Supply, Demand and Market Equilibrium

1. Supply, Demand and Market Equilibrium By: Thomas Gruca - University of Iowa Mark Pelzer - Kirkwood Community College

2. Demand: Raw data

3. Demand Schedule

4. Demand Curve D

5. Demand: Definition • Relationship between price and quantity demanded at a given price

6. Demand Curve D

7. Demand Curve I D

8. Change in quantity demanded due to change in price I II D

9. Shifts in the Demand Curve • income • related goods • tastes • number of consumers • expectations of future prices

10. Demand curve shifts to the right D

11. Demand curve shifts to the left D

12. Demand for an intangible good • For example, a promise exchanged for money • Value of the promise depends on future events • Examples • loans • insurance

13. Demand for an intangible good • Application: a futures contract • value based on a future event • possible events • price of a bushel of wheat in October • Microsoft stock price on 3rd Friday of June • value of the Euro in $ on February 1st • price of oil on April 21st

14. Assignment • Political futures contract • pays $1 if Bradley is the Democratic nominee for 2000 • pays $0 otherwise • Price that someone is willing to pay is based on their own prediction of a particular outcome • Assignment: graphing a real demand curve

15. Graph of Bradley demand data

16. The effect of NBA party on demand for Bradley contracts

17. Supply: Raw data

18. Supply Schedule

19. Supply Curve S

20. Supply: Definition • Relationship between price and quantity supplied at a given price

21. Supply Curve S I

22. Change in quantity supplied due to a change in price S II I

23. Shifts in the Supply Curve • prices of relevant resources • technology • taxes • number of sellers • expectations of future prices

24. Supply curve shifts to the right S

25. Supply curve shifts to the left S

26. Supply for an intangible good • Simplified insurance example • Why would anyone supply car insurance? • Seller expects that you will not have an accident during the next year • If you do, they pay the bills. If not, they still keep the premium (price of policy) • Prices depend on how likely there will be a claim

27. Political Futures Contract • Recall our example political futures contract • People holding this contract get $1 if Bradley is the Democratic nominee for 2000 and $0 otherwise • They may be willing to sell if they are not 100% sure that Bradley will be the nominee • Assignment 4: graphing a real supply curve

28. Graph of Bradley supply data

29. Effect of internet taxes on supply of Bradley contracts

30. A Market S D

31. Surplus S Surplus D Qd Qs

32. Market adjustment to surplus S Surplus D Qd Qs

33. Shortage S Shortage D Qs Qd

34. Market adjustment to shortage S D Shortage Qd Qs

35. Equilibrium S Eq.P D Eq.Q

36. Government interventions: Price controls • The government sets a maximum price • Example: the price of basic commodities in many countries (milk, flour, bread, rice) • what happens to the availability of this good? • The government sets a minimum price for wages • Example: minimum wage • what happens to the supply of labor?

37. Equilibrium in the Bradley market

38. Supply and demand information available in a real market Exchanges that already have occurred S Offers to sell (ask price) Market price (observed) Price Offers to buy (bid price) D Quantity

39. Supply and demand information available in a real market Price S Best Ask Last Trade Note: Eq.Q. is equilibrium quantity Best Bid D Eq.Q Eq.Q +1 Quantity

40. Iowa Electronic Market • The market for Bradley contracts is run by the Iowa Electronic Market • real $, real time futures market run by the Tippie Business School at the University of Iowa • web site: www.biz.uiowa.edu/iem

41. IEM Prices: 12/10/99 Market Quotes: DCONV00 (2000 Democratic National Convention Market) Quotes current as of 15:45:05 CST, Friday, December 10, 1999. SymbolBidAskLastLowHighAverage BRADLEY 0.310 0.324 0.311 0.311 0.323 0.314 GORE 0.682 0.694 0.682 0.681 0.698 0.682 DCROF 0.002 0.003 0.002 0.002 0.002 0.002 • DCROF is a contract for candidates other than Gore and Bradley

42. Assignment 7 • Choose one of the current markets running at the IEM • Read the prospectus to make sure you understand how the contracts work • Using various news sources, try to determine what events will affect prices in the IEM for two-weeks • Using your understanding of supply and demand, predict how prices should change • Determine if your predictions were correct and reconcile any discrepancies

43. How do bid,ask prices happen? • The bid and ask prices you see on the IEM trading screen are offers to buy and sell posted by traders in the market. • Other information available includes: • last traded price • volume of trades • historical prices

44. How do you get contracts to sell? • There are two ways to buy contracts • Buy a bundle of contracts from the market • each market has a set of contracts • only one will pay $1, all others pay 0$ • keep the contracts that you think will pay off and sell the others • Buy from another trader

45. How do you make $ in the IEM markets? • Buy and hold those contracts which eventually pay $1 • Buy contracts at a low price and sell them when the prices rise • Sell one of each contract when sum of all bid prices is greater than $1 (Why?)