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					     Demand and Supply                                    CHAPTER       4
               EYE ONS


Demand                   Law of Demand              Supply
Demand curve             Law of Market Forces       Supply curve
Demand Schedule          Law of Supply              Supply schedule
Quantity demanded        Minimum wage law           Quantity supplied
Change in demand                                    Change in supply
Change in quantity demanded                         Change in quantity supplied
Shortage/excess demand                              Shortage/excess supply
Equilibrium price        Complement                 Inferior Good
Equilibrium quantity     Complement in production   Normal Good
Market equilibrium       Substitute                 Price ceiling/cap
                         Substitute in production   Price floor
         Using Demand and Supply

             The demand and supply model
     is going to be a big part of the rest of your life!

1. You will use it again and again during your economics course.
   • D/S model is one of the major economic tools
   • Having a firm grasp of it will bring an immediate payoff.

2. You better appreciation how your economic world works
   • By understanding the laws of D/S
   • By being aware of how prices adjust to balance the two
      opposing forces

Example: When you hear someone complaining about a price hike
and blaming it on someone’s greed  think about
•The law of market forces and how demand and supply determine price
•You will know how supply and demand influence the price of clothing,
music, food, and many other items that you purchase
                                               What is
COMPETITIVE MARKETS                           a market?

In this chapter, we study a competitive market that has so
many buyers and so many sellers that no individual buyer
or seller can influence the price.
         CHAPTER 4

         Demand
• Law of Demand
   • # price = $ Qty Demanded
• Quantity Demanded:
   • Amount willing and able to BUY during a specific
     period at a specific price
   • Per unit of time (2 bottles a day)
• Demand
   • Relationship between Qty Demanded and Price
   • List of quantities at different prices
   • Portrayed as 1) schedule or 2) curve
DEMAND – Schedule and Curve
            CHAPTER 4

               Changes in Demand
• Change in Quantity Demanded:
    • Price change of given good results in a change in buying habits
• Change in Demand
    • Any Influence Other than Price results in a change in buying habits
        1. Price of related goods                  In Consumption

               • Substitute good – a good that can be consumed in the
                 place of another good
 Apples &         • # price of substitute good = $ Qty Dem for that good
 oranges
                  • # price of substitute good = # Demand for other good
               • Complement good – a good that can be consumed with
                 another good
 Ice cream &      • # price of complement good = $ Qty Dem for that good
  choc syrup
                  • # price of complement good = $ Demand for other good
         CHAPTER 4

          Changes in Demand
• Change in Quantity Demanded:
   • Price change of given good results in a change in buying habits
• Change in Demand
   • Any Influence Other than Price results in a change in buying habits
       2. Income
          • Normal good : # income = # demand             BMWs or
                                                        Ramon Noodles
          • Inferior good : # income = $ demand


       3. Expectations
          • Expected future prices #     = ‘buy it now’ = #demand
          • Expected future income #      = ‘take a vacation’
          CHAPTER 4

          Changes in Demand
• Change in Quantity Demanded:
   • Price change of given good results in a change in buying habits
• Change in Demand
   • Any Influence Other than Price results in a change in buying habits
       4. Number of Buyers
           • # # of buyers = # demand


       5. Preferences
               (Demand # for one item and $ for another item)
           • Better information: ‘Smoking’ # demand for cigarettes and $
             demand for nicotine patches
           • Introduction of new good: Introduction of MP3’s
               $ demand for CD’s, #demand for internet service
CHAPTER 4

  Changes in Demand
        A Change in the Demand for Roses

In a normal
month, the
price is $40 a
bouquet and
6 million
bouquets are
sold.
Valentine’s Day
in February the
demand for
roses increases
and the demand
curve shifts      In February, the equilibrium price rises and
rightward.        the equilibrium quantity increases.
           CHAPTER 4

           Supply
• Law of Supply
   • # price = # Qty Supplied
• Quantity Supplied:
   • Amount willing and able to SELL during a specific
     period of time at a specific price
   • Per unit of time (2 bottles a day)
• Supply
   • Relationship between Qty Supplied and Price
   • List of quantities at different prices
   • Portrayed as 1) schedule or 2) curve
SUPPLY – Schedule and Curve
             CHAPTER 4

               Changes in Supply
• Change in Quantity Supplied:
   • Price change of given good results in a change in selling plans
• Change in Supply
   • Any Influence Other than price results in a change in selling plans
                                                     In Production
          1. Price of related goods
               • Substitute good – a good that can be produced in the place of
  SUV
                 another good
    &             • # price of substitute good = # Qty Supplied for that good
  Truck
                  • # price of substitute good = $ Supply for other good
               • Complement good – a good that can be produced with
                 another good
   Cream &        • # price of complement good = # Qty Supplied for that
   Skim milk        good
                  • # price of complement good = # Supply for other good
           CHAPTER 4

           Changes in Supply
• Change in Quantity Supplied:
    • Price change of given good results in a change in
      selling plans
• Change in Supply
    • Any Influence Other than price results in a change in
      selling plans
Steel
Crisis   2. Prices of resources and other inputs
            • # price of resource = $ supply
                                                       Orange Juice
         3. Expectations                           Frost kills FL oranges

            • Expected future prices # = $ supply
            ‘suppliers stock up now to get future high prices’
         CHAPTER 4

          Changes in Supply
• Change in Quantity Supplied:
   • Price changes result in a change in Selling plans
• Change in Supply
   • Any Other Influence results in a change in selling plans
       4. Number of Sellers
          • # # of sellers= # supply
       5. Productivity – Output per unit of Input
          • Technological Change: $cost
              • Improvements = # productivity and #supply
          • Natural Events: #cost
              • hurricanes =$ productivity and $ supply
CHAPTER 4

  Changes in Supply
           A Change in the Supply of Flat Panel TVs

A few years ago,
the price of a 42-
inch flat panel TV
was $6,000.

Advances in
technology have
lowered the cost
of production
and the supply
increased.
The equilibrium      The equilibrium       The quantity
price decreased.     quantity increased.   demanded increased.
        CHAPTER 4

        Market Equilibrium
• Equilibrium is when  Qty Demanded = Qty Supplied
        CHAPTER 4

         Market Equilibrium
• Equilibrium is when  Qty Demanded = Qty Supplied
Shortage = excess demand                  Surplus = Excess supply




                           Shortage =
                           Price rises


                              Until
                           market is in
                           equilibrium


                            Surplus =
                            Price falls
          CHAPTER 4

           Effects of Changes in Demand
• When equilibrium is disturbed, the market immediately begins to adjust
  (short-term) and eventually arrives at a NEW equilibrium (long-term)
MARKET EQUILIBRIUM

Effects of Change in Demand … in action
  Event: A new zero-calorie sports drink is invented.
   To work out the effects on the market for bottled water:
  1. Does the event change demand or supply?
       •   The new drink is a substitute for bottled water, so the
           demand for bottled water changes
  2. Does the event Increase or Decrease demand or supply?
       •   The demand for bottled water decreases, the demand
           curve shifts leftward.
  3. What are the new equilibrium price and quantity and how have
     they changed (increase or decrease)?
       •   What are the new equilibrium price and equilibrium
           quantity and how have they changed?
MARKET EQUILIBRIUM – Bottled Water Market

Figure 4.7(b) shows the
outcome.
1. A decrease in demand
 shifts the demand curve
 leftward.
2. At $1.00 a bottle, there is a
 surplus, so the price falls.
3. Quantity supplied
 decreases along the
 supply curve.
4. Equilibrium quantity
 decreases.
MARKET EQUILIBRIUM

  When demand changes:

    • The supply curve does not shift.

    • But there is a change in the quantity supplied.

    • Equilibrium price and equilibrium quantity change
      in the same direction as the change in demand.
          CHAPTER 4

           Effects of Changes in Supply
• When equilibrium is disturbed, the market immediately begins to adjust
  (short-term) and eventually arrives at a NEW equilibrium (long-term)
MARKET EQUILIBRIUM

Effects of Change in Demand … in action
  Event: Drought dries up some springs in the United
     States.
   To work out the effects on the market for bottled water:
  1. Does the event change demand or supply?
       •   Drought changes the supply of bottled water.
  2. Does the event Increase or Decrease demand or supply?
       •   The supply of bottled water decreases, the supply curve
           shifts leftward.
  3. What are the new equilibrium price and quantity and how have
     they changed (increase or decrease)?
       •   What are the new equilibrium price and equilibrium
           quantity and how have they changed?
 MARKET EQUILIBRIUM – Bottled Water Market
Figure 4.8(b) shows the
outcome.
 1. A decrease in supply
    shifts the supply curve
    leftward.
2. At $1.00 a bottle, there
   is a shortage, so the
   price rises.
3. Quantity demanded
   decreases along the
   demand curve.
4. Equilibrium quantity
   decreases.
MARKET EQUILIBRIUM

  When supply changes:

    • The demand curve does not shift.

    • But there is a change in the quantity demanded.

    • Equilibrium price changes in the same direction
      as the change in supply.

    • Equilibrium quantity changes in the opposite
      direction to the change in supply.
        CHAPTER 4

        Changes in Both Demand and Supply
• We cannot say what happens to PRICE or QUANTITY
  without knowing the MAGNITUDE of the changes
    When two events occur at the same time,
      work out how each event influences the market:
    1. Does each event change demand or supply?
    2. Does either event increase or decrease demand or
       increase or decrease supply?
    3. What are the new equilibrium price and equilibrium
       quantity and how have they changed?
CHAPTER 4

Changes in Both Demand and Supply
CHAPTER 4

Changes in Both Demand and Supply
CHAPTER 4

Changes in Both Demand and Supply
CHAPTER 4

Changes in Both Demand and Supply
          CHAPTER 4

           Changes in Both Demand and Supply

                     SUPPLY CURVE   SUPPLY CURVE          SUPPLY CURVE
                     UNCHANGED      SHIFTS TO THE RIGHT   SHIFTS TO THE LEFT

DEMAND CURVE         Q unchanged    Q increases           Q decreases
UNCHANGED            P unchanged    P decreases           P increases

DEMAND CURVE                        Q increases           Q increases or
SHIFTS TO THE RIGHT Q increases     P increases or        decreases
                    P increases     decreases             P increases

DEMAND CURVE         Q decreases    Q increases or        Q decreases
SHIFTS TO THE LEFT   P decreases    decreases             P increases or
                                    P decreases           decreases
          CHAPTER 4

           Price Rigidities
• What happens if the Price does NOT adjust
     THREE COMMON REASONS WHY PRICE DOES NOT ADJUST

  • Price Floor – lowest LEGAL price to trade or sell a good,
    service or factor of production
  • Price Ceiling – highest LEGAL price to trade or sell a
    good, service or factor of production
  • Sticky Price – buyer and seller agree on price for a fixed
    period or seller infrequently changes price in given market
          CHAPTER 4

           Price Rigidities – Price Floor                Minimum
• What happens if the Price does NOT adjust               Wage
Price Floor [minimum wage]
                                   • Price Floor set ABOVE the
                                     equilibrium point DOES effect
                                     the market
                                   • Price Floor set BELOW the
                                     equilibrium point DOES NOT
                                     effect the market
                                   • Don’t forget to quantify the
                                     effects
                                       • Surplus of 4000 workers
           CHAPTER 4

            Price Rigidities – Price Ceiling             Rent Control
                                                           College
                                                           Tuition
• What happens if the Price does NOT adjust
Price Ceiling [parking spaces]
                                     • Price Floor set ABOVE the
                                       equilibrium point DOES NOT
                                       effect the market
                                     • Price Floor set BELOW the
                                       equilibrium point DOES effect
                                       the market
                                     • Don’t forget to quantify the
                                       effects
                                         • Shortage of 2000 parking
                                           spaces
        CHAPTER 4

         Price Rigidities – Sticky Prices
• Sticky Price = Buyer and Seller AGREE on a price for a
  PERIOD of time
   • Long-term contracts
   • Labor unions
   • Interest rates
   • Commodity trade
• Prices DO adjust but, NOT quick enough to avoid shortages
  and surpluses
       The Federal Minimum Wage

The federal government’s Fair Labor Standards Act sets the
minimum wage, but most states set their own minimum wage
rate at a higher level than the federal minimum.
       The minimum wage creates unemployment.
But how much unemployment does it create?
Until recently, most economists believed that a 10 percent
increase in the minimum wage rate decreased teenage
employment by between 1 and 3 percent.
       The Federal Minimum Wage

David Card and Alan Kruger claim that a rise in the minimum
wage rate increases the employment rate of low-income
workers.
They suggest three reasons:
   1. Workers become more conscientious and productive.
   2. Worker are less likely to quit, so costly labor turnover
      is reduced.
   3. Managers make a firm’s operations more efficient.
       The Federal Minimum Wage

But most economists are skeptical about these ideas.
They suggest:
   1. With labor more productive and lower turnover costs,
      firms would willingly pay a wage equal to the minimum
      wage.
   2. Firms anticipate a rise in the minimum wage, so they
      cut the number of workers ahead of the rise in the
      minimum wage. Unemployment does not increase
      after a rise in minimum wage rate.
   3. Looking at employment misses the effect on the supply
      of labor—a higher minimum wage increases the supply
      as people drop out of high school to look for work.
   CHAPTER 4
Analyzing the News
When Wal-Mart slashes prices or enters a new market the     Summary: Key Points in the Article
company has the same impact as an increase in supply as     Giant retailer Wal-Mart upended the market
shown above. A new market participant of that size forces   for flat-panel televisions last November
competitors to emulate and lower prices. However, profit    when it made the decision to drop price
margins get competed away to the point where the least      below the $1,000 mark for the 42-inch
efficient eventually go out of business.
                                                            screens. The impact on Wal-Mart was
                                                            minimal since the stores quickly sold
                                                            inventories and replenished with a flood of
                                                            new flat panels from new factories.
                                                            However the impact on the company’s
                                                            competitors was dramatic.
                                                            Circuit City Stores, Tweeter Home
                                                            Entertainment Group, and CompUSA have
                                                            all been forced to close stores and lay off
                                                            employees as the companies price-matched
                                                            Wal-Mart’s televisions. While Wal-Mart’s
                                                            move did catch some off guard, many
                                                            analysts pointed out the similar impact on
                                                            grocery store chains when Wal-Mart entered
                                                            the grocery business. Others noted that
                                                            several toy chains entered bankruptcy
                                                            largely due to Wal-Mart’s fierce price
                                                            cutting.
                                                            Wal-Mart maintains that consumers benefit
                                                            due to lower prices. Wal-Mart’s competitors
                                                            hope that at least a few customers will
                                                            continue to want their televisions installed
                                                            and might prefer a wider selection.
  CHAPTER 4
Analyzing the News                                     Summary: Key Points in the Article
A number of factors other than a change in price       The price of oil topped $72 a barrel on the
have impacted the potential supply of oil. These all   heels of news that eight foreign oil
culminate in a decrease in oil supply, or expected     workers were kidnapped from a Nigerian
decrease, and subsequent increase in the price of      oil drilling rig. Iran’s uncertain nuclear
oil.                                                   future also created additional uncertainty
                                                       about the political stability of another oil
                                                       rich region. Recent Nigerian militant
                                                       violence includes blowing up oil pipelines
                                                       and other acts of violence designed to
                                                       disrupt the country’s oil production.
                                                       To date, the Nigerian violence has resulted
                                                       in the shut-in of 500,000 barrels of oil per
                                                       day at a time when global production only
                                                       exceeds consumption by about two
                                                       million barrels of oil per day. Gasoline
                                                       futures surged as well due to a production
                                                       slowdown resulting from a Texas refinery
                                                       that sustained lightning-related fire
                                                       damage and subsequent disruption in
                                                       output.
                                                       Elsewhere, OPEC decided to leave its
                                                       output quotas unchanged. Growth in
                                                       global oil demand slowed a little but
                                                       remains strong with U.S. gasoline demand
                                                       up about one per cent over the same
                                                       period last year.
  CHAPTER 4
Analyzing the News                                      Summary: Key Points in the Article
Note that both the supply and demand shifts would       Cocoa futures are riding high due to drought,
result in a higher cocoa price taken in isolation.      political unrest, and changing consumer
Since all three factors have hit this market            tastes. Two major factors have combined to
simultaneously, it is not surprising that prices have   restrict the supply of cocoa; a drought in
risen as rapidly and are substantial increases.         Western Africa and civil unrest in the Ivory
                                                        Coast. The Ivory Coast is the planet’s biggest
                                                        producer of cocoa. The result is a 5.5% drop
                                                        in the production of cocoa over the previous
                                                        year. Cocoa prices have responded
                                                        accordingly and are near a three year high
                                                        with prices increasing by 44% since
                                                        November 2005.
                                                        The demand side is also affecting prices.
                                                        Consumer tastes have shifted toward darker
                                                        chocolates and dark chocolate requires more
                                                        cocoa to manufacture. The change in
                                                        preference is driven partially by health
                                                        reasons. Dark chocolates are higher in
                                                        antioxidants and considered to be healthier
                                                        than other chocolates. Some studies link dark
                                                        chocolate consumption to lower blood
                                                        pressure. Since dark chocolates are also
                                                        higher margin products, manufacturers have
                                                        been happy to oblige. However, the
                                                        combined effect of the supply and demand
                                                        factors is a certain recipe for higher cocoa
                                                        prices.
  CHAPTER 4
Analyzing the News                                    Summary: Key Points in the
Gold prices are being pushed by investor demand       Article
for gold increasing while at the same time jewelry    The rising price of gold as a
demand for gold is falling. The net impact, coupled   jewelry input has pushed many
with net supply changes due to lower mining           consumers to postpone jewelry
production and higher scrap production, has settled   purchases. The result is that
prices above the $900 mark. However, gold traders     gold traders are becoming more
are having difficulty forecasting direction and the   cautious about the current price
ultimate settling price.                              level until it is determined how
                                                      much of the current $900 price
                                                      is the result of inflation hedging
                                                      and how much is derived from
                                                      jewelry demand. Meanwhile
                                                      global output fell about 1
                                                      percent last year as production
                                                      costs increased.
                                                      Many traders indicate that
                                                      jewelers have evaporated from
                                                      the gold market. Meanwhile
                                                      many jewelry items are being
                                                      melted down and returned to
                                                      the market as scrap to take
                                                      advantage of the current high
                                                      prices. Much of the demand
                                                      appears to be investor driven as
                                                      stocks tumble and interest rates
                                                      fall.
  CHAPTER 4
Analyzing the News                                      Summary: Key Points in the Article
Note that at price P there are more toys demanded       Production problems, coupled with
than there are toys supplied. This shortage,            higher than expected consumer demand,
particularly in game consoles, can be best visualized   are contributing to shortages of certain
by the fact that some consumers are buying game         toys this holiday season. Many of the
consoles at store prices and selling them on Ebay       Chinese factories are experiencing labor
for a large profit. The Ebay price would be             shortages as high-tech job creation
equivalent to the price at equilibrium point A.
                                                        causes many Chinese to move off of the
                                                        assembly line. Power outages have also
                                                        contributed to lower productivity in the
                                                        manufacturing regions of southern
                                                        China. Unfortunately these problems
                                                        came at the wrong time and have limited
                                                        supplies of numbers of toys including
                                                        Sony’s PlayStation 3.
                                                        In addition to the supply problems,
                                                        consumer demand was underestimated.
                                                        Last year’s sales data were extrapolated
                                                        to this year and many retailers placed
                                                        very conservative orders. The limited
                                                        supply and underestimated demand has
                                                        created a real shortage of some toys. The
                                                        result is a hot secondary market on Ebay
                                                        for many toys such as the PlayStation 3
                                                        and Mattel’s TMX Elmo. The Elmo
                                                        retails for $40 but is fetching $65 on
                                                        Ebay.

				
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