Demand Supply Professor Heather Grob ECN 101 www. stmartin. edu
Two branches of economics: micro/macro • Microeconomics – how individuals make economic decisions » How individuals react to prices and quantities » Effects of taxes or incentives on behavior • Macroeconomics – how economies behave and perform » » www. stmartin. edu Total output Conditions of trade Supply and demand for money Fiscal and monetary policy
Plotting a line GPA Slope= rise/ run = ½ =. 5 Rise=1 Run=2 Hours of study
DEMAND for a normal good • Usually people buy less of a good when the price goes up (law of demand) • Price (p) and quantity demanded (QD) are inversely related p D Q
What explains the law of demand? • Substitution effect: people substitute the cheaper good • Income effect: purchasing power • Diminishing marginal utility: additional amount purchased is less worthy. • Exceptions to the law of demand: what do people buy more of when the price is high?
SUPPLY of a normal good • Amount of good or service a firm or household is willing to sell at each possible price • Price is directly related to quantity supplied p S Q
What explains the law of supply? • As price increases, the quantity supplied increases (law of supply) • Law of diminishing marginal physical product: output decreases with each additional input • It costs more to produce more, so employers can be induced to produce more if the price rises
Equilibrium • Supply and demand intersect: the market clears at the equilibrium price and the equilibrium quantity p S P* D Q* Q
Assumptions of equilibrium • • • Perfect competition Full employment of resources Perfect information Marginal utility falls Everyone faces the same prices Preferences cannot be imposed and can be revealed • Normal profit
Shortage vs. Surplus • When prices are too low, there will be a shortage of the good or service. • When prices are too high, there will be a surplus of the good or service.
How economists explain change: Mechanistic vs. organic www. stmartin. edu
Things that shift the DEMAND curve • • • Taste, preference, quality Number of buyers Consumer income Prices of related goods Expected future prices
Things that shift the SUPPLY curve • • • Resource prices Technology Prices of other goods Expected future prices Taxes and subsidies Number of suppliers
Shifts in demand in perfect competition • When demand increases, equilibrium price and quantity increase • When demand decreases, price and quantity decrease p S D 1 D 2 Q
Shifts in supply in perfect competition • Test yourself: An increase in supply causes… a) fall in equilibrium price and quantity b) rise in equilibrium price and quantity c) price will rise and quantity will fall d) price will fall and quantity will rise **The answer is d! • A decrease in supply causes price to rise and quantity to fall www. stmartin. edu
Quiz yourself • When will supply of gasoline shift leftward? A) increase availability of crude oil B) expect greater auto efficiency C) technological improvements in production D) lower prices of labor and capital The answer is B! The producers pull back when they expect less demand. www. stmartin. edu
Your turn! • In-class exercise • Apply shifts of supply and demand to gasoline prices and nursing shortage • As you read the economic news, try to graph what you are reading in terms of supply and demand www. stmartin. edu
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