Markets Are a mechanism that brings buyers and sellers together to exchange goods, services, and resources…. …it is a device for allocating or rationing goods, services, and resources. • Product market: where consumer goods are bought and sold. Business firms are the seller, consumers are the buyers • Resource market: where the resource services are bought and sold. Resource owners(consumers) are the sellers and business firms are the buyers
Definition: relationship between the price and the quantity demanded of a good. • Quantity demanded: amount of an item that buyers are willing and able to purchase over a certain time period, at a specific price, ceteris paribus.
1. Price 2. Income Normal good: Buy more of a good when income increases Inferior good : Buy less of that good when income increases 3. Tastes and Preferences 4. Prices of related goods Substitutes: Two goods that perform the same function (interchangeable) Complements: Two goods that are used together to enhance one another 5. Expectations (of future price, expected income, etc. ) 6. Number of consumers
1. Price • By holding all other variables constant we get our first prediction (hypothesis). . . … Law of Demand: The price and quantity demanded of a good are inversely related, ceteris paribus. • Demand schedule: A list of possible prices with the corresponding quantity demanded at that price. It is a representation of the law of demand. • What if the price was. . then what would be quantity demanded at that price. • Think of it like answering a survey. … …no other variable changes except the one you ask about
Example: A demand schedule Price (per pound) $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 $3. 00 For Coffee Quantity Demanded (pounds per week) 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000
Demand curve - a curve representing the law of demand. Price $7. 00 Plot the demand schedule on the graph. . Connect the dots and we get. . . A Demand Curve! $6. 00 $5. 00 $4. 00 $3. 00 $2. 00 $1. 00 0 Price $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 $3. 00 Quantity Demanded 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 As the price of a good decreases, buyers are willing and able decreases to purchase more of this good, all other variables constant 1 2 3 4 5 6 7 8 9 10 Quantity Demanded (QD) (In thousands)
If the price of the good decreases, the quantity demanded of the good increases…. Price. . . This is shown by moving down the demand curve $7. 00 Increase in Quantity Demanded $6. 00 $5. 00 $4. 00 $3. 00 Demand Curve $2. 00 $1. 00 0 1 2 3 4 5 6 7 8 9 10 Quantity Demanded (QD) (In thousands)
What about the other variables? • To construct a demand curve a number of variables are held constant. . . (Income, Expectations, prices of related goods, etc) • What would happen to the demand curve if one of these variables were to change? • Example: Suppose consumers income increases and coffee is a normal good. People will want to buy more coffee. . . not just at one specific price but at all prices. . .
Which means all points on the Demand curve SHIFT to the RIGHT. . . …inifother words the Demand curve. . . So the price were $7. 00, coffee drinkers Price has SHIFTED to theinstead of 1, 000 would by 2, 000 pounds right $7. 00 $6. 00 $5. 00 $4. 00 $3. 00 Demand Curve $2. 00 Increase in Demand $1. 00 0 1 2 3 4 5 6 7 8 9 10 Quantity Demanded (QD) (In thousands) Price Quantity Demand $7. 00 1, 000 $6. 50 2, 000 $6. 00 3, 000 $5. 50 4, 000 $5. 00 5, 000 $4. 50 6, 000 $4. 00 7, 000 $3. 50 8, 000 $3. 00 9, 000 QD (new) 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 10, 000 If Demandwere $4. 00 the price Curve coffee drinkers would (after income increase) buy 8, 000 pounds instead of 7, 000
What if consumers income went down instead; then they would buy less at all prices. . . causing the Demand curve to shift to the left Price $7. 00 $6. 00 Decrease in Demand $5. 00 $4. 00 Demand Curve $3. 00 Demand Curve $2. 00 (after income decrease) $1. 00 0 1 2 3 4 5 6 7 8 9 10 Quantity Demanded (QD) (In thousands)
Changes in demand vs. Changes in quantity demanded • If one of the variables held constant when first constructing the demand curve (all other variables besides the price of the good) were to change. . . this would shift the demand curve either to the right (increase in demand) or to the left (decrease in demand). • If the price of the good were to change then there would be either a decrease in quantity demanded (if price rises) or an increase in quantity demanded (if price falls)… …this is shown by moving up or down the original demand curve
Price Changes in demand vs. Changes in quantity demanded (caused by the price of the good) Original Demand curve Quantity Demanded Changes in Demand (caused by a “ceteris paribus” variable) Will shift the position of the demand curve.
How do the other “ceteris paribus” variables affect the demand curve? 1. Prices of related goods • Substitutes If the price of tea increases, then consumers will wish to increases buy more coffee. . . since coffee is now cheaper compared to tea. In general, as the price of a substitute good increases, increases the demand for the other good(coffee) increases. • Therefore, there is a direct relationship between the demand for a good and the price of a substitute good. • Other examples: Foreign cars - American cars, chicken - beef, Coke - Pepsi, etc. • Consumers always purchase more of the good that is now cheaper relative to the other good.
“Ceteris paribus” Variables 1. Prices of related goods • Complements • If the price of sugar and cream were to increase, then increase consumers will desire to buy less coffee. As the price of a complementary good increases, the increases demand for the other good(coffee) decreases • Therefore, there is an inverse relationship between the demand for a good and the price of a complementary good. • Other examples: Cars - gasoline, Computers - software, Compact discs - Compact disc players, Hot dogs - mustard • Demand decreases because the two joined products (Coffee-sugar-cream) now are more expensive.
“Ceteris paribus” Variables 2. Tastes & Preferences If consumers prefer a good there is an increase in demand. If a good falls out of favor there is a decrease in demand Advertising could have an effect on tastes & preferences 3. Expectations Of future prices, availability of goods, income. If you believe that prices will increase in the future, you will want to buy more today before the price increase (increase in demand) Important for prices of commodities, stocks, and bonds 4. # of consumers: more consumers, increase in demand
• Definition: relationship between the price of a good and the quantity supplied of a good. • Quantity supplied: amount of an item that sellers are willing and able to make available to market over a certain period, at a specific price, ceteris paribus.
1. Price of the good 2. Price of inputs (resources) 3. Technology 4. Prices of other goods that can be produced by the firm 5. Expectations of future price 6. Number of Firms 7. Taxes and Subsidies
1. Price • By holding all other variables constant we get our second prediction (hypothesis). Law of Supply: The price and quantity supplied of a good are directly related, ceteris paribus. • Supply schedule: A list of possible prices with the corresponding quantity supplied at that price. It is a representation of the law of supply. • What if the price was. . . then what would be quantity supplied at that price.
Example: A supply schedule Price (per pound) $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 $3. 00 For Coffee Quantity Supplied (pounds per week) 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000
Supply curve. . . a curve representing the law of supply Price $7. 00 Plot the supply schedule on the graph. . Connect the dots and we get. . $6. 00 $5. 00 $4. 00 $3. 00 A Supply Curve $2. 00 $1. 00 0 Price $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 $3. 00 Quantity Supplied 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 As the price of a good increases, business firms are willing to increases make more of the good available for sale, ceteris paribus sale 1 2 3 4 5 6 7 8 9 10 Quantity Supplied (QS) (In thousands)
Changes in quantity supply vs. Changes in supply Price Changes in quantity Supplied (caused by the price of the good) Original Supply curve Decrease in Supply Increase in Supply Quantity Supplied Changes in Supply (caused by a “ceteris paribus” variable) Will shift the position of the Supply curve.
How do the “ceteris paribus” variables affect the Supply curve? • Price of inputs (resources) If the price of an input increases (labor, materials, etc) this makes a good more expensive to produce (raises costs). This lowers the potential profit of the firm and the firm will wish to decrease the supply of the good • Opposite example: The decline in the price of computer processors and chips makes costs decline for computer manufacturers and they increase supply • Summary: A decline in input prices increases supply. A rise in input prices decreases supply.
“Ceteris paribus” variables (Supply) • Technology. . . allows a firm to produce the same amount of a good with less resources, which results in lower costs and an increase in supply • Price of other goods the firm can produce. . . Example: If a farmer who grows coffee beans finds that another crop will pay them more… … they devote less land to coffee(a decrease in supply) and more land to the other crop • Expectations. . . of future prices If firms expect higher prices in the future they will make less available today (decrease in supply). Why? So they will have more to sell in the future (at the higher prices
“Ceteris paribus” variables (supply) • Number of firms The more firms that produce the good the greater is the supply of the good (more it shifts to the right) • Taxes and Subsidies • • Excise taxes. . . a tax on a good (gas, cigarette, etc) An increase in excise taxes will raise the cost of the good, lower potential profits, cause a decrease in supply A subsidy gives money (directly or indirectly) to firms, lowers the cost of the good and will increase supply. Examples: Public colleges and universities receive money from state governments. Immunizations are also subsidized by the government
Market Equilibrium • Equilibrium: Definition At rest, no tendency to change, forces in balance. • Market equilibrium… …the price, once reached, when there will be no tendency to change. The price the market comes to rest at and there are forces in balance. • This can only occur when the… Quantity demand (QD) = Quantity supplied (QS) • Price is a rationing device… …based on willingness and ability to pay
Price Supply curve $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 Demand Curve $3. 00 Price $7. 00 $6. 00 $5. 00 $4. 00 $3. 00 $2. 00 QD 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 QS 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 $1. 00 0 1 2 3 4 5 6 7 8 9 Quantity Demanded & Supply of Coffee(in thousands) 10 Quantity demanded = Quantity supplied occurs where the demand curve intersects the supply curve. This will determine the equilibrium price and quantity. Equilibrium price = $5. 00 and 5, 000 pounds of coffee are bought and sold at that price
Price Supply curve $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 Shortage $3. 50 (Excess Demand) Demand Curve $3. 00 Price $7. 00 $6. 00 $5. 00 $4. 00 $3. 00 $2. 00 QD 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 QS 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 $1. 00 0 1 2 3 4 5 6 7 8 9 10 Quantity Demanded & Supply of Coffee(in thousands) Economically (not graphically), how would equilibrium be reached? Suppose that the price for coffee were $3. 50 instead. . . At the price of $3. 50 QS = 2, 000 and QD = 8, 000 ( QD > QS) • Consumers wish to buy more coffee than firms are willing to make available at $3. 50. This means we have a. . .
Price Supply curve $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 Shortage $3. 50 (Excess Demand) Some consumers Demand Curve $3. 00 Price $7. 00 $6. 00 $5. 00 $4. 00 $3. 00 $2. 00 are going without coffee when the price is $3. 50… $1. 00 0 1 2 3 4 5 6 7 8 9 10 QD 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 QS 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 Quantity Demanded & Supply of Coffee(in thousands) Some of these consumers are willing to pay more for coffee than go without. . . Like an auction, these consumers will bid up the price in order to get coffee. . . As the price is bid up some consumers drop out of the bidding. . . QD decreases and coffee grower put more of their product on the market (QS increases) This will continue consumers are able to buy all they wish to. Only when QD = QS can this occur. Which is at the equilibrium price!
Supply curve Price $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 $3. 00 Demand Curve Surplus (Excess Supply) $6. 00 $5. 00 $4. 00 At the price of $6. 00 some coffee growers are not able to sell all they wish to… $3. 00 $2. 00 $1. 00 0 1 2 3 4 5 6 7 8 9 QD 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 QS 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 Quantity Demanded & Supply of Coffee(in thousands) 10 Suppose that the price for coffee were $6. 00 instead. . . At the price of $6. 00 QS = 7, 000 and QD = 3, 000 ( QD < QS) Coffee growers would like to sell more coffee than consumers wish to buy at $6. 00. This means we have a… Some growers will want to sell more and to do so will cut prices!
Supply curve Price $7. 00 $6. 50 $6. 00 $5. 50 $5. 00 $4. 50 $4. 00 $3. 50 $3. 00 Demand Curve Surplus (Excess Supply) $6. 00 $5. 00 $4. 00 $3. 00 $2. 00 QD 1, 000 2, 000 3, 000 4, 000 5, 000 6, 000 7, 000 8, 000 9, 000 QS 9, 000 8, 000 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 $1. 00 0 1 2 3 4 5 6 7 8 9 Quantity Demanded & Supply of Coffee(in thousands) 10 As prices are decreased, consumers will wish to buy more (QD increases), and some coffee growers will take their product off the market (QS decreases) This will continue until all growers are able to sell all they wish to. Only when QS = QD can this occur. It is at the Equilibrium price!
Supply curve Price New Equilibrium $7. 00 Think of the graph as a “snapshot” of the Market. If the price of a substitute good increases, there is an increase equilibrium price and quantity. $6. 00 $5. 00 $4. 00 New Demand Curve $3. 00 $2. 00 Demand Curve $1. 00 0 1 2 3 4 5 6 7 8 9 Quantity of Coffee 10 (In thousands) The increase in Demand causes If something changes(the Supply orboth equilibrium shifts) price and quantity to go Demand curve up: in the Market the(Normal good), Decrease in price of a Increase in Income “snapshot” will change. . . Example: If the price of tea(a substitute good) increases, complementary good, Expected higher prices in the future , more consumers, Increase in preferences for(increase in demand) consumers will want more coffee the good.
Supply curve 1 Price $7. 00 Let’s return to our original equilibrium. . . Supply curve 2 $6. 00 The decline in the price of an input increases the New equilibrium quantity Equilibrium and decreases the equilibrium price $5. 00 $4. 00 $3. 00 $2. 00 Demand Curve $1. 00 0 1 2 3 4 5 6 7 8 9 Quantity of Coffee 10 (In thousands) The increase in supply causes an increase in equilibrium quantity Suppose the price of land(for growing coffee) decreases. . . and a decrease the price of price: . . . the decline in in equilibriuman input will increase the An increase in technology, a fall in the price ofwant to produce profitability of coffee growers who will other goods that can be (increase in supply)…. . future price, more firms more produced, expected fall in producing the good, a fall in taxes or an increase in subsidies
Other Examples Making predictions about price and quantity
Price 7 Question: How would an increase in the price of oil affect the S 2 price and quantity of cars? S 1 Suppose the price of oil were to increase. . . the price of gasoline will increase $3. 00 $2. 00 If the price of a complement increases this will cause a decrease in demand for the other good. . . D 1 Q 2 Q 1 Quantity of Gasoline . . . since oil is an important input in the production of gas. . . the increase in it’s price will raise the cost of producing gas. . . this lowers potential profit and firms reduce production. . . the supply curve shifts to the left. . . How are gasoline and cars related? They are complements!
Price of Cars Question: How would an increase in the price of oil affect the price and quantity of cars? S 1 If the price of a complement increases this will cause a decrease in demand for the other good. . …a decrease in the demand for cars! P 1 P 2 D 2 Q 1 D 1 Quantity of Cars The result is a decline in the price of cars as well as a decline in the amount of cars bought and sold. This example is to show you how markets are related to one another. Other examples for you to think about. . . If the price of Coke increases, what happens to the price of Pepsi? If the price of computers decrease, what happens to the price of computer software?
Summary of Demand Supply Curves Shifting Shift • • Increase in Demand Decrease in Demand Increase in Supply Decrease in Supply Effect on Eq. Price Increase Decrease Increase Effect on Eq. Quantity Increase Decrease
Example: Both Demand Supply curves shifting at the same time
S 1988 Price $800 Around 1988, the cellular phone was just beginning to be used. . it’s price was very high, and only wealthy individuals used them. . S 2008 $50 D 1988 Q 1 D 2008 Q 2 Quantity of Cellular phones Today, many people besides the wealthy have a cellular phone. . in other words there has been a large increase in demand the last 20 years According to this graph the price of cellular phones should be over $1, 000. Yet good ones today are around $50. Yet we know that demand has increased. . . How to explain this? There has also been a large increase in Supply as well the last 20 years!
S 1988 Price The increase in supply causes prices to decrease $800 S 2008 $50 D 1988 Q 1 D 2008 Q 2 1. Decrease in price of inputs 2. Increase in technology 3. Increase in number of firms making cellular phones Quantity of Cellular phones The increase in supply is greater than the increase in demand. Increase in Demand: Increase Price, Increase Quantity Increase in Supply: Decrease Price, Increase Quantity When added together: We observe the quantity increases, both increases supply and demand cause quantity to go up(re-enforce one another) Since we know price goes down it must be that the force pushing price down( supply) > force pushing the price up(demand).
Price Question: What would happen if everyone expects the price S 2 of an item to increase? S 1 Suppose most market participants expect continued economic growth in China. . . Demand increase, Supply decreases $65 $40 D 2 D 1 Quantity of oil (billions of bbls. ) Oil consumers will want to buy more oil today before the expected price increase. . . . But those non-OPEC producers of oil would rather sell in the future when it’s price is higher. . . which means selling less today. . . The price of oil increases today based on future expectations!
What if markets are not allowed to reach equilibrium? Government intervention in Market (Price not used as a rationing device)
How does the market ration? • Through the equilibrium prices that are set. . . Based on willingness and ability to pay. • Changes in prices re-allocate resources in the economy. • Example: Suppose the demand for computer software increases…. . . This increases the price of software, which leads to more profitability of software firms. . . …and encourages more firms to produce more software. . . …to do this they need to hire more computer programmers, by increasing wages. . . …which will encourage more people to become computer programmers.
Price S 1 $90 Before looking at Government intervention let’s look at a case of private industry and price rationing However at the price of $30 there are 55, 000 people who want to see the concert. There is a shortage at the price of $30 a ticket $30 D 1 20, 000 55, 000 Quantity of Concert Tickets • A popular music group will play one show at a 20, 000 seat arena. . . The supply curve of seats is fixed at 20, 000 • They decide to charge $30 a ticket so their fans can afford it Price is no longer being used as a rationing device. . The alternatives? 1. Waiting in line(queuing). Getting there first gets you the tickets 2. Hold a lottery to determine who can buy tickets (ration coupons) 3. Dealers can hold some tickets to best (favored) customers
Price S 1 Before looking at Government intervention let’s look at a case of private industry and price rationing A popular music group will play one show at a 20, 000 seat arena They decide to charge $30 a ticket $90 $30 D 1 20, 000 55, 000 Quantity of Concert Tickets What if you can’t get a ticket with these alternative rationing methods? Are you left out of this concert? 4. A Black market (scalping): Charging a price above the face value of the ticket Scalping can only exist when the existing price is below the equilibrium price. This only happens at popular events.
How would government intervention achieve the same effects as seen Price with low price tickets? S 1 Price Ceiling 1. As price decreases, the QD of Bread will increase 2. As price decreases, the QS of $2. 00 Bread will decrease Shortage $0. 60 D 1 QS 60, 000 100, 000 QD 140, 000 Prices are kept artificially low This was the reason long lines were observed in the Soviet Union for bread, meat, and toilet paper Quantity of Bread Suppose the equilibrium price of bread were $2. 00 per loaf. Enough people complain that this price is too high for low income people to afford. The government can pass a law that says it is illegal to charge more than $0. 60 for a loaf of bread. What will be the effect? This is called a Price ceiling: a maximum legal price that can be charged for a good. Price is no longer used as a rationing device. Must use one (or more) of the 4 alternatives just mentioned.
How would government intervention achieve the same effects as seen Price with low price tickets? S 1 Price Ceiling 1. As price decreases, the QD of Bread will increase 2. As price decreases, the QS of $2. 00 Bread will decrease Shortage $0. 60 D 1 QS 60, 000 100, 000 QD 140, 000 Prices are kept artificially low This was the reason long lines were observed in the Soviet Union for bread, meat, and toilet paper Quantity of Bread This is called a Price ceiling: a maximum legal price that can be charged for a good. Price is no longer used as a rationing device. Must use one (or more) of the 4 alternatives just mentioned. Who benefits? Consumers who can get the good at $0. 60 Who is hurt? Firms that product bread, consumers who can’t find bread. When the government intervenes it creates winners and losers with the policy.
Wage $7. 50 $6. 50 S 2 Unemployment $5. 00 275, 000 The Minimum wage: a Price Floor S 1 Suppose the equilibrium wage for non-skilled workers was $5. 00/hour. . . Price Floor. . . a minimum price that can be legally charged. Who benefits? Those who are still employed D 2 at the higher wages Who is hurt? Those who are now D 1 unemployed, those who can’t find jobs, employers. 300, 000 375, 000 Quantity of hours workers • The government can say that $6. 50/hour will be the minimum price that can be charged… Of course, the equilibrium wage could always go above the minimum wage…. . . for example if supply goes down or demand goes up. . . …the minimum wage will become irrelevant
Summary Law of demand: Price and quantity demanded(QD) are inversely related Law of Supply: Price and quantity supplied(QS) are directly related Many variables will shift the Demand & Supply curves Equilibrium price occurs where QD = QS. Increase in demand increase equilibrium price & quantity Increase in supply increases equilibrium quantity and lowers equilibrium price Price ceiling keeps price below equilibrium and causes a shortage of the good Price floor keeps price above equilibrium and causes a surplus of the good.
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