prices that are unfairly high for buyers or unfairly low for sellers.
The government may place legal limits on how high or low a price or prices may go.

34. Government Manipulation of Market Prices (Price Controls)
A price ceiling sets the maximum legal price a seller may charge for a good or service.
A price at or below the ceiling is legal; a price above it is not.
A price ceiling enables a consumer to obtain “essential” products which they may not be able to afford at the equilibrium price.
Examples are rent control (over 200 cities) and usury laws (Ohio 25%).
Price ceilings typically create “black markets” and shortages.

35. Government Manipulation of Market Prices (Price Controls)
A price floor is a minimum price fixed by the government. A price at or above the price floor is legal; a price below it is not.
Price floors or “supports” above the equilibrium prices are invoked when it’s believed resource suppliers or producers aren’t receiving sufficient income.
Supported prices for agricultural products and minimum wages are two examples of price floors.

36. Government Manipulation of Market Prices (Price Controls)
Possible consequences of price floors include surpluses and the distortion of resource allocation.
At any price above the equilibrium price, quantity supplied will exceed quantity demanded resulting in an excess of supply or surplus.
The government may respond to the surplus, by paying producers not to produce or by purchasing the surplus.
Resources will be allocated to those markets receiving the subsidies created by a price floor (soybeans to corn.)