Transcript Demand, Supply and the Interaction of Markets

Demand, Supply
and the
Interaction of
Markets
• Why is sugar
relatively cheap and
the price of gasoline
so high? Surprisingly
the answer to both is
the same, namely
supply and demand.
This unit will focus on both supply and demand
individually and then explore what occurs when
they are put together. In the first part of these
notes we will look more fully at
• Demand – ability and
willingness to buy
things.
The Law of Demand
• As price rises other
factors unchanged
demand will fall and
vice versa.
Income Effect
If the price of a good
goes down then the
consumer will have what
is known as the Income
Effect, this simply states
the change in
consumption resulting
from an increase in the
consumer’s real income.
Price of the meal goes down…
increase in real income.
Substitution Effect
Another concept about
demand is that when the
price of one good rises
relative to other, the
consumer will substitute
the higher priced good for
the cheaper good, this is
known as the substitution
effect.
Diminishing Marginal Utility
Unit of satisfaction
In consuming a product
we will incur what is
known in economics as
diminishing marginal
utility. This concept
states that as a person
consumes more of a
good in a specified time
they will receive less
satisfaction from each
consumed unit.
# Of
Doughnuts
Total Utils
Marginal
Utility
1
25
25
2
48
23
3
60
12
4
70
10
Creating a Demand Curve
• A demand curve simply illustrates in
Price
graphical form the amount of a good
people are willing to purchase at a given
amount of money. Occasionally we are
given a demand schedule to generate a
demand curve from. The problem with a
schedule is that they have limited utility in
that they only show us those few prices
and quantities shown in the table.
• A graph give us more utility and therefore
is more valuable to us in that it will show
us all points in-between the points on the
schedule. The schedule and curve next,
demonstrates this.
Quantity
Demand Schedule for Pizza
Demand Schedule for pizza
demand in which the
quantity refers to thousands
of pizzas demanded per
week. Notice the flaw in
the schedule in which we
only know the amount of
pizzas ordered at the prices
posted. What would people
demand at $5 or $9? This
is why these have a limited
utility.
P
Q
$4
14
$6
12
$8
10
$10
8
$12
6
Pizza Demand Curve
P
Q
$4
14
$6
12
$8
10
$10
8
$12
6
Price
You can now clearly see what quantities will be bought at all the in-between prices. This
gives the graph more utility. The key to the graph is understanding its makeup. The
vertical column is always going to be price while the horizontal base will always be
quantity. The key to understanding quantity is to know the units we are dealing in.
Always look under the graph to see what the quantity is. (example Q X 1,000)
Changes in Demand
• In the graph our demand
curve is shifting to the
right; this signifies that
demand is increasing.
• If the curve shifts to the left
then demand is
decreasing. In this
example we are also using
the supply curve to
determine equilibrium
price and quantity, which
will come into play later on
the in the unit.
An out-ward or right-ward shift in
demand increases both equilibrium
price and quantity.
Demand Response Effects
• Explanation of demand response
effects on a quantity (Q); price (P)
graph. Under inelastic demand (no
other alternative for product) (D1)
extremely high price (P1) may result
on a strained electricity market.
• If demand response measures are
employed the demand becomes
more elastic (D2). A much lower
price will result on the market (P2).
• It is estimated that a 5% lowering of
demand would result in a 50% price
reduction during the peak hours of
the California Electricity crisis in
2000-2001. The market also
becomes more resilient to
intentional withdrawal of offers from
the supply side.
Main Causes for a Change in Demand
Changes in consumer’s incomes. When
consumers experience an increase in
income they tend to buy more of those types
of goods that they like. Conversely a loss of
income tends to decrease their demand.
Main Causes for a Change in Demand
• The prices of related goods. When the prices of
other goods related to the product in question
changes, it can effect demand. In this case we
have two types of goods to consider.
– Substitute Goods – Two goods like coffee
and tea in which an increase in the price of
one increases demand for the other. In this
case, if the price of coffee were to rise and tea
prices remained stable, if we see an increase
in the demand for tea we can say that tea is a
substitute for coffee.
– Complements – Two goods for which an
increase in the price of one decreases
demand for the other. For example, if the
price of DVD movies were to drop in price
drastically and at the same time we saw a
huge spike in the demand for DVD players we
can safely assume that they are complements.
Main Causes for a Change in Demand
• The number and composition of consumers
This takes into account the growth of a
population as well as its breakdown. For
instance if we have a large number of births
we can expect to see future demand curves
shift to the right simply because of population
growth. However, we will also see the
demand curves for certain types of goods
change due to the age group of the
emerging population.
• However, we will also see the demand
curves for certain types of goods change due
to the age group of the emerging population.
For example, within four to six years after a
baby boom we can expect the demand for
tricycles to increase dramatically.
Main Causes for a Change in Demand
Changes in consumer expectations • When people assume that they will get a
job or that an economic windfall is
coming to them they tend to increase
their demand for goods and services.
• Also, if consumers feel that a product will
be cheaper today relative to future prices
they might increase their demand for
those products today. An example for
this would occur if the government
imposed new regulations on catching
fish that will cause the price for seafood
to rise in the future, many people will
demand more fish now at the lower price
before the new rules are in place.
Main Causes for a Change in Demand
Consumer tastes – Populations
change their preferences for certain
products over time. When these
tastes change so does the demand
for certain products. Look at
cigarettes. In the 40s and 50s nearly
everyone smoked, however during
the last thirty years we have seen a
shift away from smoking as more
people become aware of the
dangers involved.
Changes in Quantity Demanded
We all have certain products
that we like from Snickers
bars to Domino’s Pizza.
However much we like these
goods, what happens when
the price for those goods
rise. The law of demand tells
us the answer, when the
price goes up our demand
for those goods will fall.
Let us look at the demand
curve and how this works.
Supply
• In order to have supply you
have to have the ability and
willingness of sellers to
make goods available for
sale.
• Law of Supply – The higher
the price, the larger the
quantity supplied.
• Just as with demand, supply
uses schedules and curves,
which are simply mirror
images of their demand
counterparts.
Supply Schedule for Dr. Pibb
Five Determinants of Supply
1.The cost of the resources
used to make the good –
any changes in the cost of a
resource used to make a
good will effect the supply of
that good. Generally, an
increase in the price of
resources will generally lead
to a lessened supply while a
decrease in price will lead to
an increased supply of
goods.
Five Determinants of Supply
2. The
price of other goods these
resources could make – This really
looks at the opportunity cost of
making a good. A good example of this
is found in WW2, at the beginning of
the war silk was used to make
stockings but due to the emergency,
all silk production was put into military
applications. In short, parachutes were
deemed more important than
stockings so that their supply dropped
while parachute production increased.
In an effort to restore the equilibrium,
cosmetics manufacturers who had
materials not critical to the war effort
put them to use and developed leg
paint.
Supply and Demand in a
Wartime Economy
Silk and Nylon Stockings
WW2 brought changes to America as everyday items became scarce form
rationing and military requirements became paramount. Women were asked to
give up their stockings and the government wanted them to know why.
• Leg paint was a
substitute good. Even
though it never really
was popular the
wartime emergency
took precedence and
women complied.
Today leg paint is
being reintroduced to
American
woman…again.
• DuPont introduced nylon stockings to
American women in 1939 at the
world’s fair. A pair sold for $1 at the
time and were liked because they
came in more colors than silk and
were a bit more run resistant.
• Around the same time nylon went into
full scale production in the US, WWII
was raging in Europe. Nylon was
found to be the perfect replacement
for silk in the manufacture of
parachutes. It was just as light but
stronger and far cheaper to produce. It
was also used for ropes, tents,
ponchos and tires. Even though nylon
stockings were introduced in 1940,
they were still a scarce commodity
and the ladies had to wait until after
the war as the majority of nylon fibers
produced went into the war effort.
• Commodities in the
United States were all
rationed for the
duration. Pricing and
disbursement were at
the control of the OPA
or Office of Price
Administration. Below
is a sample of
rationing booklets that
all Americans were
required to have.
• Gasoline was not in
short supply but rubber
was. The idea behind
rationing was to
eliminate unnecessary
trips and conserve
rubber. At this point most
of the rubber plantations
of Asia were in control of
the Japanese. While
Nylon helped to reduce
or dependence on this
source of rubber it was
not enough to meet the
demands of the civilian
population as well as
military Note the urging
to keep your speed at 35
as a way to make tires
last longer.
Five Determinants of Supply
3. Changes in Technology –
Advances in technology tend to
make supplies more readily
available. Generally, advances in
chemistry, biology and
electronics create new products
like cell phones or increase the
quality of existing products like
TVs. In the picture with leg paint, it
was soon replaced by the
introduction of a new product
nylon. This new product replaced
silk in parachutes, airplane tires
and other applications and allowed
women to get nylons but not in
their pre-war quantities.
Five Determinants of Supply
4. Producer expectations –
Transforming natural resources into
finished products is what producers
do. If at any point they feel there is
more profit to be made by converting
those resources into a more
profitable product then there will be a
ripple effect on supply. For example,
with an increase in the demand for
ethanol and more demand for corn
many wheat farmers are shifting
production into that field. The net
result is more corn production but
less wheat production. The
diminished supply in this market
translates into higher prices to the
consumer.
Five Determinants of Supply
5. Changes in the number of
sellers in a market – In the past
the government has regulated
markets which keeps them
artificially small. However for the
last thirty years it has been the
government's policy to deregulate
markets such as trucking, banking,
telecommunications and airlines. In
essence this has allowed the
number of firms in this field to
expand and with it the supply of
the product.
(One Ringy-Dingy)
Supply and Demand Together
Supply and Demand Together
• When we combine Demand and
Supply curves together we develop a
very helpful tool to aid us in
understanding how a market works.
Where the two curves intersect is
known as the equilibrium point, or the
point where quantity supplied equals
quantity demanded (Qs=Qd).
• This is almost a mythical point as sit
is in a continued state of flux
changing with seasons or prevailing
preferences. Generally, the market
will be out of alignment. When you
have a price that is too much you will
find yourself north of equilibrium
which results in a surplus.
Supply and Demand Together
• The only way the market can return to
equilibrium is to lower the price of the
commodity. When the price for an item it too
low you have a much more serious problem in
that you now have a shortage. When this
occurs, you must raise the price of the good.
• This serves as a rationing mechanism
eliminating demand by those people not
wanting to pay that high a price. This is the
general layout of all S&D curves that you will
see in this and subsequent economics courses.
These curves were first used in the 1890s and
have remained virtually unchanged since then.
The Interaction of Supply and Demand
When we see changes in
both supply and demand
we are experiencing the
interaction in a market.
When this occurs we will
see changes in both the
price and quantity. To
demonstrate how this
works lets look at the
curve.
•However, at the new price of $4 the
law of demand tells us that consumers
will demand more gasoline as it is seen
as a better deal.
Let us say the gasoline hits $8 a
gallon and consumers begin to
scream to the Congress for relief.
A compliant Congress agrees and
decrees a price ceiling of $4 a
gallon. That will happen in the
above market? At eight dollars a
gallon the market was in
equilibrium and we were supplied
with all the gasoline we required.
•Facing that is the law of supply
that states as the price goes
down so to will be amount
supplied. The net result in this
market is that we will have a
shortage of gasoline resulting in
long lines at the pump and a very
nervous population wondering
when or where they will be able
to fill their tanks. In this case the
government must restore market
equilibrium artificially by rationing
gasoline to reflect the new lower
levels of supply. This was done in
WW2 and every car got a sticker
to put in the windshield.
Price Floors
• While price ceilings are the rarer of the two
interventions, price floors have happened
quite regularly in the field of agriculture.
Lets look at how this works: Say that wheat
farmers are complaining to Congress that
they cannot make a profit when the market
price for a bushel of wheat is $3.When you
factor in costs of pesticide, irrigation,
equipment and time farmers are unable to
grow the product at that price. Congress
agrees to institute a price floor which
means that the price established is the
lowest price the commodity can sell for. If
Congress decides that $5 is the new price
what will occur?