Transcript lecture 5

A Close Examination of
Supply & Demand
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Principles of
Microeconomic
Theory, ECO 284
John Eastwood
CBA 247
523-7353
e-mail address:
[email protected]
1
The Market
Any arrangement by which people
exchange goods (or services).
 These exchanges have two sides -- those
who wish to buy (demand) and those who
wish to sell (supply).
 Prices are signals that direct the behavior of
both sides.
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Demand
the inverse relationship between the price of
a good (or service) and the quantity
consumers are willing and able to buy
(during a given period of time, ceteris
paribus).
 A demand price is the greatest amount ($)
that a buyer would pay to buy one more
unit. (a.k.a. subjective price)
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Representing Demand
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The Demand Schedule
lists the quantity
people plan to buy at
each price.
The Demand Curve
plots the quantity
people plan to buy at
each price.
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Eastwood’s Demand Schedule for
White Dress Shirts
Price
($/unit)
Quantity
Demanded
(units/time)
$15/shirt
$18/shirt
$21/shirt
$24/shirt
$27/shirt
$30/shirt
$33/shirt
6 shirts per year
5 shirts per year
4 shirts per year
3 shirts per year
2 shirts per year
1 shirt per year
0 shirts per year
5
Price ($/shirt)
Demand “Curve” (Step Function)
35
30
25
20
15
10
5
0
0
1
2
3
4
5
6
Quantity (shirts/year)
6
Price ($/shirt)
Continuous Demand Curve
35
30
25
20
15
10
5
0
0
1
2
3
4
5
6
Quantity (shirts/year)
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Determinants of Demand
Prices of other related goods -- Po
 Income -- I
 Number of People -- N
 Tastes -- T
 Expectations -- E
 Subsidies or Taxes -- S
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An Important Difference:
Change in Demand -- The entire curve
shifts when one of the PoINTES changes.
 Change in Quantity Demanded -- When a
good's own price changes, this causes a
movement along a single demand curve.
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Prices of other related goods

Substitutes -- goods that satisfy similar
needs or desires. Suppose X and Y are
substitute goods. (Let X= ___, Y= ____) If
the price of Y rises, then the demand for X
will rise (shift right).
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Prices of other related goods
Complements -- goods that are consumed
jointly. (e.g., hot dogs & buns).
 Suppose X and Z are Complements and that
the price of Z rises. Then the demand for X
will fall (shift left).
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Income
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As a person's income
rises, his or her ability
to purchase any given
good also rises.
Willingness to buy is
also important, hence
we have two classes of
goods . . .
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Normal Good

a good that is
consumed voluntarily
and for which demand
will rise as income
rises, and fall as
income falls.
13
Inferior Good
An inferior good is one that is consumed
due to economic circumstances.
 Demand for an inferior good

will fall as income rises . . .
and will rise as income falls.
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Number of People
People are potential buyers.
 If the number of people increases, demand
will increase (shift right).
 If the number of people decreases, demand
will decrease (shift left).
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Tastes (or preferences)
People's tastes affect their willingness to
buy a good at any given price.
 An increase in consumers' taste for a good
X will shift the demand curve for X to the
right.
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Expectations (of price changes)
If the price of a good X is expected to rise,
current demand will increase (if the good
can be stored).
 If prices are expected to fall, current
demand will decrease.
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Subsidies and/or Taxes
From a seller’s viewpoint. . .
 A subsidy increases demand
 A tax decreases demand
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Three Demand Curves
White Dress Shirts
Price ($/shirt)
35
30
25
20
15
10
5
0
0
10
20
30
Quantity (shirts/year)
40
50
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Supply
the relationship between the quantity of a
good producers are willing and able to offer
(during a given period of time), and the
price, ceteris paribus.
 A supply price is the least amount ($) that
will induce a seller to produce one more
unit.
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Representing Supply as a
Schedule or as a Curve.
The supply curve is usually upward sloping
to the right.
 When the supply is fixed regardless of
price, supply is vertical.
 When an industry can expand output at a
constant cost per unit, supply is horizontal.
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Tailor’s Supply Schedule for White
Dress Shirts
Price
($/unit)
Quantity
Supplied
(units/time)
$15/shirt
$18/shirt
$21/shirt
$24/shirt
$27/shirt
$30/shirt
$33/shirt
0 shirts per year
1 shirt per year
2 shirts per year
3 shirts per year
4 shirts per year
5 shirts per year
6 shirts per year
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Price ($/shirt)
Supply “Curve” (Step Function)
35
30
25
20
15
10
5
0
0
1
2
3
4
5
6
Quantity (shirts/year)
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Price ($/shirt)
Continuous Supply Curve
35
30
25
20
15
10
5
0
0
1
2
3
4
5
6
Quantity (shirts/year)
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Change in Supply Versus
Change in Quantity Supplied
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A change in Supply refers to a shift in the
curve.
–
A shift to the right is an increase
 larger
–
quantity at a given price
A shift to the left is a decrease
 smaller
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quantity at a given price
A change in price causes only a change in
quantity supplied, not a shift in the curve.
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Determinants of Supply -- PEST
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Prices of other goods
–
–
Substitutes in production.
Complements in production (by-products)
Expectations (concerning the good's price in
the future)
 Supplier's Input Prices
 Technology (process technology)
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More Non-Price Determinants
PESTS WIN
Subsidies and/or Taxes
 Weather
 Import Quotas
 Number of Sellers
Short Run -- Capital fixed;
Long Run -- All factors may vary.
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Prices of other producible goods
Substitutes in production (corn,x; alfalfa,y)
If the price of Y rises, then the supply for X
will decrease (shift left).
 Complements in production (by-products)
(cornstalks,z) If the price of X rises, then
the quantity supplied of X will increase and
the supply of Z will increase (shift right).
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Expectations (of price changes)
If the price of a good X is expected to rise,
current supply will decrease (if the good
can be stored).
 If prices are expected to fall, current supply
will increase.
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Suppliers’ Input Prices
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aka resource costs
Higher input prices,
such as wages or raw
materials prices,
squeeze profits, and
decrease supply.
Higher supply price
for any quantity
Lower q for any p.
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Technology
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An improvement in
process technology
reduces the costs of
production.
Lower supply price for
any given quantity
Larger Qs at a given P
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Subsidies or Taxes
From a buyer’s viewpoint. . .
 A subsidy increases supply
 A tax decreases supply
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Weather
Often considered part of Technology
 Favorable weather increases the supply of
crops
 Unfavorable weather decreases supply
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Import Quotas
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A maximum quantity
of a good that may be
legally imported
during a specified
period of time
A quota makes supply
vertical above a
certain price.
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Price ($/shirt)
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Quota=40
20
15
10
5
0
0
20
40
60
Quantity (shirts/year)
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Number of Sellers (Firms)
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In the short run, the number of sellers is
constant
–
–
Short Run -- Capital,K, fixed, Labor, L, may
vary;
Long Run -- All factors may vary.
If the number of sellers rises, supply will
increase (shift right).
 If the number of firms decreases, supply
will decrease (shift left).
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Three Supply Curves
White Dress Shirts
Price ($/shirt)
35
30
25
20
15
10
5
0
0
10
20
30
Quantity (shirts/year)
40
50
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Marshall’s Analytical Time
Market Period -- Firms cannot change
quantity, S is vertical
 Short Run -- Firms may vary output, but
not plant size
 Long Run -- All inputs are variable
 Secular Period (Very Long Run) -population and technology vary
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Demand does NOT influence SSR
PESTS WIN -- Demand not on list!
 Demand and supply are independent in
the short-run.
 In the short run, capital (K) is fixed
 New firms cannot enter.
 Established firms cannot exit.
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The Individual and Market
Demand Curves.
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The market demand curve for a good X is a
(horizontal) summation of the quantity each
individual in the market area is willing and
able to buy at each price.
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Equilibrium -- where the forces of
supply and demand balance.
The equilibrium price (Pe) is where . . .
Qs = Qd.
 Who sets Pe?
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No one! It’s spontaneously established.
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Equilibrium is stable.
Once reached, it persists until . . .
one of the PoINTES or PESTS change.
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Balancing Supply and Demand:
Shortage
Buyers wish to buy at a low price,
but also seek to obtain the good.
 When quantity demanded (Qd) exceeds
quantity supplied (Qs), buyers may . . .
"bid-up" the price.
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Balancing Supply and Demand:
Surplus
Sellers wish to sell at a high price,
but also desire to sell their goods.
 When Qs > Qd, sellers may
"bid-down" the price.
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Price ($/shirt)
Marshall’s Cross
35
30
25
20
15
10
5
0
0
1
2
3
4
5
6
Quantity (shirts/year)
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Changes in Supply
(Demand curve unchanging)
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Increase in supply implies . . .
Pe falls and Qe rises.
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Decrease in supply implies . . .
Pe rises and Qe falls.
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Changes in Demand
(Supply curve unchanging)
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Increase in demand implies . . .
Pe rises and Qe rises.
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Decrease in demand implies . . .
Pe falls and Qe falls.
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Both Supply and Demand Change in
the Same Direction
Demand increase; Supply increase;
Qe rises. Pe ?
 Demand decrease; Supply decrease;
Qe falls. Pe ?;
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Pe? implies that Pe could rise, fall or stay
the same
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Supply and Demand Change in
Opposite Directions
Demand increase; Supply decrease;
Pe rises; Qe?
 Demand decrease; Supply increase;
Pe falls; Qe?
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Qe? implies that Qe could rise, fall or stay the
same
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Undercutting the Consumers
Arizona Daily Sun, Tuesday, January 16, 1996, page 10.
AUSTIN, Texas (AP) - Bruce Springsteen's latest album features songs
about life on the streets. But you won't find a song about this: 100
homeless people who camped out for tickets to his concert. The
homeless were shuttled to nine locations around Austin Friday night to
buy the $30 tickets for companies that resold them for as much as $400.
The homeless people were offered as much as $50 each to stay in line
overnight and buy the tickets in the morning. "I think it's wrong
because I don't think the homeless people understand how bad they're
being used," attorney Steve Boney, who waited for tickets Friday, told
the Austin-American Statesman.Jay Hill, who works for Ticket City,
said his company paid about five homeless people to stand in line for
tickets. "It's free enterprise. That's what America is based on," he said.
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Is the Market too Radical?
"If there's a buck in it, do it."
Market equilibrium results in the greatest
possible quantity produced and sold that is
agreeable to both buyers and sellers.
 Which determines price, demand or supply?
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Rationing
Goods must be allocated to consumers.
 Thus rationing is a task that every economic
system must carry out.
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Price as a Rationing Device
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One of the prime functions of the market is
to determine who shall be allowed to
acquire goods and who shall not.
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The market excludes...
certain people from economic activity
 the customers with too little money or too
weak desires,
 and suppliers unwilling or unable to operate
at a certain price.
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Rationing through Price
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Advantages:
Highly dynamic, unlike rigid tradition.
Self-enforcing, unlike command.
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Disadvantage:
The market recognizes no claims to output
except those of wealth and income.
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