Supply and Demand

1
Chapter 2 Supply and Demand
2
Market Definition

• ? A market is an arrangement whereby buyers and
  sellers interact to determine the prices and
  quantities of a commodity.

3
Market Participants

• ? Consumers
• ? Business firms
• ? Governments
• ? Foreigners

4
The Circular-Flow Model

• ? The circular-flow model is a simple way to
  visually show the economic transactions that
  occur between consumers and firms in the economy.

5
The Circular-Flow Diagram
Product Markets
Firms
Consumers
Factor Markets
6
The Market Forces of Supply and Demand

• ? Buyers determine demand.
• ? Sellers determine supply.
• ? Supply and demand are the two words that
  economists use most often.
• ? Supply and demand are the forces that make
  market economies work.

7
Demand

• ? Quantity demanded
  is the amount of a good
  that buyers are willing
  and able to purchase.

8
Demand Schedule

• ? The demand schedule is a table
  that shows the relationship between the
  price of the good and the quantity
  demanded.

9
Demand Schedule
10
Demand Curve

• ? The demand curve is the downward-sloping line
  relating price to quantity demanded.

11
Demand Curve
Price of Ice-Cream Cone
3.00
2.50
2.00
1.50
1.00
0.50
Quantity of Ice-Cream Cones
2
1
3
4
5
6
7
8
9
10
12
11
0
12
Law of Demand

• ? The law of demand states that there is an
  inverse relationship between price and quantity
  demanded.

13
Determinants of Demand

• ? Market price (P)
• ? Tastes (T)
• ? Consumer income (M)
• ? Expectations (Pe)
• ? Number of buyers (N)
• ? Other goods (Pr)

14
Demand Functions

• ? Qd f (P, M, Pr, T, Pe, N)
• Qd a bP cM dPr eT fPe gN
• Qd f (P, M, Pr, T, Pe, N)
• Qd f (P)
• Qd a bP

15
Ceteris Paribus

• ? Ceteris paribus is a Latin phrase that means
  all variables other than the ones being studied
  are assumed to be constant. Literally, ceteris
  paribus means other things being equal.
• ? The demand curve slopes downward because,
  ceteris paribus, lower prices imply a greater
  quantity demanded!

16
Change in Quantity Demanded versus Change in
Demand

• ? Change in Quantity Demanded
• ? Movement along the demand curve.
• ? Caused by a change in the price of the
  product.

17
Changes in Quantity Demanded
P
A
2.00
D1
Qd
0
20
18
Change in Quantity Demanded versus Change in
Demand

• ? Change in Demand
• ? A shift in the demand curve, either to
  the left or right.
• ? Caused by a change in a determinant other
  than the price.

19
Changes in Demand
P
Increase in demand
Decrease in demand
D2
D1
D3
0
Qd
20
Consumer Income

• ? As income increases the demand for a normal
  good will increase.
• ? As income increases the demand for an inferior
  good will decrease.

21
Consumer Income
Normal Good
Price
3.00
An increase in income...
2.50
Increase in demand
2.00
1.50
1.00
0.50
D2
D1
Quantity
2
1
3
4
5
6
7
8
9
10
12
11
0
22
Consumer Income
Inferior Good
Price
3.00
2.50
An increase in income...
2.00
Decrease in demand
1.50
1.00
0.50
D1
D2
Quantity
2
1
3
4
5
6
7
8
9
10
12
11
0
23
Prices of Related Goods

• ? When a fall in the price of one good reduces
  the demand for another good, the two goods are
  called substitutes.
• ? When a fall in the price of one good increases
  the demand for another good, the two goods are
  called complements.

24
Change in Quantity Demanded versus Change in
Demand
Variables that Affect Quantity Demanded
A Change in This Variable . . .
Price
Represents a movement
along the demand curve
Income
Shifts the demand curve
Prices of related
Shifts the demand curve
goods
Tastes
Shifts the demand curve
Expectations
Shifts the demand curve
Number of
Shifts the demand curve
buyers
25
Market Demand

• ? Market demand refers to the sum of all
  individual demands for a particular good or
  service.
• ? Graphically, individual demand curves are
  summed horizontally to obtain the market demand
  curve.

26
Supply

• ? Quantity supplied is
• the amount
• of a good that sellers are
• willing and able
• to sell.

27
Supply Schedule
28
Supply Curve
P
Qs - 1 2P
2.50
2.00
1.50
1.00
0.50
Qs
29
Law of Supply

• ? The law of supply states that there is a
  positive relationship between price and quantity
  supplied.

30
Determinants of Supply

• ? Market price (P)
• ? Taxes and subsidies (Ts)
• ? Related goods prices (Pr)
• ? Technology (T)
• ? Expectations (Pe)
• ? Number of firms (F)
• ? Factor costs(C)

31
Supply Functions

• ? Qs g (P, Ts, Pr, T, Pe, F,C)
• Qs h kP l Ts mPr nT rPe sF
  jC
• Qs g (P, Ts, Pr, T, Pe, F, C)
• Qs g (P)
• Qs h kP

32
Market Supply

• ? Market supply refers to the sum of all
  individual supplies for all sellers of a
  particular good or service.
• Graphically, individual supply curves are
  summed horizontally to obtain the market supply
  curve.

33
Change in Quantity Supplied versus Change in
Supply

• ? Change in Quantity Supplied
• ? ? Movement along the supply curve.
• ? ? Caused by a change in the market price of
  the product.

34
Change in Quantity Supplied
P
S
C
A rise in the price results in a movement along
the supply curve.
A
1.00
Qs
1
5
0
35
Change in Quantity Supplied versus Change in
Supply

• ? Change in Supply
• ? ? A shift in the supply curve, either to the
  left or right.
• ? ? Caused by a change in a determinant other
  than price.

36
Change in Supply
P
S1
Qs
0
37
Change in Quantity Supplied versus Change in
Supply
38
Shifts in Curves versus Movements along Curves

• ? A shift in the supply curve is called a change
  in supply.
• ? A movement along a fixed supply curve is called
  a change in quantity supplied.
• ? A shift in the demand curve is called a change
  in demand.
• ? A movement along a fixed demand curve is called
  a change in quantity demanded.

39
Supply and Demand Together

• ? Equilibrium Price
• ? The price that balances supply and
  demand. On a graph, it is the price at which the
  supply and demand curves intersect.
• ? Equilibrium Quantity
• ?The quantity that balances supply and
  demand. On a graph it is the quantity at which
  the supply and demand curves intersect.

40
Supply and Demand Together
Demand Schedule
Supply Schedule
At 2.00, the quantity demanded is equal to the
quantity supplied!
41
Equilibrium of Supply and Demand
P
Qd19 6P
3.00
2.50
Qd Qs
2.00
1.50
1.00
Qs - 5 6P
0.50
Q
2
1
3
4
5
6
7
8
9
10
12
11
0
42
Excess Supply
Price of Ice-Cream Cone
Supply
Surplus
3.00
2.50
2.00
1.50
1.00
0.50
Demand
Quantity of Ice-Cream Cones
2
1
3
4
5
6
7
8
9
10
12
11
0
43
Surplus

• ? When the price is above the equilibrium price,
  the quantity supplied exceeds the quantity
  demanded. There is excess supply or a surplus.
  Suppliers will lower the price to increase sales,
  thereby moving toward equilibrium.

44
Excess Demand
Price
Supply
2.00
1.50
Shortage
Demand
4
0
1
2
3
5
6
7
8
9
10
11
12
13
Quantity
45
Shortage

• ? When the price is below the equilibrium price,
  the quantity demanded exceeds the quantity
  supplied. There is excess demand or a shortage.
  Suppliers will raise the price due to too many
  buyers chasing too few goods, thereby moving
  toward equilibrium.

46
Three Steps To Analyzing Changes in Equilibrium

• ? Decide whether the event shifts the supply or
  demand curve (or both).
• ? Decide whether the curve(s) shift(s) to the
  left or to the right.
• ? Examine how the shift affects equilibrium price
  and quantity.

47
How an Increase in Demand Affects the Equilibrium
Price
1. Hot weather increases the demand for ice
cream...
Supply
2.00
Initial equilibrium
D1
0
7
Quantity
48
How a Decrease in Supply Affects the Equilibrium
Price
1. An earthquake reduces the supply of ice
cream...
S1
New equilibrium
2.00
Initial equilibrium
Demand
10
0
1
2
3
4
7
8
9
11
12
13
Quantity
49
What Happens to Price and Quantity When Supply or
Demand Shifts?
50
Price Ceilings Price Floors

• ? Price Ceiling
• ? ? A legally established maximum price at which
  a good can be sold.
• ? Price Floor
• ? ? A legally established minimum price at which
  a good can be sold.

51
A Price Ceiling That Creates Shortages
P
Supply
3
2
Demand
Q
0
52
Effects of Price Ceilings

• ? Shortages
• ? Non-price rationing
• ? Black market
• ? Corruption

53
Rent Control

• ? Rent controls are ceilings placed on the rents
  that landlords may charge their tenants.
• ? The goal of rent control policy is to help the
  poor by making housing more affordable.
• ? One economist called rent control the best way
  to destroy a city, other than bombing.

54
Rent Control in the Long Run
Because the supply and demand for apartments are
more elastic...
Rental Price of Apartment
Supply
rent control causes a large shortage
Demand
Quantity of Apartments
0
55
A Price Floor That Creates Surplus
P
Supply
4
3
Demand
Q
0
56
The Minimum Wage

• ? An important example of a price floor is the
  minimum wage. Minimum wage laws dictate the
  lowest price possible for labor that any employer
  may pay.

57
The Minimum Wage
A Free Labor Market
Wage
Labor supply
Labor demand
0
Quantity of Labor
58
The Minimum Wage
A Labor Market with a Minimum Wage
Wage
Labor supply
Labor demand
Quantity of Labor
0
59
Assignment

• ? Review chapter2 (P54-81)
• ? Do Exercises on P833,4.
• ? Preview Chapter3 (P86-103)