Transcript Supply Demand

Chapter 3: Supply and
Demand
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1
Learning Objectives: Understand
1. How the demand curve summarizes the behavior of buyers in
the marketplace.
2. How the supply curve summarizes the behavior of sellers in
the marketplace.
3. How the supply and demand curves interact to determine the
equilibrium price and quantity.
4. How shifts in supply and demand curves cause prices and
quantities to change.
5. The relationship between individual demand and supply curves
with market demand and supply curves.
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What, How, and For Whom?
Every society answers three basic questions
WHAT  Which goods will be produced?
 How much of each?
HOW
 Which technology?
 Which resources are used?
FOR
 How are outputs distributed?
 Need?
WHOM
 Income?
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Central Planning v. Market
Central Planning
 Decisions by individuals or
small groups
 Agrarian societies
 Government programs
 Sets prices and goals for the
group
 Individual influence is limited


The Market
Buyers and sellers signal
wants and costs
 Resources and goods are
allocated accordingly
Interaction of supply and
demand answer the three basic
questions
Mixed economies use both the market and central planning
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Buyers and Sellers in the Market
 Buyers and sellers have different motivations
 Buyers
want to benefit from the good
 Sellers want to make a profit
 Market = souk
A

“place” where buyers and sellers meet
Largest market is the internet
 Buyers
and sellers jointly determine outcome
 Market price balances two forces
 Value
buyers derive from the good
 Cost to produce one more unit of the good
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Demand
 The quantity buyers
would purchase at each
possible price
to pay at each
possible price
P
 Willingness
$4
 Demand curve
 Negative


slope
$2
Consumers buy less at
higher prices
Consumers buy more at
lower prices
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D
8
16
Q
6
Interpreting the Demand Curve
 Horizontal
interpretation of demand
 Given price, how much
will buyers buy?
P
$4
$2
D
8
16
Q
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Interpreting the Demand Curve

P
$4
$2
Vertical interpretation of
demand
 Given the quantity to be
bought, what will the
price be?
D
8
16
Q
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Demand Slopes Downward
 Substitution Effect
 As
pizza becomes more expensive, a consumer
may switch to other foods that substitute for pizza
 Income Effect
A
higher price lowers the purchasing power of a
consumer, resulting in reduced consumption
 Demand reflects the entire market, not one
consumer
 Lower
prices bring more buyers into the market
 Lower prices cause existing buyers to buy more
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Law of Demand
 What does the cost-benefit principle say?

Buy the good if the benefits > costs


Benefit is reflected in the buyer’s reservation price (the highest
price an individual is willing to pay for a good)
Cost of the good is the actual price paid (determined by the
market)
 Buyers value goods differently

When the price increases it satisfies the cost-benefit test
for fewer buyers  demand slopes downward
 Inverse relationship between the price of a good and
the quantity buyers are willing to purchase in a defined
time period, ceteris paribus (all else remains the same)
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Demand: Individual v. Market
Horizontal summation = adding quantities at
fixed prices
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Demand: Individual v. Market
What if everyone has the same individual
demand?
 Multiply
each quantity by the number of
consumers
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The Supply Curve
 The quantity of a good that sellers offer at
each price
 The

supply curve reflects the willingness to sell
The supplier is willing to sell if the price covers the
opportunity cost
 Opportunity cost differs among sellers due to
 Technology
■
 Skills
■
Different costs such as rent
Expectations
 Higher prices, larger quantities
 Low-Hanging
Fruit Principle
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Interpreting the Supply Curve
 Horizontal
interpretation of supply
 Given price, how much
will suppliers offer?
P
S
$4
$2
8
16
Q
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Interpreting the Supply Curve

Vertical interpretation of
supply
 Given the quantity to be sold,
what will the price be?

The seller’s reservation price
is the marginal cost of producing
that good
• It is the smallest dollar
amount for which she would
not be worse off if she sold
an additional unit.
P
S
$4
$2
8
16
Q
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Supply: Individual v. Market
Horizontal summation = adding quantities at
fixed prices
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Market Equilibrium
 Quantity supplied equals
quantity demanded AND
 Price is on supply and
demand curves
 No tendency to change P
or Q
 Buyers are on their
demand curve
 Sellers are on their
supply curve
P
S
$3
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D
12
Q
17
Excess Supply and Excess Demand

Excess Supply
At $4, 16 units are supplied and 8
units are demanded

Excess Demand
At $2, 8 units are supplied and
16 units are demanded
P
P
Surplus
S
S
$4
Shortage
$2
D
D
8
16
Q
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16
Q
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Incentive Principle: Excess Supply at $4



Each supplier has an incentive
to decrease the price in order
to sell more
Lower prices decrease the
surplus
As price decreases:
 the quantity offered for sale
decreases along the supply
curve
 the quantity demanded
increases along the demand
curve
P
S
$4
$3.50
$3
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Equilibrium
D
8 12 16
Q
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Incentive Principle: Excess Demand at $2

P

S

$3
$2.50
$2
Equilibrium
D
8 12 16
Q
Each supplier has an incentive
to increase the price in order to
sell more
Higher prices decrease the
shortage
As price increases
 the quantity offered for sale
increases along the supply
curve
 As price increases, the
quantity demanded decreases
along the demand curve.
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Equilibrium
Markets communicate information
effectively
 Value
buyers place on the product
 Opportunity cost of producing the product
Markets maximize the difference between
benefits and costs
Market outcomes are the best provided
that
 The
market is in equilibrium AND
 No costs or benefits are shared with the public
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Market Equilibrium
 Equilibrium = a price and a quantity
 The market equilibrium is stable
 If
we move away from it, market forces will take
us back to it!
 What if the equilibrium price was perceived as
too high?
 What if the equilibrium price was perceived as
too low?
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Rent Controls Are Price Ceilings


Equilibrium price perceived as too
high  set a price ceiling
 Legal maximum price
Common example: Rent
 Rent controls set a maximum
price that can be charged for a
given apartment
 Consequences:
• Shortages
• Illegal markets
• Less maintenance
• Discrimination
Market for Cairo Apartments
P
S
$1,600
$800
D
1
2
3
Q
(millions of apartments/day)
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Minimum Wage as Price Floor


Equilibrium price perceived as too
low  set a price floor
 Legal minimum price
Common example: Min Wage
 Price floors set a minimum
wage that can be offered for
labor
 Consequences:
• Unemployment
- SL > DL
• Black markets
Labor Market
W
SL
$12
$10
DL
1
2
3
Q
(millions of unskilled labor)
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Movement along the Demand Curve
 When price goes up, quantity
demanded goes down
 When price goes down, buyers
move to a new, higher quantity
demanded
 A change in quantity
demanded results from a
change in the price of a good 
movement along the curve
Demand for Canned Tuna
P
$2
$1
D
8 10
Q
(000s of cans/day)
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Shift in Demand
 If buyers are willing to buy
more at each price, then
demand has increased
 Move the entire demand
curve to the right
 Increase in demand
 If buyers are willing to buy
less at each price, then
demand has decreased
Demand for Canned Tuna
P
$2
D'
D
8
10
Q
(000s of cans/day)
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Causes of Shifts in Demand
 Price of complementary goods
 Tennis
courts and tennis balls
 Price of substitute goods
 Internet
(email) and overnight delivery (letters)
 Income: normal or inferior goods?
 Preferences
 Dinosaur
toys after Jurassic Park movie
 Number of buyers in the market
 Expectations about the future
Price changes never cause a shift in demand
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Tennis Market
 If
rent for tennis court decreases, demand for
tennis balls increases

P
Tennis courts and tennis balls are complements
Tennis Court Rentals
P
Tennis Ball Sales
S
$10
$1.40
$1.00
$7
D'
D
D
4
11
Q
(00s rentals/day)
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58
Q
(millions of balls/day)
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Internet and Overnight Delivery
 If
price for internet connection decreases,
demand for overnight letter delivery decreases

P
Internet (emails) and letters delivery are substitutes
Internet Connection
P
Overnight Letter Delivery
S
$10
$1.40
$1.00
$7
D
D
D'
4
11
Q
(00s connection/month)
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58
Q
(Letter per month)
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Conveniently Located Apartments
 If government wages rise, demand
for apartments near Metro stations
increases
 Demand increases
• Price increases
• Quantity increases
 Demand for a normal good increases
when income increases
 Demand for an inferior good
increases when income decreases
Convenient Apartments
P
D
D'
S
P'
P
Q Q'
(units/month)
Q
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Changes in Quantity Supplied
 When the price of a good
changes, move to a new
quantity supplied
 Assumes everything
except price is held
constant (ceteris
paribus)
P
Supply of Pizzas
S
$4
$2
8
16
Q
(000s of slices/day)
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Changes in Supply
 Supply increases when sellers
are willing to offer more for sale
at each possible price
 Moves the entire supply curve
to the right
 Supply decreases when
sellers are willing to offer less
for sale at each possible price
 Moves the entire supply curve
to the left
Supply of Pizzas
Supply of Tuna
P
P
S
S*
S
S'
$2
$2
8
9
Q
(000s of slices/day)
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9
Q
(000s of cans/day)
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Causes of Shifts in Supply
 A change in the price of an input
 Fiberglass
for skateboards, construction wages
 A change in technology
 Desktop
publishing and term papers
 Internet distribution of products (e-commerce)
 Weather (agricultural commodities and
outdoor entertainment)
 Number of sellers in the market
 Expectation of future price changes
Price changes never cause a shift in supply
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Shifts in Supply: Skateboards
 Costs of production affect
the supply of a product
 Cost of fiberglass for
skateboards increases
 Supply
decreases
 With no change in demand,
the price of skateboards
increases to $80 and
quantity decreases to 800
Supply of Skateboards
P
S'
$80
$60
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S
D
600 800 1,000
Q
(skateboards/month)
34
Shift in Supply: Home Construction
 Cost of labor used to
produce houses
decreases
 Supply
increases
 Demand is constant
The price of houses
decreases to $90,000
per house
 Quantity increases to
50
The Market for New Houses
P
S
$120
$90
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S'
D
40 50
Q
(houses/month)
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Supply and Demand Shifts: Four Rules
An increase in demand will lead to an
increase in both equilibrium price and
quantity
P
S
P'
P
D'
D
Q
Q'
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Q
36
Supply and Demand Shifts: Four Rules
An decrease in demand will lead to a decrease
in both equilibrium price and quantity
P
S
P
P'
D
D'
Q'
Q
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Q
37
Supply and Demand Shifts: Four Rules
An increase in supply will lead to a decrease in
the equilibrium price and an increase in the
equilibrium quantity.
P
S
S'
P
P'
D
Q
Q'
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Q
38
Supply and Demand Shifts: Four Rules
An decrease in supply will lead to an increase in
the equilibrium price and a decrease in the
equilibrium quantity.
S'
P
S
P'
P
D
Q'
Q
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Q
39
Supply and Demand Both Change: Carrot
Halwa Market
Ghee for frying halwa is harmful AND the price
of carrot harvesting equipment decreases
Price ($/kg)
S
S'
P
P'
D
D'
Q' Q
Millions of kg per month
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Changes in Supply and Demand
Supply
Demand
Increases
Decreases
Increases
P
Q
Ambiguous
Increases
P
Q
Increases
Ambiguous
Decreases
P
Q
Decreases
Ambiguous
P
Q
Ambiguous
Decreases
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Economic Naturalist
 Why do the prices of some goods, like airline
tickets to Europe, go up during the months of
heaviest consumption, while others, like sweet
corn, go down?
 Airline ticket prices go up because demand
increases.
 Sweet corn prices go down because supply
increases.
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Chapter 3 Appendix
The Algebra of Supply and Demand
From Graphs to Equations …
 Sample equations
P = 16 – 2 Qd
is a straight-line demand curve with intercept
16 on the vertical (P) axis and a slope of – 2
P = 4 + 4 Qs
is a straight-line supply curve with intercept 4
and a slope of 4
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… To Equilibrium P and Q
 Equilibrium is where P and Q are the same for
demand and supply
 Set
the two equations equal to each other (P = P)
and solve for Q (Qs = Qd = Q*)
16 – 2 Q* = 4 + 4 Q*
6 Q* = 12
Q* = 2
 Use either the supply or demand curve and Q*
= 2 to find price
P = 16 – 2 Q*
P = $12
P = 4 + 4 Q*
P = $12
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