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Bell Ringer. Explain the point that this political cartoon is making. Demand, Supply, and Market Equilibrium. Chapter 3. Supply and Demand. Supply and demand is an economic model Designed to explain how prices are determined in certain types of markets

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Bell ringer

Bell Ringer

Explain the point that this political cartoon is making.


Demand supply and market equilibrium

Demand, Supply, and Market Equilibrium

Chapter 3


Supply and demand

Supply and Demand

  • Supply and demand is an economic model

    • Designed to explain how prices are determined in certain types of markets

  • The price of a good or service is what must be given in exchange for the good. Price measures the scarcity. Prices provide our economy with incentives to use scarce resources efficiently.


Why is the first car more expensive

Why is the first car more expensive?

$105,000

$38,000

1974 Pontiac Trans AM

2009 Pontiac Solstice


Markets

Markets

  • A market is a place (including the internet) where buyers and sellers are brought together to trade goods/services

    • What are some examples of markets?


Buyers and sellers

Buyers and Sellers

  • Buyers and sellers in a market can be

    • Households

    • Business firms

    • Government agencies

  • All three can be both buyers and sellers in the same market, but are not always

  • Usually we simplify our examples by saying:

    • In markets for consumer goods, we’ll view business firms as the only sellers, and households as only buyers

    • In most of our discussions, we’ll be leaving out the “middleman”


Competition in markets

Competition in Markets

  • Perfectly competitive markets have many small buyers and sellers, e.g., farmer’s market, big city hot dog market

    • Each is a small part of the market, and the product is standardized, and each buyer and seller takes the market price as a given

  • Imperfectly competitive markets have just a few large buyers and sellers, e.g., local electricity company

    • The product of each seller is unique in some way, each buyer or seller has some influence over the price.


Using supply and demand

Using Supply and Demand

  • Supply and demand model is designed to explain how prices are determined in perfectly competitive markets

    • Perfect competition is rare but many markets come reasonably close

    • Perfect competition is a matter of degree rather than an all or nothing characteristic

  • Supply and demand is one of the most versatile and widely used models in the economist’s tool kit


Demand

Demand

  • Demand is the specific amount of a good that all buyers in the market are willing and able to buy

    • Is there demand if I want a $7000 T.V. but only have $300 to spend?

    • Is there demand if I have $5000 to spend on a fence but I don’t need a new fence?


Quantity demanded

Quantity Demanded

  • Implies a choice

    • How much households would like to buy when they take into account the opportunity cost of their decisions?

  • Is hypothetical

    • Makes no assumptions about availability of the good

    • How much would households want to buy, at a specific price, given real-world limits on their spending power?

  • Stresses price

    • Price of the good is one variable among many that influences quantity demanded

    • We’ll assume that all other influences on demand are held constant, so we can explore the relationship between price and quantity demanded


The law of demand

The Law of Demand

  • States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall (e.g., air travel, magazines, education, etc)

    • The words, “everything else remains the same” are important

      • In the real world many variables change simultaneously

      • However, in order to understand the economy we must first understand each variable separately

      • Thus we assume that, “everything else remains the same,” in order to understand how demand reacts to price


The demand schedule and the demand curve

The Demand Schedule and The Demand Curve

  • Demand schedule

    • A list showing the quantity of a good that consumers would choose to purchase at different prices, with all other variables held constant

  • The demand curve shows the relationship between the price of a good and the quantity demanded , holding constant all other variables that influence demand

    • Each point on the curve shows the total buyers would choose to buy at a specific price

  • Law of demand tells us that demand curves virtually always slope downward


Demand schedule for maple syrup in u s a

Demand Schedule for Maple Syrup in U.S.A.


Figure 1 the demand curve

Price per Bottle

When the price is $4.00 per bottle, 40,000 bottles are demanded (point A).

At $2.00 per bottle, 60,000 bottles are demanded (point B).

Number of Bottles per Month

Figure 1: The Demand Curve

A

$4.00

B

2.00

D

40,000

60,000


Shifts vs movements along the demand curve

Shifts vs. Movements Along The Demand Curve

  • A change in the price of a good causes a movement along the demand curve

    • A increase in price would cause a movement to the right along the demand curve

    • A decrease in price will cause a movement to the left along the demand curve


Movements along the demand curve

Price

Price increase moves us leftward alongdemand curve

Price decrease moves us rightwardalongdemand curve

Quantity

Movements Along The Demand Curve

P2

P1

P3

Q2

Q1

Q3


Shifts vs movements along the demand curve1

Shifts vs. Movements Along The Demand Curve

  • Changes such as more income and population growth lead to the line shifting on the graph

  • Example:

    • Demand curve has shifted to the right of the old curve as income has risen

    • A change in any variable that affects demand—except for the good’s price—causes the demand curve to shift


A shift of the demand curve

An increase in income shifts the demand curve for maple syrup from D1 to D2.

At each price, more bottles are demanded after the shift

Price per Bottle

D2

D1

Number of Bottles per Month

A Shift of The Demand Curve

B

C

$2.00

60,000

80,000


Dangerous curves change in quantity demanded vs change in demand

Dangerous Curves: “Change in Quantity Demanded” vs. “Change in Demand”

  • Language is important when discussing demand

    • “Quantity demanded” means

      • A particular amount that buyers would choose to buy at a specific price

      • It is a number represented by a single point on a demand curve

      • When a change in the price of a good moves us along a demand curve, it is a change in quantity demand

    • The term demand means

      • The entire relationship between price and quantity demanded—and represented by the entire demand curve

      • When something other than price changes, causing the entire demand curve to shift, it is a change in demand


Income factors that shift the demand curve

Income: Factors That Shift The Demand Curve

  • An increase in income has effect of shifting demand for normal goods to the right

    • However, a rise in income shifts demand for inferior goods to the left

    • Examples: housing, automobiles, health club memberships, etc.

  • A rise in income will increase the demand for a normal good, and decrease the demand for an inferior good (e.g. instant noodles).


Wealth factors that shift the demand curve

Wealth: Factors That Shift The Demand Curve

  • Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe

  • An increase in wealth will

    • Increase demand (shift the curve rightward) for a normal good

    • Decrease demand (shift the curve leftward) for an inferior good


Prices of related goods factors that shift the demand curve

Prices of Related Goods: Factors that Shift the Demand Curve

  • Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose, e.g., different types of meat

    • A rise in the price of a substitute increases the demand for a good, shifting the demand curve to the right

  • Complement—used together with the good we are interested in, e.g., pancake mix and maple syrup

    • A rise in the price of a complement decreases the demand for a good, shifting the demand curve to the left


Other factors that shift the demand curve

Other Factors That Shift the Demand Curve

  • Population

    • As the population increases in an area

      • Number of buyers will ordinarily increase

      • Demand for a good will increase

  • Expected Price

    • An expectation that price will rise (fall) in the future shifts the current demand curve rightward (leftward)

  • Tastes

    • Combination of all the personal factors that go into determining how a buyer feels about a good

    • When tastes change toward a good, demand increases, and the demand curve shifts to the right

    • When tastes change away from a good, demand decreases, and the demand curve shifts to the left


Shifts of the demand curve

Price

Quantity

Shifts of The Demand Curve

  • Entire demand curve shifts rightward when:

  • income or wealth ↑

  • price of substitute ↑

  • price of complement ↓

  • population ↑

  • expected price ↑

  • tastes shift toward good

D2

D1


Shifts of the demand curve1

Price

Quantity

Shifts of The Demand Curve

  • Entire demand curve shifts left when:

  • income or wealth ↓

  • price of substitute ↓

  • price of complement ↑

  • population ↓

  • expected price ↓

  • tastes shift toward good

D1

D2


Supply

Supply

  • Supply is the amount of a product that a producer/supplier is willing and able to produce

    • If they want to produce it but don’t have the factors of production, then they can’t produce

    • If they own the factors of production but don’t want to produce then they won’t…


The law of supply

The Law of Supply

  • States that when the price of a good rises and everything else remains the same, the quantity of the good supplied will rise

    • The words, “everything else remains the same” are important

      • In the real world many variables change simultaneously

      • However, in order to understand the economy we must first understand each variable separately

      • We assume “everything else remains the same” in order to understand how supply reacts to price


The law of supply1

The Law of Supply

  • Think about it this way…

    • If you raise the price of jeans and people are knocking down the door to purchase them still…are you going to make more or less of them?

    • If you drop the price what’s going to happen?

      • Why?

      • This is why we have clearance racks…


The supply schedule and the supply curve

The Supply Schedule and The Supply Curve

  • Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices, with all other variables held constant

  • Supply curve—graphical depiction of a supply schedule

    • Shows quantity of a good or service supplied at various prices, with all other variables held constant


The supply curve

Price per Bottle

When the price is $2.00 per bottle, 40,000 bottles are supplied (point F).

At $4.00 per bottle, quantity supplied is 60,000 bottles(pointG).

Number of Bottles per Month

The Supply Curve

S

$4.00

G

2.00

F

40,000

60,000


Movements along the supply curve

Movements Along the Supply Curve

  • A change in the price of a good causes a movement along the supply curve

    • A rise (fall) in price would cause a rightward (leftward) movement along the supply curve


Changes in supply and in quantity supplied

Price

Price increase moves us rightward alongsupply curve

Price decrease moves us leftwardalongsupply curve

Quantity

Changes in Supply and in Quantity Supplied

S

P2

P1

P3

Q3

Q1

Q2


Shift in the supply curve

Shift in the Supply Curve

  • A drop in transportation costs will cause a shift in the supply curve itself

    • Supply curve has shifted to the right of the old curve as transportation costs have dropped

  • Input prices

    • A fall (rise) in the price of an input causes an increase (decrease) in supply, shifting the supply curve to the right (left)

  • Price of Related Goods

    • When the price of an alternate good rises (falls), the supply curve for the good in question shifts rightward (leftward)

  • Technology

    • Cost-saving technological advances increase the supply of a good, shifting the supply curve to the right


Factors that shift the supply curve

Factors That Shift the Supply Curve

  • Number of Firms

    • An increase (decrease) in the number of sellers—with no other changes—shifts the supply curve to the right (left)

  • Expected Price

    • An expectation of a future price increase (decrease) shifts the current supply curve to the left (right)


Factors that shift the supply curve1

Factors That Shift the Supply Curve

  • Changes in weather

    • Favorable weather

      • Increases crop yields

      • Causes a rightward shift of the supply curve for that crop

    • Unfavorable weather

      • Destroys crops

      • Shrinks yields

      • Shifts the supply curve leftward

  • Other unfavorable natural events may effect all firms in an area

    • Causing a leftward shift in the supply curve


A shift of the supply curve

A decrease in transportation costs shifts the supply curve for maple syrup from S1 to S2.

Price per Bottle

At each price, more bottles are supplied after the shift

Number of Bottles per Month

A Shift of The Supply Curve

S1

S2

$4.00

J

G

60,000

80,000


Changes in supply and in quantity supplied1

Price

Quantity

Changes in Supply and in Quantity Supplied

S1

  • Entire supply curve shifts rightward when:

  • price of input↓

  • price of alternate good ↓

  • number of firms ↑

  • expected price ↑

  • technological advance

  • favorable weather

S2


Changes in supply and in quantity supplied2

Price

Quantity

Changes in Supply and in Quantity Supplied

S2

  • Entire supply curve shifts rightward when:

  • price of input↑

  • price of alternate good ↑

  • number of firms ↓

  • expected price ↑

  • unfavorable weather

S1


Equilibrium putting supply and demand together

Equilibrium: Putting Supply and Demand Together

  • When a market is in equilibrium

    • Both price of good and quantity bought and sold have settled into a state of rest

    • The equilibrium price and equilibrium quantity are values for price and quantity in the market but, once achieved, will remain constant

      • Unless and until supply curve or demand curve shifts

  • The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes, respectively

    • At point where supply and demand curves cross


Market equilibrium

Price per Bottle

equilibrium price is $3.00

.

Number of Bottles per Month

Market Equilibrium

S

E

$3.00

H

J

1.00

D

25,000

50,000

75,000


Excess demand putting supply and demand together

Excess Demand: Putting Supply and Demand Together

  • Excess demand

    • At a given price, the excess of quantity demanded over quantity supplied

  • Price of the good will rise as buyers compete with each other to get more of the good than is available


Market equilibrium1

2.causes the price to rise . . .

3.shrinking the excess demand . . .

Price per Bottle

4.until price reaches its equilibrium value of $3.00

.

Number of Bottles per Month

1. At a price of $1.00 per bottle an excess demand of 50,000 bottles . . .

Market Equilibrium

S

E

$3.00

H

J

1.00

Excess Demand

D

25,000

50,000

75,000


Excess supply putting supply and demand together

Excess Supply: Putting Supply and Demand Together

  • Excess Supply

    • At a given price, the excess of quantity supplied over quantity demanded

  • Price of the good will fall as sellers compete with each other to sell more of the good than buyers want


Excess supply and price adjustment

1.At a price of $5.00 per bottle an excess supply of 30,000 bottles . . .

Price per Bottle

3.shrinking the excess supply . . .

2.causes the price to drop,

4.until price reaches its equilibrium value of $3.00.

Number of Bottles per Month

Excess Supply and Price Adjustment

Excess Supply at $5.00

S

$5.00

L

K

E

3.00

D

35,000

50,000

65,000


Income rises what happens when things change

Income Rises: What Happens When Things Change

  • Income rises, causing an increase in demand

    • Rightward shift in the demand curve causes rightward movement along the supply curve

    • Equilibrium price and equilibrium quantity both rise

  • Shift of one curve causes a movement along the other curve to new equilibrium point


When one curve shifts

3.to a new equilibrium.

4.Equilibrium price increases

Price per Bottle

2.moves us along the supply curve . . .

1.An increase in demand . . .

Number of Bottles of Maple Syrup per Period

5.and equilibrium quantity increases too.

When One Curve Shifts…

S

F'

$4.00

E

3.00

D2

D1

50,000

60,000


An ice storm hits what happens when things change

An Ice Storm Hits: What Happens When Things Change

  • An ice storm causes a decrease in supply

    • Weather is a shift variable for supply curve

      • Any change that shifts the supply curve leftward in a market will increase the equilibrium price

        • And decrease the equilibrium quantity in that market


Figure 10 a shift of supply and a new equilibrium

Price per Bottle

Number of Bottles

Figure 10: A Shift of Supply and A New Equilibrium

S2

S1

E'

$5.00

3.00

E

D

35,000

50,000


Both curves shift

Both Curves Shift

  • When just one curve shifts (and we know the direction of the shift) we can determine the direction that both equilibrium price and quantity will move

  • When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantity—but not both

    • Direction of the other will depend on which curve shifts by more


Changes in the market for handheld pcs

Price per Handheld PC

3.moved the market to a new equilibrium.

2.and a decrease in demand . . .

4.Price decreased . . .

1.An increase in supply . . .

Millions of Handheld PCs per Quarter

5. and quantity decreased as well.

Changes in the Market for Handheld PCs

S2002

S2003

A

$500

B

$400

D2002

D2003

2.45

3.33


The three step process

The Three Step Process

  • Key Step 1—Characterize the Market

    • Decide which market or markets best suit problem being analyzed and identify decision makers (buyers and sellers) who interact there

  • Key Step 2—Find the Equilibrium

    • Describe conditions necessary for equilibrium in the market, and a method for determining that equilibrium

  • Key Step 3—What Happens When Things Change

    • Explore how events or government polices change market equilibrium


Using supply and demand the invasion of kuwait

Using Supply and Demand: The Invasion of Kuwait

  • Why did Iraq’s invasion of Kuwait cause the price of oil to rise?

    • Immediately after the invasion, United States led a worldwide embargo on oil from both Iraq and Kuwait

    • A significant decrease in the oil industry’s productive capacity caused a shift in the supply curve to the left

      • Price of oil increased


The market for oil

Price per Barrel of Oil

Barrels of Oil

The Market For Oil

S2

S1

E'

P2

E

P1

D

Q2

Q1


Using supply and demand the invasion of kuwait1

Using Supply and Demand: The Invasion of Kuwait

  • Why did the price of natural gas rise as well?

    • Oil is a substitute for natural gas

    • Rise in the price of a substitute increases demand for a good

    • Rise in price of oil caused demand curve for natural gas to shift to the right

      • Thus, the price of natural gas rose


The market for natural gas

Price per Cubic Foot of Natural

Gas

Cubic Feet of Natural Gas

The Market For Natural Gas

S

F'

P4

F

D2

P3

D1

Q3

Q4


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