Transcript Taylor_micro_ch03 - pm

Chapter Three
The Supply
and
Demand Model
Applications
•
The supply and demand model can
explain the following events
1. Why are ticket scalpers for Final Four seats
(or any sold out sporting event) able to sell
tickets for as much as $5000?
2. Why do gasoline prices rise and fall so
easily?
3. Why do prices of computers drop when new
models are introduced in the market?
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Demand: Definitions
• Demand: A relationship between price and the
quantity demanded, all other things equal.
• Price: The amount of money or other goods that
one must pay to obtain a particular good.
• Quantity Demanded: The quantity of a good that
people want to buy at a given price during a
specific time period.
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Demand Schedule
Demand Schedule: A
tabular representation of
demand. The information
it contains describes the
quantity of a good that a
buyer is willing to purchase
at different prices.
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Demand Schedule: An Example
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Demand Curve
• Demand Curve: The graphical
representation of demand. The information
it contains describes the quantity of a good
that a buyer is willing to purchase at
different prices.
– Note: Both the demand curve and the demand
schedule should describe the same
information.
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Demand Curve: An Example (cont’d)
Figure 3.1 The Demand Curve for Bicycles (Million Bicycles per Year)
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The Law of Demand
• The Law of Demand: The tendency for
the quantity demanded of a good to
decline as its price rises.
– Note: For a demand curve to be consistent
with the Law of Demand, the demand curve
must be downward sloping.
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The Law of Demand (cont’d)
According to the law of
demand, a lower price
will result in an
increase in the
quantity of the good
that consumers are
willing to buy, holding
all else constant.
A
B
Figure 3.1 The Demand Curve for Bicycles (Million
Bicycles per Year)
This scenario can be depicted as a movement from point A
to point B in the Figure 3.1 above.
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Demand: Definition Revisited
• Demand: Relationship between price and the
quantity demanded, all other things equal.
• What are the other things that we hold equal?
While the price of a good is a major variable that
affects the quantity of a good that consumers
are willing to buy, other variables can also affect
consumer’s quantity demanded.
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Demand: All Other Things Equal
•
The following variables also affect the quantity
demanded of a good, and are held constant
when analyzing the law of demand:
–
–
–
–
–
–
Consumer’s Preferences
Consumer’s Information
Consumer’s Income
Number of Consumers in the Market
Consumer’s Expectations of Future Prices
Prices of Closely Related Goods
a) substitutes
b) complements
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Consumer’s Preferences
• Changes in consumer’s preferences or tastes for
a product (relative to another product) will
change the amount they purchase at a given
price.
• Examples: After September 11, 2001, more
consumers were afraid to fly, resulting in a
decrease in the demand for air travel. The
demand for gasoline increased, as people chose
to drive more to different destinations.
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Consumer’s Information
• New information available to consumers can
result in a change in the quantity that consumers
buy of a good, even though the price does not
change. For example:
– Car owners bought fewer Firestone tires once they
learned of the mass recall of Firestone tires.
– Demand for Krispy Kreme doughnuts declined when
people got information that eating fewer
carbohydrates can facilitate weight loss (a.k.a., the
Atkins Diet).
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Consumer’s Incomes
• An increase in incomes can result in an
increase or a decrease in the quantity of
goods/services demanded.
• Normal Goods: Goods for which demand
increases when the consumer’s income
rises and decreases when consumer’s
income falls.
– Examples: Jewelry, luxury cars.
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Consumer’s Incomes (cont’d)
• Inferior Goods: Goods for which demand
decreases when the consumer’s income
rises and increases when consumer’s
income falls.
• Typical examples: Spam, the Big Mac,
riding the bus, snow shovels.
Note: The term “typical examples” is used above because some consumers may
consider Spam and the Big Mac as normal goods.
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Number of Consumers in the Market
• An increase in the number of consumers in the
market is likely to result in an increase in the
demand for the good or service, while a decline
in the number of consumers will likely result in a
smaller demand for the good or service.
• Example: The demand for electricity in your city
increases as the population increases.
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Consumer’s Expectation of
Future Prices
• If people expect the price of a good will
increase, they will buy it before the price
increases. If they expect the price of a
good to decrease, they will wait before the
price drops.
• Question: What will you do if a credible
source tells you that gasoline prices will go
up by $1.00 per gallon tomorrow?
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Prices of Closely Related Goods
• Two goods are related if they are either
substitutes or complements.
• Substitute: A good that has many of the same
characteristics as and can be used in place of
another good.
• Example: Coke is a substitute for Pepsi, riding a
car is a substitute for taking the bus,
downloaded music is a substitute for music CDs.
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Prices of Closely Related Goods (cont’d)
• Complement: A good that is consumed or
used together with another good.
• Examples: Gasoline is a complement to
SUVs, cream is a complement to coffee,
learning economics by reading your
economics textbook is a complement to
going to class.
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Complements and Substitutes
• If two goods are complements, then an
increase in the price of one good will result
in a decrease in the demand for the other
good.
• If two goods are substitutes, then an
increase in the price of one good will result
in a increase in the demand for the other
good.
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Complements and Substitutes (cont’d)
Examples
1) Since coffee and cream are
complements, then an increase in the
price of coffee will discourage consumers
to buy cream.
2) Since Coke and Pepsi are substitutes, an
increase in the price of Coke will
encourage consumers to buy more
Pepsi.
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Shifts vs. Movement
P
A
P1
B
P2
D
Q1
Q2
Q
Movement along the demand curve: A change in the quantity
demanded of a good brought along by a change in its price. A decrease
in price can be seen in the diagram above as a movement from A to B,
in the same supply curve. An increase in the price is depicted as a
movement from point B to A.
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Shifts vs. Movement (cont’d)
• A shift in demand: a movement of the demand
curve brought about by a change other than the
price of the good. The demand curve can shift
left (a decrease in demand) or shift right (an
increase in demand).
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An Increase in Demand
Possible causes
1) Greater preference
2) More population
3) Incomes increase
(normal good)
4) Incomes decrease
(inferior good)
5) Expected future price
increase.
6) More expensive
substitute
7) Less expensive
complement
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P
D2
D1
Q
An increase in demand is
illustrated as a shift in the
demand curve to the right.
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A Decrease in Demand
Possible causes
P
1) Less preference
2) Less population
3) Incomes decrease (normal
good)
4) Incomes increase (inferior
good)
5) Expected future price
decrease.
6) Less expensive substitute
7) More expensive
complement
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D2
D1
An decrease in demand
is illustrated as a shift in
the demand curve to the
left.
Q
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Shifts vs. Movements: Summary
Figure 3.3
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Supply: Definitions
• Supply: A relationship between price and
the quantity supplied, all other things
equal.
• Quantity Supplied: The quantity of a good
that sellers want to sell at a given price
during a specific time period.
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Supply Schedule
Supply Schedule: A tabular representation
of the supply curve. The information it
contains describes the quantity of a
particular good that a seller is willing to sell
at different prices.
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Supply Schedule (cont’d)
Table 3.2 The Supply Schedule for Bicycles (Millions of Bicycles per Year)
Price
Quantity Supplied
140
1
160
4
180
7
200
9
220
11
240
13
260
15
280
16
300
17
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Supply Curve
• Supply Curve: The graphical
representation of supply. The information
it contains describes the quantity of a good
that a seller is willing to sell at different
prices.
• Note: Both the supply curve and the
supply schedule should describe the same
information.
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Supply Curve: an Example
Figure 3.4 The Supply Curve for Bicycles (Million Bicycles per Year)
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The Law of Supply
• The Law of Supply: The tendency for the
quantity supplied of a good in a market to
increase as its price rises.
• Note: For a supply curve to be consistent
with the Law of Supply, the supply curve
must be upward sloping.
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The Law of Supply (cont’d)
According to the law of
supply, a higher price
will result in an
increase in the
quantity of the good
that sellers are willing
to sell, holding all else
constant.
This scenario can be depicted as a movement from point A to
point B in the figure above.
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Supply: Definition Revisited
• Supply: Relationship between price and the
quantity supplied, all other things equal.
• What are the other things that we hold equal?
While the price of a good is a major variable that
affects the quantity of a good that sellers are
willing to sell, other variables can also affect
seller’s quantity supplied.
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Supply: All Other Things Equal
•
The following variables also affect the quantity
supplied of a good, and are held constant when
analyzing the law of supply.
1.
2.
3.
4.
5.
Technology
The price of goods used as an input in production
Number of firms in the market
Seller’s expectations of future prices
Government taxes, subsidies and regulations
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Technology
• Any change in the amount that a firm can
produce with a given amount of inputs can
be considered a change in technology.
Improvements in technology will
encourage the firm to produce more at the
same price.
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Technology (cont’d)
• Examples: The introduction of high yielding
varieties of corn will allow corn farmers to
produce more corn, given the same amount of
land, water, fertilizer and machinery.
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The Price of Goods Used in Production
• More expensive inputs (raw materials,
land and capital) increases the cost of
production of goods and services, and
may force the firm to sell less at a given
price.
• Example: When oil and gasoline prices
increase, some airlines chose to cut back
on the number of flights on some routes.
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The Number of Firms in the Market
• If more firms in the market increase,
supply increases, as more goods or
services will be available for sale at each
price.
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Seller’s Expectations of Future Prices
• If a firm expects the price of the good they
are selling will increase in the future, they
will sell less today and sell more in the
future when prices are higher. Similarly, if
a firm expects the price of the good they
are selling will decrease in the future, they
will sell more today.
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Seller’s Expectations of
Future Prices (cont’d)
Example
• Stockholders of Google will hold off on selling
their stocks if they expect the prices of the stock
will rise in the future. On the other hand,
stockholders of Google will sell more stocks if
they expect the prices of the stock will drop in
the future.
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Government Taxes, Subsidies
and Regulations
• Increases in taxes (payments by firms to the
government) or decreases in subsidies
(payment by the government to firms) can
reduce the quantity that firms are willing to sell at
a given price. Decreases in taxes or increases
in the subsidies can increase the quantity that
firms are willing to sell at a given price.
– Example: Community colleges decreased the
number of classes offered in 2002 when the State of
California reduced the subsidies to the community
college system.
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Government Taxes, Subsidies
and Regulations (cont’d)
• Regulations: Government policies or rules
that control the firm’s behavior. These
regulations can affect the firm’s cost of
production and thereby affect supply.
– Example: Government pollution regulation
forces bus companies to seek alternative fuel
sources (natural gas) that may raise costs
and decrease supply.
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Shifts vs. Movement
P
Supply
B
P2
A
P1
Q1
Q2
Q
Movement along the supply curve: A change in the quantity
supplied of a good brought along by a change in its price. An
increase in price can be seen in the diagram above as a movement
from A to B, in the same supply curve. A decrease in the price is
depicted as a movement from point B to A.
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An Increase in Supply
Possible causes
1) Better technology
2) Less expensive inputs
3) More firms
4) A lower expected price in
the future
5) More subsidies or less
taxes
P
S
S1
Q
An increase in supply is
illustrated as a shift in the
supply curve to the right.
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A Decrease in Supply
Possible causes
1) Deteriorating technology
2) More expensive inputs
3) Fewer firms
4) A higher expected price in
the future
5) Less subsidies or more
taxes
P
S3
S2
An decrease in supply is
illustrated as a shift in the
supply curve to the left.
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Movements Vs. Shifts: Summary
Figure 3.6
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Supply and Demand: A Review
Figure 3.7
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Market Equilibrium: Combining
Supply and Demand
• When consumers buy goods and
producers sell goods, their interaction lead
to the determination of an equilibrium price
in the market.
• Equilibrium price: The price at which the
quantity that sellers are willing to sell
equals the quantity that consumers are
willing to purchase.
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Market Not in Equilibrium
• Shortage (excess demand): A situation in which
the quantity demanded is greater than the
quantity supplied. This occurs when the price in
the market is below the equilibrium price.
• Surplus (excess supply): A situation in which the
quantity supplied is greater than the quantity
demanded. This occurs when the current price
in the market is above the equilibrium price.
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Finding the Equilibrium: An Example
Table 3.3 Supply and Demand Schedule for Bicycles (millions per year)
Surplus,
Shortage
Quantity
Quantity
Price
Demanded
Supplied
or Equilibrium
or Falls
140
18
1
Shortage=17
Price rises
160
14
4
Shortage = 10
Price rises
180
11
7
Shortage = 4
Price rises
200
9
9
Equilibrium
No Change
220
7
11
Surplus = 4
Price falls
240
5
13
Surplus = 8
Price falls
260
3
15
Surplus = 12
Price falls
280
2
16
Surplus = 14
Price falls
300
1
17
Surplus = 16
Price falls
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Price rises
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Price
(Dollars per Bicycle)
Equilibrium
Supply
300
280
260
240
At equilibrium, the
quantity supplied
equals the quantity
demanded, which in
this case is at q=9.
220
200
180
160
140
Demand
5
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10
Q*=9
15
Quantity
Millions of Bicycles
20
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Price
(Dollars per Bicycle)
Shortage
Supply
300
280
At P=160, QS= 4 and
QD= 14. The
shortage = 10. The
shortage will cause the
price to rise.
260
240
220
200
180
160
140
Shortage amount
5
4
10
Quantity Millions of Bicycles
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Demand
15
14
20
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Surplus
Price
(Dollars per Bicycle)
Supply
300
Surplus Amount
280
260
At P=260, QS= 15
and QD= 3. The
surplus = 12. The
surplus will cause the
price to fall.
240
220
200
180
160
140
Demand
3
5
10
15
20
Quantity Millions of Bicycles
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Effects of a Change in Demand
and/or Supply
• Changes in either supply or demand (or
both) will result in shifts in either the
supply curve or the demand curve (or
both), respectively. These shifts in the
supply curve and the demand curve will
result in the change in prices and
quantities.
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Effects of an Increase in Demand
Figure 3.9
An increase in
demand will shift the
demand curve to the
right, resulting in a
higher equilibrium
price and quantity.
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Effects of a Decrease in Demand
Figure 3.9 cont’d
A decrease in demand
will shift the demand
curve to the left,
resulting in a lower
equilibrium price and
quantity.
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Effects of an Increase in Supply
Figure 3.10
An increase in supply
will shift the supply
curve to the right,
resulting in a lower
equilibrium price and a
higher equilibrium
quantity.
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Effects of a Decrease in Supply
Figure 3.10 cont’d
A decrease in supply
will shift the supply
curve to the left,
resulting in a higher
equilibrium price and a
lower equilibrium
quantity.
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Supply and Demand in Action:
Real World Examples
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Why Gas Prices Increased in 2005
• Gasoline Prices increased in 2005
because of two reasons.
• 1st reason: Increased use of SUVs (a
complement) increased the demand for
gasoline. This can be depicted in Fig.
3.12 as a movement from equilibrium pt. A
to equilibrium pt. B.
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Why Gas Prices Increased
in 2005 (cont’d)
• 2nd reason: Declining refining capacity for
gasoline shifted the supply curve to the
right. This moved the equilibrium price
higher, as seen in Fig. 3.12 as a
movement from equilibrium pt. B to
equilibrium pt. C.
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Combined Effects of Simultaneous Increase in Demand
and Decrease in Supply of Gasoline
Fig. 3.12
Quantity Gallons of Gasoline
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Energy Policies
• Since the high prices of gasoline hurt both
American consumers and businesses,
what can policymakers do to lower prices?
Policies aimed at increasing supply and
decreasing demand can help lower the
equilibrium price for gasoline.
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Energy Policies (cont’d)
• Supply Policies: To lower oil/gasoline prices,
one policy is to develop new sources of oil.
More oil wells can increase the supply and shift
the supply curve to the right. In Figure 3.13, this
will move the equilibrium from point A to point B.
• Note: Programs that promote the development
of new energy alternatives such as bio-diesel,
will shift the demand curve for gasoline down,
since bio-diesel is a substitute for gasoline.
However, it will increase the supply of energy.
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Energy Policies (cont’d)
• Demand Policies: Another policy to help
lower oil/gasoline prices is to encourage
energy conservation . Conservation can
decrease the demand and shift the
demand curve to the left. In Figure 3.13,
this will move the equilibrium from point B
to point C.
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Combined Effects of Two Energy Policies
Fig. 3.13
120
130
140
Quantity Gallons of Gasoline
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Interference with Market Prices
•
So far, our analysis of supply and
demand involves situations where the
equilibrium can be reached. In this
section, we will analyze the effects of
price controls on the market. The two
types of government price controls are:
1) Price Ceilings
2) Price Floors
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Interference with Market Prices (cont’d)
• Price Control: A government law or regulation
that sets or limits the price to be charged for a
particular good
• Maximum Price Laws/Price Ceiling: A
government price control that sets the maximum
allowable price for a good
• Minimum Price Laws/ Price Floor: A government
price control that sets the minimum allowable
price for a good
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Maximum Price Law
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Maximum Price Laws
• Since most maximum price laws (price ceilings)
are imposed below the equilibrium price,
quantity demanded is greater than quantity
supplied, resulting in a shortage. There is
pressure for prices to rise into the illegal region
in Fig. 3., but the price ceiling prevents this. The
shortage will persist unless demand decreases
or supply increases enough to bring the
equilibrium below the maximum price (P*).
• Note: A maximum price above the equilibrium
price will bring the market into equilibrium.
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Rent Control
• Rent control is a maximum price law.
Housing that is subject to rent control
faces a maximum price below the
equilibrium. Ultimately, rent controlled
housing experiences a shortage, as
quantity demanded is greater than the
quantity of housing supplied.
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Rent Control (cont’d)
Figure 3.14
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Minimum Price Law
• Since most minimum price laws (price floors) are
imposed above the equilibrium price, quantity
supplied is greater than quantity demanded,
resulting in a surplus. There is pressure for
prices to fall into the illegal region in the next
figure, but the price floor prevents this. The
surplus will persist unless demand increases or
supply decreases enough to bring the
equilibrium above the maximum price (P*).
• Note: a minimum price below the equilibrium
price will bring the market into equilibrium.
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Minimum Price Law (cont’d)
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Minimum Wage Laws
• Since Jan. 2002, the federal government
has imposed a minimum wage = $5.15 per
hour. This implies that all workers covered
by the minimum wage law must be paid
$5.15 or higher.
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The Federal Minimum Wage Law
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Key Words/Phrases to Remember
• Demand, demand curve and the law of
demand
• Supply, supply curve and the law of supply
• Equilibrium
• Shift in supply vs. movement along the
supply curve
• Shift in demand vs. movement along the
demand curve
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Key Words/Phrases
to Remember (cont’d)
• Surpluses and shortages
• Price floors / minimum price laws
• Price ceilings / maximum price laws
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