Transcript Chapter 3

Chapter 3
Supply and Demand
McGraw-Hill/Irwin
©2009 The McGraw-Hill Companies, All Rights Reserved
Learning Objectives: Understand how
1. Demand curves show buyers' market behaviors.
2. Supply curves show sellers' market behaviors.
3. Supply and demand determine equilibrium price and
quantity.
4. Shifts in supply and demand change equilibrium
outcomes.
5. The Efficiency Principle
6. The Equilibrium Principle
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Demand
 The quantity buyers would
purchase at each possible
price
 Demand curve
 Negative slope
 Consumers buy less at
higher prices
 Consumers buy more at
lower prices
Demand for Pizzas
P
$4
$2
D
8
16
Q
(000s of slices/day)
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Demand Slopes Downward
 Buyers value goods differently
 Reservation price: the highest price an individual is
willing to pay for a good
 Cost-Benefit Principle: Here the benefit is buyer’s
reservation price and cost is the market price.
 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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The Supply Curve
 The quantity of a good that sellers offer at each price
 Opportunity cost differs among sellers (Just as
reservation price differs among buyers)
 Higher prices, larger quantities
 Low-Hanging Fruit Principle
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Market Equilibrium
 Quantity supplied equals
quantity demanded
Market for Pizzas
P
S
$3
D
12
Q
(000s of slices/day)
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Excess Supply and Excess Demand
Excess Supply
 At $4, 16,000 slices supplied
and 8,000 slices demanded
Excess Demand
 At $2, 8,000 slices supplied
16,000 slices demanded
Market for Pizzas
Market for Pizzas
P
P
Surplus
S
S
$4
Shortage
$2
D
D
8
16
(000s of slices/day)
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Q
8
16
Q
(000s of slices/day)
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Rent Controls Are Price Ceilings
 Rent controls set a maximum
price that can be charged for
a given apartment
 If the controlled price is
below equilibrium, then
 Quantity demanded
increases and
 Quantity supplied
decreases
 A shortage results
Market for NYC Apartments
P
S
$1,600
$800
D
1
2
3
Q
(millions of apartments/day)
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Movement along the Demand Curve (Change in
Quantity Demanded)
 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.
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Demand for Canned Tuna
P
$2
$1
D
8 10
Q
(000s of cans/day)
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Shift of Demand Curve (Change 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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Changes in Quantity Supplied
 When the price of a
good changes, move to
a new quantity supplied
 Assumes everything
except price is held
constant
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
(000s of slices/day)
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Q
8
9
Q
(000s of cans/day)
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Tennis Market
 If rent for tennis court decreases, demand for tennis
balls increases
 Tennis courts and tennis balls are complements
P
Tennis Court Rentals
P
Tennis Ball Sales
S
$10
$1.40
$1.00
$7
D'
D
D
4
11
(00s rentals/day)
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Q
40
58
Q
(millions of balls/day)
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Causes of Shifts in Demand
 Price of complementary goods
 Tennis courts and tennis balls
 Price of substitute goods
 Internet and overnight delivery
 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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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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Shift in Supply: Home Construction
 Cost of labor used to produce houses decreases
 Supply increases
The Market for New Houses
 Demand is constant
 The price of houses
P
S
decreases to $90,000
S'
$120
per house
$90
 Quantity increases to 50
D
40 50
Q
(houses/month)
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Supply and Demand Both Change: Tortilla Chips
 Oils used for frying are harmful AND the price of
harvesting equipment decreases
Price ($/bag)
S
S'
P
P'
D
D'
Q' Q
Millions of bags per month
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Cash on the Table
 Buyer's surplus: buyer's reservation price minus the
market price
 Seller's surplus: market price minus the seller's
reservation price
 Total surplus = buyer's surplus + seller's surplus
 No cash on the table if there is no unexploited
opportunities, surplus is maximized. When the market
is in equilibrium, there is no cash on the table for
individuals.
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Efficiency Principle
 Socially optimal quantity maximizes the total surplus for
the economy from producing and selling a good
 Economic efficiency -- all goods at their socially
optimal level
 Efficiency Principle: Efficiency is an important social
goal because when the economic pie grows larger,
everyone can have a larger slice.
Here economic pie refers to economic surplus on a
social level.
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Equilibrium Principle
 Equilibrium Principle: no unexploited opportunities for
individuals
 BUT it may not exploit all gains at social level
 Equilibrium price and quantity are efficient if
 Sellers pay all the costs of production (exception:
social cost exists, such as environmental pollution)
 Buyers receive all the benefits of their purchase
(exception: social benefit exist, such as vaccination)
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Chapter 3 Appendix
The Algebra of Supply and Demand
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©2009 The McGraw-Hill Companies, All Rights Reserved
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 = 4 + 4 Q*
P = 16 – 2 Q*
P = $12
P = $12
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