SUPPLY AND DEMAND Supply and Demand Market Participants

Document Sample
SUPPLY AND DEMAND Supply and Demand Market Participants Powered By Docstoc
					             Chapter 3:
        SUPPLY AND DEMAND
  What determines the price of a good or
   service?

  How does the price of a product affect its
   production of consumption?

  Why do prices and production levels often
   change?




                    Supply and Demand

Q Market Participants
Q The Circular Flow
Q Demand
Q Supply
Q Equilibrium
Q Market Outcomes



Supply and Demand                           Page 2




                    Market Participants

Q   Households
     » Try to maximize satisfaction
Q Firms
     » Try to maximize profits
Q   Government
     » Try to maximize general welfare of
       society


Supply and Demand                           Page 3
                              The Circular Flow

Q   The Two Markets
     » Product Market
        –   Where goods and services are exchanged
     » Factor Market
        –   Where factors of production are exchanged


Q   Dollars and Exchange
     » Money lubricants the wheels of exchange

Supply and Demand                                       Page 4




                              The Circular Flow
                             PRODUCT
Demand                       MARKET                  Supply
                              Goods
                              Service     Revenue
                     $
                                                    Business
    Households                                       Firms

                    Income               Payment
                             FACTOR
                             MARKET
                               Land
       Supply                                       Demand
                              Labor
                              Capital



Supply and Demand                                       Page 5




                                        Demand Side
Q    Quantity Demand (QD)
      » Amount of an item that buyers are
        willing and able to purchase at a certain
        price.
Q    Demand
      » The relationship between price and QD
Q    Law of Demand
      » There is a negative relationship between
        price and QD, ceteris paribus.

Supply and Demand                                       Page 6
                                              Demand Side
                                                    Demand Curve
      Demand Schedule
                                                  for Wheat Market
      for Wheat Market                        5

        Price       Q.D.                      4




                                 Price $/bu
           $/bu     Bu/wk                     3
            $1       10
                                              2                     Demand
           $2         8
           $3         6                       1

           $4         4                       0
                                                  0   2   4   6   8 10
           $5         2
                                                   Quantity Demanded
                                                      Bushels/wk

Supply and Demand                                                      Page 7




                                              Demand Side
Q   Determinants of Demand
    » Price of good (P)
    » Tastes and preferences (T)
    » Income (Y)
       –   Normal vs. Inferior good
    » Price of related goods (Pr)
       –   Substitutes vs. complements
    » Expectations about price and income (Exp)
    » Number of buyer (Nb)
Supply and Demand                                                      Page 8




                                              Demand Side
Q   QD is a function of...
       QD = f ( P, T, Y, Pr, Exp, Nb )
Q   Ceteris paribus
     » Everything else is held constant
    QD = f ( P, T, Y, Pr, Exp, Nb )
    QD = f ( P)
Q For the demand curve
     » QD is simply a function of price

Supply and Demand                                                      Page 9
                                          Demand Side

Q   Change in Quantity Demanded
     » Movement along the curve
     » Caused by a change in price


Q   Change in Demand
     » Shift in the entire curve
     » Caused by a change in “other things”


Supply and Demand                                                   Page 10




                                          Demand Side
                    Decrease in
                    quantity
                    demanded
        Price




                     Decrease in   Increase in

                        Demand            Demand


                                                                D1
                                                      Increase in
                                                 D0   quantity
                                         D2           demanded
                                                 Quantity

Supply and Demand                                                   Page 11




                                                 Supply Side
Q   Quantity Supplied (QS)
     » Amount of an item that sellers are
       willing and able to make available at a
       certain price.
Q   Supply
     » The relationship between price and QS
Q   Law of Supply
     » There is a positive relationship between
       price and QS, ceteris paribus.
Supply and Demand                                                   Page 12
                                                 Supply Side
     Supply Schedule                           Supply Curve
    for Wheat Market                         for Wheat Market
                                         5

       Price        Q.S.                 4                           Supply



                            Price $/bu
        $/bu        Bu/wk
                                         3
         $1           2
                                         2
         $2           4
                                         1
         $3           6
                                         0
         $4           8                      0    2   4   6   8 10

         $5          10                          Quantity Supplied
                                                   Bushels/wk

Supply and Demand                                                    Page 13




                                                 Supply Side

Q   Determinants of Supply
     » Price (P)
     » Costs of factor of production (C i)
     » Current technology (Tech)
     » Price of alternative output (P a)
     » Expectations about future prices (Exp)
     » Number of sellers (N s)


Supply and Demand                                                    Page 14




                                                 Supply Side
Q   QS is a function of...
      QD = f ( P, Ci, Tech, Pa,Exp,Ns )
Q   Ceteris paribus
     » Everything else is held constant
    QD = f ( P, Ci, Tech, Pa,Exp,Ns )
    QD = f ( P)
Q For the supply curve
     » QS is simply a function of price

Supply and Demand                                                    Page 15
                                                                   Supply Side

Q   Change in Quantity Supplied
      » Movement along the curve
      » Caused by a change in price


Q   Change in Supply
      » Shift in the entire curve
      » Caused by a change in “other things”


Supply and Demand                                                                           Page 16




                                                                   Supply Side
                                                                         Increase in
                                              S2                         quantity
                                                                         supplied
         Price
                                                                                            S1
                                                                         S0

                                                               Increase in
                         Decrease in

                           Supply                              Supply




                                    Decrease in
                                    quantity
                                    supplied
                                                                       Quantity

Supply and Demand                                                                           Page 17




                                                               Equilibrium
                                                                   Wheat Market
Price Q.D. Q.S.                                                                               Supply
$/bu    Bu/wk Bu/wk Difference                                 5                   4 bu.
                                                                                  surplus
 $1      10     2      8 bu.                                   4
                            shortage
                                                  Price $/bu




 $2        8        4         4 bu.                            3                       E
                            shortage
 $3        6        6      equilibrium                         2
                                                                               4 bu.
                             4 bu.                             1              shortage
 $4        4        8                                                                        Demand
                            surplus
                             8 bu.                             0
 $5        2        10
                            surplus                                0    2     4    6       8 10
                                                                          Quantity
                                                                         Bushels/wk

Supply and Demand                                                                           Page 18
                                Equilibrium
 Q   Surplus (Excess Supply)
     » QS exceeds QD
     » Signal that price is too high
     » Downward pressure on price


 Q   Shortage (Excess Demand)
     » QD exceeds QS
     » Signal that price is too low
     » Upward pressure on price
Supply and Demand                        Page 19




                                Equilibrium

 Q   Equilibrium
     » No tendency for change
     » QD = QS
     » No pressure on price




Supply and Demand                        Page 20




                    Changes in Equilibrium

Q    Changes in Equilibrium
     » Whenever there is a change in Demand
       and/or Supply


Q    Comparative Statics
     » Examination of impact of changes in
       demand and supply on equilibrium price
       and quantity

Supply and Demand                        Page 21
                      Changes in Equilibrium

     Impact of an
                                          Price
  Increase in Demand                                        Old Demand
                                          $/disc
 on Market Equilibrium                                                                                  Supply

                                                                                     E2
Chain of causation
                                                   15
Î Increase      in demand                                                    E1               New Demand
                                                   10
Î Shortage       at old price                                                      shortage

Î Increase      in price
Î Increase      in quantity supplied

                                                                             100 125
                                                                                 Quantity of Compact
                                                                                        Discs
                                                                                (thousands per month
Supply and Demand                                                                                    Page 22




                           Changes in Equilibrium

                                                                                              Old Supply
    Impact of an                              Price
                                              $/comp.                Demand
  Increase in Supply
on Market Equilibrium

                                                                                     E1
                                                                                           surplus
Chain of causation                                 1500
Î Increase in supply                                                                             New Supply
                                                   1200                                         E2
Î Surplus   at old price
Î Decrease       in price
Î Increase   in quantity demanded

                                                                                    12    15
                                                                                  Quantity of Computers
                                                                                  (thousands per month
Supply and Demand                                                                                    Page 23




                                           Comparative Statics
            Demand constant                             Demand increase                   Demand decrease
            P               S                           P                S                P                 S
  Supply                                                                      ÇQe
                                                                              ÇPe                           ÈQe
 Constant                                                                                                   ÈPe
                                                                             D1
                            D                                            D                         D1       D
                            Q                                        Q                                      Q
             P                  S
 Supply                                                 P                S                P        D            S
Increase                             S1                                      S1
                                                                                  ÇQe         D1
                                                                                                                    S1
                                      ÇQe                                         ?Pe                       ?Q e
                                      ÈPe                                    D1                             ÈPe
                                D                                        D
                             Q                                       Q                                       Q
                            S1                                  S1                                     S1
                P                S                                   S                    P                     S
 Supply                                             P                         ?Q e
                                     ÈQe                                                                    ÈQe
Decrease                             ÇPe                                      ÇPe                           ?Pe
                                                                             D1
                                 D                                   D                                              D
                                                                                                            D1
                                Q                                    Q                                       Q

Supply and Demand                                                                                    Page 24
                                             Price Controls

   Q   Price Ceiling
       » Attempt to help buyers
       » Sets maximum legal price
       » Decreases quantity supplied
       » Increases quantity demanded
       » Creates shortages
            –   Need nonprice rationing of shortage
            –   Creates “black markets”

  Supply and Demand                                                       Page 25




                                             Price Ceilings
Rent per room
dollars / month                                                     Supply




         300                                 E


                                                           Rent Ceiling
         150

                                                                     Demand

                              Shortage = 7,000 rooms/yr

                                                              Rooms rented per year
                      2   4   6    8    10       12   14          (thousands)
  Supply and Demand                                                       Page 26




                                             Price Controls

   Q   Price Floors
       » Attempt to help sellers
       » Sets minimum legal price
       » Increases quantity supplied
       » Decreases quantity demanded
       » Creates surplus
            –   Government may have to buy surplus



  Supply and Demand                                                       Page 27
                                                   Price Floors
  Price
  $/gallon                          Surplus                     Supply

       2.00
                              M                        L Price Floor

      1.50
                                              E




                                                                 Demand




                                                             Milk (billions of
                    20   40   60   80   100       120 140     gallons per yr
Supply and Demand                                                      Page 28

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:1
posted:9/7/2011
language:English
pages:10