Markets:Supply and

Demandfor International

Economics

Prof. Bryson, Marriott School

I. Elements of

Market Theory

Understanding Market Forces

Markets 1. What is a market?

A place? A store? A bank?

A medium through which

transactions occur.

Markt am Marienplatz, Munich

Understanding Market Forces

Markets 2. Why are markets important?

• Markets are an expression of

freedom,

• They function with

automaticity and without

prejudice (except against lack

of money).

Markt am Marienplatz, Munich

Demand

3. Who are the players?

Buyers and sellers

4. What is demand? Is it a quantity? A function?

A schedule of the quantity demanded at each

possible price.

Demand

5. What actually determines quantity purchased?

a. Price and

b. Non-price variables:

tastes, population, money incomes, distribution

of incomes, prices of related (sub/comp) goods

Demand Curves and Schedules(For T Shirts, Not nasal tobacco)

• P Q

$8.00

7.50

7.00

6.50

6.00

5.50

1,000

1,200

1,400

1,600

1.800

2,000

A “change in quantity demanded” is the result of a price change. One moves to a new position in the schedule or on the D curve.

7.50

6.00

1,200 1,800

Demand

Quantity

P,$

0

7. What is the ceteris paribus assumption?All other things remain the same when you change the price.

8. Price vs. non-price variables for a demand curve.

9. Shift vs. movement on the curve.

Demand continued

Demand Curves and Schedules

• P Q

$8.00

7.50

7.00

6.50

6.00

5.50

1,000

1,200

1,400

1,600

1.800

2,000

D

Quantity

P,$

0

If the market increases greatly in size (number of buyers) orall the buyers have greater incomes over time, we have a change in demand. The entire schedule and curves must be redrawn.

D’

We call this an “increase in demand” when the schedule is rewritten and the curve shifts out to the right.

1,500

1,700

1,900

2,100

2,300

2,500

10. What is supply?

11. What are elements of the Supply side? (What determines the quantity actually sold?)

a. Price (the “focus” variable) and b. The “underlying” or “non-price” variables:

technology, the number of suppliers, attitudes and expectations or mood of sellers (business spirits), costs of factors of production , prices of other related goods or services.

12. Supply as a schedule, or function, and a curve.

13. Shift vs. movement along Supply curve.This is precisely analogous to changes in demand and in the quantity demanded.

Supply

Supply Curves and Schedules(For T Shirts, Not nasal tobacco)

• P Q

$8.00

7.50

7.00

6.50

6.00

5.50

$4,000

1,800

1,600

1,400

1.200

1,000 Quantity

P,$

0

S S’

If the price changes, we change positions in the schedule or on the curve. If a non-price variable changes, we rewrite the schedule and shift the curve.

Why does S slopeup to the right?

2,000

3,600

3,200

2,800

2,400

2,000

II. How Markets

Function

Combine Demand and Supply as a whole market. What causes a shortage?

How markets function

At a price above the equilibrium level, the quantity supplied exceeds the quantity demanded, so a surplus (“glut”) exists.

Sellers reduce the priceand reduce the quantitythey offer towards equilibrium.

0

$

Q

D

S

Combine Demand and Supply as a whole market. What causes a shortage?

How markets function

At a price below the equilibrium level, the quantity demanded exceeds the quantity supplied, so a shortage exists.

Sellers increase the quantitysupplied, but also raise the price toward equilibrium.

0

$

Q

D

S

The Price Equilibrium: Review Where the price is

set above market equilibrium, there will be a surplus, since the quantity supplied exceeds the quantity demanded.

Suppliers will reduce their output and the price as inventories build Qd

Qs

Surplus

The Price Equilibrium

Where the price is set below the market equilibrium, there will be a shortage, since the quantity demanded exceeds the quantity supplied.

Suppliers will increase their output and the price as new orders come in.

Qs Qd

Shortage

Short-run AdjustmentsA short-run change in tastes from root beer to

ginger ale will cause demand curves to shift.

DD’

D’

Ginger Ale Root Beer

D

Long-run AdjustmentsIn the long run, there is a supply response. Resources

flow to the strong demand market from the weaker one. The supply adjustment moderates price changes that can be quite dramatic in the short run.

DD’

D’ D

S

Resources flow

Long-run AdjustmentsFinal equilibrium, after labor, capital, etc. flow to

ginger ale, is at the pink price lines, with prices close to their original levels.

DD’

D’ D

SS’SS’

III. Political

Interference with Markets

Price FreezesSay that price increases in

rental housing inspire legislators to impose a price freeze on rents.

As demand continues to increase…

D’a shortage will soon appear D

Price Freezes

Market forces would cause a price increase to accommodate the increased demand automatically,…

but price increases are now illegal, so the shortage (in pink) will persist.

D’

D

Price Freezes

D’

D

But shortages can increase profits without price increases.Tighten terms of creditEliminate guarantees,Cease deliverySlacken quality controlReduce quality in other ways.

Price Freezes

If the quantity available is limited by rent controls…

buyers would be willing to pay an illegally high price, Pi, as indicated by the demand curve. D’

DQs

Pi

Price Freezes

The higher price allows black market sellers to collect economic rents, as shown by the orange block. D’

DQs

Price Floors: The Labor Market

• When the minimum wage is above the market equilibrium,..

• the quantity of labor supplied exceeds the quantity demanded. Result? Unemployment

Wmin

Wmkt

Unemployment

IV.Consumer and

Producer Surplus

What the consumer would pay rather than go without

-What the consumer actually does pay

= Consumer Surplus

Quantity D(Would Pay) Minus P(Does Pay) = Cons. Surplus

1

2

3

4

$5

4

3

2

$2

2

2

2

$3

2

1

0$6

Consumer Surplus

$5

$2 P

Q0The whole shaded area is what individual 1

would be willing to pay rather than go without. ($5)

This is what consumer 1 actually does pay ($2)

This is consumer surplus for individual 1 ($3)

Consumer Surplus

$4

$2 P

Q0The whole shaded area is what individual 2

would be willing to pay rather than go without. ($4)

This is consumer surplus for individual 2 ($2)

This is what consumer 2 actually does pay ($2)

Consumer Surplus

$3$2 P

Q0The whole shaded area is what individual 3

would be willing to pay rather than go without. ($3)

This is what consumer 3 actually does pay ($2)

This is consumer surplus for individual 3 ($1)

Consumer Surplus

$2 P

Q0The whole shaded area is what individual 4

would be willing to pay rather than go without. ($2)

This is what consumer 4 actually does pay ($2)

THERE IS NO CONSUMER SURPLUS FOR CONSUMER 4

Consumer Surplus

$2 P

Q0

This area represents total expenditures

This area represents consumer surplus ($6)

Consumer Surplus

$2 Price

Q0

D

In general, Consumer Surplus is the area below the demand curve and

above the price line

Consumer Surplus

Notice that when the price goes up or down, consumer surplus is lost or gained.

Consumer Surplus

This much consumer surplus…is lost when the price goes up.

Producer Surplus

• Producer Surplus is the difference between what sellers would be willing to sell for, should the market require it, and what they actually do sell the product for.

• It is the area above the supply curve and below the price line.

SP

Q

V. Markets in

International Trade

International Trade Markets

International trade can be represented by three markets functioning simultaneously.

• First, the domestic market, Without a comparative advantage, our high prices encourage us to look for imports.

International Trade Markets

• Second, the markets of the rest of the world (ROW), that could supply imports.

• Third, the trade market. Our imports fill a gap between domestic demand and supply. ROW exports can be supplied at prices above equilibrium (S>D).

Our Market International Trade ROW Market

Imports

ExportsROW Sx

US Dm

ROW D

ROW S

US SUS D

Our Market International Trade

Imports

US SUS D

US Dm = US Demand – US Supply

At this price, no imports are demanded

At this price, import demand = thedifference between US D and US S

In world markets, the lower world price increases our nation’s consumer surplus

But our producers lose a lot of their surplus.

Deriving Import Demand

International Trade ROW Market

ROW supply = ROW S – ROW D

ROW D

ROW S

At this price, the ROW has no excess supply to export

At this price, the ROWcan export the gap Between ROW S andROW D.

Deriving Import Supply

Our Market International Trade ROW Market

Imports

ExportsROW Sx

US Dm

ROW D

ROW S

US SUS D

So our imports (ROW’s exports to us) are determined by these markets.

P

0 Q