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Demand, Supply & Market EquilibriumECO 2013
Chapter 3Prof M. Mari
Fall 2007
P
Q
D
S
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
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.
Price of Good
Quantity Demand
ed
$3 200
$4 150
$5 100
$6 75
$7 50
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
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
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.
Demand Curve
Price
Quantity0
$3
$4
$5
$6
50 75 100 150 200
Demand
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.
A curve showing the relation between the price of a good and the quantity demanded.
Movement Along the Demand Curve Caused by a change in price
Only a change in priceOnly a change in price Move from one point to another on the same
graph Called a
Change in quantity demanded.
Quantity
Price
0
$5
100
Demand
$6
75
Movement along the Demand Curve
A
B
Demand Individual demand
The demand of an individual consumer Market demand
Sum of individual demands of all consumers in the market
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
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
Changes in determinants Results in changes to the RELATIONSHIP
BETWEEN PRICE AND QUANTITY DEMANDED.
At each and every price a DIFFERENT DIFFERENT quantity is demanded.
Results in a shift in the demand curve New curve must be drawn
Changes in Demand Increase in demand
At each and every price MOREMORE of the good is demanded
Shifts to the right
D1
$5
D2
A B
Price
Quantity100 150
P Qd1 Qd2
$4 150 200
$5 100 150
$6 75 100
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
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
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 Increase in price of Coke leads to increase in leads to increase in demand for Pepsidemand for Pepsi
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.
D2
$1
100
D1
75
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 An decrease in the price of one will price of one will increase demand increase demand for the otherfor the other
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.
D
$20
750 900
D2
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
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.
Changes in taste Consumers
prefer platform shoes.
At $50, demand increases from 100 to 200. D
$50
100
D2
200
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
Changes in Demand Decrease in demand
At each and every price LessLess of the good is demanded
Shifts to the Left
D2
$5
D1
A
B
Price
Quantity90 100
P Qd1 Qd2
$4 150 110
$5 100 90
$6 75 60
Causes of Decrease in Demand Decrease in consumer
income Causes consumers to
buy less of the product at each and every price.
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 Decrease in price of Coke leads to Decrease in leads to Decrease in demand for Pepsidemand for Pepsi
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.
D
$1
100
D2
75
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 An increase in the price of one will price of one will decrease demand decrease demand for the otherfor the other
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.
D2
$20
750 900
D1
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
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.
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
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
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.
Law of Supply The quantity of a good supplied during a
given period is usually directlydirectly related 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
Supply CurvePrice of Good
Quantity Demanded
$3 50
$4 75
$5 100
$6 150
$7 200
Supply
Quantity
Price
6
5
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
A$4
100
$6
150
Supply
B
Supply Individual supply
The supply of an individual producer Market supply
The sum of individual supplies of all producers in the market
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
Changes in Supply Caused by changes in the determinants to
the supply curve Results in changes to the relationship Results in changes to the relationship
between the price and quantity suppliedbetween the price and quantity supplied At each and every price a different
quantity is supplied New supply curve - shift in supply
Increase in Supply At each and every price moremore of the good
is supplied
400300
$6
S1S2
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
Changes in technology Technology is the economy’s stock of
knowledge about how to combine resources efficiently
Changes in Technology Improvements in technology
Causes an increase in supply More of the product is available at all prices
300
$6
S1S2
400
Changes in Relevant Resources Decrease in
resource prices Increases the
supply of the good at each and every price.
400300
$6
S1S2
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.
400300
$6
S1S2
Above is the market for the supply of leather
Q Leather
Price
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
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
Decrease in Supply At each and every price LESS LESS of the good is
supplied
5
600400
S1S2
Causes of Decrease in Supply Backward movement in Technology Changes in relevant resources
Increase in the price of resources Raises costs
Changes in price of alternative goods If price of alternative good decreases, supply of
the good decreases Changes in producers expectations
Changes in Relevant Resources Are those employed in
the production of the good in question
Increase in price of resources Results in decrease in
supply Less of the good is
available at all prices
$9
500 600
S1S2
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
decreases, producers will supply less beef thus decreasing the supply of leather.
400300
$6
S1
Above is the market for the supply of leather
Q Leather
Price
Producer’s Expectation Nationalization
Expropriation
Supply Review Change in Quantity Supplied
Caused by a change in the price of the product Movement along the supply curve
Change in Supply Caused by change in the determinants Results in a shift in the supply curve
Market Equilibrium Market
Includes all the arrangements used to buy and sell
Reduce transaction costs
The place where buyers and sellers meet to determine price and quantity
Equilibrium At specific price where:
Quantity demanded = Quantity suppliedQuantity demanded = Quantity supplied Equilibrium price –
market clearing price Equilibrium quantity –
D = S
Equilibrium At specific
price where:
Quantity Quantity demandeddemanded
EqualsEquals
Quantity Quantity SuppliedSupplied
S
D
Q
P
$5
150
Equilibrium
Reaching Equilibrium
If market price is ABOVE equilibrium
Qs > QD
Economy is at a SURPLUS
Market price will fall
S
D
Q
P
150
$5
$6
100 200
Surplus
Reaching Equilibrium If the market
price is BELOW the equilibrium price
QD > Qs
Shortage exists Market price rises
to equilibrium
S
D
Q
P
150 100 200
$4
$5
Shortage
Shifts in Demand Demand increases
Equilibrium price increases
Equilibrium quantity increases
S
D
Q
P
150 100 200
D1
$4 A
B$6
Shifts in Demand
Decrease in demand decrease in price decrease in equilibrium
S
D
Q
P
100 200
D1
A
B$6
$5
Shifts in Supply Increase in supply
Decrease in equilibrium price
Increase in quantity
400300
$6
S1S2
Q Leather
Price
$5
Shifts in Supply Decrease in supply
Price increases Quantity decreases
Simultaneous Shifts in Supply and Demand The change in equilibrium price and quantity
depends on which curve shifts the most.
S
D
S1
D1
AB
200 300
4
5
Simultaneous Changes
Change in Supply
Change in Demand
Effect on Equilibrium
Price
Effect on Equilibrium
Quantity
Increase Decrease Decrease Indeterminate
Decrease Increase Increase Indeterminate
Increase Increase Indeterminate Increase
Decrease Decrease Indeterminate Decrease
Government Intervention Government enters
the economy Price Setting Subsidies
Government payments to reduce the cost of product or to limit production.
Price Floors A minimum
legal price below which a good or service cannot be sold
If above equilibrium causes surplus
S
D
Q150 100 200
Surplus
$7
$6
Price Ceilings A maximum legal
price above which a good or service cannot be sold
Below equilibrium price
Shortage occurs
S
D
Q
P
150 100 200
$5
Shortage