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Unit 2. Chapters 3, 18, and 19. 3. Demand, Supply, and Market Equilibrium. Chapter Objectives. Demand Defined and What Affects It Supply Defined and What Affects It How Supply & Demand Together Determine Market Equilibrium

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Unit 2

Unit 2

Chapters 3, 18, and 19


3

Demand, Supply, and Market Equilibrium


Chapter objectives
Chapter Objectives

  • Demand Defined and What Affects It

  • Supply Defined and What Affects It

  • How Supply & Demand Together Determine Market Equilibrium

  • How Changes in Supply and Demand Affect Equilibrium Prices and Quantities

  • Government-Set Prices and their Implications for Surpluses & Shortages


Demand

3.1

3.2

3.3

3.4

Demand

  • Demand Defined

  • Demand Schedule

  • Law of Demand

    • Diminishing Marginal Utility

    • Income Effect

    • Substitution Effect

  • Demand Curve

  • Market Demand


4 1 what is demand
4.1: What is demand?

  • Demand – the desire to have a good or service and the ability to pay for it.

  • The 2 factors of desire and ability are both necessary

  • Ex. I have the desire to go on a European vacation, but I can not afford it. Therefore, I do not possess demand for it.


Demand defined
Demand Defined

  • Expressed on a schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time

  • Show quantities of a product that will be purchased at various psb prices, other things equal


Demand schedule
Demand Schedule

  • Table showing how much of a product an individual is willing & able to buy @ each price in the market.

  • Market demand schedule – table showing how much all consumers are willing to buy @ each price

  • See p.45 Figure 3.1


Law of demand
Law of Demand

  • Inverse relationship between price and quantity demanded

  • States that when price increases, quantity demanded decreases

  • When P. dec., QD. inc.

  • Ppl buy less at higher prices, more at lower prices


Explanations of the law of demand
Explanations of the Law of Demand

  • Why the inverse relationship b/w P and QD?

  • 1. Common sense—think about it!

  • 2. Diminishing marginal utility – marginal benefit from using each additional unit of a product during a given period will decline.

  • Ex. You get more satisfaction from the first glass of lemonade than the second, third, fourth…and are therefore not willing to pay as much for each additional unit


Explanations of the law of demand1
Explanations of the Law of Demand

  • 3. Income and substitution effects

  • income effect – change in the amount that consumers will buy b/c the purchasing power of their income changes, although income itself doesn’t change.

  • Ex. You go to the store to buy ground beef, it is on sale, you feel wealthier and buy more.


Explanations of the law of demand2
Explanations of the Law of Demand

  • 2. substitution effect – change in the amount that people will buy b.c they substitute goods instead.

  • Ex. You go to the store to buy ground beef but you see ground turkey is on sale for ½ the price so you buy that instead.


Demand curve
Demand Curve

  • Graph showing how much of a product an individual will buy @ each price

  • Graphic representation of demand schedule and law of demand

  • Slopes downward from left to right

  • Market demand curve – graph showing data from market demand schedule

  • Price on Y-axis, Quantity on X-axis

  • See p.45 Figure 3.1


Individual demand

6

5

4

3

2

1

0

Price (per bushel)

10 20 30 40 50 60 70 80

Quantity Demanded (bushels per week)

Individual Demand

P

Individual

Demand

P

Qd

$5

4

3

2

1

10

20

35

55

80

D

Q


Change in quantity demanded
Change in Quantity Demanded

  • -change in the amt. of a product consumers will buy b/c of a change in price

  • Shown by a movement along the demand curve


Individual demand1
Individual Demand

Determinants of Demand

  • Tastes

  • Number of Buyers

  • Income

    • Normal Goods

    • Inferior Goods

  • Price of Related Goods

    • Substitute Good

    • Complementary Good

    • Unrelated Goods

  • Consumer Expectations


Change in demand
Change in Demand

  • Something prompts consumers to buy different amounts @ every price

  • Represented by shifts of the demand curve

  • Inc. in demand – curve shifts right

  • Dec. in demand – curve shifts left

  • Influenced by 6factors


Factor 1 income
Factor 1: Income

  • If consumer income inc., demand inc.

  • If income dec., demand dec.

    Ex. a factory closes, ppl lose jobs, income falls and demand dec.


  • 2 types of goods:

  • Normal goods – goods for which demand inc. as income inc.

  • Ex. most goods such as TVs, steaks, IPODS, etc…

  • Inferior goods - goods for which demand dec. as income inc.

  • Ex. Generics, Ramen noodles, etc…


Factor 2 market size
Factor 2: Market Size

  • # of consumers, population changes, seasonal tourist trends

  • If market size inc., demand inc.


Factor 3 consumer tastes
Factor 3: Consumer tastes

  • Advertising, trends, styles, popularity, celebrity endorsements

  • If consumer tastes inc., demand inc.


Factor 4 consumer expectations
Factor 4: Consumer Expectations

  • Refers to expectations of future prices

  • If consumers expect a future price inc., current demand inc.


Factor 5 substitute goods
Factor 5: Substitute Goods

  • g/s that can be used in place of each other

  • Ex. Coke and Pepsi, wireless phones and traditional phones

  • If demand for substitute inc., demand for original item dec.


Factor 6 complements
Factor 6: Complements

  • Goods used together so a rise in the demand for one inc. as the demand for another inc.

  • Ex. digital cameras and photo printers, cars and gas


Individual demand2
Individual Demand

Demand Can Increase or Decrease

P

6

5

4

3

2

1

0

Individual

Demand

Increase in Demand

P

Qd

$5

4

3

2

1

10

20

35

55

80

Price (per bushel)

D2

D1

Decrease in Demand

D3

Q

2 4 6 8 10 12 14 16 18

Quantity Demanded (bushels per week)


Individual demand3
Individual Demand

Demand Can Increase or Decrease

An Increase in Demand

Means a Movement

of the Line

P

6

5

4

3

2

1

0

Individual

Demand

A Movement Between

Any Two Points on a

Demand Curve is Called a Change in Quantity

Demanded

P

Qd

$5

4

3

2

1

10

20

35

55

80

Price (per bushel)

D2

D1

Decrease in Demand

D3

Q

2 4 6 8 10 12 14 16 18

Quantity Demanded (bushels per week)


Supply
Supply

  • Supply Defined

  • Supply Schedule

  • Law of Supply

    • Revenue Implications

    • Marginal Cost

  • Supply Curve

  • Market Supply


5 1 what is supply
5.1: What is supply?

  • Willingness and ability of producers to offer a g/s for sale

  • Expressed as a schedule or curve showing the various amounts of a product that producers are willing and able to sell at each of a series of psb prices during a specified period

  • Producer = anyone who is willing to provide a g/s

  • Ex. worker, company, farmers, etc…

  • Profit motivates producers to inc. supply


Law of supply
Law of Supply

  • Direct (positive) relationship between P and QSS

  • When P. inc., QS inc.

  • When P. dec., QS dec.


Supply schedule
Supply Schedule

  • Table showing how much of a g/s an individual producer is willing and able to sell @ each P.

  • Market supply schedule – lists how much of a g/s all producers will sell @ each P.

  • See p.51 Figure 3.4


Supply curve
Supply Curve

  • Supply schedule data in graphic form

  • Shows law of supply in graph form

  • Slopes upward from left to right

  • Market supply curve – market supply schedule in graph form

  • See p.102 Figure 3.4


Individual supply
Individual Supply

P

6

5

4

3

2

1

0

Individual

Supply

S1

P

Qs

$5

4

3

2

1

60

50

35

20

5

Price (per bushel)

Q

10 20 30 40 50 60 70

Quantity Supplied (bushels per week)


5 3 what factors affect supply
5.3: What Factors Affect Supply?

  • Changes in quantity supplied – inc. or dec. in the amount of a g/s that producers are willing to sell b/c of a change in P.

  • -shown by movement to different points along the S. curve


Changes in supply
Changes in Supply

  • Occur when a change in the marketplace causes producers to sell different amounts @ every price.

  • Inc. in S, curve shifts right

  • Dec. in S, curve shifts left

  • 6 Factors influence supply


Individual supply1
Individual Supply

Determinants of Supply

  • Resource Prices

  • Technology

  • Taxes and Subsidies

  • Prices of Other Goods

  • Producer Expectations

  • Number of Sellers


Factor 1 input costs
Factor 1: Input Costs

  • Price of resources used to make products

  • Ex. Cost of nuts used to make candy bars

  • Input costs inc., Supply dec.


Labor productivity
Labor Productivity

  • Amt of a g/s a person can produce in a given time

  • Ex. More skilled & educated workers, labor strike

  • Inc. productivity, Supply inc.


Factor 2 government action
Factor 2: Government Action

  • Excise tax – taxes production/sale of certain goods

  • Tax inc., Supply dec.

  • Subsidy – gov. payment for part of production cost

  • Subsidy inc., supply inc.

  • Regulation – rules/laws controlling business beh. (Ex. Pollution, worker safety)

  • New regulation, Supply dec.


Factor 3 technology
Factor 3: Technology

  • Applying science & innovation to production

  • Ex. Robots on assembly line, computers, etc…

  • Inc. in technology, Supply inc.


Factor 4 prices of other goods
Factor 4: Prices of Other Goods

  • Substitution in production that may occur when higher prices of other goods a seller produces entice the producer to switch production to those other goods in order to increase profits.

  • See example on page 52.


Factor 5 producer expectations
Factor 5: Producer Expectations

  • If producers expect a future P. inc, they will withhold current supply.


Factor 6 of producers
Factor 6: # of Producers

  • More producers of a product, Supply inc.

  • Ex. Fast food restaurants, auto manufacturers


Individual supply2
Individual Supply

Supply Can Increase or Decrease

P

6

5

4

3

2

1

0

S3

Individual

Supply

S1

S2

P

Qs

$5

4

3

2

1

60

50

35

20

5

Price (per bushel)

Q

2 4 6 8 10 12 14

Quantity Supplied (bushels per week)


Individual supply3
Individual Supply

Supply Can Increase or Decrease

A Movement Between

Any Two Points on a

Supply Curve is Called a Change in Quantity

Supplied

P

6

5

4

3

2

1

0

S3

Individual

Supply

S1

S2

P

Qs

$5

4

3

2

1

60

50

35

20

5

Price (per bushel)

An Increase in Supply

Means a Movement

of the Line

Q

2 4 6 8 10 12 14

Quantity Supplied (bushels per week)


Market equilibrium

3.1

Market Equilibrium

  • Equilibrium Price

  • Equilibrium Quantity

  • Surplus

  • Shortage

  • Rationing Function of Prices


6 1 seeking equilibrium demand and supply
6.1: Seeking Equilibrium: Demand and Supply

  • Market equilibrium – situation in which the quantity demanded for a service is equal to the quantity supplied

  • Two curves intersect at point of market equilibrium.

  • Equilibrium price(market-clearing price) – price at which QS = QD; equilibrium quantity can also be determined


Reaching the equilibrium price
Reaching the Equilibrium Price

  • Trial and error may be necessary for the market to arrive at equilibrium.

  • Market may have a surplus: QS>QD

  • Market may have a shortage: QD>QS


Surpluses and shortages
Surpluses and Shortages

  • Surpluses happen when prices are too high relative to demand (excess supply)

  • With surplus, prices tend to fall; producers cut back production

  • Shortages happen when prices are too low relative to demand (excess demand)

  • With shortage, prices rise; producers increase quantity supplied


Market equilibrium1
Market Equilibrium

200 Buyers & 200 Sellers

Market

Demand

200 Buyers

Market

Supply

200 Sellers

6

5

4

3

2

1

0

6,000 Bushel

Surplus

S

P

Qd

P

Qs

$5

4

3

2

1

2,000

4,000

7,000

11,000

16,000

$5

4

3

2

1

12,000

10,000

7,000

4,000

1,000

$4 Price Floor

Price (per bushel)

3

$2 Price Ceiling

7,000 Bushel

Shortage

D

7

2 4 6 8 10 12 14 16 18

Bushels of Corn (thousands per week)


Rationing function of prices
Rationing Function of Prices

  • Ability of the forces of S and D to establish a P at which selling and buying decisions are consistent

  • At equilibrium, there is no shortage and no surplus


Efficient allocation
Efficient Allocation

  • Competitive market also allocate societies’

  • resources efficiently

  • Results in productive efficiency – production of any particular good in the least costly way

  • Also results in allocative efficiency – the particular mix of G&S most highly valued by society, assuming minimum-cost production.

  • Demand essentially reflects the MB of a good, while supply reflects MC of producing a good. At the intersection of the S and D curves, MB=MC, resulting in allocative efficiency!


Market equilibrium2
Market Equilibrium

  • Changes in S and D affect Equilibrium

  • Changes in Equilibrium

  • Efficient Allocation

    • Productive Efficiency

    • Allocative Efficiency


Market equilibrium3
Market Equilibrium

Price

Quantity

?

  • Supply Increase; Demand Decrease

  • Supply Decrease; Demand Increase

  • Supply Increase; Demand Increase

  • Supply Decrease; Demand Decrease

?

?

?


Government set prices

3.2

Government-Set Prices

  • Price Ceilings on Gasoline

  • Rationing Problem

  • Black Markets

  • Rent Controls

  • Price Floors on Wheat

  • Optimal Allocation of Resources


6 3 intervention in the price system
6.3: Intervention in the Price System:

  • At times the government or other entity will interfere in the price system to keep prices from going too high.

  • Price Ceiling – legal max. price a seller may charge for a product

  • -set below equilibrium price, so a shortage results

  • Ex. Rent control – legal price ceilings on rent, leads to housing shortages

  • Ex. gasoline –See p.58


Rationing resources and products
Rationing Resources and Products

  • In periods of national emergency, the gov. may distribute products or resources

  • Rationing – way of allocating products using factors other than price

  • -occurred in U.S. during WWII

  • May lead to black market – illegal buying and selling of products


Price floors
Price Floors

  • Gov. decides to intervene in the price system in order to increase income to certain producers

  • Price Floor –legal minimum price buyers may pay for a product

  • Ex. Minimum wage or price floor on wheat – See p.59


A legal market for human organs
A Legal Market for Human Organs

Last

Word

  • Waiting List for Transplants

  • Demand for Organs

  • Vertical Supply of Organs

  • Incentive Role of Market and Up-Sloping Supply

  • Increases Quantity

  • Decreases Price

  • Moral Objections

  • Increase the Cost of Health Care

  • Better to Legalize and Regulate?


A legal market for human organs1
A Legal Market for Human Organs

Last

Word

Supply With Price Incentive

S1

S2

P

Supply of Organs

Demand for Organs

Shortage at Zero Price

Q1 – Q3

P1

At Price P1 the

Shortage is Reduced

By Q1 – Q2

D1

P0

Q

Q1

Q2

Q3


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