DS
P
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Supply and Demand:An Introduction
Supply and Demand:An Introduction
Supply and Demand 2
Supply and Demand:
How do consumers get the goods and services they want in the right quantities and qualities?Some goods and services are allocated by
the market forces of supply and demand
Supply and Demand 3
Supply and Demand:
Why do some goods and services have shortages or surpluses and others do not?Some good and supplies services are
regulated by government
Supply and Demand 4
What, How, and for Whom? Central Planning Versus the Market
Three Problems All Economic Systems Must AddressWhat should be produced?How should it be produced?For whom will it be produced?
Supply and Demand 5
Centralized Economic Organizations
Agrarian societyFormer Soviet UnionCuba, North KoreaChina?Bureaucracy
Havana
Supply and Demand 6
What, How, and for Whom? Central Planning Versus the Market
Free-Market or Capitalist Economic SystemsIndividual choices determine
Which careers to pursueWhich products to produce or buyWhen to start and shut-down a businessWho gets what, which is decided by individual
preferences and purchasing power
Supply and Demand 7
Buyers and Sellers in Markets
A MarketConsists of all buyers and sellers of a good
or service What do you think?
What determines the price of pizza, gasoline, a car wash, or other goods and services?
Supply and Demand 8
The Demand Curve
A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price
Supply and Demand 9
A Property of Demand
As price of a good or service goes down the quantity consumers wish to buy will increase
Therefore, the demand curve is downward-sloping
Supply and Demand 10
The Daily DemandCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Demand
Supply and Demand 11
The Demand Curve—Taiwan Beer
Number of Bottles per Month
Price per Bottle
A
B
$40
30
D
40,000 60,000
At $30 per bottle, 60,000 bottles are demanded (point B).
When the price is $40 per bottle, 40,000 bottles are demanded (point A).
Supply and Demand 12
薄利多銷 ?
Supply and Demand 13
Using Price Elasticity of Demand: Mass Transit
Elasticity studies show that long-run demand for mass transit is inelastic Therefore, a rise in fare
would increase revenues
Supply and Demand 14
However, most cities do not raise transit fares due toDesire to provide low-income households with
affordable transportationDesire to manage traffic congestionDesire to limit air pollution in the city
An increase in fares would increase revenueWould also decrease ridership and require the
city to sacrifice these other goals
Supply and Demand 15
Buyers and Markets
The Demand CurveWhy do buyers purchase a greater quantity
at lower prices and vice-versa?The substitution effectThe income effect
Supply and Demand 16
Substitution Effect
The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes
Supply and Demand 17
Income Effect
The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer’s purchasing power
Supply and Demand 18
The Cost-Benefit Principle
The reservation price is the benefit the buyer receives from the good
The cost of the good is its market priceIf the reservation price (benefit) exceeds
the market price (cost) the consumer will purchase the good
At higher prices, benefit will exceed cost for a smaller quantity than at lower prices
Supply and Demand 19
WTP
Price($ per slice)
Quantity(1000s of slices per day)
Demand
8 12 16
The buyers reservation price: The largest dollar amount the buyer would be willing to pay for a good
4
2
3
Supply and Demand 20
Horizontal Interpretation
Price determines quantity demanded
Price($ per slice)
4
2
3
8 12 16
Demand
Supply and Demand 21
Vertical Interpretation
Quantity measures the marginal buyer’s reservation price
Price($ per slice)
4
2
3
8 12 16
Demand
Supply and Demand 22
The Supply Curve
A curve or schedule showing the quantity of a good that sellers wish to sell at each price
Supply and Demand 23
Question
Will the opportunity cost of producing additional units of pizza increase or decrease?
Hint: Low-hanging-fruit principle
Supply and Demand 24
The Supply Curve
Sellers must receive a higher price to produce additional units of a product to cover the higher opportunity costs of each additional unit
Supply and Demand 25
The Daily SupplyCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Supply and Demand 26
The Daily SupplyCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Horizontal Interpretation
Shows the quantity produced
for each price
Supply and Demand 27
The Daily SupplyCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Vertical Interpretation
Shows the marginal cost (reservation
price) for producing each additional unit
Supply and Demand 28
Market Equilibrium
Seller’s Reservation PriceThe smallest dollar amount for which a
seller would be willing to sell an additional unit, generally equal to marginal cost
Supply and Demand 29
Market Equilibrium
EquilibriumA system is in equilibrium when there is no
tendency for it to change Market Equilibrium
Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price
Supply and Demand 30
The Equilibrium Price and Quantity of Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
Supply and Demand 31
Equilibrium Price and Equilibrium Quantity
The values of price and quantity for which quantity supplied and quantity demanded are equal
Supply and Demand 32
Would buyers prefer a lower price than the equilibrium price?
Would sellers prefer a higher price than the equilibrium price?
What Do You Think?
Supply and Demand 33
Excess Supply
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Excess supply = 8,000 slices per day
Supply and Demand 34
Excess Demand
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 16
Excess demand = 8,000slices per day
Supply
Demand
Supply and Demand 35
Points Along the Demand and Supply Curves of a Pizza Market
Demand for pizza Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1 8 1 2
2 6 2 4
3 4 3 6
4 2 4 8
Supply and Demand 36
Graphing Supply and Demand and Finding the Equilibrium Price and Quantity
Price($per slice)
Quantity(1000s of slices per day)
5
2
3
4
1
4
102
Demand
0 6 8
Supply
2.50
5
The Equilibrium Price = $2.50The Equilibrium Quantity = 5
Supply and Demand 37
What Do You Think?
Is the market equilibrium always an ideal outcome for all market participants?
Supply and Demand 38
An Unregulated Housing Market
Monthly Rent($/apartment)
Quantity(Millions of apartments/day)
1600
2
Supply
Demand
What Do You Think?Is $1600 more than some people can afford?
Supply and Demand 39
Rent Controls
Monthly Rent($/apartment)
Quantity(Millions of apartments/day)
1600
2
Supply
Demand
2400
Controlled = 800
1 30
Excess demand = 2 million apartments per month
Supply and Demand 40
Market Equilibrium
Rent Controls ReconsideredOther consequences of rent controls
Maintenance will decline and housing quality will fall
Illegal paymentsCreation of co-ops and conversion to
condominiumsReduction in household mobilityDiscrimination
Supply and Demand 41
Case study:
What do you think?How can we make housing affordable for
poor people without using rent ceilings?Health insuranceTuition feeFruit/Rice exportHigh-speed railway
KTR
THR
Supply and Demand 42
Rent Controls
Monthly Rent($/apartment)
Quantity(Millions of apartments/day)
800
2
Supply
Demand
1200
1 30
What is the impact of a rent control set at $1,200/month?
600
What is the impact of a rent control set at $600/month?
Supply and Demand 43
Price Controls in the Pizza Market
Price($ per slice)
Quantity(1000s of slices per day)
Supply
Demand
Excess demand = 8,000 slices per day
4
Price ceiling = 2
3
8 12 16
Supply and Demand 44
Rental control in Paris or NCCU
Supply and Demand 45
Market Equilibrium
Pizza Price Controls?Market responses to a pizza price ceiling
Long linesPreferential treatment to selected customersAlternative pricing strategiesPoorer quality ingredientsBlack-market pizzas
Supply and Demand 46
Predicting and Explaining Changes in Prices and Quantities
Distinguishing BetweenA change in the quantity demanded
A movement along the demand curve that occurs in response to a change in price
A change in demandA shift of the entire demand curve
Supply and Demand 47
An Increase in Quantity Demanded
Price($/can)
Quantity(1000s of cans/day)
5
2
3
4
1
4
122
6
0
D
D Increase in quantity
demanded
Supply and Demand 48
an Increase in Demand
Price($/can)
Quantity(1000s of cans/day)
5
2
3
1
4
12
6
0
Increase in demand
D
D
D’
D’
Supply and Demand 49
A Shift of The Demand Curve
B C$2.00
60,000 80,000
D1D2
An increase in income shifts the demand curve for beers from D1 to D2.
Number of Bottles per Month
Price per Bottle
At each price, more bottles are demanded after the shift
Supply and Demand 50
Predicting and Explaining Changes in Prices and Quantities
Change in the quantity suppliedA movement along the supply curve that
occurs in response to a change in price Change in supply
A shift of the entire supply curve
Supply and Demand 51
An Increase in Quantity Supplied vs. an Increase in Supply
Price($/can)
Quantity(1000s of cans/day)
5
2
3
4
1
4
102
6
0 6 8
S
S
Increase in quantity supplied
Supply and Demand 52
An Increase in Quantity Supplied vs. an Increase in Supply
Price($/can)
Quantity(1000s of cans/day)
5
2
3
4
1
4
102
6 S
0 6 8
S
S’
S’
Increase in supply
Supply and Demand 53
The Effect on the Market for TennisBalls of a Decline in Court Rental Fees
Price($/ball)
Quantity(letters/month)
1.00
S
D
40
D’
1.40
58
Supply and Demand 54
Effect on the Market for Overnight Letter Deliv- ery of a Decline in the Price of Internet Access
Price($/letter)
Quantity(letters/month)
P’
P
Q’ Q
S
D
D’
Supply and Demand 55
Predicting and Explaining Changes in Prices and Quantities
Economic NaturalistWhen the Federal Government implements
a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?
Supply and Demand 56
Predicting and Explaining Changes in Prices and Quantities
Shifts in DemandComplements
Two goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other
Supply and Demand 57
Predicting and Explaining Changes in Prices and Quantities
Shifts in DemandSubstitutes
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
Supply and Demand 58
Predicting and Explaining Changes in Prices and Quantities
Shifts in DemandChanges In Demand
An increase (decrease) in the demand for a good will shift the demand curve to the right (left)
Supply and Demand 59
Predicting and Explaining Changes in Prices and Quantities
What do you think?How will a decline in airfares affect inter-
city bus fares and the price of hotel rooms in resort communities?
Supply and Demand 60
The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C.
Rent(dollars per
month)
Conveniently located apartments(units per month)
D
P
Q
S
P’
Q’
D’
Supply and Demand 61
Predicting and Explaining Changes in Prices and Quantities
A Change In IncomeNormal Good
One whose demand increases (decreases) when the incomes of buyers increase (decrease)
Supply and Demand 62
Predicting and Explaining Changes in Prices and Quantities
A Change In IncomeInferior Goods (Giffen Goods)
One whose demand decreases (increases) when the incomes of buyers increase (decrease)
Supply and Demand 63
Giffen Goods
Supply and Demand 64
The Effect of the Release of JurassicPark on the Market for Toy Dinosaurs
Price
Toy Dinosaurs(units per month)
P
Q
D
S
D’
P’
Q’
D’ = demand after release of movie
Supply and Demand 65
The Effect of a Credible Rumor onthe Market for Apple Macintosh Computers
Price
Apple Computers(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after rumor of cheaper model soon to be released
Supply and Demand 66
The Effect of the Increase inthe Population of Potential Buyers
Price
Housing NY City(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after increase in population
Supply and Demand 67
The Effect on the Skateboard Market of an Increase in the Price of Fiberglass
Price($/skateboard)
Quantity(skateboards/month)
60
1000
S
D
80
800
S’
Supply and Demand 68
Predicting and Explaining Changes in Prices and Quantities
What Do You Think?Does the increase in the cost of fiberglass
have any effect on the demand curve for skateboards?
Supply and Demand 69
The Effect on the Market for New Houses of a Decline in Carpenters’ Wage Rates
Price($1000/house)
Quantity(houses/month)
120
40
D
S
90
50
S’
Supply and Demand 70
The Effect of Technical Change on the Market for the Term Paper Revisions
Price($/revision)
Quantity(millions of revisions per year)
55
12
D
S
7.50
36
S’
Supply and Demand 71
Predicting and Explaining Changes in Prices and Quantities
Other determinants of supplyWeatherExpectationsNumber of sellers
Supply and Demand 72
Price
Quantity
P
P’
Q Q’
S
D’D
An increase in demand will lead to an increasein both the equilibrium price and quantity
Four Rules Governing the Effects of Supply and Demand Shifts: I
Supply and Demand 73
Price
Quantity
P’
P
Q’ Q
S
DD’
A decrease in demand will lead to a decreasein both the equilibrium price and quantity
Four Rules Governing the Effects of Supply and Demand Shifts: II
Supply and Demand 74
P’
P
Q Q’
S’
D
SPrice
Quantity
An increase in supply will lead to adecrease in the equilibrium priceand an increase in the equilibrium quantity
Four Rules Governing the Effects of Supply and Demand Shifts: III
Supply and Demand 75
P
P’
Q’ Q
S
D
S’Price
Quantity
An decrease in supply will lead toan increase in the equilibrium priceand a decrease in the equilibrium quantity
Four Rules Governing the Effects of Supply and Demand Shifts: IV
Supply and Demand 76
Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Demand
1. A decrease in the price of complements to the good or service
2. An increase in the price of substitutes for the good or service
3. An increase in income (for a normal good)
Supply and Demand 77
Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Demand
4. An increased preference by demanders for the good or service
5. An increase in the population of potential buyers
6. An expectation of higher prices in the future
Supply and Demand 78
Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Supply
1. A decrease in the cost of materials, labor, or other inputs used in the production of the good or service
2. An improvement in technology that reduces the cost of producing the good or service
Supply and Demand 79
Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Supply
3. An improvement in the weather, especially for agricultural products
4. An increase in the number of suppliers
5. An expectation of lower prices in the future
Supply and Demand 80
The Effects of Simultaneous Shifts in Supply and Demand
Price($/bag)
Millions of bags per month
P
Q
S
D
P’
Q’
D’
S’S’ after reduction in price of corn harvesting equipment
D’ after discovery that oils are harmful to people’s health
The Market for Corn Tortilla Chips
Supply and Demand 81
The Effects of Simultaneous Shifts in Supply and Demand
Price($/bag)
Millions of bags per month
P
Q
S
D
P’
Q’
D’
S’
D’ after discovery that oils are harmful to people’s health
S’ after reduction in price of corn harvesting equipment
The Market for Corn Tortilla Chips
Supply and Demand 82
Predicting and Explaining Changes in Prices and Demand
AssumeA vitamin found in corn chips helps protect
against cancer and heart disease A swarm of locusts destroys part of the
corn crop What Do You Think?
What will happen to the equilibrium price and quantity of corn chips?
Supply and Demand 83
Predicting and Explaining Changes in Prices and Demand
Economic NaturalistWhy do the prices of some goods, like
airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down?
Supply and Demand 84
Seasonal Variation inAir Travel and Corn Markets
Price($/ticket)
1000s of tickets
S
DS
DW
QW QS
PW
PS
High Consumption due to High Demand
Supply and Demand 85
Seasonal Variation inAir Travel and Corn Markets
Price($/bushel)
Millions of bushels
SW
D
QW QS
PW
PS
SS
High Consumption due to High Supply
Supply and Demand 86
Markets and Social Welfare
What Do You Think?When are the prices and quantities
determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?
Supply and Demand 87
Markets and Social Welfare
Cash On The TableAssume
All exchange is purely voluntary
If so The buyer’s reservation price exceeds the
seller’s reservation price and both the buyer and seller receive an economic surplus
Supply and Demand 88
Cash On The Table
Economic metaphor for unexploited gains from exchange
Buyer’s surplus The difference between the buyer’s reservation price and the
price he or she actually pays Seller’s surplus
The difference between the price received by the seller and his or her reservation price
Total surplus The difference between the buyer’s reservation price and the
seller’s reservation price
Supply and Demand 89
Price Controls in the Pizza Market
Price($ per slice)
Quantity(1000s of slices per day)
S
D
3
12
4
2
8 16
Assume •Buyer’s reservation P = $4•Sellers reservation P = $2•Pizza sells for $3
•Buyer’s surplus: $4 - $3 = $1•Seller’s surplus: $3 - $2 = $1•Total surplus: $4 - $2 = $2
Supply and Demand 90
Price Controls in the Pizza Market
Price($ per slice)
Quantity(1000s of slices per day)
Excess demand = $8,000 slices/day
D
4
2
3
8 12 16
Assume price controls = $2•Quantity supplied falls to 8,000•Buyer’s reservation price ($4) is greater than seller’s ($2)
• Both would benefit from additional production
•There is CASH ON THE TABLE
S
Supply and Demand 91
Markets and Social Welfare
Smart For One, Dumb For AllSocially optimal quantity
The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good
The socially optimal quantity occurs when MC = MB
Supply and Demand 92
Markets and Social Welfare
Smart For One, Dumb For AllEconomic efficiency occurs when all goods
and services are produced and consumed at their respective socially optimal levels
Supply and Demand 93
Markets and Social Welfare
Smart For One, Dumb For AllAchieving economic efficiency
Maximizes the economic surplusIncreases the economic pie
Supply and Demand 94
Markets and Social Welfare
Smart For One, Dumb For AllWhen is the market equilibrium efficient?
When all costs of producing the good or service are borne directly by the seller
When all benefits from the good or service accrue directly to buyers
Supply and Demand 95
Markets and Social Welfare
Smart For One, Dumb For AllInefficient market equilibrium
When some costs of production fall on people other than those who sell the good or service
Supply and Demand 96
Markets and Social Welfare
Example: PollutionThe market is in equilibrium: MC = MBMC however underestimates the cost to
society of producing the goodTherefore, the market produces more than
the efficient amount and there is no incentive for producers and consumers to alter their behavior
Supply and Demand 97
Markets and Social Welfare
Smart For One, Dumb For AllInefficient market equilibrium
When some benefits from the good or service accrue to people who did not buy the good or service
Supply and Demand 98
Markets and Social Welfare
Example: VaccinationsThe market is in equilibrium: MC = MBMB underestimates the benefits to society of
consuming the vaccinationsThe market produces less than the efficient
amount of vaccinations and there is no incentive for producers and consumers to alter their behavior
Supply and Demand 99
Markets and Social Welfare
Smart For One, Dumb For AllIn these markets
Buyers and sellers are behaving rationally Market equilibrium existsThere are no unexploited opportunities for
individualsEconomic surplus is not maximized