Demand, Supply, and Markets 1 © 2012 Cengage Learning. All Rights Reserved. May not be copied,...

Demand, Supply,

and Markets

1© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2

Demand• Demand

– The quantity consumers are willing and able to buy at each possible price during a given time period, other things constant

– Amounts purchased per period• at each possible price

– Willing and able– Specific period– Other things constant

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3

Law of Demand• Law of demand

– Quantity demanded varies inversely with price, other things constant

– Higher price: lower quantity demanded• Consumer Demand

– Not ‘consumer wants’– Not ‘consumer needs’


4

Law of Demand• Substitution effect of a price change

– When the price of a good falls• That good becomes cheaper compared to

other goods • Consumers tend to substitute that good for

other goods

– Relative price• Price of a good relative to the prices of other

goods


5

Law of Demand• Income effect of a price change

– A fall in the price of a good increases consumers’ real income

– Consumers more able to purchase goods– Normal good: quantity demanded

increases


6

Law of Demand• Money income

– Number of dollars a person receives per period

• Real income– Measured in terms of what it can buy– Purchasing power– Changes when price changes


7

Demand• Demand schedule

– Possible prices– Quantity demanded at each price– Law of demand

• Demand curve– Possible prices– Quantity demanded at each price– Downward slope– Law of demand


8

Demand• Demand

– Entire relationship between price and quantity demanded

• Quantity demanded– Amount of a good consumers are willing

and able to buy • Per period • At a particular price

– A point on the demand curve


9

Demand• Movement along the demand curve

– Change in quantity demanded– Due to a change in price

• Individual demand – Relation between the price of a good and

the quantity purchased – By an individual consumer – Per period– Other things constant


Exhibit 1

10

The Demand Schedule and Demand Curve for Pizza

D

a

b

c

d

e

Priceper

pizza

Quantity DemandedPer week (millions)

abcde

$1512963

814202632

2620148Millions of pizzas per week

32 0

9

6

3

12

Pric

e pe

r pi

zza

$15

The market demand D shows the quantity of pizza demanded, at various prices, by all consumers. Price and quantity demanded are inversely related.


11

Demand• Market demand

– Relation between the price of a good and the quantity purchased

– By all consumers in the market– During a given period– Other things constant– Sum of the individual demands in the

market


12

Shifts of the Demand Curve

1. Money income of consumers

2. Prices of other goods

3. Consumer expectations

4. The number or composition of consumers in the market

5. Consumer tastes


13

Changes in Consumer Income• Increase in consumer income

– Willing and able to buy more at each price

– Increase in demand– Demand curve shifts rightward

• Normal good– Demand increases as income increases

• Inferior good– Demand decreases as income increases


Exhibit 2

14

An Increase in the Market Demand for Pizza

D’

D

b f


32 0

9

6

3

12

Pric

e pe

r pi

zza

$15An increase in the demand for pizza is shown by a rightward shift of the demand curve, so the quantity demanded increases at each price. For example, the quantity of pizza demanded at a price of $12 increases from 14 million (point b) to 20 million (point f).


15

Changes in Prices of Other Goods• Substitutes

– An increase in the price of one good• Increases the demand for the other• Rightward shift

• Complements - used in combination– An increase in the price of one

• Decreases the demand for the other• Leftward shift

• Unrelated


16

Changes in Consumer Expectations

• Income expectations– Future income increase

• Increase the current demand

• Price expectations– Future price increases

• Increase current demand


17

Number or Composition of Consumers

• Increase in number of consumers– Increases demand– Right shift

• Composition of the population– Shift the demand


18

Changes in Consumer Tastes• Tastes

– Likes and dislikes in consumption– Assumed to remain constant along a

given demand curve • Change in tastes

– May shift the demand


19

Demand• Quantity demanded• Demand• Movement along the demand curve• Shift in the demand curve

– Movement of a demand curve right or left– Resulting from a change in one of the

determinants of demand• Other than the price of the good


20

Supply • Supply

– How much producers are willing and able to offer for sale per period at each possible price, other things constant

– Willing and able– Specific period– Other things constant


21

Law of Supply• Law of supply

– Quantity supplied is directly related to its price, other things constant

– Higher price: higher quantity supplied• Higher reward, profit

– More willing to increase quantity supplied; • Can afford to cover the marginal costs

– Increasing opportunity cost– More able to increase quantity supplied


22

Supply• Supply schedule

– Possible prices– Quantity supplied at each price– Law of supply

• Supply curve– Possible prices– Quantity supplied at each price– Upward slope– Law of supply


Exhibit 3

23

The Supply Schedule and Supply Curve for Pizza

SPriceper

pizza

Quantity SuppliedPer week (millions)

$1512963

2824201612


28 0

9

6

3

12

Pric

e pe

r pi

zza

$15

Market supply curve S shows the quantity of pizza supplied, at various prices, by all pizza makers. Price and quantity supplied are directly related.


24

Supply• Supply

– Entire relationship between price and quantity supplied

• Quantity supplied – Amount offered for sale– Per period– At a particular price– A point on the supply curve


25

Supply• Movement along the supply curve

– Change in quantity supplied– Due to a change in price

• Individual supply – Relation between the price of a good and

the quantity– An individual producer is willing and able

to sell– Per period, other things constant


26

Supply• Market supply

– Relation between the price of a good and the quantity

– All producers are willing and able to sell– Per period– Other things constant


27

Shifts of the Supply Curve

1. State of technology

2. Prices of relevant resources

3. Prices of alternative goods

4. Producer expectations

5. Number of producers in the market


28

Changes in Technology• Better technology

– Production costs decrease– Increase quantity supplied at each price– Increase supply– Rightward shift


Exhibit 4

29

An Increase in the Supply of Pizza

S’S


28 0

9

6

3

12

Pric

e pe

r pi

zza

$15 An increase in the supply of pizza is reflected by a rightward shift of the supply curve, from S to S’. Quantity supplied increases at each price level. For example, at a price of $12, the quantity of pizza supplied increases from 24 million pizzas (point g) to 28 million pizzas (point h).

gh


30

Prices of Relevant Resources• Relevant resources

– Employed in the production• Decrease in price of relevant resources

– Production costs decrease– Increase supply– Rightward shift


31

Prices of Alternative Goods• Resources

– Alternative uses• Alternative goods

– Use some resources employed to produce the good

• Decrease in price of alternative goods– Increase supply– Rightward shift


32

Changes in Producer Expectations• Higher prices in the future

– Future profits– May increase the current supply– Easily stored goods

• Reduce current supply


33

Changes in Number of Producers• Market supply

– Amount supplied– At each price– By all producers

• Number of producers increase– Increase supply– Rightward shift


34

Supply• Quantity supplied• Supply• Movement along the supply curve• Shift in the supply curve

– Movement of a supply curve left or right– Resulting from a change in one of the

determinants of supply • Other than the price of the good


35

Demand & Supply Create a Market

• Markets– Sort out differences between demanders

and suppliers– Reduce transaction costs

• Transaction costs– Costs of time and information required to

carry out market exchange• Adam Smith

– The “invisible hand”© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36

Market Equilibrium• Surplus: excess quantity supplied

– Amount by which quantity supplied exceeds quantity demanded• At a given price

– Downward pressure on price• Decrease quantity supplied• Increase quantity demanded


37

Market Equilibrium• Shortage: excess quantity demanded

– Amount by which quantity demanded exceeds quantity supplied• At a given price

– Upward pressure on price• Increase quantity supplied• Decrease quantity demanded


38

Market Equilibrium• Quantity demanded = Quantity supplied• Plans of buyers and sellers match• Equilibrium point• Equilibrium quantity• Equilibrium price• Market clears• No pressure on price• ‘X marks the spot’


Exhibit 5

39

Equilibrium in the Pizza Market (a)


Exhibit 5

40

Equilibrium in the Pizza Market (b)

S


26 0

9

6

3

12

Pric

e pe

r pi

zza

$15

D

c

Shortage

Surplus

Market equilibrium occurs at the price where quantity demanded equals quantity supplied. This is shown at point c.

Above the equilibrium price, quantity supplied exceeds quantity demanded. This creates a surplus, which puts downward pressure on the price.

Below the equilibrium price, quantity demanded exceeds quantity supplied. The resulting shortage puts upward pressure on the price.


41

Shifts of the Demand Curve

Determinants of demand1. Money income of consumers

2. Price of a substitute or a complement

3. Consumer expectations

4. Number of consumers

5. Consumer tastes


42

Shifts of the Demand Curve• Increase in demand

– Rightward shift of D curve– Shortage; Upward pressure on P

– QD decreases; QS increases

– New equilibrium: Increase in P and Q • Decrease in demand

– Surplus; Downward pressure on P– New equilibrium: Decrease in P and Q


Exhibit 6

43

Effects of an Increase in Demand

S


30 0

9

$12

Pric

e pe

r pi

zza

D

c

D’

g

An increase in demand is shown by a shift of the demand curve rightward from D to D’. Quantity demanded exceeds quantity supplied at the original price of $9 per pizza, putting upward pressure on the price. As the price rises, quantity supplied increases along supply curve S, and quantity demanded decreases along demand curve D’. When the new equilibrium price of $12 is reached at point g, quantity demanded once again equals quantity supplied.


44

Shifts in the Supply Curve

Determinants of supply1. Technological change

2. Price of a relevant resource

3. Price of an alternative good

4. Producers expectations

5. Number of producers


45

Shifts in the Supply Curve• Increase in supply

– Rightward shift of S curve– Surplus; Downward pressure on P

– QD increases; QS decreases

– New equilibrium: • P decreases; Q increases

• Decrease in supply– New equilibrium:

• P increases; Q decreases© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Exhibit 7

46

Effects of an Increase in Supply

S

2620

Millions of pizzas per week

30 0

$9

6Pric

e pe

r pi

zza

D

c S’

d

An increase in supply is shown by a shift of the supply curve rightward, from S to S’. Quantity supplied exceeds quantity demanded at the original price of $9 per pizza, putting downward pressure on the price. As the price falls, quantity supplied decreases along supply curve S’, and quantity demanded increases along demand curve D. When the new equilibrium price of $6 is reached at point d, quantity demanded once again equals quantity supplied


47

Simultaneous Shifts• Both S and D increase:

– Q increases– D shifts more: P increases– S shifts more: P decreases

• Both S and D decrease: – Q decreases– D shifts more: P decreases– S shifts more: P increases


Exhibit 8

48

Indeterminate effect of an increase in both demand and supply

S

p’

p

Pric

e

D

S’

a

D’

b

Q’QUnits per

period 0

S

p’’

p

Pric

e

D

S’’

a

D’’

c

Q’’QUnits per

period 0

When both demand and supply increase, the equilibrium quantity also increases. The effect on price depends on which curve shifts more. In panel (a), the demand curve shifts more, so the price rises. In panel (b), the supply curve shifts more, so the price falls.


Simultaneous Shifts• S increases; D decreases

– P decreases– D shifts more: Q decreases– S shifts more: Q increases

• S decreases; D increases– P increases– D shifts more: Q increases– S shifts more: Q decreases


Exhibit 9

50

Effects of Shifts of Both Demand and Supply

When the demand and supply curves shift in the same direction, equilibrium quantity also shifts in that direction. The effect on equilibrium price depends on which curve shifts more. If the curves shift in opposite directions, equilibrium price will move in the same direction as demand. The effect on equilibrium quantity depends on which curve shifts more.


Exhibit 10

51

NBA Pay Leaps

Because the supply of the world’s top few hundred basketball players is relatively fixed by definition, the big jump in the demand for such talent caused average league pay to explode. Average pay increased from $170,000 in 1980 to $6,000,000 in 2010. Because the number of teams in the NBA increased, the number of players in the league grew from about 300 to about 450.


Disequilibrium• Disequilibrium

– Plans of buyers do not match those of sellers

– Temporary mismatch between quantity supplied and quantity demanded • As the market seeks equilibrium

– Can last a while• Result of government intervention

– Price floors– Price ceilings


Disequilibrium • Price Floors

– Minimum legal price below which a product cannot be sold

– To have an impact, it must be set above the equilibrium price

– Surplus– Distort markets– Reduce economic welfare


Disequilibrium • Price Ceilings

– Maximum legal price above which a product cannot be sold

– To have an impact, it must be set below the equilibrium price

– Shortage– Distort markets– Reduce economic welfare


Exhibit 11

55

Price Floors and Price Ceilings

S

D

$2.50

1.90

Pric

e pe

r ga

llon

1914Millions of gallons per month

0 24

S

D

$1,000

600

Mon

thly

ren

tal p

rice

5040Thousands of rental units per month 0 60

Surplus

Shortage

A price floor set above the equilibrium price results in a surplus, as shown in panel (a). A price floor set at or below the equilibrium price has no effect.

A price ceiling set below the equilibrium price results in a shortage, as shown in panel (b). A price ceiling set at or above the equilibrium price has no effect.


Demand, Supply, and Markets 1 © 2012 Cengage Learning. All Rights Reserved. May not be copied,...

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