Supply and Demand

Supply and Demand is the essential issue of economics.

Economic agents: Households Economic agents: Business firms Markets for Outputs (products) Markets for Inputs (factors)

The framework of an economy

Households

Business Firms

Markets for Outputs(products)

Markets for Inputs(factors)

Supply

Demand

Demand

Supply

Price and QuantityPrice and Quantity

Quantity and PriceQuantity and Price

The most important information The most important information of our interest in the marketof our interest in the market

Price and quantity demandedPrice and quantity demanded

Quantity demandedQuantity demanded

is the number of units is the number of units households are willing to buy.households are willing to buy.

Price and Quantity DemandedPrice and Quantity Demanded

““Law of demand”Law of demand” We generally believe that there is an We generally believe that there is an

inverse relationship between price inverse relationship between price and quantity demanded. If price and quantity demanded. If price goes up, then quantity demanded goes up, then quantity demanded goes down, and vice versagoes down, and vice versa

P P ----→ Qd ----→ Qd P P ----→ Qd ----→ Qd

Demand schedule and Demand schedule and demand curvedemand curve

Demand schedule and demand curve Demand schedule and demand curve shows the relationship between shows the relationship between quantities demanded and prices of a quantities demanded and prices of a good.good.

It is in general downward sloping. (Its It is in general downward sloping. (Its slope is negative)slope is negative)

Demand curveDemand curve

Find quantity demanded at each price Find quantity demanded at each price from the demand curvefrom the demand curve

2000

P ($)

1.50

0

Demand for milk

1.00

3000

Movement versus Shift in DemandMovement versus Shift in Demand

Movement along the demand curveMovement along the demand curveIf there is a change in the If there is a change in the own price, own price,

whereas other determinants (shifters) of demand whereas other determinants (shifters) of demand remain unchanged, it just produces a movement remain unchanged, it just produces a movement along the demand curve.along the demand curve.

Shift in the demand curveShift in the demand curveIf instead there is a change in the If instead there is a change in the

determinants (shifters) other than the price, then determinants (shifters) other than the price, then at each price we observe that the quantity at each price we observe that the quantity demanded increases or decreases, which is a shift demanded increases or decreases, which is a shift in the demand curve.in the demand curve.

Shifters of demandShifters of demand

IncomeIncome Consumer preferences (taste)Consumer preferences (taste) Prices of related goods (substitutes Prices of related goods (substitutes

and complements)and complements) Population sizePopulation size ExpectationsExpectations

Difference between Difference between DemandDemand and and Quantity DemandedQuantity Demanded

Demand Demand

refers to the entire demand curverefers to the entire demand curve Quantity demandedQuantity demanded

refers to a point on the demand refers to a point on the demand curvecurve

Change in Demand: ShiftChange in Demand: Shift Change in Quantity demanded: likely Change in Quantity demanded: likely

to be a movementto be a movement

Supply Supply

Quantity suppliedQuantity supplied

is the number of units firms are is the number of units firms are willing to supply (sell). willing to supply (sell).

““Law of Supply”Law of Supply” There is a direct relationship between There is a direct relationship between

price and quantity supplied. price and quantity supplied.

P P ----→ Qs ----→ Qs P P ----→ Qs ----→ Qs

Supply curveSupply curve

The supply curve shows the The supply curve shows the relationship between quantities relationship between quantities supplied and prices of a good.supplied and prices of a good.

It is upward sloping (its slope is It is upward sloping (its slope is positive)positive)

Supply of milk

3000

P ($)

1.50

0

S

Supply of Milk

1.00

4500

Movement and Shift in SupplyMovement and Shift in Supply Movement along the supply curveMovement along the supply curve

If there is a change in theIf there is a change in the own price, own price, whereas other determinants (shifters) of quantity whereas other determinants (shifters) of quantity supplied remain unchanged, it just produces a supplied remain unchanged, it just produces a movement along the supply curve.movement along the supply curve.

Shifts of the supply curveShifts of the supply curveIf instead there is a change in the If instead there is a change in the

determinants (shifters) other than the price, then determinants (shifters) other than the price, then at each price we observe that the quantity at each price we observe that the quantity supplied increases or decreases, which is a shift supplied increases or decreases, which is a shift in the supply curve.in the supply curve.

Shifters of SupplyShifters of Supply

Prices of inputsPrices of inputs Technological progressTechnological progress Changes in natural resource Changes in natural resource

endowment and production capacity endowment and production capacity Size of the industrySize of the industry Price of related outputsPrice of related outputs

Difference between Difference between SupplySupply and and Quantity SuppliedQuantity Supplied

SupplySupply

refers to the entire supply curverefers to the entire supply curve Quantity suppliedQuantity supplied

refers to a point on the supply refers to a point on the supply curvecurve

Change in Supply: ShiftChange in Supply: Shift Change in Quantity supplied: likely to Change in Quantity supplied: likely to

be a movementbe a movement

Place Supply and Demand together Place Supply and Demand together

Analyze how the supply and demand Analyze how the supply and demand together determines the market price together determines the market price and quantity transacted.and quantity transacted.

The Supply and Demand Diagram

Q*

S

Q

P

0

D

P*

EquilibriumEquilibrium

The point where the supply and The point where the supply and demand curves intersect is called demand curves intersect is called equilibrium. At the point quantity equilibrium. At the point quantity demanded equals quantity supplied. demanded equals quantity supplied.

Equilibrium Equilibrium

is the state where quantity is the state where quantity demanded equals quantity supplied.demanded equals quantity supplied.

Equilibrium price and equilibrium Equilibrium price and equilibrium quantityquantity

Equilibrium price and equilibrium Equilibrium price and equilibrium quantityquantity

The price at the equilibrium is The price at the equilibrium is called equilibrium price and the called equilibrium price and the quantity in the equilibrium is called quantity in the equilibrium is called equilibrium quantity. equilibrium quantity.

Equilibrium price and quantity are Equilibrium price and quantity are the prevailing price and quantity the prevailing price and quantity transacted in the market. transacted in the market.

Market forces push or pull the price to the equilibrium level.

S

Q

P

0

D

P*=1.00

3000

P=1.60 high

surplus

2000 4500

Market forces push or pull the price to the equilibrium level.

S

Q

P

0

D

P*

Q*

P=0.70 low

shortage

1800 4000

Market forces push or pull the price to the equilibrium level.

S

Q

P

0

D

P*

Q*

P low

P high

An equilibrium state An equilibrium state

is a situation in which there are no is a situation in which there are no inherent forces that produce change.inherent forces that produce change.

Changes away from the equilibrium Changes away from the equilibrium position will occur only as a result of position will occur only as a result of "outside events" which disturb the "outside events" which disturb the status quo.status quo.

Equilibrium State and ChangesEquilibrium State and Changes

"Outside events" and changes in "Outside events" and changes in equilibrium price and quantity equilibrium price and quantity

The supply and demand diagram. The supply and demand diagram.

is the most essential analytical is the most essential analytical tool in economics.tool in economics.

ExamplesExamples

Case 1: Suppose the weather suddenly turns to be very cold. What will happen to the equilibrium price and quantity

in the heating oil market?

S

Q

P

0

D

P*

Q*

Case 1: Suppose the weather suddenly turns to be very cold. What will happen to the equilibrium price and quantity

in the heating oil market?

S

Q

P

0

D

P*

Q*

P’

Q’

D’

Case 2: Again, suppose the same outside event---the weather suddenly turns to be very cold. What will happen to the equilibrium quantity and equilibrium price in the ice

cream market?

S

Q

P

0

D

P*

Q*

P’

Case 2: Again, suppose the same outside event---the weather suddenly turns to be very cold. What will happen to the equilibrium quantity and equilibrium price in the ice

cream market?

S

Q

P

0

D

P*

Q*

P’

Q’

D’

Case 3: Suppose the cold weather brought a frost in Florida, what happens to the equilibrium price and quantity

in the orange market?

S

Q

P

0

D

P*

Q*

Freeze Oranges in FloridaJan 2010

Case 3: Suppose the cold weather brought a frost in Florida, what happens to the equilibrium price and quantity

in the orange market?

S

Q

P

0

D

P*

Q*

P’

Q’

S’

Case 4: Suppose a technological innovation takes place in manufacturing LCD TV sets. What happens to the equilibrium price and quantity of the LCD TV sets?

S

Q

P

0

D

P*

Q*

Case 4: Suppose a technological innovation takes place in manufacturing fax machines. What happens to the equilibrium price and quantity of the fax machines?

S

Q

P

0

D

P*

Q*

P’

Q’

S’

Comparative Statics AnalysisComparative Statics Analysis

Comparative statics analysisComparative statics analysis

is an analysis about how the is an analysis about how the equilibrium price and quantity equilibrium price and quantity change in response to changes in the change in response to changes in the outside forces.outside forces.

Steps to do the comparative static Steps to do the comparative static analysisanalysis

1. Ask which curve shifts and to 1. Ask which curve shifts and to which direction?which direction?

2. Find the new equilibrium state and 2. Find the new equilibrium state and new equilibrium price and quantity.new equilibrium price and quantity.

3. Draw conclusions about changes 3. Draw conclusions about changes in equilibrium price and quantity.in equilibrium price and quantity.

ExerciseExercise

The drug BGH (bovine growth The drug BGH (bovine growth hormone) dramatically increases the hormone) dramatically increases the milk output of dairy cows. Farmers in milk output of dairy cows. Farmers in Wisconsin, a big dairy state, Wisconsin, a big dairy state, vigorously oppose licensing the drug, vigorously oppose licensing the drug, fearing that excess supply and a fearing that excess supply and a consumer reaction on the purity of consumer reaction on the purity of food issue will put many of them out food issue will put many of them out of business. of business.

ExerciseExercise

Which graph in Figure 5-13 best Which graph in Figure 5-13 best illustrates the farmers' fears?illustrates the farmers' fears?

a. 1a. 1 b. 2b. 2 c. 3c. 3 d. 4d. 4

Exercise

“A severe drought has reduced the supply of oranges and increased their price. But the higher price will reduce the demand for oranges and push their price back toward the original level.” True or false? Comment too.