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Demand_ Supply_ and Market Equilibrium

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					Bell Ringer

        Explain the point that
        this political cartoon is
        making.
Demand, Supply, and Market
      Equilibrium

          CHAPTER 3
                  Supply and Demand
                                3

 Supply and demand is an economic model
   Designed to explain how prices are determined in certain types
    of markets
 The price of a good or service is what must be given
  in exchange for the good. Price measures the scarcity.
  Prices provide our economy with incentives to use
  scarce resources efficiently.
Why is the first car more expensive?
                          4


     $105,000                      $38,000




  1974 Pontiac Trans AM       2009 Pontiac Solstice
                            Markets
                                  5

 A market is a place (including the internet) where
 buyers and sellers are brought together to trade
 goods/services
    What are some examples of markets?
                  Buyers and Sellers
                              6

 Buyers and sellers in a market can be
   Households
   Business firms
   Government agencies
 All three can be both buyers and sellers in the same market,
  but are not always
 Usually we simplify our examples by saying:
   In markets for consumer goods, we’ll view business firms
    as the only sellers, and households as only buyers
   In most of our discussions, we’ll be leaving out the
    “middleman”
              Competition in Markets
                          7

 Perfectly  competitive markets have many small
  buyers and sellers, e.g., farmer’s market, big city
  hot dog market
  Each is a small part of the market, and the
    product is standardized, and each buyer and
    seller takes the market price as a given
 Imperfectly competitive markets have just a few
  large buyers and sellers, e.g., local electricity
  company
  The product of each seller is unique in some
    way, each buyer or seller has some influence
    over the price.
           Using Supply and Demand
                             8

 Supply and demand model is designed to explain
 how prices are determined in perfectly competitive
 markets
  Perfect competition is rare but many markets come
   reasonably close
  Perfect competition is a matter of degree rather than an
   all or nothing characteristic
 Supply and demand is one of the most versatile
 and widely used models in the economist’s tool kit
                       Demand
                             9

 Demand is the specific amount of a good that all
 buyers in the market are willing and able to buy
  Is there demand if I want a $7000 T.V. but only have
   $300 to spend?
  Is there demand if I have $5000 to spend on a fence but I
   don’t need a new fence?
                    Quantity Demanded
                                   10

 Implies a choice
   How much households would like to buy when they take into account
    the opportunity cost of their decisions?
 Is hypothetical
   Makes no assumptions about availability of the good
   How much would households want to buy, at a specific price, given
    real-world limits on their spending power?
 Stresses price
   Price of the good is one variable among many that influences
    quantity demanded
   We’ll assume that all other influences on demand are held constant,
    so we can explore the relationship between price and quantity
    demanded
                    The Law of Demand
                                   11

 States that when the price of a good rises and
 everything else remains the same, the quantity of
 the good demanded will fall (e.g., air travel,
 magazines, education, etc)
    The words, “everything else remains the same” are
     important
      In the real world many variables change simultaneously
      However, in order to understand the economy we must first
       understand each variable separately
      Thus we assume that, “everything else remains the same,” in order
       to understand how demand reacts to price
The Demand Schedule and The Demand
Curve               12

 Demand schedule
 A   list showing the quantity of a good that
    consumers would choose to purchase at different
    prices, with all other variables held constant
 The demand curve shows the relationship
  between the price of a good and the quantity
  demanded , holding constant all other variables
  that influence demand
   Each point on the curve shows the total buyers
    would choose to buy at a specific price
 Law of demand tells us that demand curves
  virtually always slope downward
Demand Schedule for Maple Syrup in U.S.A.
                     13

         Price            Quantity Demanded
      (per bottle)        (Bottles per Month)
        $1.00                  75,000

         2.00                  60,000

         3.00                  50,000

         4.00                  40,000

         5.00                  35,000
            Figure 1: The Demand Curve
                            14


Price per
   Bottle

                                  When the price is $4.00
                                  per bottle, 40,000
                                  bottles are demanded
                                  (point A).
                      A
  $4.00
                                             At $2.00 per bottle,
                                             60,000 bottles are
                                     B       demanded (point B).
    2.00

                                                       D

                   40,000        60,000           Number of Bottles
                                                       per Month
Shifts vs. Movements Along
The Demand Curve
                            15

 A change in the price of a good causes a
 movement along the demand curve
  A increase in price would cause a movement to the
   right along the demand curve
  A decrease in price will cause a movement to the left
   along the demand curve
Movements Along The Demand Curve
                  16


Price
             Price increase moves us
             leftward along demand
             curve
  P2
                       Price decrease moves us
                       rightward along
                       demand curve
  P1

  P3




        Q2   Q1        Q3              Quantity
 Shifts vs. Movements Along The Demand Curve
                                 17

 Changes such as more income and population
  growth lead to the line shifting on the graph
 Example:
    Demand curve has shifted to the right of the old curve as
     income has risen
    A change in any variable that affects demand—except for the
     good’s price—causes the demand curve to shift
   A Shift of The Demand Curve
                   18


 Price
  per                    An increase in income
Bottle                   shifts the demand curve for
                         maple syrup from D1 to D2.

                         At each price, more bottles
                         are demanded after the
                         shift

               B             C
$2.00

                        D1          D2



             60,000     80,000   Number of Bottles
                                      per Month
     Dangerous Curves: “Change in Quantity
      Demanded” vs. “Change in Demand”
                                    19

 Language is important when discussing demand
   “Quantity demanded” means
      A particular amount that buyers would choose to buy at a specific
       price
      It is a number represented by a single point on a demand curve
      When a change in the price of a good moves us along a demand
       curve, it is a change in quantity demand
    The term demand means
      The entire relationship between price and quantity demanded—
       and represented by the entire demand curve
      When something other than price changes, causing the entire
       demand curve to shift, it is a change in demand
Income: Factors That Shift The Demand
Curve             20

 An increase in income has effect of shifting demand
 for normal goods to the right
    However, a rise in income shifts demand for inferior goods to
     the left
    Examples: housing, automobiles, health club memberships, etc.
 A rise in income will increase the demand for a
 normal good, and decrease the demand for an
 inferior good (e.g. instant noodles).
Wealth: Factors That Shift The Demand
                Curve
                                 21

 Your wealth—at any point in time—is the total value
  of everything you own minus the total dollar amount
  you owe
 An increase in wealth will
    Increase demand (shift the curve rightward) for a normal good
    Decrease demand (shift the curve leftward) for an inferior
     good
     Prices of Related Goods: Factors that
            Shift the Demand Curve
                                22

 Substitute—good that can be used in place of some
 other good and that fulfills more or less the same
 purpose, e.g., different types of meat
    A rise in the price of a substitute increases the demand
     for a good, shifting the demand curve to the right
 Complement—used together with the good we are
 interested in, e.g., pancake mix and maple syrup
    A rise in the price of a complement decreases the demand
     for a good, shifting the demand curve to the left
   Other Factors That Shift the Demand
                  Curve
                                        23

 Population
   As the population increases in an area
        Number of buyers will ordinarily increase
        Demand for a good will increase
 Expected Price
   An expectation that price will rise (fall) in the future shifts the
    current demand curve rightward (leftward)
 Tastes
   Combination of all the personal factors that go into determining how
    a buyer feels about a good
   When tastes change toward a good, demand increases, and the
    demand curve shifts to the right
   When tastes change away from a good, demand decreases, and the
    demand curve shifts to the left
        Shifts of The Demand Curve
                    24


Price
                         Entire demand curve shifts
                         rightward when:
                         • income or wealth ↑
                         • price of substitute ↑
                         • price of complement ↓
                         • population ↑
                         • expected price ↑
                         • tastes shift toward good




                                          D2
                                 D1

                                               Quantity
        Shifts of The Demand Curve
                    25


Price
                         Entire demand curve shifts
                         left when:
                         • income or wealth ↓
                         • price of substitute ↓
                         • price of complement ↑
                         • population ↓
                         • expected price ↓
                         • tastes shift toward good




                                          D1
                                 D2

                                               Quantity
                   Supply
                       26

 Supply is the amount of a product that a
 producer/supplier is willing and able to
 produce
  If they want to produce it but don’t have
   the factors of production, then they can’t
   produce
  If they own the factors of production but
   don’t want to produce then they won’t…
                   The Law of Supply
                              27

 States that when the price of a good rises and
 everything else remains the same, the quantity of
 the good supplied will rise
    The words, “everything else remains the same” are
     important
       In the real world many variables change simultaneously
       However, in order to understand the economy we must
        first understand each variable separately
       We assume “everything else remains the same” in order
        to understand how supply reacts to price
               The Law of Supply
                         28

 Think about it this way…
  If you raise the price of jeans and people are
   knocking down the door to purchase them
   still…are you going to make more or less of
   them?
  If you drop the price what’s going to happen?

   Why?
   This is why we have clearance racks…
     The Supply Schedule and The Supply
                   Curve
                                  29

 Supply schedule—shows quantities of a good or
  service firms would choose to produce and sell at
  different prices, with all other variables held
  constant
 Supply curve—graphical depiction of a supply
  schedule
    Shows quantity of a good or service supplied at various prices,
     with all other variables held constant
                The Supply Curve
                               30



 Price   When the price is $2.00
  per    per bottle, 40,000 bottles
Bottle                                S
         are supplied (point F).


$4.00                                 G


                                          At $4.00 per bottle,
 2.00                      F              quantity supplied is
                                          60,000 bottles (point G).



                      40,000    60,000             Number of Bottles
                                                        per Month
 Movements Along the Supply Curve
                          31

 A change in the price of a good causes a movement
 along the supply curve
 A   rise (fall) in price would cause a rightward
   (leftward) movement along the supply curve
Changes in Supply and in Quantity
Supplied           32



  Price   Price increase moves                     S
          us rightward along
          supply curve

    P2




    P1
                                      Price decrease moves
                                      us leftward along
    P3                                supply curve



                Q3               Q1         Q2         Quantity
                  Shift in the Supply Curve
                                      33

 A drop in transportation costs will cause a shift in the
  supply curve itself
     Supply curve has shifted to the right of the old curve as
      transportation costs have dropped
 Input prices
   A fall (rise) in the price of an input causes an increase
    (decrease) in supply, shifting the supply curve to the right (left)
 Price of Related Goods
   When the price of an alternate good rises (falls), the supply
    curve for the good in question shifts rightward (leftward)
 Technology
   Cost-saving technological advances increase the supply of a
    good, shifting the supply curve to the right
 Factors That Shift the Supply Curve
                                 34

 Number of Firms
   An increase (decrease) in the number of sellers—with no other
    changes—shifts the supply curve to the right (left)
 Expected Price
   An expectation of a future price increase (decrease) shifts the
    current supply curve to the left (right)
 Factors That Shift the Supply Curve
                                    35

 Changes in weather
   Favorable weather
      Increases crop yields
      Causes a rightward shift of the supply curve for that crop

    Unfavorable weather
      Destroys crops
      Shrinks yields
      Shifts the supply curve leftward

 Other unfavorable natural events may effect all
 firms in an area
    Causing a leftward shift in the supply curve
         A Shift of The Supply Curve
                                      36



 Price    A decrease in transportation
  per     costs shifts the supply curve for
Bottle    maple syrup from S1 to S2.
                                                  S1           S2
          At each price, more bottles
          are supplied after the shift
 $4.00                                                     J
                                              G




                                           60,000      80,000 Number of Bottles
                                                                   per Month
Changes in Supply and in Quantity
Supplied           37



 Price   Entire supply curve shifts    S1
         rightward when:                       S2
         • price of input ↓
         • price of alternate good ↓
         • number of firms ↑
         • expected price ↑
         • technological advance
         • favorable weather




                                            Quantity
Changes in Supply and in Quantity
Supplied           38



 Price
         Entire supply curve shifts    S2
         rightward when:                      S1
         • price of input ↑
         • price of alternate good ↑
         • number of firms ↓
         • expected price ↑
         • unfavorable weather




                                            Quantity
Equilibrium: Putting Supply and
Demand Together 39
 When a market is in equilibrium
   Both price of good and quantity bought and sold have
    settled into a state of rest
   The equilibrium price and equilibrium quantity are
    values for price and quantity in the market but, once
    achieved, will remain constant
         Unless and until supply curve or demand curve shifts
 The equilibrium price and equilibrium quantity
  can be found on the vertical and horizontal axes,
  respectively
     At point where supply and demand curves cross
         Market Equilibrium
                   40



 Price
  per
Bottle
                            S


                     E
                            equilibrium price is $3.00
 $3.00
                                              .
             H
  1.00                          J
                                    D
            25,000 50,000 75,000        Number of Bottles
                                             per Month
    Excess Demand: Putting Supply and
            Demand Together
                                41

 Excess demand
   At a given price, the excess of quantity demanded over
    quantity supplied
 Price of the good will rise as buyers compete with
  each other to get more of the good than is available
                        Market Equilibrium
                                            42



        Price     2. causes the price            3. shrinking the
         per         to rise . . .                  excess demand . . .
       Bottle
                                                        S


                                              E
                                                        4. until price reaches its
         $3.00
                                                           equilibrium value of
                                                           $3.00            .
                                 H
          1.00                                              J
                                        Excess Demand
                                                                D
                                25,000 50,000 75,000                Number of Bottles
1. At a price of $1.00 per
                                                                         per Month
   bottle an excess demand of
   50,000 bottles . . .
     Excess Supply: Putting Supply and
             Demand43Together
 Excess Supply
   At a given price, the excess of quantity supplied over quantity
    demanded
 Price of the good will fall as sellers compete with
  each other to sell more of the good than buyers want
Excess Supply and Price Adjustment
                                      44



          1. At a price of $5.00 per
  Price      bottle an excess supply
   per       of 30,000 bottles . . .
 Bottle
                              Excess Supply at $5.00 S    3. shrinking the
                                                             excess supply . . .
 $5.00                                            L
                               K
          2. causes the
             price to drop,                E
   3.00                                               4. until price reaches its
                                                         equilibrium value of
                                                         $3.00.

                                                                      D
                              35,000 50,000 65,000         Number of Bottles
                                                                per Month
   Income Rises: What Happens When
                     Change
             Things 45
 Income rises, causing an increase in demand
   Rightward shift in the demand curve causes rightward
    movement along the supply curve
   Equilibrium price and equilibrium quantity both rise

 Shift of one curve causes a movement along the other
  curve to new equilibrium point
              When One Curve Shifts…
                                    46


          4. Equilibrium      3. to a new
 Price       price               equilibrium.
  per        increases
Bottle
                                                      2. moves us along
                                                S        the supply
                                                         curve . . .
 $4.00                                     F'
                                                          1. An increase in
  3.00                             E                         demand . . .

                                                                  D2

                                                         D1

                              50,000 60,000         Number of Bottles of
 5. and equilibrium                                    Maple Syrup per
    quantity increases too.                                      Period
   An Ice Storm Hits: What Happens When
               Things Change
                                     47

 An ice storm causes a decrease in supply
   Weather is a shift variable for supply curve
       Any change that shifts the supply curve leftward in a market will
        increase the equilibrium price
          And decrease the equilibrium quantity in that market
Figure 10: A Shift of Supply and A New
             Equilibrium
                    48


 Price
  per            S2         S1
Bottle
 $5.00          E'




  3.00                 E




                                      D

            35,000 50,000        Number of Bottles
                    Both Curves Shift
                               49

 When just one curve shifts (and we know the
  direction of the shift) we can determine the
  direction that both equilibrium price and quantity
  will move
 When both curves shift (and we know the direction
  of the shifts) we can determine the direction for
  either price or quantity—but not both
    Direction of the other will depend on which curve shifts
     by more
Changes in the Market for Handheld PCs
                                        50


  Price       3. moved the market to
     per         a new equilibrium.
Handhel
   d PC                                  2. and a decrease in
                                            demand . . .
  4. Price
     decreased . . .                                 S2002
                                                        S2003
                                         A
    $500                                                        1. An increase in
                                   B                               supply . . .
    $400

            5. and quantity                                         D2002
            decreased as well.                             D2003
                                 2.45   3.33       Millions of Handheld PCs
                                                                per Quarter
              The Three Step Process
                              51

 Key Step 1—Characterize the Market
   Decide which market or markets best suit problem being
    analyzed and identify decision makers (buyers and sellers)
    who interact there
 Key Step 2—Find the Equilibrium
   Describe conditions necessary for equilibrium in the
    market, and a method for determining that equilibrium
 Key Step 3—What Happens When Things Change
   Explore how events or government polices change market
    equilibrium
         Using Supply and Demand: The
                        of
               Invasion 52 Kuwait
 Why did Iraq’s invasion of Kuwait cause the price of
 oil to rise?
    Immediately after the invasion, United States led a worldwide
     embargo on oil from both Iraq and Kuwait
    A significant decrease in the oil industry’s productive capacity
     caused a shift in the supply curve to the left
        Price of oil increased
            The Market For Oil
                      53


Price per
Barrel of                       S2
      Oil                            S1


                 E'
      P2

      P1                    E



                                          D


                 Q2    Q1                     Barrels of Oil
         Using Supply and Demand: The
               Invasion of Kuwait
                                      54

 Why did the price of natural gas rise as well?
   Oil is a substitute for natural gas

   Rise in the price of a substitute increases demand for a good

   Rise in price of oil caused demand curve for natural gas to shift
    to the right
       Thus, the price of natural gas rose
     The Market For Natural Gas
                 55


   Price per
Cubic Foot of
     Natural                    S
         Gas


                           F'
           P4
                      F
           P3                               D2

                                      D1



                      Q3   Q4       Cubic Feet
                                    of Natural
                                          Gas

				
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