Transcript S&D - Kenston Local Schools

Unit One
Demand, Supply,
and Market Equilibrium
Markets
• Markets bring together buyers (demanders) and
sellers (suppliers) in search of satisfaction.
• A market can exist anywhere at anytime and be
global, national or local. It may be face-to-face
or digital. It may involve millions of participants
or just two (consumer & producer.)
• Markets work through a process of voluntary
exchange and self-interest.
• The law of supply and demand is based on a
pure market economy with pure competition
(large numbers of independently acting buyers &
sellers of standardized products.)
Demand
• Demand is a schedule or a curve that
shows the various amounts of a product
that consumers are willing and able to
purchase at each of a series of possible
prices during a specified period of time.
• We say “willing and able” because
willingness alone is not effective in the
market.
• Consumers must be able as well. They
must have the necessary dollars or use
of credit.
The Law of Demand
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The law of demand states that if all else is
equal (ceteris paribus), as price falls, the
quantity demanded rises, and as price rises,
the quantity demanded falls.
There is a negative or inverse relationship
between the price and quantity demanded
(downward slope of the demand curve.)
The law of demand is consistent with
common sense. People typically buy more of
a product at a low price than at a high price.
If the price changes, causing a change in the
quantity demanded, the demand curve does
not shift. It simply moves up or down the
original demand curve placement.
The 3 Price Determinants of
Quantity Demand
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#1 The Income Effect: indicates that a lower
price increases the “purchasing power” of a
buyer’s money income (also known as real
income.)
If income stays the same and the price level
(CPI) increases, then real income or
purchasing power goes down, causing a
decrease in the quantity demanded (inflation).
If income stays the same and the price level
(PL) decreases, then real income or purchasing
power goes up, causing an increase in the quantity
demanded (deflation or disinflation.)
The 3 Price Determinants of
Quantity Demanded
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#2 The Law of Diminishing Marginal Utilities:
Every time an individual purchases a unit of a good or
service they begin to move towards 100% total
satisfaction.
Each additional (marginal) unit purchased moves
them closer to total satisfaction, but brings less
satisfaction than the previously purchased unit.
Eventually, the market will get to a place where it
stops purchasing additional units (greater
satisfaction from saving their income than spending
it.)
If the market price goes down the market will get to
that place where they stop buying additional units
later (QD up.) If, the market price goes up, the
market will get to that point sooner (QD down.)
The 3 Price Determinants of
Quantity Demanded (QD)
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#3 The Substitution Effect: suggests that at a
lower price, buyers have the incentive to
substitute what is now a less expensive
product for similar products that are now
relatively more expensive.
The product whose price has fallen is now “a
better deal” relative to the other products.
For example, a decline in the price of chicken
will increase the QD of chicken, but decrease
the “demand” for pork, lamb, beef, fish
(substitutes.)
The Demand Curve
The inverse relationship between price
and quantity demanded for any product
can be represented on a simple graph.
Quantity demanded (QD) is measured on
the horizontal axis and price on the vertical
axis.
The downward slope reflects the inverse
or negative relationship between the
price and quantity demanded.
Non Price Determinants of
Demand
 Economists
assume that price is the most
important influence on the amount of
product purchased.
 But they know other non price factors
can and do affect purchases.
 These factors are known as determinants
of demand or “demand shifters” (move
the curve right or left.)
 They are the “other things equal” in the
relationship between price and quantity
demanded.
5 Non Price Determinants
of Demand (Shifters)
 #1 Consumers Tastes: A favorable change in
consumer tastes or preferences for a product will
increase demand at all prices (The Apple
IPHONE) and cause the demand curve to shift to
the right.
 An unfavorable change in consumer preferences
will decrease demand at all prices(HP no longer
making PCs), shifting demand curve to the left.
 New products may have a large impact on
consumer taste. The introduction of digital
cameras greatly decreased the demand for film
cameras.
5 Non Price Determinants
of Demand (Shifters)
 #2 Number of Buyers: An increase in the
number of buyers in the market is likely to
increase product demand and vice versa.
 Population growth or decline of various
geographic regions (urban flee) directly
impacts the demand for products at all
prices.
 An increase in buyers at all prices will shift
the demand curve to the right and a
decrease in buyers at all prices, shift the
demand curve to the left.
5 Non Price Determinants
of Demand (Shifters)
 #3 Income: How income affects demand
varies depending on the good or service.
 Consumers typically buy more products
when their income increases - direct
relationship. (But there are exceptions).
 Products whose demand varies directly
with money income are called normal or
superior goods (i.e. name brands).
 Products whose demand varies inversely
with money income are called inferior
goods ( i.e. generic brands).
5 Non Price Determinants
of Demand (Shifters)
 #4 Prices of Related Goods: A change in the price of a
related good may either increase or decrease the
demand for a product.
 A substitute good is one that can be used “in place of”
another good. When two products are substitutes, an
increase in the price of one will increase the demand for
the other. Conversely, a decrease in the price of one will
decrease the demand for the other.
 Complementary goods are “used together,” they are
typically demanded jointly. If the price of a complement
goes up, the demand for the related good will decline.
Conversely, if the price of a complement falls, the
demand for a related good will increase.
 The vast majority of goods are unrelated or independent.
5 Non Price Determinants
of Demand (Shifters)
 #5 Consumer Future Expectations: A newly
formed expectation of higher future prices may
cause consumers to buy now in order to “beat”
the anticipated price rises, thus increasing
current demand.
 Similarly, a change in expectations concerning
future income may prompt consumers to change
their current spending. Which may either
increase or decrease current demand.
Changes in Demand &
Quantity Demanded
• A change in demand must not be confused
with a change in quantity demanded.
• A change in demand is a shift of the
demand curve to the right (increase) or to
the left (decrease.) It occurs, because the
consumer’s state of mind about purchasing
the product has been altered in response
to a change in one or more of the
determinants of demand.
• In contrast, a change in quantity
demanded is a movement from one point to
another point. The cause of such a change
is an increase or decrease in the price of
the product under consideration.
Supply
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Supply is a schedule or curve showing the
various amounts of a product that producers
are willing and able to make available for
sale at each of a series of possible prices
during a specific period.
Firms may be willing, but not able to
produce a product (time lags, resource
availability, patent or copyright infringement.)
Law of Supply
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The Law of Supply reflects a positive or direct
relationship that prevails between price and
quantity supplied.
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As price rises, the quantity supplied rises; as
price falls, the quantity supplied falls.
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A supply schedule illustrates that firms will produce
and offer for sale more of their product at a high
price than at a low price.
Price & the Law of Supply
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Price is an obstacle from the standpoint of the
consumer, who is on the paying end. But the
supplier is on the receiving end of the product’s
price. Price represents revenue and therefore
serves as an incentive.
The higher the price, the greater the incentive to
produce, the greater the willingness to risk, and
therefore the greater the quantity supplied (original
and potential producers.)
Price and quantity supplied are directly related.
The Supply Curve
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As with demand, it is convenient to represent
individual supply graphically.
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The upward slope of the supply curve reflects the
law of supply.
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Producers offer more of a good, service, or
resource for sale as its price rises.
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The relationship between price and quantity
supplied is positive, or direct.
Determinants of Supply (Shifters)
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In constructing a supply curve, it is
assumed that price is the most significant
influence on the quantity supplied of
any product.
But other factors (“other things equal”)
can and do affect supply.
These factors or determinants (other
than price,) cause a change in supply
and shift the entire supply curve.
6 Non-Price Determinants of
Supply (Shifters)
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#1 Resource Prices: The prices of the resources or
inputs used in the production process help determine the
costs of production.
Higher resource prices raise production costs and reduce
profits lessening the incentive to take risks, therefore
decreasing supply (shift the supply curve to the left.) A
“Supply Shock” may substantially drive up an input price.
In contrast, lower resource prices reduce production
costs and increase profits, therefore increasing supply
(shift to the right.)
Cost of a barrel of crude oil is a good example of this
determinant.
6 Non-Price Determinants of
Supply (Shifters)
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#2 Technology: Improvements in technology
enable firms to produce units of output with
fewer resources. 90’s “I.T.” boom led to
substantial increases in productivity.
Fewer resources equates to a lower cost of
production raising profit and increasing the
supply of the product (shift right.)
Removing technology (D.D.T. in 1972) is highly
unusual, but would increase the cost of
production and decreasing supply (shift
left.)
6 Non-Price Determinants of
Supply (Shifters)
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#3 Taxes and Subsidies: Businesses count taxes as a
cost of production (Role of Government ? )
An increase in sales, property or corporate taxes will
increase production costs and therefore reduce supply.
If the government subsidizes the production of a good
(“taxes in reverse”) it lowers the producers’ costs and
increases supply (shift left).
Tax cuts are a major component of expansionary fiscal
policy and are typically adhered to by conservatives and
supply-siders.
Reaganomics (81-89) lowered tax rates significantly and
the economy grew by an average GDP of 3.4%.
Believe excessive tax rates can reduce tax revenue.
6 Non-Price determinants of
Supply (Shifters)
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#4 Prices of Other Goods: Firms that
produce a particular product can sometimes use
their plant to produce alternative goods.
Firms may shift production to a higher priced
good to reap greater profits (substitution in
production.)
Corn production up 24% and Soybean
production down 18%, “The Ethanol Effect.”
6 Non-Price Determinants of
Supply (Shifters)
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#5 Future Price Expectations of Producers:
Changes in expectations about the future price of a
product may affect the producer’s current willingness
to supply that product.
It is difficult to generalize how future price
expectations may impact current supply.
If wheat farmers expect prices to go up in the near
future they may hold back some of their current
harvest, decreasing supply.
On the other hand, expectations that a price will
increase on a product may induce firms to add another
shift of workers or expand their production facilities,
causing current supply to increase.
6 Non-Price Determinants of
Supply (Shifters)
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#6 Number of Sellers: Other things equal, the larger
the number of suppliers, the greater the market supply.
As more firms enter an industry, the supply curve shifts to
the right.
The smaller the number of firms in the industry, the less
the market supply and the curve shifts to the left.
Pure Competition involves numerous independent
firms (price takers) while a monopoly involves one firm
(price maker).
Many industries are oligopolies, where a few major firms
dominate the market ( 3 or 4 firms produce 80%).
Difference between Supply &
“Quantity” Supplied
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Remember, a change in supply means a
change in the schedule and a shift of the
curve (right or left.)
Changes in supply occur, because of a change
in one or more non-price determinants.
In contrast, a change in quantity supplied is
a movement from one point to another on a
fixed supply curve.
An increase or decrease in the quantity
supplied is caused by a change in the price
of the specific product being considered.
Market Equilibrium
Equilibrium Price & Quantity
 The equilibrium price (market-clearing price) is
the price where quantity demanded equals
quantity supplied.
 At equilibrium, there is neither a shortage nor a
surplus, the market is cleared and everyone is
satisfied (buyers and sellers.)
 Competition among buyers and among sellers
bids (moves) the price to the equilibrium price
(balance.)
 Non-Price Shifters in demand or supply (shifts
to the curves) will change the equilibrium price.
Above the Equilibrium
Price
 At any above-equilibrium price, quantity
supplied exceeds quantity demanded and
the result is a market surplus.
 Surpluses drive prices down by encouraging
competing sellers to lower the price to attract
buyers to take the surplus off their hands.
 As the price falls, the incentive to produce
decreases and the incentive to consume
increases.
 The market is always in search of the
equilibrium price.
Below the Equilibrium
Price
 Any price below the equilibrium price will
create a shortage (quantity demanded
exceeds quantity supplied.)
 The market price below the equilibrium price
discourages sellers from devoting additional
resources to production and encourages
consumers to desire more goods than are
available.
 Consumers desiring to purchase the good at
below equilibrium prices will compete for the
good and drive up the price to equilibrium
(helping to eliminate the shortage.)
Rationing Functions of Prices
The ability of the competitive forces
of “supply and demand” to establish
a price at which buying and selling
decisions are made is called the
“rationing function of prices.”
Command or centrally planned
economies do not enjoy this “natural
market force.”
Freely made individual decisions
set a market-clearing price.
“Laissez-faire” or “let it be.”
Efficient Allocation
Productive & Allocative Efficiency
A competitive market not only rations
goods to consumers, but also allocates
society’s resources efficiently to the
particular product.
Competition among producers results in
“productive efficiency” (lowest cost of
production) in an attempt to minimize
cost (right mix of resources.)
Competitive markets also produce
“allocative efficiency” (desired mix of
goods) in search of the elusive “dollar
votes” of consumers (consumer
sovereignty.)
Government Manipulation of
Market Prices (Price Controls)
• Prices in most markets are free to
rise or fall to their equilibrium levels,
no matter how high or low those
levels might be.
• However, the government
sometimes concludes that supply
and demand will produce prices that
are unfairly high for buyers or
unfairly low for sellers.
• The government may place legal
limits on how high or low a price or
prices may go.
Government Manipulation of
Market Prices (Price Controls)
• A price ceiling sets the maximum
legal price a seller may charge for a
good or service.
• A price at or below the ceiling is
legal; a price above it is not.
• A price ceiling enables a consumer
to obtain “essential” products which
they may not be able to afford at the
equilibrium price.
• Examples are rent control (over 200
cities) and usury laws (Ohio 25%).
• Price ceilings typically create “black
markets” and shortages.
Government Manipulation of
Market Prices (Price Controls)
• A price floor is a minimum price
fixed by the government. A price at
or above the price floor is legal; a
price below it is not.
• Price floors or “supports” above the
equilibrium prices are invoked when
it’s believed resource suppliers or
producers aren’t receiving sufficient
income.
• Supported prices for agricultural
products and minimum wages are
two examples of price floors.
Government Manipulation of
Market Prices (Price Controls)
• Possible consequences of price floors
include surpluses and the distortion of
resource allocation.
• At any price above the equilibrium
price, quantity supplied will exceed
quantity demanded resulting in an
excess of supply or surplus.
• The government may respond to the
surplus, by paying producers not to
produce or by purchasing the surplus.
• Resources will be allocated to those
markets receiving the subsidies
created by a price floor (soybeans to
corn.)