Demand and supply In a market system, the 3 fundamental questions are resolved by a decentralized decision making process encompassinga large number of buyers and sellers. A vast numberof individual decisions to buyand sell add up to “market forces”—or the forces of demand and supply.
Markets, demand, and supply A market is group of buyers and sellers with the potential to trade
Markets • Defining the good or service • Buyers and sellers • Geography of the market
Imperfect Competition If a market is imperfectly competitive, buyers or sellers have some influence over market price. Buyers or sellers are price makers, not takers
Perfect competition In perfectly competitive markets (or just competitive markets), each buyer and seller takes the market price as a given
Supply and Demand The supply and demand model is designed to explain how prices are determined in perfectly competitive markets.
What is demand? • Definitions: • Demand: The quantities of a good or service buyers are willing (and able) to buy at alternative market prices, ceteris paribus. • Quantity demanded: The quantity of a good or service buyers are willing (and able) to buy at a specific price, ceteris paribus.
Price (per Bottle) Quantity Demanded (Bottles per Month) $1.00 2.00 3.00 4.00 5.00 7,500 6,500 5,000 4,000 3,500 Demand schedule The schedule showing the quantities demanded of a good or service at various prices, ceteris paribus Maple Syrup
Demand curve The Demand Curve shows the relationship between the price of a good and the quantity demanded, holding constant all other variables that affect demand
When the price is $4.00 per bottle, 4,000 bottles are demanded (point A). At $2.00 per bottle, 6,000 bottles are demanded (point B). The Demand Curve Maple Syrup Price A $4.00 B $2.00 D 0 4,000 6,500 Number of Bottles
Individual demand An individual’s quantity demanded of any good is the total amount that individual would choose to buy at a particular price.
Here we derive the market demand curve by summing up the individual demand curves for cantaloupe.
Deriving the market demand curve for cantaloupe Price ($) Anita 2.50 BO 2.00 1.50 Market demand 1.00 0 3 4 6 7 10 12 Quantity
Law of demand Holding all other factors that can influence demand constant, market price and quantity-demanded are inversely related.
Why is the demand curve downward sloping? The Substitution effect Price • As the price of oranges decrease, ceteris paribus, oranges become cheaper relative to substitutes. • Some buyers substitute oranges for tangerines, nectarines, and other fruits. oranges P2 P1 D 0 q2 q1 Quantity
Original Quantity Demanded (Bottles per Month) New Quantity Demanded After Increases in Income (Bottles per Month) Price (per Bottle) $1.00 2.00 3.00 4.00 5.00 7,500 5,000 5,000 4,000 3,500 9,500 8,000 7,000 6,000 5,500 Shift of the demand curve Price Maple Syrup B C $2.00 D2 D1 0 5,000 8,000 Number of Bottles
Change in demand versus movement along the demand curve • A change in demand (increase or decrease in demand) refers to a shift of the demand curve—resulting from a change in some factor that can influence the demand for this good other than its price. • A movement along the demand curve results from a change in the price of the good, holding all other factors constant.
Shift versus movement along the demand curve A→ B : Movement along the demand curve Price D1→ D2 : Increase in demand Maple Syrup A $4.00 B C $2.00 D2 D1 0 4,000 5,000 8,000 Number of Bottles
Determinants of demand Besides price, what factors might influence the demand for maple syrup, or any other good or service.
Determinants of demand A change in any of the following factors would cause a change in demand, or a shift of the entire demand curve. These influences on demand include: • The price of substitute goods • The price of complementary goods • Income • Expectations • Number of buyers • Tastes and preferences
Substitutes A good that can be consumed in the place of another. • Cheesecake—Tiramisu • Orange juice—grapefruit juice • Pizza-tacos • Cab rides—subway rides • VCRs-DVD players • Pork-chicken
Let the price of chicken increase, ceteris paribus. This should cause the demand for pork to shift to the right Price/lb. H A P2 P1 B D2 D1 q1 q2 0 Quantity (lbs.)
Complements A good that is consumed with another good • Computers—printers • Tortilla chips-salsa • Tents—sleeping bags • Airline service—rental cars • Shot guns--shells
Cheaper air fares should stimulate sales in the rental car business Rental fee H A P2 P1 B D2 D1 q1 q2 0 Cars rented per day
Normal and Inferior Goods • A normal good is a good for which demand increases (shifts right) when income increases.Examples: Scotch whiskey, Swiss-made watches, lobster, air travel, vacations abroad. • An inferior good is a good for which demand decreases (shifts left) when income increases.Examples: macaroni, used clothing, bus service.
Expectations Price/lb Salmon D1 D2 0 Quantity (lbs.) If buyers anticipate that prices of fresh salmon will be falling shortly, they may purchase less today.
Shifts of the demand curve • Demand could shift right due to: • Increase in the price of substitutes • Decrease in the price of complements • Increase in income (normal good) • Increase in the number of buyers • Change of preferences Price H A P2 P1 B D2 D1 q1 q2 0 Quantity
What is Supply? • Quantity supplied :The amount of a good or service sellers are willing (and able) to sell during a specified period at a specific price, ceteris paribus. • Supply: The relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same.
The Supply Schedule A list of quantities supplied at each different price when all other influences on selling plans remain the same.
The Supply Curve A graph of the relationship between the quantity supplied of a good and its price when other influences on selling plans remain constant. Price Supply Curve A 2.00 B 1.00 C D 0 2,500 4,500 Number of Bottles
Law of supply Holding all other factors that can influence selling plans constant, market price and quantity-supply are directly related.
Change in quantity supplied: movement along a supply curve in response to a change in price Change in supply: shift of a supply curve in response to some variable other than price Change in supply versus change in quantity- supplied
A decrease in labor costs causes the supply curve S S for maple syrup to shift 1 2 from S to S . At each 1 2 price, more bottles are supplied after the shift. G J Changes in Quantity Supplied and Supply Maple Syrup Price per Bottle $4.00 Number of Bottles 6,000 8,000 a a a a
What can cause a change in supply • Change in input prices • Change in the profitability of producing alternative products • Change in technology • Change in productive capacity • Change in expectations about future prices
Inputs can be economic resources (raw materials, labor) or semi-finished articles (aluminum, camshafts, soybeans)
Prices of Inputs • A rise in price of an input causes a decrease in supply that shifts the supply curve to the left • A fall in price of an input causes an increase in supply that shifts the supply curve to the right
Profitability of Alternate Goods • Alternate goods: other goods a firm could produce using some of the same kinds of inputs as the original good • When an alternate good becomes more profitable to produce because • its price rises • the cost of producing it falls • the supply curve for the original good will shift leftward
Technology • Cost-saving technological advances increase the supply of a good, shifting the supply curve to the right
Productive Capacity • An increase in productive capacity shifts the supply curve rightward. • A decreasein productive capacity shifts the supply curve leftward.
Expectation of Future Prices • A rise in the expected price of a good will decrease the supply, shifting the supply curve leftward.
S Price increase moves us rightward along supply curve Price decrease moves us leftward along supply curve S S 2 1 Entire supply curve Entire supply curve S shifts rightward when: shifts leftward when: S 2 1 • price of input • price of input • profitability of alternate • profitability of alternate good good • productive capacity • productive capacity • expected price • expected price • technology improves Expectation of Future Prices (a) Price P 2 P 1 P 3 Q Q Q Quantity 3 1 2 (b) (c) Price Price Quantity Quantity a a a
Putting demand and supply together Equilibrium: state of rest - a situation that, once achieved, will not change unless there is a change in something we have been assuming constant
Putting demand and supply together Maple Syrup S PriceperBottle $3.00 E C H $1.00 D 0 2,500 5,000 7,500 Bottles