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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
"Demand_ Supply_ and Market Equilibrium"