Demand and Supply: How Markets Work

1. Demand and Supply: How Markets Work Lecture 1 – academic year 2014/15 Introduction to Economics Fabio Landini

2. Today’s Plan: • The market: what is it? • Demand: what changes the quantities demanded? • Supply: what changes the quantities supplied? • How do we explain changes in prices as a result of shifts in demand and supply?

3. Market Definition: “A market consists of a group of buyers and sellers of a given good or service” • Buyers determine the demand. • Sellers determine the supply. • During the first part of the course we will focus mainly on markets for goods. However, the same reasoning hold also for factors of production (e.g. labour, capital).

4. Typologies of Markets Perfect competition • Many sellers and many buyers, each of them with no influence on market prices • Goods are perfect substitute • Fruits market in Panajii - India

5. Typologies of Markets Monopoly • Only one seller that fix the price

6. Typologies of Markets Oligopoly • Few sellers, not always in competition with each other (cartels)

7. Typologies of Markets Monopolistic competition • Many sellers, tough competition, and product differentiation • …

8. The Demand The quantity demanded is the quantity that buyers want and can buy

9. Demand Table and Curve The demand table contains information on the relationship between the price of a good and the quantity demanded. The demand curve is a graph that shows the relationship between the price of a good and the quantity demanded.

10. Price of ice-cream 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of ice-cream Example: Demand of Ice-cream

11. Price of ice-cream 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of ice-cream Example: Demand of Ice-cream

12. Price of ice-cream 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of ice-cream Example: Demand of Ice-cream

13. Price of ice-cream 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of ice-cream Law of the Demand Law of the Demand There exist an inverse relationshipbetween price and quantity demanded

14. The Determinants of Demand What determines the quantity of ice-cream that is demanded ? • Market price. • Consumer’s income. • Price of other goods. • Consumer’s preferences. • Consumer’s expectations.

15. Why does the quantity demanded vary? The quantity demanded can vary for two reasons • Movements along the demand curve: caused by a Δ in market prices; • Shifts of the demand curve: caused by a Δ of the other determinants of demand (income, price of other goods, preferences, expectations).

16. Why does the quantity demanded vary?

17. Changes of the quantity demanded

18. Changes of the quantity demanded Price of cigarettes (a packet in euro) 4.00 2.00 D1 0 12 20 Number of cigarettes smoked in a day

19. Changes of the quantity demanded A tax on the production of tobacco increases the price of cigarettes. Therefore, it induces a movement along the demand curve. Price of cigarettes (a packet in euro) 4.00 2.00 D1 0 12 20 Number of cigarettes smoked in a day

20. Changes of the quantity demanded A tax on the production of tobacco increases the price of cigarettes. Therefore, it induces a movement along the demand curve. Price of cigarettes (a packet in euro) C 4.00 A 2.00 D1 0 12 20 Number of cigarettes smoked in a day

21. Changes of the quantity demanded A tax on the production of tobacco increases the price of cigarettes. Therefore, it induces a movement along the demand curve. Price of cigarettes (a packet in euro) C 4.00 A 2.00 D1 0 12 20 Number of cigarettes smoked in a day

22. Shift of the Demand Curve

23. Shift of the Demand Curve Price of cigarettes (a packet in euro) 4.00 2.00 D1 0 10 20 Number of cigarettes smoked in a day

24. Shift of the Demand Curve Price of cigarettes (a packet in euro) A public provision aimed at discouraging smoking induces a leftward shift in the demand curve. 4.00 2.00 D1 0 10 20 Number of cigarettes smoked in a day

25. Shift of the Demand Curve Price of cigarettes (a packet in euro) A public provision aimed at discouraging smoking induces a leftward shift in the demand curve. 4.00 2.00 D 2 D1 0 10 20 Number of cigarettes smoked in a day

26. Shift of the Demand Curve Price of cigarettes (a packet in euro) A public provision aimed at discouraging smoking induces a leftward shift in the demand curve. 4.00 B A 2.00 D 2 D1 0 10 20 Number of cigarettes smoked in a day

27. What about a change in income? Price of cigarettes (a packet in euro) 4.00 2.00 D1 30 0 10 20 Number of cigarettes smoked in a day

28. What about a change in income? Price of cigarettes (a packet in euro) 4.00 2.00 D 2 D1 30 0 10 20 Number of cigarettes smoked in a day

29. What about a change in income? Price of cigarettes (a packet in euro) 4.00 2.00 D 2 D1 30 0 10 20 Number of cigarettes smoked in a day

30. What about a change in income? Price of Ice-ream (a cone in euro) 4.00 2.00 D 2 D1 3 0 1 2 Number of cigarettes smoked in a day

31. What about a change in income? Price of Ice-ream (a cone in euro) For a normal good, an increase in income increases the quantity demanded 4.00 2.00 D 2 D1 3 0 1 2 Number of cigarettes smoked in a day

32. Price of other goods When a decrease in the price of one good causes a decrease in the quantity demanded of another good, the two goods are called substitute (e.g. tea and coffee).

33. Price of other goods When a decrease in the price of one good causes an increase in the quantity demanded of another good, the two goods are called complementary(e.g. PCs and High-speed Internet access).

34. Example: what shifts the demand of a Toshiba PC? How does the demand of a Toshiba personal computer (PC) shift if: • Consumers’ income decrease; • The price of a Compaq PC decreases; • The price of high-speed Internet connection reduces; • The use of Internet across households increases;

35. From Individual Demand… Caterina’s demand Nicola’s Demand Price of Price of ice-cream ice-cream 3.00 3.00 2.50 2.50 2.00 2.00 1.50 1.50 1.00 1.00 0.50 0.50 Quantity of 0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-cream Ice-cream

36. 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 ( = 4 + 3) …. To Market Demand Price of ice-cream Quantity of Ice-cream

37. Supply The quantity supplied is the quantity that sellers want and can sell

38. The Determinants of Supply • Market prices • Cost of factors of production • Technology • Expectations

39. Law of the Supply Law of the Supply: the quantity supplied of a given good increases with the price. Why? Because, for given costs of production and commercialization, an increase in price generates greater revenues (all costs being equal) and thus it induces sellers to increase production.

40. Supply Table and Curve The supply table is a table that contains information on the relationship between the price of a good and the quantity supplied The supply curve is a graph that shows the relationship between the price of a good and the quantity supplied

41. 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 Supply Curve Price of ice-cream Quantity of ice-cream

42. 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 Supply Curve Price of ice-cream Quantity of ice-cream

43. 3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 Supply Curve Price of ice-cream Quantity of ice-cream

44. Why does the quantity supplied vary? The quantity supplied can vary for two reasons: • Movements along the supply curve, caused by a Δ in market prices; • Shifts of the supply curve, caused by a Δ of the other determinants of supply (technology, cost of factors of production, expectations)

45. Why does the quantity supplied vary?

46. Increase of Supply

47. Increase of Supply Price of ice-cream S1 0 Quantity of ice-cream

48. Increase of Supply Price of ice-cream S1 S2 Increase of supply 0 Quantity of ice-cream

49. Increase of Supply Price of ice-cream S1 0 Quantity of ice-cream

50. Increase of Supply Price of S3 ice-cream S1 Decrease of supply 0 Quantity of ice-cream