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Demand, Supply & Market Equilibrium

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  1. Demand, Supply & Market Equilibrium P S ECO 2013 Chapter 3 Prof M. Mari Fall 2007 D Q

  2. Demand • A relation between the price of a good and the quantity that consumers are willing and able to buy during a given period, other things constant. • Willing: you want to buy the product • Able: you can afford the buy the product

  3. Demand Schedule and Curve • Demand curve: • a curve showing the relation between the price of a good and quantity demanded during a given period, other things constant. • Suppose we are making pizza.

  4. Law of Demand • States that a quantity of a good demanded during a given period relates inversely to its price, other things constant. • Price increases  Quantity Demanded decreases • Price decreases  Quantity demanded increases • Creates a downward sloping demand curve

  5. Why? • Substitution Effect • Unlimited wants/scarce resources • When the price of a good falls, consumers substitute that good for other goods, which become relatively more expensive. • Reverse also holds true

  6. Why? • Income Effect • Money income: is simply the number of dollars received per period • Real income: your income measured in terms of what it can buy. • A fall in the price of a good increases consumers’ real income making consumers more able to purchase goods; for a normal good, the quantity demanded increases.

  7. Demand Curve A curve showing the relation between the price of a good and the quantity demanded. Price $6 $5 Point on the line that matches the schedule Every point on the line matches the schedule. It is a price/quantity demanded that consumers are willing and able to buy. $4 $3 Demand Quantity 0 200 150 50 75 100

  8. Movement Along the Demand Curve • Caused by a change in price • Only a change in price • Move from one point to another on the same graph • Called a • Change in quantity demanded.

  9. Movement along the Demand Curve Price B $6 $5 A Demand 0 Quantity 75 100

  10. Demand • Individual demand • The demand of an individual consumer • Market demand • Sum of individual demands of all consumers in the market

  11. Shifts in the Demand Curve • A demand curve isolates the relation between prices of a good and quantities demanded when other factors that could affect demand remain unchanged. • Factors called assumptions or determinants

  12. Determinants of Demand • Changes in consumer income • Changes in prices of related goods • Changes in consumer expectations • Changes in the number or composition of consumers • Changes in consumer tastes

  13. Changes in determinants • Results in changes to the RELATIONSHIP BETWEEN PRICE AND QUANTITY DEMANDED. • At each and every price a DIFFERENT quantity is demanded. • Results in a shift in the demand curve • New curve must be drawn

  14. Changes in Demand • Increase in demand • At each and every price MORE of the good is demanded • Shifts to the right Price A B $5 D2 D1 Quantity 100 150

  15. Causes of Increase in Demand • Increase in consumer income • Causes consumers to buy more of the product at each and every price. • Normal goods • Inferior goods

  16. Change in consumer income • Normal goods • A good for which demand increases as consumer income rise • Inferior goods • A good which demand increases as consumer income falls

  17. Changes in Price of Related Goods • Substitutes • Goods that are not consumed jointly • Goods that are related in such a way that an increase in the price of one shifts the demand curve for the other rightward. • Increase in price of Coke leads to increase in demand for Pepsi

  18. Changes in Price of Related Goods • Substitutes • Suppose that the price of Coke rises from $1 to $1.50, then the demand for Pepsi will decrease from 75 to 100. $1 D2 D1 100 75

  19. Changes in the price of related goods • Complements • Goods that are related in a such a way that an increase in the price of one shifts the demand of the other leftward • Two goods that are consumed jointly. • An decrease in the price of one will increase demand for the other

  20. Changes in Price of Related Goods • Complements • An decrease in the price of DVD players, increases the demand for DVDs • Suppose that DVD players decrease in price from $145 to $100, now the demand for DVDs will decrease from 750 at $20 to 900. $20 D2 D 900 750

  21. Changes in Consumer Expectations • Such as expectations in • Prices and income • Affect how consumers spend their money and their demand • If product cheaper today than tomorrow, then increase in demand

  22. Changes in consumer tastes • Consumer preferences likes and dislikes in consumption assumed to be constant along a given demand curve assumed constant along a given demand curve • Changes in taste will cause a shift in the demand curve as different quantities are demanded at each and every price.

  23. Changes in taste • Consumers prefer platform shoes. • At $50, demand increases from 100 to 200. $50 D2 D 100 200

  24. Change in the number and composition of consumers • The market demand curve is the sum of the individual demand curves. • If the number of consumers falls then the sum will be smaller thus shifting the demand curve

  25. Changes in Demand • Decrease in demand • At each and every price Less of the good is demanded • Shifts to the Left Price B $5 A D1 D2 Quantity 90 100

  26. Causes of Decrease in Demand • Decrease in consumer income • Causes consumers to buy less of the product at each and every price.

  27. Changes in Price of Related Goods • Substitutes • Goods that are not consumed jointly • Goods that are related in such a way that an increase in the price of one shifts the demand curve for the other rightward. • Decrease in price of Coke leads to Decrease in demand for Pepsi

  28. Changes in Price of Related Goods • Substitutes • Suppose that the price of Coke drops from $1 to $0.50, then the demand for Pepsi will decrease from 100 to 75. $1 D D2 100 75

  29. Changes in the price of related goods • Complements • Goods that are related in a such a way that an increase in the price of one shifts the demand of the other leftward • Two goods that are consumed jointly. • An increase in the price of one will decrease demand for the other

  30. Changes in Price of Related Goods • Complements • An decrease in the price of DVD players, increases the demand for DVDs • Suppose that DVD players increase in price from $100 to $145, now the demand for DVDs will decrease from 900 at $20 to 750. $20 D1 D2 900 750

  31. Changes in Consumer Expectations • Such as expectations in • Prices and income • Affect how consumers spend their money and their demand • If product more expensive today than tomorrow, then decrease in demand

  32. Changes in consumer tastes • Consumer preferences likes and dislikes in consumption assumed to be constant along a given demand curve assumed constant along a given demand curve • Changes in taste will cause a shift in the demand curve as different quantities are demanded at each and every price.

  33. Change in the number and composition of consumers • The market demand curve is the sum of the individual demand curves. • If the number of consumers falls then the sum will be smaller thus shifting the demand curve

  34. Review of Demand • A change in quantity demanded is not a change in demand • Change in quantity demanded is caused by a change in price • Change in quantity demanded is a movement along the demand curve • Change is demand is caused by a change in the determinants • Change in demand shifts the demand curve

  35. Supply • Producer’s side • A relation between the price of a good and the quantity that the producers are willing and able to offer for sale during a given period, other things constant.

  36. Law of Supply • The quantity of a good supplied during a given period is usually directlyrelated to the price of the good • Increase in price leads to increase in quantity supplied • Decrease in price leads to decrease in quantity supplied. • Creates upward sloping supply curve

  37. Supply Curve Price 6 Supply 5 Quantity

  38. Movement along the supply curve • A change in price and only in price • Causes a movement along the supply curve • Called a Change in Quantity Supplied Supply $6 B $4 A 100 150

  39. Supply • Individual supply • The supply of an individual producer • Market supply • The sum of individual supplies of all producers in the market

  40. Determinants for the Supply Curve • Changes in technology • Changes in prices of relevant resources • Changes in the prices of alternative goods • Changes in Producer Expectations • Changes in the number of producers

  41. Changes in Supply • Caused by changes in the determinants to the supply curve • Results in changes to the relationship between the price and quantity supplied • At each and every price a different quantity is supplied • New supply curve - shift in supply

  42. Increase in Supply • At each and every price more of the good is supplied S1 S2 $6 300 400

  43. Causes of increase in Supply • Improvements in Technology • Changes in relevant resources • Decrease in the price of resources • Lowers costs • Changes in price of alternative goods • If price of alternative good increases, supply of the good increases • Changes in producers expectations

  44. Changes in technology • Technology is the economy’s stock of knowledge about how to combine resources efficiently

  45. Changes in Technology • Improvements in technology • Causes an increase in supply • More of the product is available at all prices S1 S2 $6 300 400

  46. Changes in Relevant Resources • Decrease in resource prices • Increases the supply of the good at each and every price. S1 S2 $6 300 400

  47. Changes in prices of Alternative Goods • Alternative goods • Other goods that use some or all of the same resources as the good in question • Beef and leather. • If the price of beef increases, producers will supply more beef thus increasing the supply of leather. Price S1 S2 $6 Q Leather 300 400 Above is the market for the supply of leather

  48. Changes in Producers Expectations • Expectation of future prices of resources or their own product can cause producers to change what they offer at each individual price

  49. Changes in the Number of Producers • As the number of producers change so does the supply of the product • A decrease in the number of producers will lead to a decrease in supply

  50. Decrease in Supply • At each and every price LESS of the good is supplied 5 S1 S2 400 600