Transcript P 1

Chapter 3
Demand, supply and the market
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
9th Edition, McGraw-Hill, 2005
PowerPoint presentation by Alex Tackie and Damian Ward
©The McGraw-Hill Companies, 2008
Some key terms
• Market
– a set of arrangements by which buyers and
sellers are in contact to exchange goods or
services
• Demand
– the quantity of a good buyers wish to
purchase at each conceivable price
• Supply
– the quantity of a good sellers wish to sell at
each conceivable price
• Equilibrium price
– price at which quantity supplied = quantity
demanded
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Some key terms (2)
• Some goods are related to each other.
• Substitutes: If the two goods fulfill similar
needs they are called substitutes. E.g. Tea and
Coffee.
• Complements: If the two goods complete each
other when consumed, they are called
complements. E.g. Tea and sugar.
©The McGraw-Hill Companies, 2008
Some Key Terms (3)
• Prices of Related Goods
– When a fall in the price of one good
reduces the demand for another good,
the two goods are called substitutes.
– When a fall in the price of one good
increases the demand for another good,
the two goods are called complements.
©The McGraw-Hill Companies, 2008
Some Key Terms (4)
• Consumer Income
– As income increases the demand for a
normal good will increase. E.g. Cars
– As income increases the demand for an
inferior good will decrease. E.g Bread
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Price
The Demand curve shows the relation between price
and quantity demanded holding other things
constant
D
Quantity
• “Other things” include:
– the price of related
goods
– consumer incomes
– consumer preferences
• Changes in these other
things affect the position
of the demand curve
Law of Demand: The quantity
demanded of a good
decreases as its prices
increases, all other things
equal. ©The McGraw-Hill Companies, 2008
Price
The Supply curve shows the relation between price
and quantity supplied holding other things constant
S
Quantity
• “Other things” include:
– technology
– input costs
– government
regulations
• Changes in these other
things affect the position
of the demand curve
Law of Supply: The quantity
supplied of a good increases
as its prices increases, all
other things equal.
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Market equilibrium (1)
S
D0

P0
E0
• Market equilibrium is
at E0 where quantity
demanded equals
quantity supplied
– with price P0 and
quantity Q0
D0
S
Q0
Quantity
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Market equilibrium and
disequilibrium
D

P1
S
excess
supply
E


P0

P2
S

excess
demand
D
Q0
Quantity
• If price were below P0
there would be excess
demand
– consumers wish to
purchase more than
producers wish to
supply
• If price were above P0 there
would be excess supply
– producers wish to supply
more than consumers
wish to purchase
©The McGraw-Hill Companies, 2008
A shift in demand
D1
D0
If the price of a substitute
good decreases ...
S
P0
less will be demanded at
each price.
E0
P1
The demand curve shifts
from D0D0 to D1D1.
E1
S
D1
Q1 Q0
D0
Quantity
If price stayed at P0 there
would be excess supply.
So the market moves to a
new equilibrium at E1.
©The McGraw-Hill Companies, 2008
Shift in demand (2)
• Consumer income:
• Normal goods: Demand shifts right if
the income increases
• Inferior goods: Demand shifts left if
the income increases.
• Preferences: If the change in
preference is in favor of the good,
the demand will shift to the right.
E.g: Ice cream in summer.
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Shift in demand (3)
• Population increase shifts the market
demand curve to the right.
• Subsititutes: If a substitute good
price increases, the other good’s
demand will shift to the right.
• Complements: If a complement
good’s price increases, the other
good’s demand will shift to the left.
©The McGraw-Hill Companies, 2008
A shift in supply
S1
S0
D
E2
P1
P0
The supply curve
shifts to S1S1
E0
If price stayed at P0 there
would be excess demand
S1
D
S0
Q1 Q0
Suppose safety
regulations are tightened,
increasing producers’ costs
So the market moves to a
new equilibrium at E2
Quantity
©The McGraw-Hill Companies, 2008
Shift in supply (2)
• Increase in input’s price shift the
supply curve to the left.
• Taxes shifts the supply curve to the
left.
• Expectation about future consumers
shifts the supply curve to the right.
• External conditions also shift the
supply curve. E.g Weather conditions
for agricultural products.
©The McGraw-Hill Companies, 2008
Two ways in which demand may
increase (1)
• (1) A movement along
the demand curve from A
to B
• represents consumer
reaction to a price
change
• could follow a supply
shift
A
P0
P1
B
D
Q0 Q1 Quantity
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Two ways in which demand may
increase (2)
P0
P1
C
A
B
F
D0 D1
Q0 Q1 Q2 Q3
• (2) A movement of the
demand curve from D0 to
D1
• leads to an increase in
demand at each price
• e.g. at P0 quantity
demanded increases
from Q0 to Q2: at P1
quantity demanded
increases from Q1 to Q3
Quantity
©The McGraw-Hill Companies, 2008
A market in disequilibrium
S
D
P2
E
P0
P1
A
B
excess
demand
D
RATIONING is needed to cope
S
QS Q0
• Suppose a disastrous
harvest moves the
supply curve to SS
• government may try to
protect the poor, setting
a price ceiling at P1
• which is below P0, the
equilibrium price level
• The result is excess
demand
QD Quantity
with the resulting excess
demand
©The McGraw-Hill Companies, 2008
What, how and for whom
• The market:
– decides how much of a good should be
produced
• by finding the price at which the quantity demanded
equals the quantity supplied
– tells us for whom the goods are produced
• those consumers willing to pay the equilibrium price
– determines what goods are being produced
• there may be goods for which no consumer is
prepared to pay a price at which firms would be
willing to supply
©The McGraw-Hill Companies, 2008