Transcript PPT

Demand, Supply, and
Market Equilibrium
PREPARED BY:
FERNANDO QUIJANO, YVONN QUIJANO,
KYLE THIEL & APARNA SUBRAMANIAN
© 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan • Sheffrin • Perez
chapter
1 How do changes in demand affect prices?
Hurricane Katrina and Baton Rouge Housing Prices
2 What could explain a decrease in price?
Ted Koppel Tries to Explain Lower Drug Prices
3 How does the adoption of new technology affect prices?
Electricity from the Wind
4 How do changes in supply affect prices?
The Bouncing Price of Vanilla Beans
5 How do changes in one market affect other markets?
Platinum, Jewelry, and Catalytic Converters
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DEMAND, SUPPLY, AND MARKET EQUILIBRIUM
• perfectly competitive market
A market with so many buyers and
sellers that no single buyer or seller
can affect the market price.
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4.1
THE DEMAND CURVE
Here is a list of the variables that affect an individual consumer’s decision, using the pizza
market as an example:
• The price of the product (for example, the price of a pizza)
• The consumer’s income
• The price of substitute goods (for example, the prices of tacos or sandwiches)
• The price of complementary goods (for example, the prices of beer or lemonade)
• The consumer’s preferences or tastes and advertising that may influence preferences
• The consumer’s expectations about future prices
• quantity demanded
The amount of a product that
consumers are willing and
able to buy.
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4.1
THE DEMAND CURVE
The Individual Demand Curve and the Law of Demand
• demand schedule
A table that shows the relationship
between the price of a product and
the quantity demanded, ceteris
paribus.
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4.1
THE DEMAND CURVE
The Individual Demand Curve and the Law of Demand
• individual demand curve
A curve that shows the relationship between
the price of a good and quantity demanded by
an individual consumer, ceteris paribus.
 FIGURE 4.1
The Individual Demand Curve
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4.1
THE DEMAND CURVE
The Individual Demand Curve and the Law of Demand
• law of demand
There is a negative relationship
between price and quantity
demanded, ceteris paribus.
• change in quantity demanded
A change in the quantity consumers
are willing and able to buy when the
price changes; represented
graphically by movement along the
demand curve.
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4.1
THE DEMAND CURVE
From Individual Demand to Market Demand
• market demand curve
A curve showing the
relationship between price
and quantity demanded by all
consumers, ceteris paribus.
 FIGURE 4.2
From Individual to Market Demand
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Extra Application 6
STARBUCKS GAINS ON CHANGES IN EXPECTATIONS
Starbucks, the specialty coffee chain, announced September sales that were higher than
investors expected. The company’s sales growth was six percent higher than the previous
period. The street estimate had only projected an increase of 3.4 percent. How does a
change in expectations impact stock prices?
• The sales growth was attributed to reintroduction of some popular products, falling
gas prices providing some “economic relief,” and colder weather.
• The company’s stock price responded accordingly to the increased sales numbers
and closed up 7.6 percent.
As investors adjust sales (and profits) expectations, the
demand for Starbucks’ stocks will increase and is
represented by a rightward shift in the demand curve. Note
that prices will move higher as a result. It is only the
“unexpected” portion of the sales announcement that will
actually shift the demand and move price. The “expected”
increase of 3.4 percent is already factored into the price by
investors.
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Extra Application 11
SIP SLOWLY—THESE DRINKS ARE EXPENSIVE
Beverage consultants and barkeepers note that the newest trend in the business is exotic
cocktails. The trade is moving upscale with some new drinks costing thousands of dollars.
• The most expensive list is topped by drinks with diamonds and other precious stones
used as garnish.
• One drink blends champagne and vintage cognac poured over a sugar cube. Add
a 0.6 carat diamond and the blend runs $4,350 a drink.
• The most expensive non-garnished drink is the “Ritz Side Car” served at Bar
Hemingway in the Paris Ritz which uses an 1830 vintage cognac. For the equivalent
of $515 a drink, patrons can sample a cognac from the days of Napoleon.
Scarcity drives prices higher. In the case of rare drinks,
the fact that supply is so limited causes any increase in
demand to push the price higher. Lately an increase in
demand for exotic drinks has pushed many of truly rare
alcohols higher.
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4.2
THE SUPPLY CURVE
Suppose you ask the manager of a firm, “How much of your product are you willing to
produce and sell?” The manager’s decision about how much to produce depends on many
variables, including the following, using pizza as an example:
• The price of the product (for example, the price per pizza)
• The wage paid to workers
• The price of materials (for example, the price of dough and cheese)
• The cost of capital (for example, the cost of a pizza oven)
• The state of production technology (for example, the knowledge used in making pizza)
• Producers’ expectations about future prices
• Taxes paid to the government or subsidies (payments from the government to firms to
produce a product)
• quantity supplied
The amount of a product that firms
are willing and able to sell.
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4.2
THE SUPPLY CURVE
The Individual Supply Curve and the Law of Supply
• supply schedule
A table that shows the relationship between
the price of a product and quantity supplied,
ceteris paribus.
• individual supply curve
A curve showing the relationship between
price and quantity supplied by a single firm,
ceteris paribus.
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4.2
THE SUPPLY CURVE
The Individual Supply Curve and the Law of Supply
 FIGURE 4.3
The Individual Supply Curve
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4.2
THE SUPPLY CURVE
The Individual Supply Curve and the Law of Supply
• law of supply
There is a positive relationship between
price and quantity supplied, ceteris paribus.
• change in quantity supplied
A change in the quantity firms are willing and
able to sell when the price changes;
represented graphically by movement along
the supply curve.
• minimum supply price
The lowest price at which a product will
be supplied.
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4.2
THE SUPPLY CURVE
Why Is the Individual Supply Curve Positively Sloped?
From Individual Supply to Market Supply
• market supply curve
A curve showing the relationship
between the market price and quantity
supplied by all firms, ceteris paribus.
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4.2
THE SUPPLY CURVE
From Individual Supply to Market Supply
 FIGURE 4.4
From Individual to Market Supply
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4.2
THE SUPPLY CURVE
From Individual Supply to Market Supply
 FIGURE 4.5
The Market Supply
Curve with Many Firms
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4.2
THE SUPPLY CURVE
Why Is the Market Supply Curve Positively Sloped?
To explain the positive slope, consider the two responses by firms to
an increase in price:
• Individual firm. As we saw earlier, a higher price encourages a
firm to increase its output by purchasing more materials and hiring
more workers.
• New firms. In the long run, new firms can enter the market and
existing firms can expand their production facilities to produce
more output.
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4.3
MARKET EQUILIBRIUM: BRINGING
DEMAND AND SUPPLY TOGETHER
• market equilibrium
A situation in which the
quantity demanded equals
the quantity supplied at the
prevailing market price.
 FIGURE 4.6
Market Equilibrium
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4.3
MARKET EQUILIBRIUM: BRINGING
DEMAND AND SUPPLY TOGETHER
Excess Demand Causes the Price to Rise
• excess demand (shortage)
A situation in which, at the
prevailing price, the quantity
demanded exceeds the quantity
supplied.
Excess Supply Causes the Price to Drop
• excess supply (surplus)
A situation in which at the
prevailing price the quantity
supplied exceeds the quantity
demanded.
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4.4
MARKET EFFECTS OF CHANGES IN DEMAND
▼FIGURE 4.7
Change in Quantity Demanded
Versus Change in Demand
Change in Quantity Demanded Versus Change in Demand
• change in demand
A shift of the demand curve caused by a change
in a variable other than the price of the product.
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4.4
MARKET EFFECTS OF CHANGES IN DEMAND
Increases in Demand Shift the Demand Curve
• normal good
A good for which an increase in
income increases demand.
• inferior good
A good for which an increase in
income decreases demand.
• substitutes
Two goods for which an increase
in the price of one good increases
the demand for the other good.
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4.4
MARKET EFFECTS OF CHANGES IN DEMAND
Increases in Demand Shift the Demand Curve
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4.4
MARKET EFFECTS OF CHANGES IN DEMAND
Increases in Demand Shift the Demand Curve
• complements
Two goods for which a decrease
in the price of one good increases
the demand for the other good.
 FIGURE 4.8
An Increase in Demand
Increases the Equilibrium Price
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4.4
MARKET EFFECTS OF CHANGES IN DEMAND
Decreases in Demand Shift the Demand Curve
 FIGURE 4.9
A Decrease in
Demand Decreases
the Equilibrium Price
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4.4
MARKET EFFECTS OF CHANGES IN DEMAND
Decreases in Demand Shift the Demand Curve
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Extra Application 9
HOME LOAN APPLICATIONS FALL
Consumer home mortgage applications fell to the lowest level of the year according to an
industry trade group. The seasonally adjusted applications fell by 1.6 from the previous
week. While mortgage rates fell slightly from the previous week, the average rate is still
near its four year high.
• Much of the blame was laid on rising adjustable rate mortgages (ARMs) since these
mortgages have been more popular recently.
• Overall, the number of ARMs represents about 28 percent of all new applications,
substantially lower than the high of 36.6 percent in March 2005.
While some homeowners appear to be switching ARMs to fixed rates, most analysts
expect fixed rates to go even higher in the coming year.
A decrease in the demand for home mortgages would be
represented by a shift in the demand curve from D1 to D0. If
the change in mortgage quantities demanded is truly due to a
change in mortgage interest rates then it is not a demand shift.
Since the interest rate is the “price” of a mortgage, it would
really be a movement up an existing curve as represented by
moving from Point a to Point c which would happen if the price
rises due to a change in the supply of home mortgages.
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4.5
MARKET EFFECTS OF CHANGES IN SUPPLY
A Decrease in Demand Decreases the Equilibrium Price
Change in Quantity Supplied Versus Change in Supply
 FIGURE 4.10
Change in Quantity Supplied
Versus Change in Supply
• change in supply
A shift of the supply curve caused
by a change in a variable other
than the price of the product.
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4.5
MARKET EFFECTS OF CHANGES IN SUPPLY
Increases in Supply Shift the Supply Curve
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4.5
MARKET EFFECTS OF CHANGES IN SUPPLY
An Increase in Supply Decreases the Equilibrium Price
 FIGURE 4.11
An Increase in
Supply Decreases
the Equilibrium Price
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4.5
MARKET EFFECTS OF CHANGES IN SUPPLY
Decreases in Supply Shift the Supply Curve
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4.5
MARKET EFFECTS OF CHANGES IN SUPPLY
A Decrease in Supply Increases the Equilibrium Price
 FIGURE 4.12
A Decrease in
Supply Increases
the Equilibrium Price
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4.5
MARKET EFFECTS OF CHANGES IN SUPPLY
Simultaneous Changes in Demand and Supply
 FIGURE 4.13
Market Effects of Simultaneous
Changes in Demand and Supply
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Extra Application 7
MONTANA STONE BUSINESS IS ROCK SOLID
Strong construction in western states and design trends are pushing the demand for
Montana stone higher. More than 100 stone quarries have begun operations in the past
seven years. Architects increasingly utilize stone to create distinctiveness and fit with the
natural surroundings. Montana has capitalized on this growth industry and producers
market Montana stone since the state’s name is synonymous with ruggedness.
• Thirty-five states currently produce stone.
• According to the U.S. Geological Survey, production of non-crushed stone increased
by 19 percent between 2001 and 2005 with expected continued growth.
• Stone imports are also expected to increase with Italy leading the way.
• Prices of natural stone vary tremendously.
An increase in demand for building stone has pushed
prices higher moving equilibrium from point a to point b.
The higher prices attracted more suppliers to the market
which pushes prices back down to point c. Of course each
variety of stone will have its own market with high
substitutability between markets.
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Extra Application 8
OIL CLOSES AT RECORD HIGH
Iran’s nuclear program concerns and Nigerian supply problems combined to push oil to a
record high of $70.40 a barrel. Some analysts expect prices to rise above $75 a barrel in
the near future unless there is a substantial fall in demand. The recent price spike
surpasses the post-Katrina supply induced problems although Katrina’s aftermath
continues to reduce supply in the Gulf of Mexico by about 300,000 barrels a day.
• High oil prices continue to push gasoline prices closer to the $3 a gallon mark.
• Experts contend that while current prices are high, oil would have to exceed $90 a
barrel to exceed inflation adjusted highs set twenty years ago.
• Minor supply disruptions or small increases in demand could quickly create a
shortage, placing even more upward pressure on prices.
An increase in demand along with a reduction in supply
creates a recipe for rising prices. Price is the market
mechanism that allocates scarce resources among
competing ends.
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Extra Application 10
FDA PANEL APPROVES NEW OVER-THE-COUNTER DIET PILL
An advisory committee to the Food and Drug Administration (FDA) voted to recommend
approval of an over-the-counter (OTC) version of the prescription diet pill orlistat. The fatblocking drug has been approved as a prescription-only diet medication since 1999.
GlaxoSmithKline Consumer Healthcare, the drug’s manufacturer, still needs to obtain final
FDA approval to market the proposed reduced strength OTC form of orlistat. While the
final approval could still be months away, the FDA typically follows committee
recommendations.
• Glaxo estimates that between five and six million Americans would buy the pill on a
consistent basis, at a cost expected to be between $12 and $25 a week.
FDA approval to market this diet pill over-the-counter
is equivalent to opening a new market. Many more
individuals will purchase the product since a
prescription will no longer be required. Graphically
these sales will be shown as a shift in demand from D0
to D1. Since most of a drug’s cost is in development
and marketing, the profit margin on selling this drug
over-the-counter will also be quite lucrative.
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4.6
PREDICTING AND EXPLAINING MARKET CHANGES
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4.7
APPLICATIONS OF DEMAND AND SUPPLY
HURRICANE KATRINA AND BATON ROUGE HOUSING PRICES
APPLYING THE CONCEPTS #1: How do changes in demand
affect prices?
 FIGURE 4.14
Hurricane Katrina and Housing in Baton Rouge
• Hurricane Katrina flooded much of New
Orleans, causing about 250,000 residents
to relocate to nearby Baton Rouge.
• An increase in the population of Baton
Rouge increased the demand for housing,
shifting the demand curve to right.
• The excess demand caused fierce
competition among buyers for the limited
supply of homes.
• The equilibrium price increased from
$130,000 (point a) to $156,000 (point b).
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TED KOPPEL TRIES TO EXPLAIN LOWER DRUG PRICES
APPLYING THE CONCEPTS #2: What could explain a decrease in price?
 FIGURE 4.15
Ted Koppel and the Falling Price of Drugs
• According to Ted Koppel, the price of drugs
dropped because the government’s efforts to
control the supply of illegal drugs had failed.
• According to the U.S. Department of Justice,
the quantity of drugs consumed actually
decreased during the period of dropping prices.
• When both the price and the quantity
decrease, that means demand has decreased.
• The decrease in price was caused by a
decrease in demand, not an increase in supply.
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ELECTRICITY FROM THE WIND
APPLYING THE CONCEPTS #3: How does the adoption of new technology affect prices?
• Technological innovations
in generating electricity
from the wind decreased
production costs, shifting
the supply curve
downward and to the
right.
• The equilibrium price
decreased and the
equilibrium quantity
increased.
 FIGURE 4.16
Wind Power and Electricity
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THE BOUNCING PRICE OF VANILLA BEANS
APPLYING THE CONCEPTS #4: How do changes in supply affect prices?
 FIGURE 4.17
The Bouncing Price of Vanilla Beans
• A cyclone destroyed much
of Madagascar’s crop in
2000, shifting the supply
curve upward and to the left.
• By 2005, the vines replanted in Madagascar along with new vines planted in other
countries - started producing vanilla beans,
and the supply curve shifted downward and
to the right, beyond the supply curve for
2000.
• The price dropped to $25 per kilogram, half
the price that prevailed in 2000.
• An example of technological progress: The
increase in supply from other countries was
facilitated by the development of a suntolerant variety of the vanilla plant.
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PLATINUM, JEWELRY, CATALYTIC CONVERTERS
APPLYING THE CONCEPTS #5: How do changes in one market affect other markets?
•
The law of demand for jewelry. The increase in the price of platinum increased the
equilibrium price of platinum jewelry, and consumers responded by purchasing less
platinum jewelry. As a result, the amount of platinum used in jewelry decreased, from
2.88 million ounces to 2.20 million ounces.
•
The law of supply for recycling. The increase in the price of platinum increased the payoff
from recycling used platinum, increasing the quantity of platinum supplied through
recycling from 0.42 million ounces to 0.70 million ounces.
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change in demand
law of demand
change in quantity demanded
law of supply
change in quantity supplied
market demand curve
change in supply
market equilibrium
complements
market supply curve
demand schedule
minimum supply price
excess demand (shortage)
normal good
excess supply (surplus)
perfectly competitive market
individual demand curve
quantity demanded
individual supply curve
quantity supplied
inferior good
substitutes
supply schedule
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