Ch. 3: Demand Supply Objectives § Determinants of demand supply § Use demand supply to § understand how markets determine prices and quantities § make predictions about how various “shocks” affect prices and quantities
Markets and Prices • Market – any arrangement that enables buyers and sellers to get information and do business with each other. • Competitive market – a market that has many buyers and many sellers – no single buyer or seller can influence the price. • Money price of a good – the amount of money needed to buy it. • Relative price of a good – ratio of its money price to the money price of the next best alternative good – the opportunity cost of the good expressed in units of the other good.
Demand • Quantity demanded of a good or service – the amount that consumers plan to buy during a particular time period at a particular price. • The Law of Demand – Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. – The law of demand results from • a substitution effect • an income effect – Normal versus inferior good
Demand – the entire relationship between the price of the good and quantity demanded of the good. Demand curve – shows the relationship between the QD of a good and its price, ceteris parabus
Demand • This figure shows a demand curve for gasoline • A rise in the price, ceteris paribus, brings a decrease in the QD and a movement along the demand curve. Price D # gallons per week
Demand A D-curve is also – Willingness-to-pay curve. – Willingness to pay measures marginal benefit. Price D # gallons per week
Demand • A Change in Demand § Quantity of the good that people plan to buy changes at each and every price § Shift of demand curve. § When demand increases, – QD increases at each and every price – the demand curve shifts rightward. § When demand decreases, – QD decreases at each and every price – the demand curve shifts leftward.
Demand Change in Demand vs. Change in Quantity Demanded
Factors that change demand 1. Prices of related goods § substitute in consumption § complement in consumption 2. Income § Normal good § Inferior good § Luxury good 3. Expected future prices 4. Population 5. Taxes on buyers 6. Consumer preferences
Supply Quantity supplied (QS) of a good or service • the amount that producers plan to sell during a given time period at a particular price. The Law of Supply • Other things remaining the same, the higher the price of a good, the greater is the quantity supplied. § results from tendency for the marginal cost of producing a good or service to increase as the quantity produced increases (more later) § Producers are willing to supply only if they at least cover their marginal cost of production.
Supply – Supply • the entire relationship between the quantity supplied and the price of a good. – Supply curve • shows relationship between QS and price of a good, ceteris paribus.
Supply Curve • A supply curve for gasoline. • A rise in the price, ceteris paribus, brings an increase in QS and a movement along the supply curve. $ per gallon S Gallons per day
Supply –A supply curve is also a minimumsupply-price curve. –The greater the quantity produced, the higher is the price that producers must be offered to be willing to produce that quantity. S Gallons per day
Supply • A Change in Supply § occurs when the quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve. § When supply increases, • QS increases at each and every price • supply curve shifts rightward. § When supply decreases, • QS decreases at each and every price • supply curve shifts leftward.
Supply Change in supply vs. change in quantity supplied
Factors that change supply. 1. Prices of inputs 2. Prices of related goods produced § Substitutes in production § Complements in production 3. 4. 5. 6. Expected future prices Number of sellers Taxes on Sellers Technology
Market Equilibrium § situation in which opposing forces balance each other. § occurs when the price balances the plans of buyers and sellers. Equilibrium price § price at which the quantity demanded equals the quantity supplied. Equilibrium quantity § quantity bought and sold at the equilibrium price.
Market Equilibrium Price Adjustments If P>Pequil: – a surplus forces the price down. If P<Pequil: – a shortage forces the price up. At the equilibrium price, – QS=QD – and the price doesn’t change. S D
Predicting Changes in Price and Quantity Illustrate Effect on Equilibrium Price and Quantity if: a. Demand increases b. Supply increases c. Demand supply simultaneously increase. Practice with Supply/Demand to: a. Predict effect of “shock” to market. b. Understand the type of “shock” that might have caused an observed change in P & Q.
Price controls 1. A price ceiling is a maximum allowable price. • Results in a continuing shortage if ceiling is BELOW equilibrium price. 2. A price floor is a minimum allowable price. § Results in a continuing surplus if floor is ABOVE equilibrium price.
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