Combining Supply and Demand

1
Combining Supply and Demand

• How do supply and demand create balance in the
  marketplace?
• What are differences between a market in
  equilibrium and a market in disequilibrium?
• What are the effects of price ceilings and price
  floors?

2
Balancing the Market

• The point at which quantity demanded and quantity
  supplied come together is known as equilibrium.

3
Market Disequilibrium
If the market price or quantity supplied is
anywhere but at the equilibrium price, the market
is in a state called disequilibrium. There are
two causes for disequilibrium

• Excess Demand
• Excess demand occurs when quantity demanded is
  more than quantity supplied.

• Excess Supply
• Excess supply occurs when quantity supplied
  exceeds quantity demanded.

Interactions between buyers and sellers will
always push the market back towards equilibrium.
4
Shortage
when quantity demanded is greater than quantity
supplied

• 0

• Example If P 1,

• then QD 21 lattes

• and QS 5 lattes

• resulting in a shortage of 16 lattes

• Shortage

5
Shortage
when quantity demanded is greater than quantity
supplied

• 0

• Facing a shortage, sellers raise the price,

• causing QD to fall

• and QS to rise,

• which reduces the shortage.

6
Shortage
when quantity demanded is greater than quantity
supplied

• 0

• Facing a shortage, sellers raise the price,

• causing QD to fall

• and QS to rise.

• Prices continue to rise until market reaches
  equilibrium.

• Shortage

7
Surplus
when quantity supplied is greater than quantity
demanded

• 0

• Example If P 5,

• Surplus

• then QD 9 lattes

• and QS 25 lattes

• resulting in a surplus of 16 lattes

8
Surplus
when quantity supplied is greater than quantity
demanded

• 0

• Surplus

• Facing a surplus, sellers try to increase sales
  by cutting the price.

• Falling prices cause QD to rise and QS to fall.

• Prices continue to fall until market reaches
  equilibrium.

9
Surplus
when quantity supplied is greater than quantity
demanded

• 0

• Facing a surplus, sellers try to increase sales
  by cutting the price.

• This causes QD to rise

• and QS to fall

• which reduces the surplus.

10
Price Ceilings
In some cases the government steps in to control
prices. These interventions appear as price
ceilings and price floors.

• A price ceiling is a maximum price that can be
  legally charged for a good.
• An example of a price ceiling is rent control, a
  situation where a government sets a maximum
  amount that can be charged for rent in an area.

11
Price Floors

• A price floor is a minimum price, set by the
  government, that must be paid for a good or
  service.

• One well-known price floor is the minimum wage,
  which sets a minimum price that an employer can
  pay a worker for an hour of labor.

12
Section 1 Assessment

• 1. Equilibrium in a market means which of the
  following?
• (a) the point at which quantity supplied and
  quantity demanded are the same
• (b) the point at which unsold goods begin to pile
  up
• (c) the point at which suppliers begin to reduce
  prices
• (d) the point at which prices fall below the cost
  of production
• 2. The governments price floor on low wages is
  called the
• (a) market equilibrium
• (b) base wage rate
• (c) minimum wage
• (d) employment guarantee

Want to connect to the PHSchool.com link for this
section? Click Here!
13
Section 1 Assessment

• 1. Equilibrium in a market means which of the
  following?
• (a) the point at which quantity supplied and
  quantity demanded are the same
• (b) the point at which unsold goods begin to pile
  up
• (c) the point at which suppliers begin to reduce
  prices
• (d) the point at which prices fall below the cost
  of production
• 2. The governments price floor on low wages is
  called the
• (a) market equilibrium
• (b) base wage rate
• (c) minimum wage
• (d) employment guarantee

Want to connect to the PHSchool.com link for this
section? Click Here!
14
Changes in Market Equilibrium

• How do shifts in supply affect market
  equilibrium?
• How do shifts in demand affect market
  equilibrium?
• How can we use supply and demand curves to
  analyze changes in market equilibrium?

15
Shifts in Supply

• Understanding a Shift
• Since markets tend toward equilibrium, a change
  in supply will set market forces in motion that
  lead the market to a new equilibrium price and
  quantity sold.
• Excess Supply
• A surplus is a situation in which quantity
  supplied is greater than quantity demanded. If a
  surplus occurs, producers reduce prices to sell
  their products. This creates a new market
  equilibrium.
• A Fall in Supply
• The exact opposite will occur when supply is
  decreased. As supply decreases, producers will
  raise prices and demand will decrease.

16
Shifts in Demand

• Excess Demand
• A shortage is a situation in which quantity
  demanded is greater than quantity supplied.
• Search Costs
• Search costs are the financial and opportunity
  costs consumers pay when searching for a good or
  service.
• A Fall in Demand
• When demand falls, suppliers respond by cutting
  prices, and a new market equilibrium is found.

17
Analyzing Shifts in Supply and Demand

• Graph A shows how the market finds a new
  equilibrium when there is an increase in supply.

• Graph B shows how the market finds a new
  equilibrium when there is an increase in demand.

18
Three Steps to Analyzing Changes in Equilibrium

• 1. Decide whether event shifts S curve, D curve,
  or both.
• 2. Decide in which direction curve shifts.
• 3. Use supply-demand diagram to see how the
  shift changes equilibrium P and Q.

To determine the effects of any event,
19
EXAMPLE The Market for Hybrid Cars
20
EXAMPLE 1 A Change in Demand

• EVENT TO BE ANALYZED Increase in price of gas.

STEP 1 D curve shifts because price of gas
affects demand for hybrids. S curve does not
shift, because price of gas does not affect cost
of producing hybrids.
STEP 2 D shifts rightbecause high gas price
makes hybrids more attractive relative to other
cars.
STEP 3 The shift causes an increase in price
and quantity of hybrid cars.
21
EXAMPLE 1 A Change in Demand
Notice When P rises, producers supply a
larger quantity of hybrids, even though the S
curve has not shifted.

• P2

Always be careful to distinguish b/w a shift in a
curve and a movement along the curve.

• Q2

22
Terms for Shift vs. Movement Along Curve

• Change in supply a shift in the S curve
• occurs when a non-price determinant of supply
  changes (like technology or costs)
• Change in the quantity supplied a movement
  along a fixed S curve
• occurs when P changes
• Change in demand a shift in the D curve
• occurs when a non-price determinant of demand
  changes (like income or of buyers)
• Change in the quantity demanded a movement
  along a fixed D curve
• occurs when P changes

23
EXAMPLE 2 A Change in Supply

• EVENT New technology reduces cost of producing
  hybrid cars.

STEP 1 S curve shifts because event affects
cost of production. D curve does not shift,
because production technology is not one of the
factors that affect demand.
STEP 2 S shifts rightbecause event reduces
cost, makes production more profitable at any
given price.
STEP 3 The shift causes price to fall and
quantity to rise.
24
EXAMPLE 3 A Change in Both Supply and
Demand

• EVENTS price of gas rises AND new technology
  reduces production costs

STEP 1 Both curves shift.
STEP 2 Both shift to the right.
STEP 3 Q rises, but effect on P is ambiguous
If demand increases more than supply, P rises.
25
Supply and Demand Together

• 0

• Equilibrium P has reached the level where
  quantity supplied equals quantity demanded

26
EXAMPLE 1 A Change in Demand

• EVENT TO BE ANALYZED Increase in price of gas.

STEP 1 D curve shifts because price of gas
affects demand for hybrids. S curve does not
shift, because price of gas does not affect cost
of producing hybrids.
STEP 2 D shifts rightbecause high gas price
makes hybrids more attractive relative to other
cars.
STEP 3 The shift causes an increase in price
and quantity of hybrid cars.
27
EXAMPLE 1 A Change in Demand
Notice When P rises, producers supply a
larger quantity of hybrids, even though the S
curve has not shifted.

• P2

Always be careful to distinguish b/w a shift in a
curve and a movement along the curve.

• Q2

28
EXAMPLE 2 A Change in Supply

• EVENT New technology reduces cost of producing
  hybrid cars.

STEP 1 S curve shifts because event affects
cost of production. D curve does not shift,
because production technology is not one of the
factors that affect demand.
STEP 2 S shifts rightbecause event reduces
cost, makes production more profitable at any
given price.
STEP 3 The shift causes price to fall and
quantity to rise.
29
Terms for Shift vs. Movement Along Curve

• Change in supply a shift in the S curve
• occurs when a non-price determinant of supply
  changes (like technology or costs)
• Change in the quantity supplied a movement
  along a fixed S curve
• occurs when P changes
• Change in demand a shift in the D curve
• occurs when a non-price determinant of demand
  changes (like income or of buyers)
• Change in the quantity demanded a movement
  along a fixed D curve
• occurs when P changes

30
Section 2 Assessment

• 1. When a new equilibrium is reached after a
  fall in demand, the new equilibrium has a
• (a) lower market price and a higher quantity
  sold.
• (b) higher market price and a higher quantity
  sold.
• (c) lower market price and a lower quantity sold.
• (d) higher market price and a lower quantity
  sold.
• 2. What happens when any market is in
  disequilibrium and prices are flexible?
• (a) market forces push toward equilibrium
• (b) sellers waste their resources
• (c) excess demand is created
• (d) unsold perishable goods are thrown out

Want to connect to the PHSchool.com link for this
section? Click Here!
31
Section 2 Assessment

• 1. When a new equilibrium is reached after a
  fall in demand, the new equilibrium has a
• (a) lower market price and a higher quantity
  sold.
• (b) higher market price and a higher quantity
  sold.
• (c) lower market price and a lower quantity sold.
• (d) higher market price and a lower quantity
  sold.
• 2. What happens when any market is in
  disequilibrium and prices are flexible?
• (a) market forces push toward equilibrium
• (b) sellers waste their resources
• (c) excess demand is created
• (d) unsold perishable goods are thrown out

Want to connect to the PHSchool.com link for this
section? Click Here!
32
The Role of Prices

• What role do prices play in a free market system?
• What advantages do prices offer?
• How do prices allow for efficient resource
  allocation?

33
The Role of Prices in a Free Market

• Prices serve a vital role in a free market
  economy.
• Prices help move land, labor, and capital into
  the hands of producers, and finished goods in to
  the hands of buyers.
• Prices create efficient resource allocation for
  producers and a language that both consumers and
  producers can use.

34
Advantages of Prices
Prices provide a language for buyers and sellers.

• 1. Prices as an Incentive
• Prices communicate to both buyers and sellers
  whether goods or services are scarce or easily
  available. Prices can encourage or discourage
  production.
• 2. Signals
• Think of prices as a traffic light. A
  relatively high price is a green light telling
  producers to make more. A relatively low price
  is a red light telling producers to make less.
• 3. Flexibility
• In many markets, prices are much more flexible
  than production levels. They can be easily
  increased or decreased to solve problems of
  excess supply or excess demand.
• 4. Price System is "Free"
• Unlike central planning, a distribution system
  based on prices costs nothing to administer.

35
Efficient Resource Allocation

• Resource Allocation
• A market system, with its fully changing prices,
  ensures that resources go to the uses that
  consumers value most highly.
• Market Problems
• Imperfect competition between firms in a market
  can affect prices and consumer decisions.
• Spillover costs, or externalities, are costs of
  production, such as air and water pollution, that
  spill over onto people who have no control over
  how much of a good is produced.
• If buyers and sellers have imperfect information
  on a product, they may not make the best
  purchasing or selling decision.

36
Section 3 Assessment

• 1. What prompts efficient resource allocation in
  a well-functioning market system?
• (a) businesses working to earn a profit
• (b) government regulation
• (c) the need for fair allocation of resources
• (d) the need to buy goods regardless of price
• 2. How do price changes affect equilibrium?
• (a) Price changes assist the centrally planned
  economy.
• (b) Price changes serve as a tool for
  distributing goods and services.
• (c) Price changes limit all markets to people who
  have the most money.
• (d) Price changes prevent inflation or deflation
  from affecting the supply of goods.

Want to connect to the PHSchool.com link for this
section? Click Here!
37
Section 3 Assessment

• 1. What prompts efficient resource allocation in
  a well-functioning market system?
• (a) businesses working to earn a profit
• (b) government regulation
• (c) the need for fair allocation of resources
• (d) the need to buy goods regardless of price
• 2. How do price changes affect equilibrium?
• (a) Price changes assist the centrally planned
  economy.
• (b) Price changes serve as a tool for
  distributing goods and services.
• (c) Price changes limit all markets to people who
  have the most money.
• (d) Price changes prevent inflation or deflation
  from affecting the supply of goods.

Want to connect to the PHSchool.com link for this
section? Click Here!
38
A C T I V E L E A R N I N G 3 A. fall in
price of CDs

• The market for music downloads

STEPS
1. D curve shifts
2. D shifts left
3. P and Q both fall.

• 38

39
A C T I V E L E A R N I N G 3 B. fall in
cost of royalties

• The market for music downloads

(royalties are part of sellers costs)
STEPS
1. S curve shifts
2. S shifts right
3. P falls, Q rises.

• 39

40
A C T I V E L E A R N I N G 3 C. fall in
price of CDs AND fall in cost of royalties

• STEPS
• 1. Both curves shift (see parts A B).
• 2. D shifts left, S shifts right.
• 3. P unambiguously falls.
• Effect on Q is ambiguous The fall in demand
  reduces Q, the increase in supply increases Q.

• 40

41
EXAMPLE 3 A Change in Both Supply and Demand
EVENTS price of gas rises AND new technology
reduces production costs

• STEP 3, cont.

But if supply increases more than demand, P
falls.
42
A C T I V E L E A R N I N G 3 Changes in
supply and demand

• Use the three-step method to analyze the effects
  of each event on the equilibrium price and
  quantity of music downloads.
• Event A A fall in the price of compact discs
• Event B Sellers of music downloads negotiate a
  reduction in the royalties they must pay for each
  song they sell.
• Event C Events A and B both occur.

• 42

43
CONCLUSION How Prices Allocate Resources

• Markets are usually a good way to organize
  economic activity.

• In market economies, prices adjust to balance
  supply and demand. These equilibrium prices are
  the signals that guide economic decisions and
  thereby allocate scarce resources.