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Chapter 4 Demand and Supply

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					    CHAPTER 4:

Demand and Supply
    Analysis
    CHAPTER CHECKLIST


1. Distinguish between quantity demanded and
   demand and explain what determines demand.
2. Distinguish between quantity supplied and supply
   and explain what determines supply.
3. Explain how demand and supply determine price
   and quantity in a market and explain the effects of
   changes in demand and supply.
4. Explain how price ceilings, price floors, and sticky
   prices cause shortages, surpluses, and
   unemployment.
   LECTURE TOPICS
Demand

Supply

Market Equilibrium

Price Rigidities
   MARKETS
A market is any arrangement that bring buyers and sellers
together.
   MARKETS
In this chapter, we study a simple model of a market: a
market that has so many buyers, all small relative to the
size of the market, and so many sellers, all small relative to
the size of the market, that no individual buyer or seller can
influence the price by their individual actions.


This is called a ―perfectly competitive market.‖
  4.1 DEMAND
Quantity demanded
  The amount of a good, service, or resource that people
  are willing and able to buy during a specified period at a
  specified price.
  The quantity demanded is an amount per unit of time.
  For example, the amount per day or per month.


  How much people want to buy, given the price.
 4.1 DEMAND



The Law of Demand
  Other things remaining the same, [―ceteris paribus‖]
    • If the price of a good rises, the quantity
      demanded of that good decreases.
    • If the price of a good falls, the quantity
      demanded of that good increases.
    • I.e., if something becomes more expensive,
      people want to buy less of it; if it becomes
      cheaper, people want to buy more of it.
  4.1 DEMAND
Demand Schedule and Demand Curve
  Demand
  The relationship between the quantity demanded and
  the price of a good when all other influences on buying
  plans remain the same.
  Demand is a list of quantities at different prices and is
  illustrated by the demand curve.
  ―Demand‖ means all the amounts people will want to
  buy at all possible different prices, everything else
  unchanged; it is the relationship between price and how
  much people want to buy.
4.1 DEMAND
Demand schedule
  A list of the quantities demanded at each different
  price when all the other influences on buying plans
  remain the same.
Demand curve
  A graph of the relationship between the quantity
  demanded of a good and its price when all other
  influences on buying plans remain the same; i.e. the
  graph of the good‘s own-price and how much people
  want to buy at each own-price.
4.1 DEMAND
   Economists have their own traditions ….


It is usual to draw graphs with the dependent
 variable on the y (vertical) axis and the
 independent variable on the x (horizontal) axis

Economics does it the other way round in
 demand and supply diagrams -- own-price
 determines the amount buyers want to buy, but
 own-price is on the vertical [y] axis.
   Why?


Economists started drawing [and publishing in
 books] supply and demand diagrams in the 19th
 century, before the standard y = f(x) convention
 was strongly established

The standard supply and demand diagrams are
 so firmly established, nobody dares try to
 change them to conform to what is standard in
 math, science, and engineering
  4.1 DEMAND
Changes in Demand
  Change in the quantity demanded
  A change in the quantity of a good that people plan to
  buy that results from a change in the price of the good.

  Change in demand
  A change in the quantities that people plan to buy [at
  various prices] when any influence other than the own-
  price of the good changes. In other words, a shift or
  change in the relationship between the price of the
  good and how much of it people want to buy.
      4.1 DEMAND


   When demand
   changes, the
   demand curve shifts.
1. When demand
   decreases, the
   demand curve shifts
   leftward from D0 to D1.

2. When demand
   increases, the demand
   curve shifts rightward
   from D0 to D2.
 4.1 DEMAND
The main influences on buying plans that change
demand are:
    • Prices of related goods
    • Income
    • Expectations
    • Number of buyers
    • Preferences
  Make a Mnemonic to remember:




Economists use “Y” for income a lot; so
Prices of related goods
Y -- income of [potential] buyers
Number of [potential] buyers
Tastes [preferences] of [potential] buyers
Expectations about the future
4.1 DEMAND
 Prices of Related Goods
  Substitute
  A good that can be consumed in place of another
  good. For example, apples and oranges.

  The demand for a good increases, if the price of one
  of its substitutes rises.
  The demand for a good decreases, if the price of
  one of its substitutes falls.
4.1 DEMAND
  Complement
  A good that is consumed with another good. For
  example, ice cream and fudge sauce.

  The demand for a good increases, if the price of
  one of its complements falls.
  The demand for a good decreases, if the price of
  one of its complements rises.
4.1 DEMAND
Income
  The demand for a normal good increases if income
  increases.
  The demand for an inferior good decreases if
  income increases.
4.1 DEMAND
Expectations
Expected future income and expected future prices
influence demand today.
For example, if the price of a computer is expected to
fall next month, the demand for computers today
decreases.
Number of Buyers
The greater the number of buyers in a market, the
larger is the demand for any good.
4.1 DEMAND
Preferences
When preferences change, the demand for one item
increases and the demand for another item (or items)
decreases.
Preferences change when:
  • People become better informed, or new
  information becomes available.
  • New goods become available.
  • Fashions [opinions] shift for some reason.
  • Advertisers succeed in influencing tastes.
   4.1 DEMAND


Demand: A Summary
  4.2 SUPPLY

Quantity supplied
The amount of a good, service, or resource that people
are willing and able to sell during a specified period at a
specified price – how much people want to sell at the
given price.
The Law of Supply
Other things remaining the same,
     • If the price of a good rises, the quantity supplied
       of that good increases. When price rises, people
     will want to sell more.
     • If the price of a good falls, the quantity supplied of
       that good decreases. If the good‘s price falls,
     people will want to sell less.
  4.2 SUPPLY
Supply Schedule and Supply Curve
  Supply
  The relationship between the quantity supplied of a good
  and the price of the good when all other influences on
  selling plans remain the same.


  Supply is a list of quantities at different prices and is
  illustrated by the supply curve, just like demand and the
  demand curve.
4.2 SUPPLY
 Supply schedule
 A list of the quantities supplied at each different price
 when all other influences on selling plans remains
 the same.
 Supply curve
 A graph of the relationship between the quantity
  supplied and the good‘s own-price when all other
 influences on selling plans remain the same. As with
 demand, this is the relationship between the
 amounts sellers will want to sell and the price of the
 good, other things constant.
4.2 SUPPLY
  4.2 SUPPLY
Changes in Supply
  Change in quantity supplied
  A change in the quantity of a good that suppliers plan
  to sell that results from a change in the price of the
  good.
  Change in supply
  A change in the quantities that suppliers plan to sell at
  all different prices when any influence on selling plans
  other than the own-price of the good changes; i.e. a
  change in the relationship between own-price and how
  much sellers want to sell caused by some change in
  something other than the good‘s price.
      4.2 SUPPLY
           4.2 SUPPLY

When supply changes,
the supply curve shifts.

1. When supply
   decreases, the supply
   curve shifts leftward
   from S0 to S1.

2. When supply
   increases, the supply
   curve shifts rightward
   from S0 to S2.
   4.2 SUPPLY
The main influences on selling plans that change supply
are:
      • Prices of related goods
      • Prices of resources and other Inputs
      • Expectations
      • Number of sellers
      • Productivity
  Things that shift supply ..



Prices of inputs used to make the good and
 of related outputs;
Expectations about future prices
Supplier numbers
Technology
4.2 SUPPLY


Prices of Related Goods
 A change in the price of one good can bring a change in the
 supply of another good.
 Substitute in production
 A good that can be produced in place of another good. For
 example, a truck and an SUV in an auto factory.
    • The supply of a good increases if the price of one of its
      substitutes in production falls.
    • The supply a good decreases if the price of one of its
      substitutes in production rises.
4.2 SUPPLY
Complement in production
A good that is produced along with another good. For
example, straw is a complement in production of wheat.
Manufacturing examples are hard to find except in
things like metal-refining.
   • The supply of a good increases if the price of one
     of its complements in production rises.
   • The supply a good decreases if the price of one of
     its complements in production falls.
4.2 SUPPLY
Prices of Resources and Other Inputs
 Resource and input prices influence the cost of
 production. And the more it costs to produce a good,
 the smaller will be supply of that good.
Expectations
   • Expectations about future prices influence supply.
   • Expectations of future input prices also influence
     supply.
4.2 SUPPLY
Number of Sellers
 The greater the number of sellers in a market, the
 larger is supply.
Productivity
 Productivity is output per unit of input.
 An increase in productivity lowers costs and increases
 supply.
  4.2 SUPPLY


 Supply: A Summary
   Supply and Market Structure


Remember, we ONLY talked about markets
 where there are many suppliers, all small
 compared to the market

With other market structures, there may not be a
 ‗supply curve‘ in a meaningful sense; ECO 2023
 will deal with those cases
  4.3 MARKET EQUILIBRIUM
Market equilibrium
 When the quantity demanded equals the
 quantity supplied—when buyers‘ and sellers‘
 plans are consistent.

Equilibrium price
 The price at which the quantity demanded
 equals the quantity supplied.

Equilibrium quantity
 The quantity bought and sold at the equilibrium
 price.
       4.3 MARKET EQUILIBRIUM


 Figure 4.5 shows the
 equilibrium price and
 equilibrium quantity.
1. Market equilibrium is
   at the intersection of
   the demand curve and
   the supply curve.
2. The equilibrium
   price is $1 a bottle.

3. The equilibrium
   quantity is 10 million
   bottles a day.
  4.3 MARKET EQUILIBRIUM



Price: A Market’s Automatic Regulator
  Law of market forces
     • When there is a shortage, the price tends to rise.
     • When there is a surplus, the price tends to fall.
  Surplus or Excess Supply
  The quantity supplied exceeds the quantity demanded.
  Shortage or Excess Demand
  The quantity demanded exceeds the quantity supplied.
      4.3 MARKET EQUILIBRIUM

Figure 4.6(a) market
achieves equilibrium.
At $1.50 a bottle:

1. Quantity supplied is 11
   bottles.
2. Quantity demanded is 9
   bottles.
3. There is a surplus.
4. Price falls until the
   market is in equilibrium.
      4.3 MARKET EQUILIBRIUM

Figure 4.6(b) market
achieves equilibrium.
At 75 cents a bottle:

5. Quantity demanded is
   11 bottles.
6. Quantity supplied is 9
   bottles.
7. There is a shortage.
8. Price rises until the
   market is in equilibrium.
      4.3 MARKET EQUILIBRIUM


Figure 4.7(a) shows the
effects of an increase in
demand.
1. An increase in demand
   shifts the demand curve
   rightward.
2. The price rises to restore
   market equilibrium.
3. Quantity supplied increases
   along the supply curve.
4. Equilibrium quantity
   increases.
      4.3 MARKET EQUILIBRIUM


Figure 4.7(b) shows the
effects of a decrease in
demand.
1. A decrease in demand shifts
   the demand curve leftward.

2. The price falls to restore
   market equilibrium.

3. Quantity supplied decreases
   along the supply curve.
4. Equilibrium quantity
   decreases.
  4.3 MARKET EQUILIBRIUM
Effects of Changes in Demand

  When demand changes:

    • The supply curve does not shift.

    • But there is a change in the quantity supplied –
      sellers change how much they want to sell,
      because price changes.

    • Price and quantity change in the same direction as
      the change in demand.
      4.3 MARKET EQUILIBRIUM


Figure 4.8(a) shows the
effects of an increase in
supply.
1. An increase in supply shifts
   the supply curve rightward.
2. The price falls to restore
   market equilibrium.
3. Quantity demanded
   increases along the supply
   curve.
4. Equilibrium quantity
   increases.
      4.3 MARKET EQUILIBRIUM


Figure 4.8(b) shows the
effects of a decrease in supply.

1. A decrease in supply shifts
   the supply curve leftward.
2. The price rises to restore
   market equilibrium.
3. Quantity demanded
   decreases along the supply
   curve.
4. Equilibrium quantity
   decreases.
   4.3 MARKET EQUILIBRIUM
 Effects of Changes in Supply

   When supply changes:

      • The demand curve does not shift.

      • But there is a change in the quantity demanded – buyers
        change how much they want to buy, because the price
        changes.

      • Price changes in the same direction as the change in
        supply.

      • Quantity changes in the opposite direction to the change in
        supply.
      4.3 MARKET EQUILIBRIUM


Figure 4.9(a) shows the
effects of an increase in
both demand and supply.

An increase in demand
shifts the demand curve
rightward and an increase
in supply shifts the supply
curve rightward.

1. Quantity increases.

2. Price might rise or fall.
   4.3 MARKET EQUILIBRIUM
Increase in Both Demand and Supply
     • Increases the equilibrium quantity.
     • The change in the equilibrium price is ambiguous
       because the:
        Increase in demand raises the price.
        Increase in supply lowers the price.
      4.3 MARKET EQUILIBRIUM


Figure 4.9(b) shows the
effects of a decrease in
both demand and supply.

A decrease in demand
shifts the demand curve
leftward and a decrease in
supply shifts the supply
curve leftward.

3. Quantity decreases.

4. Price might rise or fall.
   4.3 MARKET EQUILIBRIUM
Decrease in Both Demand and Supply
     • Decreases the equilibrium quantity.
     • The change in the equilibrium price is ambiguous
       because the:
        Decrease in demand lowers the price
        Decrease in supply raises the price.
      4.3 MARKET EQUILIBRIUM

Figure 4.10(a) shows the
effects of an increase in
demand and a decrease in
supply.

An increase in demand
shifts the demand curve
rightward, and a decrease
in supply shifts the supply
curve leftward.
1. Price rises.

2. Quantity might increase,
   decrease, or not change.
   4.3 MARKET EQUILIBRIUM
Increase in Demand and Decrease in Supply
     • Raises the equilibrium price.
     • The change in the equilibrium quantity is
       ambiguous because the:
        Increase in demand increases the quantity.
        Decrease in supply decreases the quantity.
       4.3 MARKET EQUILIBRIUM

Figure 4.10(b) shows the
effects of a decrease in
demand and an increase
in supply.

A decrease in demand
shifts the demand curve
leftward, and an increase
in supply shifts the supply
curve rightward.
3. Price falls.

2. Quantity might increase,
   decrease, or not change.
   4.3 MARKET EQUILIBRIUM
Decrease in Demand and Increase in Supply
     • Lowers the equilibrium price.
     • The change in the equilibrium quantity is
       ambiguous because the:
        Decrease in demand decreases the quantity.
        Increase in supply increases the quantity.
Kinds of Equilibrium
Market Equilibrium



 One of the neat things about the market is that the
  Demand and Supply model shows that market
  equilibrium is generally stable

 I.e., it is like

 If the ball moves a little, it will go back where it
  started; if conditions don‘t change, but price is
  perturbed [moved] a little from equilibrium, it will go
  back where it started.
4.4 PRICE RIGIDITIES
Price adjustments bring market equilibrium.
But sometimes prices do not adjust. What happens
then?
Three reasons why price adjustment might not occur
are:
   • Price ceiling
   • Price floor
   • Sticky price
  4.4 PRICE RIGIDITIES
Price Ceiling
  Price Ceiling
  The highest price at which it is legal to trade a particular
  good, service, or factor of production.

  Rent Ceiling
  A law that makes it illegal for landlords to charge a rent
  that exceeds a set limit.
    4.4 PRICE RIGIDITIES


Figure 4.11 shows a rental
apartment market.
1. Market equilibrium is
determined by demand and
supply.
2. The equilibrium rent is $550
a month.
3. The equilibrium quantity is
4,000 apartments.
    4.4 PRICE RIDIGITIES


Figure 4.12 shows a rental
apartment market.
The rent ceiling is introduced
below the equilibrium rent at
$400 a month.
The quantity of apartments
supplied decreases to 3,000.
The quantity for apartments
demanded increases to 6,000.
There is a shortage of 4,000
apartments.
  4.4 PRICE RIGIDITIES
Price Floor
  Price floor
  The lowest price at which it is legal to trade a particular
  good, service, or factor of production.

  Minimum wage law
  A government regulation that makes hiring labor for less
  than a specified wage illegal.
    4.4 PRICE RIGIDITIES


Figure 4.13 shows a market
for fast food servers.

1. Market equilibrium is
determined by demand and
supply.

2. The equilibrium wage
rate is $5 an hour.

3. The equilibrium quantity
is 5,000 servers.
      4.4 PRICE RIGIDITIES


Figure 4.14 shows how a
minimum wage creates
unemployment.

The minimum wage rate is
set at $7 an hour.
1. The quantity demanded
decreases to 3,000 workers.

2. The quantity supplied
increases to 7,000 workers.
3. A surplus of workers occurs
and 4,000 are unemployed.
  4.4 PRICE RIGIDITIES
Sticky Price
  In most markets, a law does not restrict the price.
  But in some markets, either the buyer and seller agree
  on a price for a fixed period or the seller sets a price
  that changes infrequently.
  In these markets, prices adjust slowly and not quickly
  enough to avoid shortages and surpluses.
Methodology

How to use Demand and Supply:

Identify the Ceteris Paribus variable(s)
 that changed.
Shift the Demand and/or Supply curve.
Find the new Equilibrium.
Make your prediction.
It will be qualitative – direction of
 change, not how much.

				
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