Demand and Supply

Market and the Economy Demand The Demand Curve Demand versus Quantity Demanded Supply Supply versus Quantity Supplied Market Equilibrium Changes in Market Equilibrium

Specialization and Trade

In a market economy people can trade what they have (or have produced) for economic resources or goods they would like to have. Places, institutions, or mechanisms at or through which these trades take • palace are called markets. •

Money

as a medium of exchange, standard of value, and store of vale facilitates trade. Trade allows people to

specialize

greater efficiency in production. , resulting in

The Circular Flow Model

Markets and Prices Inputs Income > Households A Products Exp Input Markets Inputs Exp Firms V Product Markets

<

Rev Products

The Role of Price in the Market

Price is in essence the means of communication in the market. By offering higher prices buyers signal their desire to buy more of a good or a resource to sellers. Sellers, on the other hand, communicate the information about the cost of a good or a resource to buyers through price.

• • If too much of a good is produced => Price If not enough of a good is produced => Price

A Network of Markets

A market economy functions through a vast network of individual markets bringing together buyers and sellers of various goods and services as well as resources; e.g., the corner grocery store, the McDonald's restaurant, the New York Stock Exchange, The Chicago Mercantile Exchange In each market it is the interaction of

demand

and

supply

that determines the

price.

Competitive Markets

• • • • A competitive market is characterized by: Many sellers and many buyers Free (unhindered) entry and free exit Full information Homogenous products

No individual buyer or seller’s decisions would have a noticeable impact on the market price.

DEMAND

Demand and its Determinants

: A General Definition: Demand is the quantity of a good or resource that buyers (or demanders) are willing and able to buy under a given set of

conditions

over a given period of time.

Conditions

: price, income, taste, prices of related goods, expected prices, number of buyers, etc.

Demand and Price

Demand and Price, Ceteris Paribus:

A Narrower (More Specific) Definition Demand is a

schedule

or a

curve

showing the various amounts of a good or a service consumers (buyers) are willing and able to buy at various prices,

ceteris paribus

, over a specified period of time.

DEMAND SCHEDULE FOR MILK Price per Quart Quantity Demanded $1.50

1.40

1.30 1.20 1.10 1.00

0.90

45 50 55 60 65 70 75

NOTE: Quantity is in billions of quarts per year.

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

Law of Demand

Other things unchanged, as price rises, the quantity demanded decreases, and as price falls, the quantity demanded increases; the relationship between price and the quantity demanded is negative.

The Demand Curve:

A graphical representation of the demand schedule

The demand curve is a line or a curve showing the relationship between price and quantity demanded; it is a curve plotted in a two-dimensional space with

price

measured along the vertical axis and the

quantity demanded

measured along the horizontal axis. A demand curve shows the relationship between

price

and quantity demanded only ; all (other) factors affecting demand are assumed to remain unchanged

along

a demand curve.

$1.50

D

1.40

1.30

1.20

1.10

1.00

.90

A B C E F G

0 45 50 55 60 65 70 Quantity Demanded in Billions of Quarts per Year

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

75

H D

The Reasons Behind the Law of Demand

• The price a consumer pays for a good is, in fact, the opportunity cost of having it • The principle of diminishing marginal utility • Income and substitution effects

Individual Demand and Market Demand

An individual demand curve reflects the quantities of a good

a

consumer is willing and able to purchase at a range of possible prices, ceteris paribus, during a given period of time. A market demand (curve) is the (horizontal) sum of individual demands.

Demand (Curve) versus Quantity Demanded

By “demand”or “demand curve” we mean a range of quantities corresponding to various prices reflected along a line or a curve. By “quantity demanded” we mean

a

specific quantity demanded corresponding to

a

specific price.

Changes in Demand versus Changes in Quantity Demanded

• A change in

price

,

ceteris paribus

, results in a change in

quantity demanded

; that is a movement along the curve

not

a change in demand. • A

change in demand

(curve) results from changes in

factors other than price

. Such changes cause

shifts

of the demand curve.

Factors causing changes (shifts) in demand (curve):

• • • • • • Changes in income taste prices of related goods (substitutes or complementary goods) expectations about future prices, number of buyers Other non-self-price factors

D 1

An increase in income D 2

D 0

A decrease in income

C

$1.30

1.10

F

D 1

D 2

D 0 Quantity Demanded in Billions of Quarts per year

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

Supply

A General Definition

: Supply is the quantity of a good or resource that sellers (or suppliers) are willing and able to offer to the market for sale under a given set of conditions over a specific period of time.

Determinants of Supply

Factors affecting supply of a good include price, prices of inputs, technology, prices of related goods, taxes, expectations, number of firms, etc.

Supply and Price: A Narrower Definition

Supply (or a

supply curve

) is a schedule or curve showing the quantities of a product a firm (or firms) is (are) willing and able to produce and offer to the market for sale at a range of possible prices,

ceteris paribus

, over a certain period of time.

Supply Curve

The supply curve is a line or a curve showing the relationship between price and quantity supplied; it is a curve plotted in a two-dimensional space with price measured along the vertical axis and the quantity supplied measured along the horizontal axis. A supply curve shows the relationship between price and quantity supplied only; all (other) factors affecting supply are assumed to remain unchanged along a supply curve.

$1.50

1.40

1.30

1.20

1.10

1.00

.90

0

a S b c e f g h S

30 40 50 60 70 80 Quantity Supplied in Billions of Quarts per Year

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

90

Law of Supply

Other things remaining constant, as the price of a good rises, the corresponding quantity supplied increases, and as the price falls the quantity supplied decreases; the relationship between price and the quantity supplied is positive.

The Reason Behind the Law of Supply

As more and more of a good is produced, beyond some production level, the costs of producing additional units begin to rise. In order for a firm to produce more of that good it has to charge (or be offered) higher prices.

Individual Supply and Market Supply

An individual supply curve reflects the quantities of a good a producer (a firm) is willing and able to produce and offer for sale at a range of possible prices, ceteris paribus, during a given period of time. A market supply (curve) is the (horizontal) sum of individual supply curves.

Supply (Curve) versus Quantity Supplied

By Supply or supply curve we mean a

range

of quantities corresponding to various prices reflected along a line or a curve. By quantity supplied we mean a specific quantity supplied corresponding to a specific price.

Supply and Quantity supplied

• • • A change in price (ceteris paribus) results in a change in quantity supplied ( a movement along the curve), not a change in supply. A change in supply (or the supply curve) is caused by changes in factors other than price. Such changes cause shifts of the supply curve. Changes in resource prices, technology, prices of related goods (substitutes or accompanying products), expectations, number of firms, etc. will result in changes in (market) supply or shifts of the supply curve.

1.30

1.10

S 0

c f

S 1 Quantity Supplied in Billions of Quarts per Year

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

S 0 S 1

S 0 S 1

V U E

S 0 S 1 S 1

Quantity (a)

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

S 0

Quantity (b)

S 1 S 0

Market Equilibrium

Market equilibrium is a condition under which the quantity supplied is equal to the quantity demanded; when a market is in equilibrium, there is no tendency for change. The equilibrium price is the price at which the quantity demanded is equal to the quantity supplied.

Shortages

occur when price is below the equilibrium price; shortages cause the price to rise.

Surpluses

occur when price is above the equilibrium price; surpluses cause the price to fall.

Price per Quart

$1.50 1.40 (i $ - i Y ) 1.30 = p 1.20

1.10 1.00

0.90

Quantity Demanded

45 50 55 60 65 70 75

Quantity Supplied

90 80 70 60 50 40 30

Surplus or Shortage?

Surplus Surplus Surplus Neither Shortage Shortage Shortage NOTE: Quantity is in billions of quarts per year.

Copyright г 2000 by Harcourt, Inc. All rights reserved.

Price Direction

Fall Fall Fall Unchanged Rise Rise Rise

D A

$1.50

1.40

1.30

1.20

1.10

1.00

.90

0

S g E G D

30 40 50 60 70 Quantity in Billions of Quarts per Year

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

80

a S

90

$1.30

1.20

S D 0 D 1 E T R S

$1.20

1.10

D 2 D 0 E

L

M S D 0 D 1

60 70 75 Quantity

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

S

45

D 2 D 0

50 60 Quantity

D

$1.20

1.10

S 0 S 1 E J

60 65

D

78

S 0 S 1 S 2 D V

$1.40

1.20

U E

S

2

S 0

37.5

50 60 Quantity

D S 0

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

Changes in the Market Equilibrium

Changes (shifts) in the market supply and/or the market demand result in changes in the market equilibrium.

Using the S&D Tool to Address Some Policy Questions

• Who pays the excise taxes?

• Rent control • Subsidies for farmers • Minimum wage

P

D

$1.14

1.10

X 1.04

S 1 E 1 M S 1

t .1

0/g allo n

S 0 E 0 S 0 Q 2 Q 1

30 50 Quantity

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

D

Q

D

Market rent $2,000 1,200 Rent ceiling

C

0

S E

2.5

3 Millions of Dwellings Rented per Month

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

3.5

B S D

The Minimum Wage Controversy

Wage Surplus S 7.00

6.00

5.25

D Labor 0

D S 1 S 0

$1.30

$.90

S 1 S 0

Quantity

C op y ri g ht г 20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .

D