Chapter 3 Demand Supply and Market Equilibrium Images

Chapter 3 Demand, Supply and Market Equilibrium Images and graphs from Mc. Connell and Brue

Learning Objectives: Students will be able to explain and graph: l l l What demand is and what it affects. What supply is and what it affects. How supply and demand together determine market equilibrium. How changes in supply and demand affect equilibrium prices and quantities. What government-set prices are and how they can cause product surpluses and shortages.

Markets l Bring together buyers “DEMANDERS” and sellers “SUPPLIERS”, and they exist in many forms l We will focus on markets consisting of large numbers of independently acting buyers and sellers of standardized products: central grain exchange, stock market, or a market foreign currencies.

Demand l By definition: a schedule or curve that shows various amounts of a products that consumers are willing and able to purchase at each of a series of possible prices during a specific period in time. l “other things equal”

Demand: l A simple statement of a buyer’s plans, or intentions, with respect to the purchase of a product. l Qunatities at each price point must relate to a specific period

Shift a Change in Demand

Demand Curve:

Law of Demand l “All else equal”, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. l Negative or inverse relationship between price and quantity demanded. l This inverse relationship is know as “the law of demand”

Law of Demand l Why an inverse relationship? 1) People ordinarily do buy more of a product at a low price than at a high price. Price is an obstacle that deters consumers from buying. 2) Consumption is subject to diminishing marginal utility because successive units of a particular products yield less and less marginal utility, consumers will by additional units only if the price of those units is progressively reduced.

Explanations continued: Income and substitution effects: Income effect: a lower price increases the purchasing power of a buyer’s income, therefore enabling a buyer to purchase more. 3) Substitution effect: a higher price has the opposite effect. At a lower price buyers have incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive. *Income and substitution effects combine to make consumers able and willing to buy more of a product at a lower price than at a high price*

The Demand Curve l Inverse relationship l Measured quantity (Q) demanded on the horizontal axis and price (P) on the vertical axis l People by more of a product/service or resource as its price falls

Market Demand l Add the quantities demanded by all consumers at each of the various possible prices, move from individual demand to market demand l In constructing a demand curve economist assume that price is the most important influence on the amount of any product purchases

Market Demand continued…. . l Economists know that other factors affect purchases – determinants of demand are demand shifters are considered to be constant when the curve is drawn 1) 2) 3) 4) 5) Consumers’ taste preferences Number of buyers Consumers’ income Price of related goods Consumer expectations

Change in Demand l l l Is a shift in the demand curve An increase shifts to the right we say is an “increase in demand” A decrease shifts to the left we say is a “decrease in demand”

Basic Determinants 1. Tastes – a favorable change means more will be demanded – more desirable – demand will increase unfavorable-decrease in demand l News products, health concerns, technology

Basic Determinants 2. Number of Buyers increase in number of buyers likely increase demand (Shift to the right) decrease in number of buyers likely to decrease demand (shift to the left)

Basic Determinants Change in Income – consumers typically buy more consumer products as their income increase and less as it decreases Normal goods – products whose demand varies directly with income (most goods) (restaurant meals, necklaces) 3. Inferior goods – products whose demand varies inversely with income (cabbage, turnips, inexpensive wine)

Basic Determinants 4. Prices of Related Goods – change in price of a related good may increase or decrease demand Substitute Good – is one that can be used in the place of another (leather jackets for fleece; Nike for Reeboks, Crest for Colgate) when the price for one increased the demand for another will decrease Complement Goods – goods are used together (computers and computer printers, hot dogs and hot dog buns) the price of a complement goes up, the demand for a related good will decline Unrelated Goods - majority

Basic Determinants 5. Consumer Expectations – a newly formed expectation of higher future prices may cause consumers to buy now in order to beat the anticipated price rises Real estate market – being priced out of the market

Changes in Quantity Demanded l Change in Demand = shift l Change in Quantity Demanded is movement from one point to another – from one P-Q combination to another

Supply l A schedule or curve showing various amounts of a product that producers are willing and able to make available for sale at each of a series during a specific period

Law of Supply l Positive or direct relationship that prevails between price and quantity l As private rises, the quantity supplied rises; as price falls, the quantity supplied falls l Price is an obstacle from the standpoint of the consumer, and they are on the paying end

Law of Supply Continued………. l To the supplier, represents revenue – an incentive to produce and sell l The higher the price the greater the incentive and greater the quantity l Beyond some quantity of production, manufacturers usually encounter increasing marginal cost – the added cost of producing one more unit of the firm’s plant and machinery but – cannot be expanded that quickly so the firm uses more of other resources like labor, to produce more output – as more labor relative to fixed plant and equipment-workers have less space and access to machinery…. .

The Supply Curve

Determinants of Supply

Changes in Supply

Market Equilibrium l l How buyers and sellers determine price and quantity Equilibrium price: the price where the intensions buyers and sellers match Equilibrium quantity: neither a shortage or surplus Graphically, EP is indicated by the intersection of SC and DC

Equilibrium price and quantity Do questions page 54….

l Surplus = excess supply l Shortage = excess demand

Rationing Function of Prices l Ability of the competitive forces of S and D to establish a price at which selling and buying decisions are consistent l Equilibrium clears the market l All producers who do not sell at clearing price will not sell their product

Efficient Allocation

Changes in Supply, Demand Equilibrium

Application: Government Set Prices l Price Ceilingmaximum legal price for a seller - @ or below legal – above not

Problems: l Rationing – how will the available supply be apportioned among buyers (making a line, coupons) l Black Markets – illegally bought and sold – counterfeiting ration coupons l Example - Rent Control

Price Floors l Price floor – minimum price fixed by government- price at or above is legal; below is not

Price Floor Graphically