1. Demand, Supply and Market Equilibrium 03 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Markets Interaction between buyers and sellers Markets may be: Local National International Price is discovered in the interactions of buyers and sellers LO1 3-2

3. Demand Schedule or curve Amount consumers are willing and able to purchase at a given price Other things equal Individual demand Market demand LO1 3-3

4. Law of Demand Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. Reasons: Common sense Law of diminishing marginal utility Income effect and substitution effects LO1 3-4

5. 6 5 4 3 2 1 0 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week) Price (per bushel) PQdQd $5 4 3 2 1 10 20 35 55 80 P Q D The Demand Curve LO1 The Demand Curve 3-5

6. Market Demand LO1 Market Demand for Corn, Three Buyers Price per bushel Quantity Demanded Total Q d per week JoeJenJay $5 1012830 4 20231760 3 353926100 2 556039154 1 808754221 3-6

7. Changes in Demand LO1 6 5 4 3 2 1 0 Quantity Demanded (bushels per week) Price (per bushel) Individual Demand P Q D1D1 2 4 6 8 10 12 14 16 18 Demand Can Increase or Decrease Increase in Demand Decrease in Demand D2D2 D3D3 3-7

8. Changes in Demand LO1 6 5 4 3 2 1 0 Quantity Demanded (bushels per week) Price (per bushel) Individual Demand P Q D1D1 2 4 6 8 10 12 14 16 18 Demand Can Increase or Decrease Decrease in Demand D2D2 D3D3 Change in Demand Change in Quantity Demanded 3-8

9. Determinants of Demand Change in consumer tastes and preferences Change in number of buyers Change in income Normal goods Inferior goods LO1 3-9

10. Determinants of Demand Change in prices of related goods Complements Substitutes Change in consumers’ expectations Future prices Future income LO1 3-10

11. Substitutes Orange Juice—Grapefruit Juice Cab rides—Subway rides Chicken—Pork DVDs—Blue Ray disks Cane Sugar—Beet Sugar

12. Complements Game Consoles—Video Games Blue Ray Plays—High Definition TVs Airline Service—Rental Cars Bagels—Cream Cheese

13. Normal and Inferior Goods A normal good is a good for which demand increases (shifts right) when income increases. Examples: Scotch whiskey, Swiss-made watches, lobster, air travel, vacations abroad. An inferior good is a good for which demand decreases (shifts left) when income increases. Examples: macaroni, used clothing, bus service.

14. Determinants of Demand LO1 Table 3.1 Determinants of Demand: Factors That Shift the Demand Curve DeterminantExamples Change in buyers’ tastesPhysical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones. Change in the number of buyersA decline in the birthrate reduces the demand for children’s toys. Change in incomeA rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine. Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods). Change in consumer expectationsInclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans. 3-14

15. Supply Schedule or curve Amount producers are willing and able to sell at a given price Individual supply Market supply LO2 3-15

16. Law of Supply Other things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls. Reason: Price acts as an incentive to producers At some point, costs will rise LO2 3-16

17. The Supply Curve LO2 5 4 3 2 1 0 Price (per bushel) Quantity supplied (bushels per week) S 10 20 30 40 50 60 70 Supply of Corn Price per Bushel Q s per Week $5 60 4 50 3 35 2 20 1 5 P Q 3-17

18. Changes in Supply LO2 $6 5 4 3 2 1 0 Price (per bushel) S1S1 Quantity supplied (thousands of bushels per week) 2 4 6 8 10 12 14 16 P Q S2S2 S3S3 Increase in supply Decrease in supply 3-18

19. Changes in Supply LO2 $6 5 4 3 2 1 0 Price (per bushel) S1S1 Quantity supplied (thousands of bushels per week) 2 4 6 8 10 12 14 16 P Q S2S2 S3S3 Change in Quantity Supplied Change in Supply 3-19

20. Determinants of Supply A change in resource prices A change in technology A change in the number of sellers A change in taxes and subsidies A change in prices of other goods A change in producer expectations LO2 3-20

21. Determinants of Supply LO2 Table 3.2 Determinants of Supply: Factors That Shift the Supply Curve DeterminantExamples Change in resource pricesA decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline. Change in technologyThe development of more effective wireless technology increases the supply of cell phones. Change in taxes and subsidiesAn increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education. Change in prices of other goodsAn increase in the price of cucumbers decreases the supply of watermelons. Change in producer expectationsAn expectation of a substantial rise in future log prices decreases the supply of logs today. Change in the number of suppliersAn increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games. 3-21

22. Market Equilibrium Equilibrium occurs where the demand curve and supply curve intersect. Surplus and shortage Rationing function of prices Efficient allocation Productive efficiency Allocative efficiency LO3 3-22

23. Market Equilibrium LO3 6 5 4 3 2 1 0 2 4 6 8 10 12 14 16 18 Bushels of Corn (thousands per week) Price (per bushel) PQdQd $5 4 3 2 1 2,000 4,000 7,000 11,000 16,000 Market Demand 200 Buyers PQsQs $5 4 3 2 1 12,000 10,000 7,000 4,000 1,000 Market Supply 200 Sellers 200 Buyers & 200 Sellers 7 3 D S 6,000 Bushel Surplus 7,000 Bushel Shortage 3-23

24. Rationing Functions of Prices The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent. LO3 3-24

25. Efficient Allocation Productive efficiency Producing goods in the least costly way Using the best technology Using the right mix of resources Allocative Efficiency Producing the right mix of goods The combination of goods most highly valued by society LO3 3-25

26. ` Changes in Demand and Equilibrium LO4 0 P D4D4 D3D3 ` Changes in Demand and Equilibrium LO4 0 P D1D1 D2D2 S Increase in demand D increase: P , Q  D decrease: P , Q  Decrease in demand S 3-26

27. ` Changes in Demand and Equilibrium LO4 0 P D S4S4 ` Changes in Supply and Equilibrium LO4 S3S3 0 P D S2S2 S1S1 Increase in supply S increase: P , Q  S decrease: P , Q  Decrease in supply 3-27

28. Complex Cases LO4 TABLE 3.3 Effects of Changes in Both Supply and Demand Change in SupplyChange in Demand Effect on Equilibrium Price Effect on Equilibrium Quantity 1. IncreaseDecrease Indeterminate 2. DecreaseIncrease Indeterminate 3. IncreaseIncreaseIndeterminateIncrease 4. DecreaseDecreaseIndeterminateDecrease 3-28

29. 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′′

30. 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′′

31. Government Set Prices Price Ceilings Set below equilibrium price Rationing problem Black markets Examples: Rent controls, human organs, grain storage fees in some states. LO5 3-31

32. I believe increasing the minimum wage will cause unemployment among the unskilled and less- educated to rise

33. Government Set Prices LO5 S P Q D P0P0 PCPC Q0Q0 Shortage QdQd QsQs ceiling $3.50 3.00 3-33

34. Government Set Prices Price Floors Prices are set above the market price Chronic surpluses Example: Minimum wage laws, Department of Agriculture loan rates. LO5 3-34

35. Government Set Prices LO5 S P Q D P0P0 PfPf Q0Q0 Surplus QsQs QdQd floor 2.00 $3.00 3-35

36. P/BU bushels 0 #2 Hard KC Wheat S D 550700850 $2.52 $3.20 Surplus A price floor of $3.20 per bushel will produce a surplus of 300 bushels. But what if the floor were set at $2.35?

37. Legal Market for Human Organs What if we created a legal market for human organs? Positive effects Increase the incentive to donate Eliminate the persistent shortage of eyes, livers, hearts, kidneys, etc. 3-37

38. Legal Market for Human Organs Negative effects Increases the cost of medical care Diminishes the special nature of life by commercializing it 3-38