Supply and Demand

1. Supply and Demand • Supply and Demand is the essential issue of economics. • Economic agents: Households • Economic agents: Business firms • Markets for Outputs (products) • Markets for Inputs (factors)

2. The framework of an economy

3. Price and Quantity • Quantity and Price The most important information of our interest in the market

4. Price and quantity demanded • Quantity demanded is the number of units households are willing to buy.

5. Price and Quantity Demanded • “Law of demand” • We generally believe that there is an inverse relationship between price and quantity demanded. If price goes up, then quantity demanded goes down, and vice versa • P ----→ Qd  • P ----→ Qd 

6. Demand schedule and demand curve • Demand schedule and demand curve shows the relationship between quantities demanded and prices of a good. • It is in general downward sloping. (Its slope is negative)

7. Demand curve

8. P ($) 1.50 2000 0 Find quantity demanded at each price from the demand curve Demand for milk 1.00 3000

9. Movement versus Shift in Demand • Movement along the demand curve If there is a change in the own price, whereas other determinants (shifters) of demand remain unchanged, it just produces a movement along the demand curve. • Shift in the demand curve If instead there is a change in the determinants (shifters) other than the price, then at each price we observe that the quantity demanded increases or decreases, which is a shift in the demand curve.

10. Shifters of demand • Income • Consumer preferences (taste) • Prices of related goods (substitutes and complements) • Population size • Expectations

11. Difference between Demand and Quantity Demanded • Demand refers to the entire demand curve • Quantity demanded refers to a point on the demand curve • Change in Demand: Shift • Change in Quantity demanded: likely to be a movement

12. Supply • Quantity supplied is the number of units firms are willing to supply (sell). • “Law of Supply” • There is a direct relationship between price and quantity supplied. P ----→ Qs  P ----→ Qs 

13. Supply curve • The supply curve shows the relationship between quantities supplied and prices of a good. It is upward sloping (its slope is positive)

14. P ($) 1.50 3000 0 Supply of milk Supply of Milk S 1.00 4500

15. Movement and Shift in Supply • Movement along the supply curve If there is a change in the own price, whereas other determinants (shifters) of quantity supplied remain unchanged, it just produces a movement along the supply curve. • Shifts of the supply curve If instead there is a change in the determinants (shifters) other than the price, then at each price we observe that the quantity supplied increases or decreases, which is a shift in the supply curve.

16. Shifters of Supply • Prices of inputs • Technological progress • Changes in natural resource endowment and production capacity • Size of the industry • Price of related outputs

17. Difference between Supply and Quantity Supplied • Supply refers to the entire supply curve • Quantity supplied refers to a point on the supply curve • Change in Supply: Shift • Change in Quantity supplied: likely to be a movement

18. Place Supply and Demand together • Analyze how the supply and demand together determines the market price and quantity transacted.

19. P S P* D 0 Q The Supply and Demand Diagram Q*

20. Equilibrium • The point where the supply and demand curves intersect is called equilibrium. At the point quantity demanded equals quantity supplied. • Equilibrium is the state where quantity demanded equals quantity supplied.

21. Equilibrium price and equilibrium quantity • Equilibrium price and equilibrium quantity The price at the equilibrium is called equilibrium price and the quantity in the equilibrium is called equilibrium quantity. • Equilibrium price and quantity are the prevailing price and quantity transacted in the market.

22. Market forces push or pull the price to the equilibrium level. surplus P S P=1.60 high P*=1.00 D 0 2000 3000 4500 Q

23. Market forces push or pull the price to the equilibrium level. P S P* P=0.70 low shortage D 0 1800 Q* 4000 Q

24. P S P high P* P low D 0 Q* Q Market forces push or pull the price to the equilibrium level.

25. An equilibrium state • is a situation in which there are no inherent forces that produce change. • Changes away from the equilibrium position will occur only as a result of "outside events" which disturb the status quo.

26. Equilibrium State and Changes • "Outside events" and changes in equilibrium price and quantity • The supply and demand diagram. is the most essential analytical tool in economics. • Examples

27. Case 1: Suppose the weather suddenly turns to be very cold. What will happen to the equilibrium price and quantity in the heating oil market? P S P* D 0 Q* Q

28. Case 1: Suppose the weather suddenly turns to be very cold. What will happen to the equilibrium price and quantity in the heating oil market? P S P’ P* D’ D 0 Q Q* Q’

29. Case 2: Again, suppose the same outside event---the weather suddenly turns to be very cold. What will happen to the equilibrium quantity and equilibrium price in the ice cream market? P S P’ P* D 0 Q* Q

30. Case 2: Again, suppose the same outside event---the weather suddenly turns to be very cold. What will happen to the equilibrium quantity and equilibrium price in the ice cream market? P S P* P’ D D’ 0 Q’ Q* Q

31. Case 3: Suppose the cold weather brought a frost in Florida, what happens to the equilibrium price and quantity in the orange market? P S P* D 0 Q* Q

32. Freeze Oranges in FloridaJan 2010

33. Case 3: Suppose the cold weather brought a frost in Florida, what happens to the equilibrium price and quantity in the orange market? S’ P S P’ P* D 0 Q’ Q Q*

34. Case 4: Suppose a technological innovation takes place in manufacturing LCD TV sets. What happens to the equilibrium price and quantity of the LCD TV sets? P S P* D 0 Q* Q

35. Case 4: Suppose a technological innovation takes place in manufacturing fax machines. What happens to the equilibrium price and quantity of the fax machines? P S S’ P* P’ D 0 Q* Q’ Q

36. Comparative Statics Analysis • Comparative statics analysis is an analysis about how the equilibrium price and quantity change in response to changes in the outside forces.

37. Steps to do the comparative static analysis • 1. Ask which curve shifts and to which direction? • 2. Find the new equilibrium state and new equilibrium price and quantity. • 3. Draw conclusions about changes in equilibrium price and quantity.

38. Exercise • The drug BGH (bovine growth hormone) dramatically increases the milk output of dairy cows. Farmers in Wisconsin, a big dairy state, vigorously oppose licensing the drug, fearing that excess supply and a consumer reaction on the purity of food issue will put many of them out of business.

39. Exercise • Which graph in Figure 5-13 best illustrates the farmers' fears? • a. 1 b. 2 c. 3 d. 4

40. Exercise • “A severe drought has reduced the supply of oranges and increased their price. But the higher price will reduce the demand for oranges and push their price back toward the original level.” True or false? Comment too.