PART I INTRODUCTION TO ECONOMICS 3 CHAPTER 3

PART I INTRODUCTION TO ECONOMICS 3 CHAPTER 3 Demand, Supply, and Market Equilibrium © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 1 of 49

Firms and Households: The Basic Decision-Making Units CHAPTER 3 Demand, Supply, and Market Equilibrium Households: Individuals and families who buy goods and services for consumption. Firms: Business organizations that transforms resources (inputs) into products (outputs) for profit. Entrepreneurs: Persons who organize, manage, and assume the risks of a firm, taking new ideas or new products and turning them into profit. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 2 of 49

Input Markets and Output Markets: The Circular Flow CHAPTER 3 Demand, Supply, and Market Equilibrium Product or output markets: Markets in which goods and services are exchanged. Input or factor markets: Markets in which the resources are exchanged. Resources: labor, land, capital, entrepreneurship © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 3 of 49

CHAPTER 3 Demand, Supply, and Market Equilibrium Input Markets and Output Markets: The Circular Flow Labor markets: Markets in which households supply work for wages to firms that demand labor. Capital markets: Markets in which households supply their savings, for interest, to firms that demand funds to buy capital goods. Land markets: Markets in which households supply land in exchange for rent. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 4 of 49

Input Markets and Output Markets: The Circular Flow CHAPTER 3 Demand, Supply, and Market Equilibrium The Circular Flow of Economic Activity A diagram showing interactions between households and firms in product markets and resource markets. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 5 of 49

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Household’s decision about what quantity of a particular product to demand depends on a number of factors: § The price of the product § Household income and wealth § The prices of other products § Consumer taste § Expectations of change in income, wealth, and prices. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 6 of 49

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Quantity Demanded: The amount of a product that a household would buy at a given price. Demand: The amount of a product that a household is willing and able to buy in at various prices. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 7 of 49

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Changes in Quantity Demanded vs. Changes in Demand Changes in the price of a product affect the quantity demanded. For example: an increase in the price of Coca-Cola would cause a decrease in the quantity of Coca-Cola demanded, all being equal. Changes in any other factor, such as household income or taste, will affect demand. For example, an increase in household income would cause an increase in the demand for Coca-Cola, given the price. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 8 of 49

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Price and Quantity Demanded: The Law of Demand schedule: A table showing how much of a product a household is willing and able to buy at different prices. Demand curve: A graph illustrating how much of a product a household is willing and able to buy at different prices. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 9 of 49

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium The Law of Demand: price and quantity demanded are negatively related. Anna’s Demand Schedule for Telephone Calls Price (Per Call) $ Quantity Demanded (Calls Per Month) 0 30 . 50 25 3. 50 7 7. 00 3 10. 00 1 15. 00 0 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 10 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Demand Income Normal goods: Goods for which demand goes up when income increases and demand goes down when income decreases. Inferior goods: Goods for which demand goes up when income decreases and demand goes down when income increases. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 11 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Prices of Other Goods and Services Substitute goods: Goods that serve as “replacements” for one another; when the price of one increases, demand for the other increases. Complementary goods: Goods that “go together”; a decrease in the price of one product results in an increase in demand for the other. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 12 of

Demand in Products CHAPTER 3 Demand, Supply, and Market Equilibrium Consumer Taste Within the constraints of prices and incomes, consumer taste shapes the demand curve; an improvement in consumer taste for a good would increase the demand for the good. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 13 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Expectations What you decide to buy today certainly depends on today’s product prices and your income and wealth. • Expectations of a price increase will raise the demand. • Expectations of higher income or increased wealth will increase the demand. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 14 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Shift of Demand vs. Movement Along a Demand Curve Shift of Anna’s Demand Schedule Due to increase I Income Schedule D 0 Schedule D 1 Quantity Demanded (Calls Per Month at an Income of $300 Per Month) Quantity Demanded (Calls Per Month at an Income of $600 Per Month) $ 0. 00 30 35 0. 50 25 33 3. 50 7 18 7. 00 3 12 10. 00 1 7 15. 00 0 2 20. 00 0 0 Price (Per Call) © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 15 of

CHAPTER 3 Demand, Supply, and Market Equilibrium Demand for Products Shift of the demand: A shift is caused by a change in the determinants of the demand, given the price. Movement along the demand: A movement along the demand is caused by a change in the price, all being equal. Change in price of leads to change in quantity demanded: movement along the demand Change in income, preferences, or prices of other goods or services leads to change in demand: shift of the demand © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 16 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Change in Income and Shift of Demand © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 17 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium Shift of Demand versus Movement Along a Demand Curve If the price of hamburger rises, the quantity of hamburger demanded declines— this is a movement along the demand curve. The price rise for hamburger would shift the demand for chicken (its substitute) to the right and the demand for ketchup (its complement) to the left. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 18 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium From Household Demand To Market Demand Market demand is the horizontal sum of all households’ demands. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 19 of

Demand for Products CHAPTER 3 Demand, Supply, and Market Equilibrium From Household Demand To Market Demand © 2009 Pearson Education, Inc. Publishing as Prentice Hall FIGURE 3. 5 Deriving Market Demand from Individual Demand Curves Total demand in the marketplace is simply the sum of the demands of all the households shopping in a particular market. It is the sum of all the individual demand curves—that is, the sum of all the individual quantities demanded at each price. Principles of Macroeconomics 9 e by Case, Fair and Oster 20 of

CHAPTER 3 Demand, Supply, and Market Equilibrium Supply of Products Quantity supplied: The amount of a product that a firm offers for sale at a given price. Supply: The amount of a product that a firm is willing and able to sell at various prices, all being equal. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 21 of

CHAPTER 3 Demand, Supply, and Market Equilibrium Supply of Products Supply schedule: A table showing how much of a product a firm is willing and able to sell at different prices. Supply curve: A graph illustrating how much of a product a firm is willing and able to sell at different prices. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 22 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium The Law of Supply: price and quantity supplied are positively related. TABLE 3. 3 Clarence Brown’s Supply Schedule for Soybeans Price (Per Bushel) Quantity Supplied (Bushels Per Year) $1. 50 0 1. 75 10, 000 2. 25 20, 000 30, 000 45, 000 5. 00 45, 000 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 23 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium Determinants Of Supply The Cost of Production In order for a firm to make a profit, its revenue must exceed its costs. Cost of production depends on a number of factors, including available technology and input prices paid by the firm (wages, salaries, interest, rent, etc. ). © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 24 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium Determinants Of Supply Prices of Related Products Assuming that its objective is to maximize profits, a firm’s decision about what quantity of a product to supply depends on: 1. The price of the good or service 2. The cost of producing the product 3. The prices of related products © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 25 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium Shift of Supply vs. Movement Along a Supply Curve Movement along supply: The change in quantity supplied caused by a change in price, all being equal. Shift of supply: The shift caused by a change in the determinants of the supply, given the price. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 26 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium Shift of Supply vs. Movement Along a Supply Curve TABLE 3. 4 Shift of Supply Schedule for Soybeans Following Development of a New Disease-Resistant Seed Strain SCHEDULE D 0 SCHEDULE D 1 Quantity Supplied Price (Bushels per Year (per Bushel) Using Old Seed) Using New Seed) $1. 50 0 5, 000 1. 75 10, 000 23, 000 2. 25 20, 000 33, 000 30, 000 45, 000 54, 000 5. 00 45, 000 54, 000 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 27 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium Shift of Supply vs. Movement Along a Supply Curve Shift of the supply: A shift is caused by a change in the determinants of the supply, given the price. Movement along the supply: A movement along the supply is caused by a change in the price, all being equal. Change in price of a good or service leads to Change in quantity supplied: movement along supply. Change in income, preferences, or prices of other goods or services leads to Change in supply: shift of supply. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 28 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium From Individual Supply to Market Supply Market supply is the horizontal sum of all individual firms’ supplies. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 29 of

Supply of Products CHAPTER 3 Demand, Supply, and Market Equilibrium From Individual Supply to Market Supply © 2009 Pearson Education, Inc. Publishing as Prentice Hall FIGURE 3. 8 Deriving Market Supply from Individual Firm Supply Curves Total supply in the marketplace is the sum of all the amounts supplied by all the firms selling in the market. It is the sum of all the individual quantities supplied at each price. Principles of Macroeconomics 9 e by Case, Fair and Oster 30 of

CHAPTER 3 Demand, Supply, and Market Equilibrium: A condition at which quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for price to change. Excess demand or Shortage: A condition at which quantity demanded exceeds quantity supplied at the market price. Excess supply or Surplus: The condition at which quantity supplied exceeds quantity demanded at the market price. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 31 of

Market Equilibrium CHAPTER 3 Demand, Supply, and Market Equilibrium Excess Demand When quantity demanded exceeds quantity supplied, price tends to rise. When the price in a market rises, quantity demanded falls and quantity supplied rises until an equilibrium is reached at which quantity demanded and quantity supplied are equal. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 32 of

Market Equilibrium CHAPTER 3 Demand, Supply, and Market Equilibrium Excess Supply When quantity supplied exceeds quantity demanded at the current price, the price tends to fall. When price falls, quantity supplied is likely to decrease and quantity demanded is likely to increase until an equilibrium price is reached where quantity supplied and quantity demanded are equal. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 33 of

Market Equilibrium CHAPTER 3 Demand, Supply, and Market Equilibrium Changes In Equilibrium When supply and demand curves shift, the equilibrium price and quantity change. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Before the freeze, the coffee market was in equilibrium at a price of $1. 20 per pound. At that price, quantity demanded equaled quantity supplied. The freeze shifted the supply curve to the left (from S 0 to S 1), increasing the equilibrium price to $2. 40. Principles of Macroeconomics 9 e by Case, Fair and Oster 34 of

Market Equilibrium CHAPTER 3 Demand, Supply, and Market Equilibrium Changes In Equilibrium FIGURE 3. 12 Examples of Supply and Demand Shifts for Product X © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 35 of

Demand Supply Applications CHAPTER 3 Demand, Supply, and Market Equilibrium Changes In Equilibrium Bad News for Orange Juice Fanatics Orange Juice Prices Could Skyrocket After Freeze Destroys Most of California Output City News © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 36 of

CHAPTER 3 Demand, Supply, and Market Equilibrium Demand Supply Applications Why Do the Prices of Newspapers Rise? In 2006, the average price for a daily edition of a Baltimore newspaper was $0. 50. In 2007, the average price had risen to $0. 75. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9 e by Case, Fair and Oster 37 of