Transcript E 13-14 Unit II Demand _ Supply _posted_

Unit II: The Market
Economy
Demand
• Demand indicates how much of a product
consumers are both willing and able to buy
at each possible price during a given period,
other things remaining constant.
Law of Demand
• The law of demand says that quantity
demanded varies inversely with price, other
things constant.
• Thus, the higher the price, the smaller the
quantity demanded.
What Explains the Law of Demand
• The Substitution Effect – many goods & services
are capable of satisfying your particular wants
• Some options have more appeal than others
(ex. pizza vs. raw oysters)
• However, scarcity is a reality
• As one good becomes relatively cheaper,
consumers are more willing to buy it
• As a good becomes more expensive, consumers
turn to substitutes
What Explains the Law of Demand
• Income effect –
• As price declines for a product, your real
income increases
• This increases your ability to buy more of
that good, and indirectly other goods
• Conversely, an increase in price reduces
your real income
Diminishing Marginal Utility
• Marginal utility – the change in total utility
resulting from a one-unit change in
consumption of a good
• Law of diminishing marginal utility – the
more of a good a person consumes per
period, the smaller the increase in total
utility from consuming one more unit,
ceteris paribus
Diminshing Marginal Utility for Chick-fil-A
Spicy Chicken Sandwiches
Price
$2
$1
$.50
$.25
$.13
Quantity of Sandwiches Consumed
What is Demand?
• There is a limited amount of goods out there
• How do we decide what we want?
• Demand is made up of two elements:
– Desire for Goods and Services
– Means to purchase those Goods and Services
Demand Schedules
• Let consider how many CDs you might
demand in a month. (This is called
“Quantity Demanded”)
• We will first look at this information in a
table called a “Demand Schedule”
• Demand Schedule - a table showing the
relationship between the price of a good and
the quantity demanded per period of time,
ceteris paribus.
Demand Schedule
Price of CDs ($)
Quantity Demanded
per month
Demand Schedule
P ($)
Qd
$20
5
Demand Schedule
P ($)
Qd
$20
5
$15
7
Demand Schedule
P ($)
Qd
$20
5
$15
7
$10
15
Demand Schedules and Curves
• Another way of characterizing Demand
instead of using a schedule is a Demand
Curve.
• Demand Curve - a diagram showing the
relationship between the price of a good and
the quantity demanded per period of time,
ceteris paribus.
Demand Curve
Demand Curve
P($)
Note: ALWAYS label your axes!
Qd per month
Demand Curve
P($)
20
15
10
5
0
5
10
15
Qd per month
Demand Curve
P($)
A
20
15
10
5
0
5
10
15
Qd per month
Demand Curve
P($)
A
20
B
15
10
5
0
5
10
15
Qd per month
Demand Curve
P($)
A
20
B
15
C
10
5
0
5
10
15
Qd per month
Demand Curve
P($)
A
20
B
15
C
10
D
5
0
5
10
15
Qd per month
Market Demand Curve
• The demand curve we just drew was the
Demand for CDs by one person.
• Market Demand Curve - a curve showing
the relationship between the price of a good
and the total quantity demanded by all
consumers in the market per period of time,
ceteris paribus.Market demand curves are
obtained by summing the demand curves of
individual consumers.
Market Demand Schedule
• Market Demand Schedule - a table showing
the relationship between the price of a good
and the total quantity demanded by all
consumers in the market per period of time,
ceteris paribus.
• Market demand schedules are obtained by
summing the demand schedules of
individual consumers.
Market Demand Schedule
5
Mary’s
Qd
3
10
2
15
1
P($)
Market Demand Schedule
5
Mary’s
Qd
3
John’s
Qd
12
10
2
8
15
1
3
P($)
Market Demand Schedule
5
Mary’s
Qd
3
John’s
Qd
12
Tom’s
Qd
7
10
2
8
5
15
1
3
4
P($)
Market Demand Schedule
5
Mary’s
Qd
3
John’s
Qd
12
Tom’s
Qd
7
Market
Qd
22
10
2
8
5
15
15
1
3
4
8
P($)
Individual Demand for Pizzas
(a) Hector
(b) Brianna
(c) Chris
$12
$12
8
4
8
4
8
4
Price
$12
dH
1 2 3
Figure 4.4
1 2
Pizzas
(per week)
dB
dC
1
Market Demand for Pizzas
(d) Market demand for pizzas
dH + dB + dC = D
Price
$12
8
4
1 2 3
Figure 4.4
6
Pizzas
(per week)
Elasticity of Demand
• Elasticity = responsiveness
• Elasticity of demand measures how
responsive quantity demanded is to a price
change
Elasticity of Demand
• A demand curve can show how sensitive
quantity demanded is to a price change
• Example: A superstore would like to know
what will happen to its total revenue if it
introduces an “Everything for a Dollar”
section
• The law of demand says the lower price will
increase quantity demanded.
• But by how much?
Computing the
Elasticity of Demand
• Elasticity of demand measures the
percentage change in quantity demanded
divided by percentage change in price.
Elasticity
of demand
=
Percentage change in
quantity demanded
Percentage
change in price
Elasticity Values
• Elastic: > 1.0
• Unit elastic: = 1.0
• Inelastic: < 1.0
Elasticity and Total Revenue
• Knowing a product’s elasticity can help
businesses with their pricing decisions.
• Total revenue is price multiplied by the
quantity demanded at that price.
• TR = P x Q
Elasticity & Total Revenue
• What happens to total revenue when price
decreases?
• A) lower price = producers paid less per unit
- this tends to lower TR
• B) BUT law of demand says a lower price =
increase in quantity demanded which tends
to increase TR
Elasticity & Total Revenue
• Example:
• When elasticity is > 1.0 (elastic), reducing
the price by 5% will cause quantity
demanded to increase by more than 5 %;
thus TR will increase
• When elasticity is 1.0 (unit elastic),
reducing the price by 5% will cause
quantity demanded to increase by 5 %; thus
TR will remain unchanged
Elasticity & Total Revenue
• When elasticity is < 1.0 (inelastic), reducing
the price by 5% will cause quantity
demanded to increase, but by less than 5 %;
thus TR will fall
• If demand is inelastic – producers will never
willingly cut the price since that would
reduce TR
• Why cut price if selling more reduces TR?
The Revenue Test
•
•
•
•
•
•
Price ↑ total revenue ↓ = Elastic demand
Price ↓ total revenue ↑ = Elastic demand
Price ↑ total revenue unchanged = Unit elastic
Price ↓ total revenue unchanged = Unit elastic
Price ↑ total revenue ↑ = Inelastic demand
Price ↓ total revenue ↓ = Inelastic demand
Determinants of Demand
Elasticity
• 1) Availability of substitutes
• the more substitutes there are for a good, the
greater its elasticity of demand
• The more broadly a good is defined, the
fewer substitutes there are and the less
elastic the demand
• Ex. Shoes (inelastic)
• Nike shoes (elastic)
Determinants of Demand Elasticity
• 2) Share of consumer’s budget spent on the
good
• If a good represents a large share of a
consumer’s budget, a ∆ in price of such a
good has a substantial impact on the amount
consumers are able to purchase
• The more important the item is as a share of
the consumer’s budget, the more elastic is
the demand for them
Determinants of Demand Elasticity
• 3) A matter of time
• consumers may substitute lower-priced goods for
higher-priced goods, but finding substitutes usually
takes time
• OPEC: ’73-’74 gas prices ↑ 45%; Qd ↓ 8%
• Over time people  smaller cars, public
transportation, energy efficient appliances, etc.
• The longer the period of adjustment, the more
elastic in demand a good is
• Demand is more elastic in the long run than in the
short run
Demand Becomes
More Elastic Over Time
$3.50
3.00
Price per gallon
Dy
Dm
Dw
0
Figure 4.4
50
75
95100 Millions of gallons per day
Selected Elasticities of Demand
Product
Short Run
Long Run
Electricity (residential)
0.1
1.9
Air travel
0.1
2.4
Medical care and hospitalization
0.3
0.9
Gasoline
0.4
1.5
Movies
0.9
3.7
Natural gas (residential)
1.4
2.1
Figure 4.5
Change in D vs. Change in Qd
• Change in Quantity Demanded - a change in
the desire or means to purchase the good,
thus there is a change in quantity demanded
at EVERY price. (Price Effect)
• Change in Demand - a shift of the demand
curve
Change in D vs. Change in Qd
• Changes in Demand
• Increase in demand - demand curve shifts to the
right
• Decrease in demand - demand curve shifts to
the left
Change in Demand
•
Factors Which Cause a Change in
Demand
1)
2)
3)
4)
5)
Consumer Income
Price of Related Goods
Number & Composition of Buyers
Consumer Expectations about Future Prices
Consumer Tastes and Preferences
Change in Demand - Income
• If you graduate from college and start
making a substantial income - What might
happen to the amount of CDs you would
want to buy?
– It would increase! You would be willing and
able to purchase more CDs at every price.
– Thus, demand has increased.
Change in Demand - Income
• If after a year at your new job the boss cuts
salaries by 30%. What happens to Demand?
– It would decrease.
– You are now have less means to purchase CDs
at all prices.
Normal and Inferior Goods
• Given the information we have, CDs are a
“normal good”
• Normal Good - any good which increases in
demand as income increases (and vice-versa)
• Most goods are normal
• Inferior Good - any good which decreases in
demand as income increases (and vice-versa)
• Ex. - Macaroni and Cheese
Change in Demand - Price of
Related Goods
• Substitute - a good which can be consumed in
place of another good
• What would happen to the demand for pizza
if the price of hamburgers fell?
– The demand for pizza would probably fall since
people would be buying hamburgers instead.
Change in Demand - Price of
Related Goods
• Complement - a good which is consumed along
with the consumption of another good
• Ex - Peanut Butter and Jelly are complements.
• If price of peanut butter increases, consumers
purchase less peanut butter
• Result  Consumers purchase less jelly
• Since people buy less peanut butter they need less
jelly for PB&J sandwiches
Change in Demand - Price of
Related Goods
• Thus, either of the following will increase
Demand
• Price of a substitute good increases
• Price of a complement good decreases
• And either of the following will decrease
Demand
• Price of a substitute good decreases
• Price of a complement good increases
Change in Demand –
Number of Buyers
The more buyers in the market for a good, the
greater the TOTAL quantity demanded (by the
whole economy) of the good at a given price.
Since the quantity demanded is higher at EVERY
given price, the demand has increased.
Likewise, if there are less buyers in the market there
is less quantity demanded at every price, so
demand has decreased.
Change in Demand Expectations about Future Prices
• If we were to hear a new story about how
CD prices were going to go up next month,
would you buy that CD you have had your
eye on now or later?
– Now. If you know prices will rise, you will
want to buy more now, so you can avoid paying
the higher price in the future.
– So demand will increase in response to this
information
Change in Demand Expectations about Future Prices
• Likewise, if we hear that CD prices are
going to drop next month, what do we do
now?
– It is likely that we will buy less now, waiting to
buy that new CD until the prices fall next
month, thus demand will decrease.
Change in Demand - Tastes and
Preferences
• Let’s say we find out listening to CDs can
improve your hearing, or what if suddenly
CDs become very fashionable to buy? If
consumers prefer more of a good, the
demand for the good increases (a rightward
shift of the demand curve).
• What if we find out CDs emit dangerous
radiation? If consumers prefer a good less,
the demand for the good decreases (a
leftward shift of the demand curve).
Increase in Demand
Increase in Demand
P
Qd
Increase in Demand
P
D
Qd
Increase in Demand
P
D
Qd
Increase in Demand
P
D
D’
Qd
Increase in Qd
Increase in Qd
P($)
Qd
Increase in Qd
P($)
D
Qd
Increase in Qd
P($)
A
D
Qd
Increase in Qd
P($)
A
D
Qd
Increase in Qd
P($)
A
B
D
Qd
Supply
What is Supply?
• Supply is how much a firm is willing to sell
at every given price, ceteris paribus
• Thus, if the price of a good goes up, what
would you expect the response of a firm to
be?
– To produce more, since prices are going up, so
will profits
Law of Supply
• Law of Supply - the price of a product (or
service) is directly related to the quantity
supplied, ceteris paribus.
• Quantity Supplied - the amount of a good
(or service) produced by firms at a
particular price.
• While demand typically refers to
consumers, supply typically refers to firms.
Supply Schedules and Curves
• Supply Schedule - a table showing the
relationship between the price of a good and
the quantity supplied per period of time,
ceteris paribus.
Supply Schedule
Price of CDs ($)
Quantity of CDs
Supplied per month
Supply Schedule
P ($)
Qs per month
$20
15
Supply Schedule
P ($)
Qs per month
$20
15
$15
7
Supply Schedule
P ($)
Qs per month
$20
15
$15
7
$10
5
Supply Schedules and Curves
• Supply Curve - a diagram showing the
relationship between the price of a good and
the quantity supplied per period of time,
ceteris paribus.
Supply Curve
Supply Curve
P($)
Remember to ALWAYS label
your axes!
Qs per month
Supply Curve
P($)
20
15
10
5
0
5
10
15
Qs per month
Supply Curve
P($)
A
20
15
10
5
0
5
10
15
Qs per month
Supply Curve
P($)
A
20
B
15
10
5
0
5
10
15
Qs per month
Supply Curve
P($)
A
20
B
15
10
C
5
0
5
10
15
Qs per month
Supply Curve
P($)
AS
20
B
15
10
C
5
0
5
10
15
Qs per month
Market Supply Curve
• Market Supply Curve - a curve showing the
relationship between the price of a good and
the total quantity supplied by all firms in the
market per period of time, ceteris paribus.
• Market supply curves are obtained by
summing the supply curves of individual
firms.
Market Supply Schedule
• Market Supply Schedule - a table showing
the relationship between the price of a good
and the total quantity supplied by all firms
in the market per period of time, ceteris
paribus.
• Market supply schedules are obtained by
summing the supply curves of individual
firms.
Market Supply Schedule
P($)
5
Firm A Firm B Firm C Market
Qs
Qs
Qs
Qs
1
3
4
8
10
2
8
5
15
15
3
12
7
22
Change in S vs. Change in Qs
• Change in Supply - a shift of the supply
curve
• Increase in supply - supply curve shifts to the
right
• Decrease in supply - supply curve shifts to the
left
Change in Supply
Factors Which Cause a Change in Supply
• 1) The cost of resources used to make the
good
• 2) The prices of other goods these resources
could make
• 3) Technology used to make the good
• 4) Producer expectations
• 5) Number of sellers in the market
1) The cost of resources used to
make the good
• If the cost of plastic (making CDs) decreases
• It’s now cheaper to make every quantity of
CDs
• In summary, if the price of a resource goes
down, supply increases (shifts to the right)
Supply Curve
P($)
A
20
A’
15
10
5
0
5
10
15
Qs per month
Supply Curve Shift
Old Supply Curve
A
P($)
20
A’
15
New Supply Curve
10
5
0
5
10
15
Qs per month
Price of Relevant Resources
• Let’s say the cost of plastic (making CDs)
increases
• It is now more expensive to make every
quantity of CDs
• In summary, if the cost of a resource goes
up, supply decreases (shifts to the left)
Supply Curve
P($)
B’
20
B
15
10
5
0
5
10
15
Qs per month
Supply Curve Shift
P($)
New Supply Curve
Old Supply Curve
B’
20
B
15
10
5
0
5
10
15
Qs per month
2) The prices of other goods these
resources could make
• Nearly all resources have alternative uses
• The labor, building, machinery, materials,
& knowledge needed to make CDs could
make other products such as DVDs
• A change in price of another good these
resources could make, affects the
opportunity cost of making CDs
2) The prices of other goods these
resources could make
• If the price of DVDs falls, the opportunity
cost of making CDs declines.
• These resources are not as profitable in their
best alternative use – which is making CDs
• Now CD production becomes more
attractive
• As resources shift from DVD to CD
production , the supply of CDs increases, or
shifts to the right.
2) The prices of other goods these
resources could make
• On the other hand, if the price of DVDs
increases, so does the opportunity cost of
making CDs.
• Some CD producers may make more DVDs
& less CDs, so the supply of CDs decreases,
or shifts to the left.
• A change in the price of another good these
resources could produce affects the profit
opportunities of CD producers.
3) Technology
• Improvement in technology lowers costs
• Lower cost of production increases Supply
• Worsening of technology increases costs
• Higher cost of production decreases Supply
4) Expectations of Future Prices
• Firms expect the price of their good to
decrease in the future
• Supply increases today
• Firm would prefer to sell today when price is
higher
Expectations of Future Prices
• Firms expect price of their good to increase
in the future
• Supply decreases today
• Firm would prefer to wait until the good can be
sold for a higher price
5) Number of Sellers
• More sellers in the market means more
quantity is being supplied at every price
• Increase in supply of the good
• Less sellers in the market means less
quantity is being supplied at every price
• Decrease supply of the good
Number of Sellers
• Government regulation
• Strict government regulation  fewer
sellers in the market
• Restrictions eased  more sellers in the
market
• Taxes
• Higher taxes  reduces supply
• Lower taxes  increases supply
Change in Quantity Supplied
• Change in Quantity Supplied (DQs) movement along a supply curve
• A change in quantity supplied can only be
caused by a change in the price of the good.
• Changes in Quantity Supplied
• Increase in Qs - a movement to the right along a
supply curve
• Decrease in Qs - a movement to the left along a
supply curve
Increase in Supply
Increase in Supply
P
Qs
Increase in Supply
P
S
Qs
Increase in Supply
P
S
Qs
Increase in Supply
P
S
S’
Qs
Increase in Qs
Increase in Qs
P($)
Qs per month
Increase in Qs
P($)
S
Qs per month
Increase in Qs
S
P($)
A
Qs per month
Increase in Qs
S
P($)
A
Qs per month
Increase in Qs
S
P($)
B
A
Qs per month
Elasticity of Supply
• The elasticity of supply measures how
responsive producers are to a price change.
• Responsiveness depends on how costly it is
to alter output when the price changes
Elasticity of Supply
• If the cost of supplying an additional unit
rises sharply as output expands, then a
higher price will generate little increase in
quantity supplied  inelastic
• Example: producers of cars or electricity
Elasticity of Supply
• If the cost of an additional unit rises slowly
as output expands, the profit lure of a higher
price will prompt a relatively large boost in
output  elastic
• Examples: hot dog vending & landscaping
Measurement
• Elasticity of supply equals percentage
change in quantity supplied divided by
percentage change in price.
Elasticity
of supply
=
Percentage change in
quantity supplied
Percentage
change in price
Categories of Supply Elasticity
• Supply is elastic if supply elasticity exceeds
1.0.
• Supply is unit elastic if supply elasticity
equals 1.0.
• Supply is inelastic if supply elasticity is less
than 1.0.
Market Supply Becomes
More Elastic Over Time
Sw
Sm
Sy
Price per gallon
$3.50
3.00
0
Figure 5.4
100
200
Millions of gallons per day
300
Determinants of Supply Elasticity
• One important determinant of supply
elasticity is the length of the adjustment
period under consideration.
• The elasticity of supply is typically greater
the longer the period of adjustment.
Market Equilibrium
• When the quantity that consumers are
willing and able to buy equals the quantity
that producers are willing and able to sell,
that market reaches market equilibrium.
Equilibrium in the Pizza Market
Figure 6.1
Surplus Forces the Price Down
• At a given price, the amount by which
quantity supplied exceeds quantity
demanded is called the surplus.
• As long as quantity supplied exceeds
quantity demanded, the surplus forces the
price lower.
Shortage Forces the Price Up
• At a given price, the amount by which
quantity demanded exceeds quantity
supplied is called the shortage.
• As long as quantity demanded and quantity
supplied differ, this difference forces a price
change.
Market Forces Lead to
Equilibrium Price and Quantity
• The equilibrium price, or market-clearing
price, equates quantity demanded with
quantity supplied.
• Because there is no shortage and no surplus,
there is no longer any pressure for the price
to change.
Adam Smith’s Invisible Hand
• Although each individual pursues his or her
own self-interest, the “invisible hand” of
market competition promotes the general
welfare.
Equilibrium in the Pizza Market
Figure 6.1
Market Exchange Is Voluntary
• Neither buyers nor sellers would participate
in the market unless they expected to be
better off.
• Prices help people recognize market
opportunities to make better choices as
consumers and as producers.
Markets Reduce Transaction
Costs
• Transaction costs are the cost of time and
information needed to carry out market exchange.
• The higher the transaction cost, the less likely the
exchange will take place.
• Example: car dealers find land on outskirts of
town (land is cheaper); tend to locate near each
other to be on hand when buyers shop for cars
• Doing this, dealers reduce transaction costs of
car shopping
An Increase in Demand
A Decrease in Demand
An Increase in Supply
A Decrease in Supply
Both Curves Shift
• Curves shift in the same direction
– Equilibrium quantity will increase.
– What happens to price depends on which curve
shifts more.
• Curves shift in opposite directions
– Equilibrium price will increase if demand
increases and supply decreases.
– Equilibrium price will decrease if demand
decreases and supply increases.
Change in Demand
Change in Supply
Increases
Figure 6.6
Decreases
Equilibrium price change
is indeterminate.
Equilibrium price falls.
Equilibrium quantity
increases.
Equilibrium quantity
change is indeterminate.
Equilibrium price rises.
Equilibrium price change
is indeterminate.
Equilibrium quantity
change is indeterminate.
Equilibrium quantity
decreases.
Competition and Efficiency
• Productive efficiency
– Making stuff right
• Allocative efficiency
– Making the right stuff
• Market competition promotes both
productive efficiency and allocative
proficiency.
Productive Efficiency:
Making Stuff Right
• Productive efficiency occurs when a firm
produces at the lowest possible cost per
unit.
• Competition ensures that firms produce at
the lowest possible cost per unit.
Allocative Efficiency:
Making the Right Stuff
• Allocative efficiency occurs when firms
produce the output that is most valued by
consumers.
• Competition among sellers encourage
producers to supply more of what
consumers value the most.
Disequilibrium
• Disequilibrium is a mismatch between
quantity demanded and quantity supplied as
the market seeks equilibrium
• A price floor is a minimum selling price
that is above the equilibrium price.
• A price ceiling is a maximum selling price
that is below the equilibrium.
Price Floor
Figure 6.7a
• If a price floor is
established above
the equilibrium
price, a permanent
surplus results.
• A price floor
established at or
below the
equilibrium price
has no effect.
Price Ceiling
Figure 6.7b
• If a price ceiling
is established
below the
equilibrium
price, a
permanent
shortage results.
• A price ceiling
established at or
above the
equilibrium
price has no
effect.
The Black Market
• If a price ceiling
is imposed below
the equilibrium
price, a black
market could
develop.
Other Sources of Disequilibrium
• Government intervention in the market
• Sometimes the market takes a while
to adjust
– New products
– Sudden change in demand or supply
Consumer Surplus
• Consumer surplus is the difference
between the most that consumers would be
willing and able to pay for a given quantity
and the amount they actually do pay.
Market Demand
and Consumer Surplus
• Consumer surplus at a
price of $2 is shown by
the darker area.
• If the price falls to $1,
consumer surplus
increases to include the
lighter area between $1
and $2.
• If the good is free,
consumer surplus would
increase by the lightest
area under the demand
curve.
Figure 6.8