1 / 82

Chapter 2

Chapter 2. The Basics of Supply and Demand. S. P 2. P 1. Q 1. Q 2. The Supply Curve. Price ($ per unit). The Supply Curve Graphically. The supply curve slopes upward demonstrating that at higher prices firms will increase output. Quantity. Introduction.

shamara-amena
Download Presentation

Chapter 2

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 2 The Basics of Supply and Demand

  2. S P2 P1 Q1 Q2 The Supply Curve Price ($ per unit) The Supply Curve Graphically The supply curve slopes upward demonstrating that at higher prices firms will increase output Quantity Chapter 2

  3. Introduction • What are supply and demand? • What is the market mechanism? • What are the effects of changes in market equilibrium? • What are elasticities of supply and demand? Chapter 2

  4. Topics to Be Discussed • How do short-run and long-run elasticities differ? • How do we understand and predict the effects of changing market conditions? • What are the effects of government intervention – price controls? Chapter 2

  5. Supply and Demand • Supply and demand analysis can: • Help us understand and predict how world economic conditions affect market price and production • Analyze the impact of government price controls, minimum wages, price supports, and production incentives on the economy • Determine how taxes, subsidies, tariffs and import quotas affect consumers and producers Chapter 2

  6. Supply and Demand • The Supply Curve • The relationship between the quantity of a good that producers are willing to sell and the price of the good. • Measures quantity on the x-axis and price on the y-axis Chapter 2

  7. The Supply Curve • Other Variables Affecting Supply • Costs of Production • Labor • Capital • Raw Materials • Lower costs of production allow a firm to produce more at each price and vice versa Chapter 2

  8. S S’ P1 P2 Q0 Q1 Q2 Change in Supply P • The cost of raw materials falls • Produced Q1 at P1 and Q0 at P2 • Now produce Q2 at P1 and Q1 at P2 • Supply curve shifts right to S’ Q Chapter 2

  9. The Supply Curve • Change in Quantity Supplied • Movement along the curve caused by a change in price • Change in Supply • Shift of the curve caused by a change in something other than price • Change in costs of production Chapter 2

  10. Supply and Demand • The Demand Curve • The relationship between the quantity of a good that consumers are willing to buy and the price of the good. • Measures quantity on the x-axis and price on the y-axis Chapter 2

  11. P2 P1 D Q2 Q1 The Demand Curve Price ($ per unit) The demand curve slopes downward demonstrating that consumers are willing to buy more at a lower price as the product becomes relatively cheaper. Quantity Chapter 2

  12. The Demand Curve • Other Variables Affecting Demand • Income • Increases in income allow consumers to purchase more at all prices • Consumer Tastes • Price of Related Goods • Substitutes • Complements Chapter 2

  13. The Demand Curve • Changes in quantity demanded • Movements along the demand curve caused by a change in price. • Changes in demand • A shift of the entire demand curve caused by something other than price. • Income • Preferences Chapter 2

  14. The Market Mechanism • The market mechanism is the tendency in a free market for price to change until the market clears • Markets clear when quantity demanded equals quantity supplied at the prevailing price • Market Clearing price – price at which markets clear Chapter 2

  15. S Price ($ per unit) P0 D Quantity Q0 The Market Mechanism The curves intersect at equilibrium, or market- clearing, price. Quantity demanded equals quantity supplied at P0 Chapter 2

  16. Oun Lopez: Start of Lecture 3 The Market Mechanism • In equilibrium • There is no shortage or excess demand • There is no surplus or excess supply • Quantity supplied equals quantity demanded • Anyone who wished to buy at the current price can and all producers who wish to sell at that price can Chapter 2

  17. S Price ($ per unit) P0 D Quantity Q0 The Market Mechanism -Market S and D curves include the S and D curves of individual consumers and producers. Who Supplies? -Producers with willingness-to-accept (WTA) prices below P*. Who Buys? -Only those consumers who are willing-to-pay (WTP) above P*. Chapter 2

  18. Market Surplus • The market price is above equilibrium • There is excess supply - surplus • Downward pressure on price • Quantity demanded increases and quantity supplied decreases • The market adjusts until new equilibrium is reached Chapter 2

  19. Price ($ per unit) S Surplus P1 P0 D Quantity QD Q0 QS The Market Mechanism • Price is above the market clearing price – P1 • Qs > QD • Price falls to the market-clearing price • Market adjusts to equilibrium Chapter 2

  20. Price ($ per unit) S P3 P2 D Shortage Quantity QS QD Q3 The Market Mechanism • Price is below the market clearing price – P2 • QD > QS • Price rises to the market-clearing price • Market adjusts to equilibrium Chapter 2

  21. The Market Mechanism • The market price is below equilibrium: • There is a excess demand - shortage • Upward pressure on prices • Quantity demanded decreases and quantity supplied increases • The market adjusts until the new equilibrium is reached. Chapter 2

  22. The Market Mechanism • Supply and demand interact to determine the market-clearing price. • When not in equilibrium, the market will adjust to alleviate a shortage or surplus and return the market to equilibrium. • Markets must be competitive for the mechanism to be efficient. Chapter 2

  23. Changes In Market Equilibrium • Equilibrium prices are determined by the relative level of supply and demand. • Changes in supply and/or demand will change in the equilibrium price and/or quantity in a free market. Chapter 2

  24. D P S S’ P1 P3 Q1 Q3 Q Q2 Changes In Market Equilibrium • Raw material prices fall • S shifts to S’ • Surplus at P1 between Q1, Q2 • Price adjusts to equilibrium at P3, Q3 Chapter 2

  25. D D’ P S P1 P3 Q1 Q3 Q2 Q Changes In Market Equilibrium • Income Increases • Demand increases to D1 • Shortage at P1 of Q1, Q2 • Equilibrium at P3, Q3 Chapter 2

  26. P2 P1 D P D’ S S’ Q1 Q2 Q Changes In Market Equilibrium • Income Increases & raw material prices fall • Quantity increases • If the increase in D is greater than the increase in S price also increases Chapter 2

  27. Shifts in Supply and Demand • When supply and demand change simultaneously, the impact on the equilibrium price and quantity is determined by: • The relative size and direction of the change • The shape of the supply and demand models Chapter 2

  28. The Price of a College Education • The real price of a college education rose 55 percent from 1970 to 2002. • Increases in costs of modern classrooms and wages increased costs of production – decrease in supply • Due to a larger percentage of high school graduates attending college, demand increased Chapter 2

  29. S Price ($ per unit) P0 D Quantity Q0 The Market Mechanism -Market S and D curves include the S and D curves of individual consumers and producers. Who Supplies? -Producers with willingness-to-accept (WTA) prices below P*. Who Buys? -Only those consumers who are willing-to-pay (WTP) above P*. Chapter 2

  30. S2002 P (annual cost in 1970 dollars) $3,917 S1970 $2,530 D2002 D1970 Q (millions enrolled)) 8.6 13.2 Market for a College Education New equilibrium was reached at $4,573 and a quantity of 12.3 million students Chapter 2

  31. S1900 S1950 Price S2002 Long-Run (LR) Path of Price and Consumption (LR demand) D1900 D2002 D1950 Quantity Resource Market Equilibrium Chapter 2

  32. Elasticities of Supply and Demand • How much do markets change? • Elasticity gives a way to measure how a variable will change when another variable changes. • Elasticity (Def): the percentage change in one variable resulting from a one percent change in another. Chapter 2

  33. Price Elasticity of Demand • Measures the sensitivity of quantity demanded to price changes. • It measures the percentage change in the quantity demanded of a good that results from a one percent change in price. Chapter 2

  34. Price Elasticity of Demand • The percentage change in a variable is the absolute (actual) change in the variable divided by the original level of the variable. • Therefore, elasticity can also be written as: Chapter 2

  35. Price Elasticity of Demand • Usually a negative number • As price increases, quantity decreases • As price decreases, quantity increases • When EQ,P > 1, the good is price elastic • %Q > % P • When EQ,P < 1, the good is price inelastic • %Q < % P Chapter 2

  36. Price Elasticity of Demand • Primary determinant of -Availability of substitutes. • Many substitutes: demand is price elastic • Few substitutes demand is price inelastic Chapter 2

  37. Price Elasticity of Demand • Linear demand curve: Q/P is constant • Values of P and Q change • Price elasticity of demand must therefore be measured at a particular point on the demand curve • Elasticity will change along the demand curve in a particular way Chapter 2

  38. Price Elasticity of Demand • Given a linear demand curve • Elasticity depends on slope and on the values of P and Q • The top portion of demand curve is elastic • Price is high and quantity small • The bottom portion of demand curve is inelastic • Price is low and quantity high Chapter 2

  39. EP = - Price 4 Elastic Ep = -1 2 Inelastic Ep = 0 4 8 Q Price Elasticity of Demand Demand Curve Q = 8 – 2P Chapter 2

  40. Price Elasticity of Demand • The steeper the demand curve becomes, the more inelastic the good. • The flatter the demand curve becomes, the more elastic the good Chapter 2

  41. Price D P* Quantity Infinitely Elastic Demand (Extreme Case) QD changes infinitely with the smallest possible change in price. EP =  Chapter 2

  42. Price Quantity Completely Inelastic Demand (Extreme Case) D EP = 0 QD never changes, even with large changes in price. Q* Chapter 2

  43. Other Demand Elasticities • Income Elasticity of Demand • Measures how much quantity demanded changes with a change in income. Chapter 2

  44. Other Demand Elasticities • Cross-Price Elasticity of Demand • Measures the percentage change in the quantity demanded of one good that results from a one percent change in the price of another good. Chapter 2

  45. Other Demand Elasticities • Complements: Cars and Tires • Cross-price elasticity of demand is negative • Price of cars increases, quantity demanded of tires decreases • Substitutes: Butter and Margarine • Cross-price elasticity of demand is positive • Price of butter increases, quantity of margarine demanded increases Chapter 2

  46. Price Elasticity of Supply • Measures the sensitivity of quantity supplied given a change in price • Measures the percentage change in quantity supplied resulting from a 1 percent change in price. Chapter 2

  47. Point v. Arc Elasticities • Point elasticity of demand • Price elasticity of demand at a particular point on the demand curve • Arc elasticity of demand • Price elasticity of demand calculated over a range of prices Chapter 2

  48. Elasticity: An Application • Wheat Market Changes (1980s and 1990s) • Analyzing the Wheat Market Chapter 2

  49. Elasticity: An Application • Supply: QS = 1800 + 240P • Demand: QD = 3550 – 266P Analyze this market. 1)What are the initial P* and Q*? 2)How does demand change when price changes? 3)How does supply change when price changes? Chapter 2

  50. Elasticity: An Application QD = QS 1800 + 240P = 3550 – 266P 506P = 1750 P = $3.46 per bushel Q = 1800 + (240)(3.46) = 2630 million bushels Chapter 2

More Related