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Supply and Demand: An Introduction

Slide 2. Why do diamonds cost more than water? . Why are Some Goods Cheap and Others Expensive?. Slide 3. Why are Some Goods Cheap and Others Expensive?. Why do Gauguin's paintings sell for more than JIA Juanli's?. Sept. 15, 2006 -- Christie's International said it may sell Paul Gauguin's painting ``L'Homme a la Hache'' for a record $45 million at a New York auction on Nov. 8. .

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Supply and Demand: An Introduction

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    2. Slide 2 Why are Some Goods Cheap and Others Expensive?

    3. Slide 3 Why are Some Goods Cheap and Others Expensive?

    4. Slide 4 Why are Some Goods Cheap and Others Expensive? Why do Qi BaiShi’s (???) crabs sell for more than the real ones?

    5. Slide 5 Is it cost of production that determines prices (as Adam Smith thought)? Why are Some Goods Cheap and Others Expensive?

    6. Slide 6 Or is it willingness to pay that determines prices (as Stanley Jevons thought)? Why are Some Goods Cheap and Others Expensive?

    7. Slide 7 Cost of production? Value to the user? Alfred Marshall (Principles of Economics, 1890) was the first to explain clearly how both costs and willingness to pay interact to determine market prices. Markets and Prices

    8. Slide 8 Markets and Prices The market for any good or service consists of all (actual or potential) buyers or sellers of that good or service.

    9. Slide 9 Markets and Prices How the interaction among buyers and sellers in markets determine the prices and quantities of the various goods and services traded in those markets?

    10. Slide 10 Demand Suppose you enjoy drinking coffee… Suppose the price of a regular coffee at Starbucks is $14 and at that price you drink 2 cups of coffee per day. Suppose the price drops to $10. How much coffee will you buy? (Will you buy more or fewer?) Suppose the price further drops to $6. How much will you buy? (More of fewer?) How much will you buy if the price goes to $20? (More or fewer?)

    11. Slide 11 The Demand Curve for Coffee

    12. Slide 12 The Demand Curve The demand curve is the set of all price-quantity pairs for which buyers are satisfied. [“Satisfied” means being able to buy the amount they want to at any given price.]

    13. Slide 13 The Daily Demand Curve for Coffee in Starbucks

    14. Slide 14 Horizontal Interpretation of the Demand Curve

    15. Slide 15 Vertical Interpretation of the Demand Curve

    16. Slide 16 The Buyer’s Reservation Price Consumers differ in terms of how much they are willing to pay for the good. The highest price a consumer will pay for an item is called the reservation price. Different buyers have different reservation prices. The reservation price is also the benefit the buyer receives from the good.

    17. Slide 17 The Buyer’s Reservation Price

    18. Slide 18 The Cost-Benefit Principle: If the reservation price (benefit) exceeds the market price (cost), the consumer will purchase the good. At higher prices, benefit will exceed cost for a smaller quantity of buyers than at lower prices. The Buyer’s Reservation Price

    19. Slide 19 The Law of Demand As the price of a good or service goes down (up), the quantity consumers wish to buy will increase (decrease).

    20. Slide 20 Demand Curves Slope Downward for Two Main Reasons The substitution effect: As the good becomes more expensive, people switch to substitutes. The income effect: As the good becomes more expensive, people can’t afford to buy as much of it.

    21. Slide 21 The Substitution Effect Consumers typically select the low-cost option when purchasing similar products. When the price of coffee falls, coffee becomes more desirable because it is now less expensive than some other beverage options. Buyers substitute coffee for the more expensive options and more are sold at the lower price. When the price of coffee rises, other beverages become the cheaper beverage, so they replace coffee.

    22. Slide 22 The Income Effect Consumers have a budget for daily beverages. The budget includes some idea of how many cups of coffee will be purchased at the going price. If the price falls, the “coffee budget” releases funds from the budgeted amount and allows the purchase of more cups. The drop in price is the same as an increase in income, hence, the income effect.

    23. Slide 23 Supply The supply curve shows the quantity of a good that sellers wish to sell at each price. The supply curve is the set of price-quantity pairs for which sellers are satisfied. ["Satisfied" means being able to sell the amount they want to at any given price.]

    24. Slide 24 The Daily Supply Curve for Coffee in Starbucks

    25. Slide 25 Horizontal Interpretation of the Supply Curve

    26. Slide 26 Vertical Interpretation of the Supply Curve

    27. Slide 27 The minimum price that a producer must receive before any product is placed on the market, generally equal to marginal cost. As prices rise, more and more producers find that the price meets or exceeds their reservation price, so they enter the market and larger and larger quantities are available. The Seller’s Reservation Price

    28. Slide 28 Supply Curves Slope Upward for One Reason The Low-hanging-fruit principle Starbucks will be willing to sell additional cups of coffee as long as the price it receives is sufficient to cover its opportunity cost of supplying them. As we expand the production of any good, we turn first to those whose opportunity costs of producing that good are lowest, and only then to others with higher opportunity costs.

    29. Slide 29 Market Equilibrium Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price. Describes the price and quantity relationship that satisfies all the buyers and sellers who are in the market.

    30. Slide 30 The Equilibrium Price and Quantity of Coffee In Starbucks

    31. Slide 31 Would sellers prefer a higher price than the equilibrium price? Would buyers prefer a lower price than the equilibrium price? What Do You Think?

    32. Slide 32 Excess Supply

    33. Slide 33 Excess Demand

    34. Slide 34 The Trading Locus

    35. Slide 35 From Disequilibrium to Equilibrium

    36. Slide 36 From Disequilibrium to Equilibrium

    37. Slide 37 No one consciously plans or directs this equilibrating process. The actual steps that consumers and producers must take to move toward equilibrium are often indescribably complex. And yet the adjustment toward equilibrium results more or less automatically from the natural reactions of self-interested individuals facing either surpluses or shortages. From Disequilibrium to Equilibrium

    38. Slide 38 From Disequilibrium to Equilibrium – A Summary

    39. Slide 39 Buyer’s surplus = the difference between the buyer’s reservation price and the market price for a given quantity of a good. Seller’s surplus = the difference between the market price and the seller’s reservation price for a given quantity of a good. Economic surplus = the buyer’s reservation price (MB) - the seller’s reservation price (MC) for a given quantity of a good. Economic Surplus

    40. Slide 40 Economic Surplus

    41. Slide 41 Economic Surplus

    42. Slide 42 Economic Surplus

    43. Slide 43 Economic Surplus

    44. Slide 44

    45. Slide 45

    46. Slide 46 “Producers raised prices, and the resulting fall in demand caused prices to fall back to their original level.” True or False? Newspaper Story

    47. Slide 47 An Increase In Quantity Demanded vs. An Increase In Demand

    48. Slide 48 “Producers raised prices, and the resulting fall in demand caused prices to fall back to their original level.” WRONG!! A rise in price causes a fall in the quantity demanded, not a fall in demand. Newspaper Story

    49. Slide 49 An Increase In Quantity Supplied vs. An Increase In Supply

    50. Slide 50 Impact of an Increase in Demand

    51. Slide 51 Impact of a Decrease in Demand

    52. Slide 52 Impact of an Increase in Supply

    53. Slide 53 Impact of a Decrease in Supply

    54. Slide 54 Determinants of Demand 1. A Change in Income For most goods, the quantity demanded at any price will rise with income. Goods that have this property are called normal goods.

    55. Slide 55 For inferior goods, the quantity demanded at any price will fall with income. Determinants of Demand 1. A Change in Income

    56. Slide 56 Consumers abandon inferior goods in favor of higher quality substitutes as soon as they can afford to. Examples: Instant noodles Rice Bicycles with no gears. Determinants of Demand 1. A Change in Income

    57. Slide 57 Determinants of Demand 2. Tastes Example: Following the release of Jurassic Park and The Lost World, tastes in children’s toys shifted toward designs involving prehistoric reptiles.

    58. Slide 58 Jurassic Park and the Market for Toy Dinosaurs

    59. Slide 59 Determinants of Demand 3. Price of Substitutes Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other.

    60. Slide 60 The Price of Tea and the Market for Coffee

    61. Slide 61 The Price of Tea and the Market for Coffee

    62. Slide 62 Determinants of Demand 4. Price of Complements Two goods are complements in consumption if an increase (decrease) in the price of one causes a decrease (increase) in the demand for the other.

    63. Slide 63 Bicycle Price and the Market for Helmets

    64. Slide 64 Bicycle Price and the Market for Helmets

    65. Slide 65 Determinants of Demand A Summary Factors That Cause an Increase in Demand A decrease in the price of complements to the good or service An increase in the price of substitutes for the good or service An increase in income (for a normal good) An increased preference of buyers for the good or service An increase in the population of potential buyers An expectation of higher prices in the future

    66. Slide 66 Determinants of Supply 1. Technology Anything that changes the amount a firm can produce with a given amount of inputs to production can be considered a change in technology. What is the impact of the invention of digital cameras for the movies industry?

    67. Slide 67 Determinants of Supply 1. Technology

    68. Slide 68 Determinants of Supply 2. Factor Prices If the price of the inputs to production (raw material, labor, capital) increases, then it becomes more costly to produce goods and firms will produce less at a given price.

    69. Slide 69 The Price of Gasoline and the Relocation Market

    70. Slide 70 Determinants of Supply A Summary Factors That Cause an Increase in Supply A decrease in the cost of materials, labor, or other inputs used in the production of the good or service An improvement in technology that reduces the cost of producing the good or service An improvement in the weather, especially for agricultural products An increase in the number of suppliers An expectation of lower prices in the future

    71. Slide 71 Predicting and Explaining Changes In Prices and Demand Why do the prices of some goods, like apples, go down during the months of heaviest consumption, while others, like beachfront cottages, go up?

    72. Slide 72 Predicting and Explaining Changes In Prices and Demand The seasonal consumption increase is the result of a supply increase in the case of apples, and a demand increase in the case of cottages.

    73. Slide 73 Seasonal Variation in Apples Market

    74. Slide 74 Seasonal Variation in Cottage Market

    75. Slide 75 The Effects of Simultaneous Shifts in Supply and Demand What will happen to the equilibrium price and quantity in the chicken market if both of the following events occur? Avian flu cases are reported and A more efficient chicken battery equipment is released on the market.

    76. Slide 76 The Effects of Simultaneous Shifts in Supply and Demand

    77. Slide 77 The Effects of Simultaneous Shifts in Supply and Demand

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