Transcript Understanding Markets: Supply and Demand

Demand and Supply
Principles of Microeconomics
Professor Dalton
ECON 202 – Fall 2013
Boise State University
Markets
Market : any institution, mechanism, or
arrangement which facilitates voluntary
cooperation among individuals.
A market is a group of buyers and sellers of
a particular good or service.
• Buyers determine demand.
• Sellers determine supply.
The Concept of Demand
Demand
refers to the
offers of buyers to purchase
a good or service.
Determinants of Demand
1.
2.
3.
4.
5.
6.
7.
Market Price
Consumer Income
Prices of Related Goods
Tastes
Expectations
Taxes on/subsidies to consumers
Number of Consumers (demographic
changes)
“Ceteris Paribus “
 All the relevant variables
(e.g., determinants of
demand) are held constant,
except the one(s) being
studied at the time.
The ceteris paribus proviso is a constraint on
theorizing, not an aspect of the real world. It
focuses attention on one aspect of change so
that the analysis does not become confused (or
confusing).
Demand Curve
The Demand Curve
shows the maximum
quantity that consumers
are willing to purchase at
any given price, or the
maximum price that
consumers are willing to
pay for any given
quantity.
Price
At P1, Q1 is the
maximum quantity that
will be purchased
At Q0, P0 is the
maximum price
that consumers
will pay
P1
P0
Q1
Q0
D
Quantity/time
The Law of Demand
The Law of Demand
The quantity
demanded of a good
or service is an
inverse function of the
good or service’s ownprice, ceteris paribus.
Price
As the price of
a good falls...
…the quantity
demanded of the
good increases
P1
P0
D
Q1
Q0
Quantity/time
Non-Price Determinants
of Demand
A demand curve
shows the inverse
relationship between
price and quantity
demanded. The
magnitude of nonprice determinants
determine “where” the
demand curve lies in
price/quantity space.
Price
D2
D0
D1
Quantity/time
Non-Price Determinants
of Demand
Changes in all nonprice determinants
of demand shift the
demand curve to
either the left or
right, depending on
the change.
Price
Demand Curve
shifts right -Increase in
Demand
Demand Curve
shifts left -Decrease in
Demand
D0
D1
D2
Quantity/time
Change in Demand
Increase in Demand
 an increase in the maximum quantity consumers will
purchase at a given price, or an increase in the price
consumers will pay for any given quantity.
Decrease in Demand
 a decrease in the maximum quantity consumers will
purchase at a given price, or a decrease in the price
consumers will pay for any given quantity.
D Quantity Demanded
v. D Demand
 Change in Quantity Demanded
A movement along a demand curve; caused
only by a change in a good’s own-price.
 Change in Demand
A shift in the entire demand curve, either right
or left, caused by a change in a non-price
determinant of demand.
Change in Quantity
Demanded
Price
$2.00
$1.00
Demand
7
13
Quantity/time
Change in Demand
Price
$2.00
D2
D1
7
15
Quantity/time
Changes in Non-Price
Determinants of Demand
2.
3.
4.
5.
6.
7.
Consumer Income
Prices of Related Goods
Tastes
Expectations
Taxes on/subsidies to consumers
Number of Consumers
Change in Consumer Income
Consumer Income
Normal goods and Inferior goods
 For normal goods: An increase in income will
increase demand; and a decrease in income will
decrease demand. Demand moves in the same
direction as changes in income.
 For inferior goods: An increase in income will
decrease demand; and a decrease in income will
increase demand. Demand moves in the
opposite direction as changes in income.
Change in
Price of Related Goods
Prices of Related Goods
Substitutes and Complements
 For substitutes: An increase in the price of a substitute increases demand; a decrease in the price of a
substitute decreases demand. Demand moves in the
same direction as changes in substitute good prices.
 For complements: An increase in the price of a complement decreases demand; a decrease in the price of
a complement increases demand. Demand moves in
the opposite direction as changes in complementary
good prices.
Change in Tastes
Tastes
 An increase in the taste (or preference) for a
good will increase demand; a decrease in the
taste (or preference) for a good will decrease
demand. Demand moves in the same direction
as changes in tastes (preferences).
Change in Expectations
Expectations
Price and Income
 An expectation that price will rise in the future will
increase demand now, and vice versa. Demand moves
in the same direction as changes in expectations of
future price. (storable v. non-storable goods)
 An expectation that income will rise in the future will
increase demand now, and vice versa. Demand moves
in the same direction as changes in expectations of
future income. (normal v. inferior goods)
Change in Taxes/Subsidies
Taxes and subsidies
 Taxies levied on consumers increase the cost of
goods to consumers. Demand moves in the
opposite direction as changes in taxes on
consumers (increase in tax reduces demand).
 Subsidies provided to consumers decrease the
cost of goods to consumers. Demand moves in
the same direction as changes in subsidies to
consumers (increase in subsidy increases
demand).
Change in Number of Consumers
Number of Consumers
 An increase in the number of consumers for a
good will increase demand; a decrease in the
number of consumers for a good will decrease
demand. Demand moves in the same direction
as changes in the number of consumers.
From Individual Demands
to Market Demand
$4.00
G
3.50
F
Price per unit of X (in dollars)
3.00
E
2.50
D
2.00
C
1.50
B
1.00
0.50
0
A
Cathy
2
Bruce
4
6
Market demand
Alice
8
10
12
14
16
X per week
The Concept of Supply
Supply
refers to the
offers of sellers to sell
a good or service.
Determinants of Supply
1. Market Price
2. Input Prices
3. Technology
4. Expectations
5. Taxes on/subsidies to sellers
6. Number of Sellers
Supply Curve
The Supply Curve
shows the maximum
quantity that sellers are
willing to sell at any given
price, or the minimum
price that sellers are
willing to receive for any
given quantity.
Price
At P1, Q1 is the
maximum quantity
that will be offered
for sale
S
At Q0, P0 is the
minimum price
that sellers will
accept
P1
P0
Q0
Q1
Quantity/time
The Law of Supply
The Law of Supply
The quantity supplied
of a good or service is
a positive function of
the good or service’s
own-price, ceteris
paribus.
Price
S
As the price of
a good rises...
…the quantity
supplied of the
good increases
P1
P0
Q0
Q1
Quantity/time
Non-Price Determinants
of Supply
A supply curve shows
the positive
relationship between
price and quantity
supplied. The
magnitude of nonprice determinants
determine “where” the
supply curve lies in
price/quantity space.
Price
S0
S1
S2
Quantity/time
Non-Price Determinants
of Supply
Changes in all nonprice determinants
of supply shift the
Supply curve to
either the left or
right, depending on
the change.
Price
Supply Curve
shifts left -Decrease in
Supply
S0
S1
S2
Supply Curve
shifts right -Increase in
Supply
Quantity/time
Change in Supply
Increase in Supply
 an increase in the maximum quantity sellers will offer to
sell at a given price, or a decrease in the minimum price
sellers will accept for any given quantity.
Decrease in Supply
 a decrease in the maximum quantity sellers will offer to
sell at a given price, or an increase in the minimum price
sellers will accept for any given quantity.
D Quantity Supplied
v. D Supply
 Change in Quantity Supplied
A movement along a Supply curve; caused only
by a change in a good’s own-price.
 Change in Supply
A shift in the entire Supply curve, either right or
left, caused by a change in a non-price
determinant of Supply.
Change in Quantity Supplied
Price
Supply
$2.00
$1.00
7
13
Quantity/time
Change in Supply
Price
S1
S2
$2.00
7
15
Quantity/time
Changes in Non-Price
Determinants of Supply
2. Input Prices
3. Technology
4. Expectations
5. Taxes on/subsidies to sellers
6. Number of Sellers
Change in Input Prices
Input Prices
 An increase in an input price increases costs
and at given market price for output reduces
profits, decreasing the incentive to supply, and
vice versa. Supply moves in the opposite
direction as changes in input price.
Change in Technology
Technology
 Advances in technology reduce costs and at
given market price for output increases profits,
increasing the incentive to supply, and vice
versa. Supply moves in the same direction as
changes in technology.
Change in Expectations
Expectations
Future output price and future input price
 An expectation that output price will rise in the future
will decrease supply now, and vice versa. Supply
moves in the opposite direction as changes in
expectations of future output price. (storable v. non-
storable goods; production v. supply)
 An expectation that input prices will rise in the future
will increase production now, but may not affect
supply. (storable v. non-storable goods; production v.
supply)
Change in Taxes/Subsidies
Taxes and subsidies

Taxies levied on sellers reduce the price
received. Supply moves in the opposite
direction as changes in taxes on sellers
(increase in tax reduces supply).

Subsidies provided to sellers increase the price
received. Supply moves in the same direction
as changes in subsides to sellers (increase in
subsidy increases supply).
Change in Number of Sellers
Number of Sellers

An increase in the number of sellers of a good
will increase supply; a decrease in the number
of sellers of a good will decrease supply.
Supply moves in the same direction as
changes in the number of sellers.
From Individual Supplies to
Market Supply
$4.00
Charlie
Barry
Ann
Market Supply
Price per DVD
3.50
H
3.00
G
2.50
F
2.00
E
1.50
D
1.00
0.50
0 A
C
B
CA
Quantity of DVDs supplied (per week)
I
Demand and Supply
Putting It Together
Suppose sellers expect a
price of Pe to exist in the
market this time period.
Then they supply Q0 units.
But when they arrive at
market, buyers bid the price
up to PD.
Since the demand price is
greater than the supply
price, suppliers increase
output.
P
S
PD
Pe
D
Q0
Q/t
Demand and Supply
Putting It Together
Suppose sellers expect a
price of Pe to exist in the
market this time period.
P
S
Pe
Then they supply Q1 units.
But when they arrive at
market, buyers bid the price
down to PX.
Since the demand price is
less than the supply price,
suppliers decrease output.
PX
D
Q1
Q/t
Equilibrium
Only when the quantity
of output is such that
the maximum price
buyers are willing to
pay is equal to the
minimum price that
sellers are willing to
receive is there no
change in behavior.
Equilibrium occurs!!!!!
P
S
P*
D
Q*
Q/t
Equilibrium
 Equilibrium Price
The price at which the supply and demand
curves intersect. Quantity Supplied and
Quantity Demanded are equal at this price.
 Equilibrium Quantity
The quantity at which the supply and demand
curves intersect. Demand Price and Supply
Price are equal at this quantity.
Equilibrium
 Equilibrium occurs when…
(1) At the current quantity, the demand price
equals the supply price; or,
(2) At the current price, the quantity demanded
equals the quantity supplied; or,
(3) The plans of all participants in the market
have been fulfilled at the current price.
The Nature of Equilibrium
 In a free market, the forces of supply and
demand interact to push actual market
price and quantity toward equilibrium
price and quantity.
 Equilibrium isn’t necessarily a state of the
world; but rather is a characteristic of our
reasoning about markets.
Disequilibrium
 Excess Supply (Surplus)
Price is above equilibrium price, therefore
producers are unable to sell all they want at
the going price.
 Excess Demand (Shortage)
Price is below equilibrium price, therefore
consumers are unable to buy all they want at
the going price.
Disequilibrium
P
If price is above the
equilibrium price...
…then QS > QD.
S
Excess Supply
PH
An excess supply
(surplus) of the good
occurs.
Excess supply creates
competition among
sellers, lowering price.
D
QD
QS
Q/t
Disequilibrium
P
If price is below the
equilibrium price...
S
…then QD > QS.
An excess demand
(shortage) for the
good occurs.
Excess demand
creates competition
among buyers, raising
price.
PL
Excess Demand
QS
QD
D
Q/t
Disequilibrium
 Disequilibrium occurs when…
(1) At the current quantity, the demand price
differs from the supply price; or,
(2) At the current price, the quantity demanded
differs from the quantity supplied; or,
(3) The plans of all participants in the market
have not been fulfilled (at least some
participants’ plans have been frustrated).
The Gains from Trade
At the equilibrium:
P*, Q*.
Consumer surplus
equals…
Producer surplus
equals…
The total gains from
trade (economic
surplus) equals…
P
P*
S
CS
Total
surplus
PS
D
Q*
Q/t
The Gains from Trade
If output is smaller…
P
S
e.g., at Q’
The total gains from
trade (economic
surplus) are
smaller…
The foregone
gains from trade
equal…
P*
Total
surplus
D
Q’
Q*
Q/t
The Gains from Trade
If output is larger…
P
S
e.g., at Q’’
The total gains from
trade (economic
surplus) are also
smaller…
Because the
additional units are
valued less than the
foregone output
elsewhere…
P*
Total
surplus
D
Q* Q’’
Q/t
The Gains from Trade
At the equilibrium:
P*, Q*… the gains from
trade are maximized.
No other output level,
given the conditions of
demand and supply will
create greater social
value!
P
P*
S
CS
Total
surplus
PS
D
Q*
Q/t
Comparative Statics:
Analyzing Changes in Equilibrium
 Determine if event shifts supply curve, the
demand curve, or both.
 Determine if curve(s) shift to left or right.
 Determine how shift affects equilibrium
price and quantity.
Comparative Statics
P
Begin in equilibrium at P*, Q*.
Increase in price of
substitute occurs...
P**
Demand increases...
…creating an excess
P*
demand at P*...
…and buyers bid up price.
As price rises, QS increases
and QD decreases, until...
… a new equilibrium occurs at
a higher price and higher
quantity.
S
Excess Demand
D1
D
Q*
Q**
Q/t
Comparative Statics
P
Begin in equilibrium at P*, Q*.
Decrease in price of inputs
occurs...
Supply increases...
…creating an excess
P*
supply at P*...
…and sellers bid down price. P**
As price falls, QS decreases
and QD increases, until...
… a new equilibrium occurs at
a lower price and higher
quantity.
S
S1
Excess Supply
D
Q*
Q**
Q/t
Comparative Statics:
Summary
Market Change
Change Pe
Change Qe
Increase D
Increase
Increase
Decrease D
Decrease
Decrease
Increase S
Decrease
Increase
Decrease S
Increase
Decrease
Increase D and Increase S
?
Increase
Decrease D and Decrease S
?
Decrease
Increase D and Decrease S
Increase
?
Decrease D and Increase S
Decrease
?
Real-World Supply and
Demand Applications
 Supply and demand can be used to
evaluate real-world events and the
policies of government.
• Examples of real world markets and price
determination
• Impact of specific real world events
• Impact of government policies
The Price of a Foreign
Currency
 The market for foreign currencies is called
the foreign exchange (forex) market.
 The exchange rate – the price of one
currency in terms of another currency.
• People demand currencies of other countries to
buy those countries’ goods and assets.
• A currency is just another good.
• The determination of exchange rate is the same
as the determination of price.
The Price of a Foreign
Currency
 The euro is the currency used by the 12
members of the European Union.
• Belgium, Germany, Greece, Spain, France, Ireland,
Italy, Luxembourg, Netherlands, Austria, Portugal,
Finland
 The euro was first introduced on January 1,
1999, and Euro notes and coins entered
circulation on January 1, 2002.
• (From Jan. 1, 1999 to December 31, 2001, the euro
was an accounting currency with a fixed exchange
rate among national currencies.)
The Price of a Foreign
Currency
 When first introduced in January of 1999
the price of a euro in US dollars was
$1.17. Over the next two years the price
of a euro fell to about $0.90.
 From a low in June 2001, the euro has
rebounded to a price of around $1.34 in
December of 2004.
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$/Euro
The Price of a Foreign
Currency
Dollar Price of Euro
1.600
1.400
1.200
1.000
0.800
0.600
0.400
0.200
0.000
Tim e
The Price of a Foreign
Currency
 Changes in the price of one currency in
terms of another are primarily driven by
international trade requirements.
 To buy a BMW, I need to exchange
dollars for euros (because German
workers want to be paid in euros, not
dollars).
 Importers usually do this at the wholesale stage,
rather than consumers at the retail stage.
The Price of a Foreign
Currency
 Typically then, the price of euros will rise
with a greater demand for European
Union assets/goods by Americans relative
to European Union demand for U.S.
assets/goods.
 The price of euros will fall with a greater
demand by Europeans for American
assets/goods relative to American demand
for European assets/goods.
The Price of a Foreign
Currency
 From 1999 to mid-2001, Europeans
increased their demand for dollars (supply
of euros) as the US stock market rose;
simultaneously Americans exited
European stock markets, decreasing the
supply of dollars (demand for euros).
 The supply of euros rose and the demand
for euros fell, driving the dollar price of
euros down.
Euro Market
Dollar Price of Euros
S0
S1
P1
D0
P2
D1
Q0
Quantity of Euros
The Price of a Foreign
Currency
 From mid-2001, except for a brief rally in late 2001 and
early 2002, the American stock market fell to a bottom
in mid 2003; at the same time, American demand for
foreign goods relative to foreign demand for American
goods accelerated.
 Europeans decreased their demand for dollars (supply of
euros) as the US stock market fell; simultaneously
Americans re-entered European stock markets and
demanded greater quantities of foreign goods,
increasing the supply of dollars (demand for euros).
 The supply of euros fell and demand for euros rose,
driving the dollar price of euros up.
Euro Market
Dollar Price of Euros
S1
S0
P2
D1
P1
D0
Q0
Quantity of Euros