C H A P T E R 4 Prepared by: Fernando and Yvonn Quijano © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 2 of 42 Perfectly Competitive Market supply and demand—the most important tool of economic analysis—the simplest! The model of supply and demand explains how a perfectly competitive market operates. A perfectly competitive market is a market has a very large number of firms, each of which produces the same standardized product in amounts so small that no individual firm can affect the market price.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 3 of 42 The Demand Curve Here is a list of variables that affect the individual consumer’s decision, using the pizza market as an example: The price of the product, for example, the price of pizza The consumer’s income The price of substitute goods such as pasta or satay

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 4 of 42 The Demand Curve Here is a list of variables that affect the individual consumer’s decision, using the pizza market as an example: The price of complementary goods such as beer or lemonade The consumer’s tastes and advertising that may influence tastes The consumer’s expectations about future prices

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 5 of 42 The Individual Demand Curve and the Law of Demand The demand schedule is a table that shows the relationship between price and quantity demanded by an individual consumer, ceteris paribus (everything else held fixed). Table 4.1 Al’s Demand Schedule for Pizza Price Quantity of pizzas per month $213 410 67 84 1

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 6 of 42 The Individual Demand Curve and the Law of Demand The individual demand curve is a graphical representation of the demand schedule. LAW OF DEMAND: The higher the price, the smaller the quantity demanded, ceteris paribus (everything else held fixed).LAW OF DEMAND: The higher the price, the smaller the quantity demanded, ceteris paribus (everything else held fixed).

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 7 of 42 The Individual Demand Curve and the Law of Demand Quantity demanded is the amount of a good an individual consumer or consumers as a group are willing to buy. A change in quantity demanded is a change in the amount of a good demanded resulting from a change in the price of the good. In this case, an increase in price causes a decrease in quantity demanded, and a movement upward along the individual’s demand curve.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 8 of 42 From Individual to Market Demand The market demand curve shows the relationship between price and quantity demanded by all consumers together, ceteris paribus (everything else held fixed).

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 9 of 42 The Supply Curve Here are the variables that affect the decisions of sellers, using the market for pizza as an example: The price of the product—in this case, the price of pizza. The cost of the inputs used to produce the product, for example, wages paid to workers, the cost of dough and cheese, and the cost of the pizza oven. The state of production technology, such as the knowledge used in making pizza.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 10 of 42 The Supply Curve Here are the variables that affect the decisions of sellers, using the market for pizza as an example: The number of producers—in this case, the number of pizzerias. Producer expectations about the future price of pizza. Taxes paid to the government or subsidies received from the government.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 11 of 42 The Individual Supply Curve and the Law of Supply A firm’s supply schedule is a table that shows the relationship between price and quantity supplied, ceteris paribus (everything else held fixed). Table 4.2 Nora’s Schedule for Pizza PriceQuantity of pizzas per month $4100 6200 8300 10400 12500

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 12 of 42 The Individual Supply Curve and the Law of Supply The individual supply curve is a graphical representation of the supply schedule. Its positive slope reflects the law of supply. LAW OF SUPPLY: The higher the price, the larger the quantity supplied, ceteris paribus.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 13 of 42 Quantity supplied is the amount of a good an individual firm or firms as a group are willing to sell. A change in quantity supplied is a change in the amount of a good supplied resulting from a change in the price of the good; represented graphically by a movement along the supply curve. The Individual Supply Curve and the Law of Supply In this case, an increase in price causes an increase in quantity supplied and a movement upward along the supply curve.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 14 of 42 Why is the Individual Supply Curve Positively Sloped? To determine how much to produce, the individual firm chooses the quantity of output that satisfies the marginal principle. Marginal PRINCIPLE Increase the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible, pick the level at which the activity’s marginal benefit equals its marginal cost.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 15 of 42 The Marginal Principle and the Output Decision The marginal benefit of selling a pizza is the price received when the pizza is sold. Marginal cost is the cost of producing an additional pizza. The marginal cost of producing the first 299 pizzas is less than the $8 marginal benefit. The marginal principle is satisfied when 300 pizzas are produced.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 16 of 42 The Marginal Principle and the Output Decision An increase in the price shifts the marginal benefit curve upward and increases the quantity at which the marginal principle is satisfied.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 17 of 42 From Individual Supply to Market Supply The market supply curve shows the relationship between price and quantity supplied by all producers together, ceteris paribus (everything else held fixed). If there are 100 identical pizzerias, market supply equals 100 times the quantity supplied by a single firm at each price level.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 18 of 42 Market Equilibrium Market equilibrium is a situation in which the quantity of a product demanded equals the quantity supplied, so there is no pressure to change the price.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 19 of 42 Excess Demand Causes the Price to Increase Excess demand is a situation in which, at the prevailing price, consumers are willing to buy more than producers are willing to sell. The market moves upward along the demand curve, decreasing quantity demanded, and upward along the supply curve, increasing quantity supplied.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 20 of 42 Excess Supply Causes the Price to Drop Excess supply is a situation in which, at the prevailing price, producers are willing to sell more than consumers are willing to buy. The market moves downward along the demand curve, increasing quantity demanded, and downward along the supply curve, decreasing quantity supplied.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 21 of 42 Market Effects of Changes in Demand A change in price causes a change in quantity demanded. A change in demand (caused by changes in something other than the price of the good) shifts the entire demand curve. Change in Quantity Demanded versus Change in Demand

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 22 of 42 Increases in Demand An increase in demand shifts the market demand curve to the right. At the initial price of $8, there is now excess quantity demanded. Equilibrium is restored at point n, with a higher equilibrium price and a larger equilibrium quantity.Equilibrium is restored at point n, with a higher equilibrium price and a larger equilibrium quantity.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 23 of 42 Causes of an Increase in Demand An increase in demand can occur for several reasons: An increase in income (for a normal good). A normal good is a good that consumers buy more of when their income increases. Most goods fall in this category.An increase in income (for a normal good). A normal good is a good that consumers buy more of when their income increases. Most goods fall in this category. A decrease in income (for an inferior good). An inferior good is the opposite of a normal good. Consumers buy more of inferior goods when their income decreases.A decrease in income (for an inferior good). An inferior good is the opposite of a normal good. Consumers buy more of inferior goods when their income decreases.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 24 of 42 Causes of an Increase in Demand An increase in demand can occur for several reasons: A decrease in the price of a complementary good. Two goods are complements when an increase in the price of one good decreases the demand for the other good.A decrease in the price of a complementary good. Two goods are complements when an increase in the price of one good decreases the demand for the other good. An increase in the price of a substitute good. When to goods are substitutes, an increase in the price of one good increases the demand for the other good.An increase in the price of a substitute good. When to goods are substitutes, an increase in the price of one good increases the demand for the other good.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 25 of 42 Causes of an Increase in Demand An increase in demand can occur for several reasons: An increase in populationAn increase in population A shift in consumer tastesA shift in consumer tastes Favorable advertisingFavorable advertising Expectations of higher future pricesExpectations of higher future prices

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 26 of 42 Decreases in Demand A decrease in demand shifts the demand curve to the left. At the initial price of $8, there is now an excess supply. Equilibrium is restored at point n, with a lower equilibrium price ($6) and a smaller equilibrium quantity (20,000 pizzas).Equilibrium is restored at point n, with a lower equilibrium price ($6) and a smaller equilibrium quantity (20,000 pizzas).

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 27 of 42 Decreases in Demand A decrease in demand can occur for several reasons: A decrease in income (for a normal good)A decrease in income (for a normal good) A decrease in the price of a substitute goodA decrease in the price of a substitute good An increase in the price of a complementary goodAn increase in the price of a complementary good A decrease in populationA decrease in population A shift in consumer tastesA shift in consumer tastes Favorable advertisingFavorable advertising Expectations of lower future pricesExpectations of lower future prices

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 28 of 42 Market Effects of Changes in Demand Table 4.3 Changes in Demand Shift the Demand Curve (pg. 1) An increase in demand shifts the demand curve to the right when: A decrease in demand shifts the demand curve to the left when: The good is normal and income increases The good is normal and income decreases The good is inferior and income decreases The good is inferior and income increases The price of a substitute good increases The price of a substitute good decreases The price of a complementary good decreases The price of a complementary good increases

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 29 of 42 Market Effects of Changes in Demand Table 4.3 Changes in Demand Shift the Demand Curve (pg. 2) An increase in demand shifts the demand curve to the right when: A decrease in demand shifts the demand curve to the left when: Population increasesPopulation decreases Consumer tastes shift in favor of the product Consumer tastes shift away from the product Consumers expect a higher price in the future Consumers expect a lower price in the future

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 30 of 42 Market Effects of Changes in Supply A change in price causes a change in quantity supplied. A change in supply (caused by changes in something other than the price of the good) shifts the entire supply curve. Change in Quantity Supplied versus Change in Supply

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 31 of 42 Increases in Supply An increase in supply shifts the market supply curve to the right. At the initial price of $8, there is now excess supply. Equilibrium is restored at point n, with a lower equilibrium price and a larger equilibrium quantity.Equilibrium is restored at point n, with a lower equilibrium price and a larger equilibrium quantity.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 32 of 42 Causes of an Increase in Supply An increase in supply can occur for several reasons: A decrease in input costs.A decrease in input costs. An increase in the number of producers.An increase in the number of producers. Expectations of lower future prices.Expectations of lower future prices. Product is subsidized.Product is subsidized.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 33 of 42 Decreases in Supply A decrease in supply shifts the supply curve to the left. At the initial price of $8, there is now an excess demand. Equilibrium is restored at point n, with a higher equilibrium price ($10) and a smaller equilibrium quantity (23,000 pizzas).Equilibrium is restored at point n, with a higher equilibrium price ($10) and a smaller equilibrium quantity (23,000 pizzas).

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 34 of 42 Causes of a Decrease in Supply A decrease in supply can occur for several reasons: An increase in input costs.An increase in input costs. A decrease in the number of producers.A decrease in the number of producers. Expectations of higher future prices.Expectations of higher future prices. Taxes. If a tax per unit is imposed, which will make the product less profitable, firms will produce less.Taxes. If a tax per unit is imposed, which will make the product less profitable, firms will produce less.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 35 of 42 Market Effects of Changes in Supply Table 4.4 Changes in Supply Shift the Supply Curve An increase in supply shifts the supply curve to the right when: A decrease in supply shifts the supply curve to the left when: The cost of an input decreasesThe cost of an input increases A technological advance decreases production cost The number of firms increasesThe number of firms decreases Producers expect a lower price in the future Producers expect a higher price in the future Product is subsidizedProduct is taxed

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 36 of 42 Market Effects of Simultaneous Changes in Supply and Demand The equilibrium price will decrease and the equilibrium quantity will increase. Both the equilibrium price and the equilibrium quantity will increase.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 37 of 42 Using the Model to Predict Changes in Price and Quantity An increase in university enrollment will increase the demand for apartments, shifting the demand curve to the right. Both the equilibrium price and the equilibrium quantity will increase. A report of pesticide residue on apples decreases the demand for apples, shifting the demand curve to the left. Both the equilibrium price and the equilibrium quantity will decrease. Predicting the Effects of Changes in Demand

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 38 of 42 Using the Model to Predict Changes in Price and Quantity Technological innovation decreases production costs, shifting the supply curve to the right. The equilibrium price decreases, and the equilibrium quantity increases. Bad weather decreases the supply of coffee beans, shifting the supply curve to the left. The equilibrium price increases, and the equilibrium quantity decreases. Predicting the Effects of Changes in Supply

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 39 of 42 Explaining Changes in Price or Quantity At the same time the quantity increased, the price decreased. Therefore, the increase in consumption resulted from an increase in supply, not an increase in demand. At the same time the price decreased, the quantity decreased. Therefore, the decrease in price was caused by a decrease in demand, not an increase in supply.

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 40 of 42 The Market of Love How many are looking for true love? Opportunities for Love Value of Love eros phileo agape D S

C H A P T E R 4: Supply, Demand, and Market Equilibrium C H A P T E R 4: Supply, Demand, and Market Equilibrium © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin 41 of 42 Key Terms perfectly competitive market perfectly competitive market demand schedule demand schedule individual demand curve individual demand curve quantity demanded quantity demanded law of demand law of demand change in quantity demanded change in quantity demanded substitution effect substitution effect income effect income effect market demand curve market demand curve supply schedule supply schedule quantity supplied quantity supplied change in quantity supplied change in quantity supplied market supply curve market supply curve market equilibrium market equilibrium excess demand excess demand excess supply excess supply change in demand change in demand normal good normal good substitute good substitute good complementary good complementary good inferior good inferior good change in supply change in supply

C H A P T E R 4 Prepared by: Fernando and Yvonn Quijano © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin.

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C H A P T E R 4 Prepared by: Fernando and Yvonn Quijano © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin.

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Presentation on theme: "C H A P T E R 4 Prepared by: Fernando and Yvonn Quijano © 2006 Prentice Hall Business Publishing Economics: Principles and Tools, 4/e O’Sullivan/ Sheffrin."— Presentation transcript:

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