Ch. 3: Demand and Supply

1. Ch. 3: Demand and Supply Objectives • Determinants of demand and supply • Use demand and supply to • understand how markets determine prices and quantities • make predictions about how various “shocks” affect prices and quantities

2. Markets and Prices • Market • any arrangement that enables buyers and sellers to get information and do business with each other. • Competitive market • a market that has many buyers and many sellers • no single buyer or seller can influence the price. • Money price of a good • the amount of money needed to buy it. • Relative price of a good • ratio of its money price to the money price of the next best alternative good • the opportunity cost of the good expressed in units of the other good.

3. Demand • Quantity demanded of a good or service • the amount that consumers plan to buy during a particular time period at a particular price. • The Law of Demand • Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. • The law of demand results from • a substitution effect • an income effect • Normal versus inferior good

4. Demand Demand • the entire relationship between the price of the good and quantity demanded of the good. Demand curve • shows the relationship between the QD of a good and its price, ceteris parabus

5. Demand • This figure shows a demand curve for gasoline • A rise in the price, ceteris paribus, brings a decrease in the QD and a movement along the demand curve. Price D # gallons per week

6. Demand A D-curve is also • Willingness-to-pay curve. • Willingness to pay measures marginal benefit. Price D # gallons per week

7. Demand • A Change in Demand • Quantity of the good that people plan to buy changes at each and every price • Shift of demand curve. • When demand increases, • QD increases at each and every price • the demand curve shifts rightward. • When demand decreases, • QD decreases at each and every price • the demand curve shifts leftward.

8. Demand Change in Demand vs. Change in Quantity Demanded

9. Factors that change demand • Prices of related goods • substitute in consumption • complement in consumption • Income • Normal good • Inferior good • Luxury good • Expected future prices • Population • Taxes on buyers • Consumer preferences

10. Supply Quantity supplied (QS) of a good or service • the amount that producers plan to sell during a given time period at a particular price. The Law of Supply • Other things remaining the same, the higher the price of a good, the greater is the quantity supplied. • results from tendency for the marginal cost of producing a good or service to increase as the quantity produced increases (more later) • Producers are willing to supply only if they at least cover their marginal cost of production.

11. Supply • Supply • the entire relationship between the quantity supplied and the price of a good. • Supply curve • shows relationship between QS and price of a good, ceteris paribus.

12. Supply Curve $ per gallon • A supply curve for gasoline. • A rise in the price, ceteris paribus, brings an increase in QS and a movement along the supply curve. S Gallons per day

13. Supply • A supply curve is also a minimum-supply-price curve. • The greater the quantity produced, the higher is the price that producers must be offered to be willing to produce that quantity. S Gallons per day

14. Supply • A Change in Supply • occurs when the quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve. • When supply increases, • QS increases at each and every price • supply curve shifts rightward. • When supply decreases, • QS decreases at each and every price • supply curve shifts leftward.

15. Supply Change in supply vs. change in quantity supplied

16. Factors that change supply. • Prices of inputs • Prices of related goods produced • Substitutes in production • Complements in production • Expected future prices • Number of sellers • Taxes on Sellers • Technology

17. Market Equilibrium Equilibrium • situation in which opposing forces balance each other. • occurs when the price balances the plans of buyers and sellers. Equilibrium price • price at which the quantity demanded equals the quantity supplied. Equilibrium quantity • quantity bought and sold at the equilibrium price.

18. Market Equilibrium Price Adjustments If P>Pequil: • a surplus forces the price down. If P<Pequil: • a shortage forces the price up. At the equilibrium price, • QS=QD • and the price doesn’t change. S D

19. Predicting Changes in Price and Quantity • Illustrate Effect on Equilibrium Price and Quantity if: • Demand increases • Supply increases • Demand and supply simultaneously increase. • Practice with Supply/Demand to: • Predict effect of “shock” to market. • Understand the type of “shock” that might have caused an observed change in P & Q.

20. Price controls • A price ceiling is a maximum allowable price. • Results in a continuing shortage if ceiling is BELOW equilibrium price. • A price floor is a minimum allowable price. • Results in a continuing surplus if floor is ABOVE equilibrium price.