Demand, Supply, & Market Equilibrium

1. Demand, Supply, & Market Equilibrium Chapter 3

2. Demand • A schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time • A statement of a buyer’s plans, or intentions, with respect to the purchase of a product

3. Law of Demand • Other-Things-Equal Assumption • As the Price (P) falls, the Quantity Demanded (QD) rises. (P↓ QD ↑) • As the Price (P) rises, the Quantity Demanded (QD) falls. (P↑ QD ↓) • Thus, there is an inverse (or negative) relationship between Price and Quantity Demanded.

4. Law of Demand • Common Sense • People do buy more at low prices • Sales!!! • Diminishing Marginal Utility • Each additional unit of the product produces less satisfaction (or benefit, or utility) • Income Effect • Lower prices increase the purchasing power of a buyer’s income • Substitution Effect • Lower prices give buyers the incentive to substitute similar products

5. 6 5 4 3 2 1 0 Price (per bushel) 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week) Individual Demand P Individual Demand P Qd $5 4 3 2 1 10 20 35 55 80 D Q

6. Determinants of Demand • Tastes • Favorable change in consumer tastes (preferences) = More Demanded at each price • Number of Buyers • Increase in number of buyers = Increase in Demand • Income • Normal (Superior) Goods – Demand Varies Directly with Income • Inferior Goods – Demand Varies Inversely with Income • Prices of Related Goods • Substitutes: Used in place of another good • Example: Leather vs. Cloth Coats • Complements: Used together with another good • Example: Computers & Software • Unrelated Goods: Not related at all • Example: Potatoes & Automobiles • Consumer Expectations

7. Determinants of Demand • Therefore, an Increase in Demand may be caused by: • A favorable change in consumer tastes/preferences • An increase in the number of buyers • Rising incomes if the product is a normal good • Falling incomes if the product is an inferior good • An increase in the price of a substitute good • A decrease in the price of a complimentary good • A new consumer expectation that either prices or income will be higher in the future

8. Individual Demand Demand Can Increase or Decrease P 6 5 4 3 2 1 0 Individual Demand Increase in Demand P Qd $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 D1 Decrease in Demand D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week)

9. Changes in Quantity Demanded • Not to be confused with Change in Demand • A shift of the demand curve to the right (increase in demand) or to the left (decrease in demand) • Cause: A change in one or more determinants of demand • Change in Quantity Demanded • A movement from one point to another point – from one price/quantity combination to another– on a fixed demand schedule/curve • Cause: An increase or decrease in the price of the product under consideration

10. Individual Demand Demand Can Increase or Decrease An Increase in Demand Means a Movement of the Line P 6 5 4 3 2 1 0 Individual Demand A Movement Between Any Two Points on a Demand Curve is Called a Change in Quantity Demanded P Qd $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 D1 Decrease in Demand D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week)

11. Supply • A schedule or curve showing the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period

12. Law of Supply • As the Price (P) falls, the Quantity Supplied (Qs) falls. (P↓ Qs ↓) • As the Price (P) rises, the Quantity Supplied (Qs) rises. (P↑ Qs ↑) • Thus, there is a direct (or positive) relationship between Price and Quantity Supplied. • Remember, the supplier is on the receiving end of the product’s price. Therefore, higher prices don’t pose the same obstacle on the supply side as they do on the demand side.

13. Individual Supply P 6 5 4 3 2 1 0 Individual Supply S1 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Q 10 20 30 40 50 60 70 Quantity Supplied (bushels per week)

14. Determinants of Supply • Resource Prices • Higher Resource Prices raise production costs & squeeze profits • Lower Resource Prices reduce production costs & increase profits • Technology • Improvements in technology enable firms to produce units of output with fewer resources • Taxes & Subsidies • Businesses treat most taxes as costs. • Increase in sales or property taxes will increase production costs & reduce supply • Subsidies are considered “taxes in reverse” • Thus, lower production costs/increase in supply

15. Determinants of Supply • Prices of other Goods • Substitution in Production • Example: Producing basketballs instead of soccer balls results in a decline in the supply of soccer balls • Producer Expectations • Future Prices of Products • Number of Sellers in the Market • Other things equal, the larger the number of suppliers, the greater the market supply • As more firms enter the industry, the supply curve shifts to the right • The smaller the number of suppliers, the less the market supply • As more firms leave the industry, the supply curve shifts to the left

16. Individual Supply Supply Can Increase or Decrease P 6 5 4 3 2 1 0 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Q 2 4 6 8 10 12 14 Quantity Supplied (bushels per week)

17. Changes in Quantity Supplied • Not to be confused with Change in Supply • A change in the schedule & shift of the curve • An increase in supply shifts curve to the right • A decrease in supply shifts curve to the left • Cause: A change in one or more of the determinants of supply • Change in Quantity Supplied • A movement from one point to another on a fixed supply curve • Cause: A change in the price of the specific product being considered

18. Individual Supply Supply Can Increase or Decrease A Movement Between Any Two Points on a Supply Curve is Called a Change in Quantity Supplied P 6 5 4 3 2 1 0 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) An Increase in Supply Means a Movement of the Line Q 2 4 6 8 10 12 14 Quantity Supplied (bushels per week)

19. Market Equilibrium • Equilibrium Price (PE) • Market Clearing Price • The price where the intentions of buyers & sellers match • QD = QS • Equilibrium Quantity • The quantity demanded & supplied at the equilibrium price in a competitive market • Competition among buyers & sellers drives the price to equilibrium • Surplus: Excess Supply • Shortage: Excess Demand

20. Market Equilibrium 200 Buyers & 200 Sellers Market Demand 200 Buyers Market Supply 200 Sellers 6 5 4 3 2 1 0 6,000 Bushel Surplus S P Qd P Qs $5 4 3 2 1 2,000 4,000 7,000 11,000 16,000 $5 4 3 2 1 12,000 10,000 7,000 4,000 1,000 $4 Price Floor Price (per bushel) 3 $2 Price Ceiling 7,000 Bushel Shortage D 7 2 4 6 8 10 12 14 16 18 Bushels of Corn (thousands per week)

21. Government-Set Prices • Price Ceilings • The maximum legal price a seller may charge for a product or service • Prices at or below the ceiling are legal • Prices above are not • Examples: Rent Controls • Sometimes leads to black markets & political pressure to lower prices • Price Floors • A minimum price fixed by the government • A price at or above the floor are legal • Prices below are not • Distort resource allocation

22. Efficient Allocation • Productive Efficiency • The production of any particular good in the least costly way • Example: Have $100 worth of resources • Can produce a bushel of corn using either $5 or $3 of those resources, leaving either $95 or $97 remaining for alternative uses • Which is better? • Allocative Efficiency • The particular mix of goods & services most highly valued by society (minimum cost production assumed) • Society wants iPods instead of cassette tapes • However, society also wants cell phones • Competitive markets help assign allocative efficiency

23. Equilibrium Price & Quantity • In competitive markets, produces an assignment of resources that is “right” from an economic perspective • Demand reflects MB based on utility received • Supply reflects MC of producing good • Remember: • MB>MC Expand Output • MB<MC Reduce Output • MB=MC Optimal Output

24. Changes in Supply, Demand, & Equilibrium • Changes in Demand • Supply Constant, Demand Increases • Raises PE and QE • See pg 57, Figure 3.7 a • Supply Constant, Demand Decreases • Reduces PE and QE • See pg 57, Figure 3.7b • Changes in Supply • Demand Constant, Supply Increases • Reduces PE, Increases QE • See pg 57, Figure 3.7c • Demand Constant, Supply Decreases • Increases PE, Reduces QE • See pg 57, Figure 3,7d

25. Changes in Supply, Demand, & Equilibrium • Complex Cases: (See pg. 57, Table 3.7) • Supply ↑ Demand ↓ PE ↓QE ? • Supply ↓ Demand ↑ PE ↑ QE ? • Supply ↑ Demand ↑ PE ? QE ↑ • Supply ↓ Demand ↓ PE ? QE ↓