Transcript Consumer Choice and Demand:

Market Equilibrium:
The Invisible Hand
Randy Rucker
Professor
Department of Agricultural Economics
and Economics
June 19, 2013
Review:
Consumer Choice and Demand

Determinants of the Demand for a Good:







Price of the good of interest
Prices of Substitutes
Prices of Complements
Incomes
Tastes and Preferences
Quality
etc.
2
Review:
Consumer Choice and Demand

The Demand Curve Shows the
Relationship Between the Price of a Good
and the Quantity of that Good Demanded

Ceteris Paribus (Other Factors are Held
Constant)

The Law of Demand—What does it say?
3
Review:
Consumer Choice and Demand

A Change in Price Causes a Change in
Quantity Demanded


This is a movement along the demand curve.
A Change in Other Factors (e.g., Income)
Causes a Change in Demand

This is a shift in the demand curve.
4
Review:
Firms, Profits, and Supply

Determinants of the Supply of a Good:






Price of the good of interest
Prices of Inputs
Changes in Technology
Number of Firms in the Industry
Quality
etc.
5
Review:
Firms, Profits, and Supply

The Supply Curve Shows the Relationship
Between the Price of a Good and the
Quantity of that Good Supplied

Ceteris Paribus (Other Factors are Held
Constant)

The Law of Supply—What does it say?
6
Review:
Firms, Profits, and Supply

A Change in Price Causes a Change in
Quantity Supplied


This is a movement along the supply curve.
A Change in Other Factors (e.g., an input
price) Causes a Change in Supply

This is a shift in the supply curve.
7
Market Equilibrium

Now, let’s put Demand and Supply on the
same Graph . . .
8
Market Equilibrium

What Will Be the Price and Quantity that
“Clear the Market”?

To Answer This, Suppose the Price Is
Initially Below the Price Where the
Demand and Supply Curves Intersect ($4).

What Will Happen?
9
Shortage: Weekly Supply
and Demand for Babysitting
10
Market Equilibrium

At a Price of $2 per Hour, there is a
“Shortage.” At that Price, the quantity
demanded exceeds the quantity supplied.

Babysitters have way more requests than
they are willing to provide at $2 per hour.

What will happen?
11
Market Equilibrium

Parents who can’t get a babysitter, and are willing
to pay more than $2 per hour, will offer, say $3 per
hour.

This higher price will cause some parents to stay
home, or not stay out as long. That is, quantity
demanded will fall.

The higher price will also induce some babysitters
to work more hours. That is, quantity supplied will
increase.

Thus, the shortage gets smaller and these “market
forces” will continue to drive prices up.
12
Market Equilibrium

Alternatively, Suppose the Price Is Initially
Above the Price Where the Demand and
Supply Curves Intersect.

What Will Happen?
13
Surplus: Weekly Supply
and Demand for Babysitting
14
Market Equilibrium

At a price of $6 per hour, there is a
“Surplus.” At that price, the quantity
supplied exceeds the quantity demanded.

Babysitters are willing to work way more
hours than parents are willing to purchase.

What will happen?
15
Market Equilibrium

Some babysitters who can’t get any work at $6
per hour, and are willing to babysit for less, will
offer their services for, say $5 per hour.

This lower price will induce some parents to go
out on a date. That is, quantity demanded will
increase.

The lower price will also cause some babysitters
to work fewer hours. That is, quantity supplied
will decrease.

Thus, the surplus gets smaller and these “market
forces” will continue to drive prices down.
16
Market Equilibrium

So, if price is below $4, there will be a
shortage, and price will increase.

Alternatively, if price is above $4, there will
be a surplus and price will fall.

In each case above, what causes prices to
change? An all-knowing central planner?
Happenstance? Market forces?
17
Market Equilibrium

When the price is equal to $4, quantity
supplied is equal to quantity demanded.
That is, the market clears—all parents who
are willing to pay that price for a babysitter
are able to get one,
and
 all babysitters who are willing to babysit at
that price are able to.

18
Market Equilibrium

Note: If market forces are allowed to work,
prices will adjust and shortages and
surpluses will go away.

Think: What if prices are not allowed to
adjust?

Let’s come back to this if we have time.
19
Market Equilibrium

The fundamental forces just described in
the market for babysitters will also be at
work in markets for other goods.
 QUESTIONS???
20
Market Equilibrium

Next, let’s apply these principles to see
what happens if the market equilibrium
described above is disturbed . . .

NOTE: Such disturbances are the rule
rather than the exception. Markets are
always adjusting to changing conditions.
21
Market Equilibrium

First, what happens to the market for
Tenderloin Steaks if incomes increase?

Recall that Tenderloin Steaks are a “normal
good.”
22
The Market for Tenderloin Steaks
Price
($/Q)
S0
P0
D0
Q0
Q
(Quantity/week)
The Initial Equilibrium Price and Quantity
23
The Market for Tenderloin Steaks
Price
($/Q)
S0
1
P1
P0
2
2
D0
Q0
Q1
D1
Q
(Quantity/week)
Impacts of an Increase in Demand
Resulting from an Increase in Incomes
24
Market Equilibrium

Second, what happens to the market for
Top Ramen if incomes increase?

Recall that Top Ramen is an “inferior good.”
25
Price
The Market for Top Ramen
($/Q)
S0
P0
D0
Q0
Q
(Quantity/week)
The Initial Equilibrium Price and Quantity
26
Price
The Market for Top Ramen
($/Q)
S0
1
P0
P1
2
2
Q1
D1
Q0
D0
Q
(Quantity/week)
Impacts of a Decrease in Demand
Resulting from an Increase in Income
27
Market Equilibrium

Third, what happens in the wheat market
if there is an increase in supply due to
favorable growing conditions in China and
Russia?
28
Price
The Market for Wheat
($/Q)
S0
P0
D0
Q0
Q
(Bushels/year)
The Initial Equilibrium Price and Quantity
29
Price
($/Q)
The Market for Wheat
S0
S1
P0
1
2
P1
2
D0
Q
(Bushels/year)
Impacts of an Increase in Supply Resulting
from Good Growing Conditions
Q0
Q1
30
Market Equilibrium

Fourth, what happens to the market for
peanut butter if there is a drought in the
Southeastern United States?
31
Price
The Market for Peanut Butter
($/Q)
S0
P0
D0
Q0
Q
(Quantity/year)
The Initial Equilibrium Price and Quantity
32
The Market for Peanut Butter
Price
($/Q)
S1
S0
1
P1
2
P0
2
D0
Q1
Q0
Impacts of a Drought in the
Southeastern United States
Q
(Quantity/year)
33
QUESTIONS???
34
Cautionary Notes
■ Choose your examples carefully

Why babysitters, steaks, Top
Ramen, wheat, and peanuts?
Rather than, say

Cars, houses, or shoes?
35
Cautionary Notes (cont.)
■ Analyze the effects of one change at a
time.


It is easy to try to analyze real-world
examples and create confusion because
more than one factor is changing.
Examples
36
Cautionary Notes (cont.)
■ Shortages and surpluses and the
media.
 Does a decrease in supply cause a
shortage?
 Does an increase in supply cause a
surplus?
37
Cautionary Notes (cont.)
■ What if prices are not allowed to adjust?
Quickly?
or
Another day?

These stories can be complex . . .
38
Cautionary Notes (cont.)
■ Maximum prices (price ceilings)
 Apartments in NYC and CA
 Anti-price gouging laws
 Gas price controls in the 1970s
 Rationing of health care services
 Others . . .
39
Cautionary Notes (cont.)
■ Minimum prices (price floors or price
supports)
 Minimum wages
 Farm programs
 Proposal for minimum price for alcohol
in the U.K.
 Others . . .
40