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Hall and Lieberman, 3rd edition, Thomson South-Western, Chapter 3
Market (who, what, how) Supply and demand is an economic model
– – Designed to explain how prices are determined in certain types of markets
What you will learn in this chapter
How the model of supply and demand works and how to use it The law of demand The law of supply The determination of market equilibrium Factors shifting demand or supply curves
1. 2. 3. 4.
In economics, a market is not a place but rather a
group of buyers and sellers with the potential to trade with each other
– Market is defined not by its location but by its participants – First step in an economic analysis is to define and characterize the market or collection of markets to analyze
Economists think of the economy as a collection
of individual markets
depending on our purpose – How broadly or narrowly markets are defined is one of the most important differences between Macroeconomics and Microeconomics 4 .How Broadly Should We Define The Market Defining the market often requires economists to group things together – Aggregation is the combining of a group of distinct things into a single whole Markets can be defined broadly or narrowly.
Defining Macroeconomic Markets Goods and services are aggregated to the highest levels – Macro models lump all consumer goods into the single category ―consumption goods‖ – Macro models will also analyze all capital goods as one market – Macroeconomists take an overall view of the economy without getting bogged down in details 5 .
Defining Microeconomic Markets Markets are defined narrowly – Focus on models that define much more specific commodities Always involves some aggregation – But stops it reaches the highest level of generality that macroeconomics investigates 6 .
Buyers and Sellers Buyers and sellers in a market can be – Households – Business firms – Government agencies • All three can be both buyers and sellers in the same market. and households as only buyers – In most of our discussions. we’ll view business firms as the only sellers. but are not always For purposes of simplification this text will usually follow these guidelines – In markets for consumer goods. we’ll be leaving out the ―middleman‖ 7 .
individual buyers or sellers can influence the price of the product In perfectly competitive markets (or just competitive markets). and the product is standardized – Imperfectly competitive markets have just a few large buyers and sellers • Or else the product of each seller is unique in some way 8 . each buyer and seller takes the market price as a given What makes some markets imperfectly competitive and others perfectly competitive? – Perfectly competitive markets have many small buyers and sellers • Each is a small part of the market.Competition in Markets In imperfectly competitive markets.
Using Supply and Demand Supply and demand model is designed to explain how prices are determined in perfectly competitive markets – Perfect competition is rare but many markets come reasonably close – Perfect competition is a matter of degree rather than an all or nothing characteristic Supply and demand is one of the most versatile and widely used models in the economist’s tool kit 9 .
Demand A household’s quantity demanded of a good – Specific amount household would choose to buy over some time period. given • A particular price that must be paid for the good • All other constraints on the household Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period. given – A particular price they must pay for the good – All other constraints on households 10 .
given real-world limits on their spending power? Stresses price – Price of the good is one variable among many that influences quantity demanded – We’ll assume that all other influences on demand are held constant. so we can explore the relationship between price and quantity demanded 11 . at a specific price.Quantity Demanded Implies a choice – How much households would like to buy when they take into account the opportunity cost of their decisions? Is hypothetical – Makes no assumptions about availability of the good – How much would households want to buy.
―everything else remains the same. the quantity of the good demanded will fall – The words.The Law of Demand The price of a good rises and everything else remains the same.‖ in order to understand how demand reacts to price 12 . in order to understand the economy we must first understand each variable separately • Thus we assume that. ―everything else remains the same‖ are important • In the real world many variables change simultaneously • However.
demand is the entire relationship between price and quantity . with all other variables held constant Demand V.The Demand Schedule Demand schedule – A list showing the quantity of a good that consumers would choose to purchase at different prices.S. Quantities demanded .quantities demanded are specific amount of goods buyers want to buy 13 .
The Demand Curve The market demand curve (or just demand curve) shows the relationship between the price of a good and the quantity demanded . holding constant all other variables that influence demand – Each point on the curve shows the total buyers would choose to buy at a specific price Law of demand tells us that demand curves virtually always slope downward 14 .
000 bottles are demanded (point A).00 B D 40. 60.000 bottles are demanded (point B).00 per bottle.000 Number of Bottles per Month 15 .00 per bottle.00 A At $2. 40.000 60. 2.Figure 1: The Demand Curve Price per Bottle When the price is $4. $4.
―Movements Along‖ The Demand Curve Move along the demand curve – From a change in the price of the good we analyze In maple syrup example. Figure 1 – A fall in price would cause a movement to the right along the demand curve (point A to B) See figure 3(a) 16 .―Shifts‖ vs.
Figure 3(a): Movements Along and Shifts of The Demand Curve Price Price increase moves us leftward along demand curve P2 Price increase moves us rightward along demand curve P1 P3 Q2 Q1 Q3 Quantity 17 .
―Movements Along‖ The Demand Curve Shift of demand curve – a change in other things than price of the good causes a shift in the demand curve itself.―Shifts‖ vs. for example. income In Figure 2 – Demand curve has shifted to the right of the old curve (from Figure 1) as income has risen – A change in any variable that affects demand—except for the good’s price—causes the demand curve to shift 18 .
00 D1 D2 C 60. At each price.000 Number of Bottles per Month 19 .Figure 2: A Shift of The Demand Curve Price per Bottle An increase in income shifts the demand curve for maple syrup from D1 to D2. more bottles are demanded after the shift B $2.000 80.
causing the entire demand curve to shift.―Change in Quantity Demanded‖ vs. it is a change in demand 20 . ―Change in Demand‖ Language is important when discussing demand – ―Quantity demanded‖ means • A particular amount that buyers would choose to buy at a specific price • It is a number represented by a single point on a demand curve • When a change in the price of a good moves us along a demand curve. it is a change in quantity demand – The term demand means • The entire relationship between price and quantity demanded—and represented by the entire demand curve • When something other than price changes.
and decrease the demand for an inferior good Normal good and inferior good are defined by the relation between demand and income 21 .Income: Factors That Shift The Demand Curve An increase in income has effect of shifting demand for normal goods to the right – However. a rise in income shifts demand for inferior goods to the left A rise in income will increase the demand for a normal good.
Wealth: Factors That Shift The Demand Curve Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe .Example An increase in wealth will – Increase demand (shift the curve rightward) for a normal good – Decrease demand (shift the curve leftward) for an inferior good 22 .
shifting the demand curve to the right Complement—used together with the good we are interested in – Example – A rise in the price of a complement decreases the demand for a good. shifting the demand curve to the left 23 .Prices of Related Goods: Factors that Shift the Demand Curve Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose – Example – A rise in the price of a substitute increases the demand for a good.
demand decreases. and the demand curve shifts to the right – When tastes change away from a good. and the demand curve shifts to the left 24 . demand increases.Other Factors That Shift the Demand Curve Population – As the population increases in an area • Number of buyers will ordinarily increase • Demand for a good will increase Expected Price – An expectation that price will rise (fall) in the future shifts the current demand curve rightward (leftward) Tastes – Combination of all the personal factors that go into determining how a buyer feels about a good – When tastes change toward a good.
Small Summary -.Factors Affecting Demand Income (depends on good’s nature: normal or inferior) Wealth (depends on good’s nature) Prices of substitutes (positively related) Prices of complements (negatively related) Population (positively related) Expected price (positively related) Tastes (positively related) 25 .
Figure 3(b): Movements Along and Shifts of The Demand Curve Price Entire demand curve shifts rightward when: • income or wealth ↑ • price of substitute ↑ • price of complement ↓ • population ↑ • expected price ↑ • tastes shift toward good D2 D1 Quantity 26 .
Figure 3(c): Movements Along and Shifts of The Demand Curve Price Entire demand curve shifts leftward when: • income or wealth ↓ • price of substitute ↓ • price of complement ↑ • population ↓ • expected price ↓ • tastes shift toward good D1 D2 Quantity 27 .
given – A particular price for the good – All other constraints on the firm Market quantity supplied (or quantity supplied) is the specific amount of a good that all sellers in the market would choose to sell over some time period.Supply A firm’s quantity supplied of a good is the specific amount its managers would choose to sell over some time period. given – A particular price for the good – All other constraints on firms 28 .
so we can explore the relationship between price and quantity supplied 29 .Quantity Supplied Implies a choice – Quantity that gives firms the highest possible profits when they take account of the constraints presented to them by the real world Is hypothetical – Does not make assumptions about firms’ ability to sell the good – How much would firms’ managers want to sell. given the price of the good and all other constraints they must consider? Stresses price – The price of the good is just one variable among many that influences quantity supplied – We’ll assume that all other influences on supply are held constant.
in order to understand the economy we must first understand each variable separately • We assume ―everything else remains the same‖ in order to understand how supply reacts to price 30 . the quantity of the good supplied will rise – The words. ―everything else remains the same‖ are important • In the real world many variables change simultaneously • However.The Law of Supply States that when the price of a good rises and everything else remains the same.
The Supply Schedule and The Supply Curve Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices. with all other variables held constant Supply curve—graphical depiction of a supply schedule – Shows quantity of a good or service supplied at various prices. with all other variables held constant 31 .
000 bottles are supplied (point F).000 Number of Bottles per Month 32 .00 per bottle.00 G At $4. 2. S $4. 40.Figure 4: The Supply Curve Price per Bottle When the price is $2.000 60.000 bottles (point G).00 per bottle.00 F 40. quantity supplied is 60.
Movements Along the Supply Curve A change in the price of a good causes a movement along the supply curve – In Figure 4 • A rise (fall) in price would cause a rightward (leftward) movement along the supply curve A drop in transportation costs will cause a shift in the supply curve itself – In Figure 5 • Supply curve has shifted to the right of the old curve (from Figure 4) as transportation costs have dropped • A change in any variable that affects supply—except for the good’s price—causes the supply curve to shift 33 .Shifts vs.
00 G J S1 S2 60.Figure 5: A Shift of The Supply Curve Price per Bottle A decrease in transportation costs shifts the supply curve for maple syrup from S1 to S2.000 Number of Bottles per Month 34 . At each price. more bottles are supplied after the shift $4.000 80.
Factors That Shift the Supply Curve Input prices – A fall (rise) in the price of an input causes an increase (decrease) in supply. shifting the supply curve to the right (left) Price of Related Goods – When the price of an alternate good rises (falls). the supply curve for the good in question shifts leftward (rightward) Technology – Cost-saving technological advances increase the supply of a good. shifting the supply curve to the right 35 .
Factors That Shift the Supply Curve Number of Firms – An increase (decrease) in the number of sellers—with no other changes—shifts the supply curve to the right (left) Expected Price – An expectation of a future price increase (decrease) shifts the current supply curve to the left (right) 36 .
Factors That Shift the Supply Curve Changes in weather – Favorable weather • Increases crop yields • Causes a rightward shift of the supply curve for that crop – Unfavorable weather • Destroys crops • Shrinks yields • Shifts the supply curve leftward Other unfavorable natural events may effect all firms in an area – Causing a leftward shift in the supply curve 37 .
Figure 6(a): Changes in Supply and in Quantity Supplied Price Price increase moves us rightward along supply curve S P2 P1 P3 Price increase moves us leftward along supply curve Q3 Q1 Q2 Quantity 38 .
Figure 6(b): Changes in Supply and in Quantity Supplied
Price Entire supply curve shifts rightward when: • price of input ↓ • price of alternate good ↓ • number of firms ↑ • expected price ↑ • technological advance • favorable weather S1 S2
Figure 6(c): Changes in Supply and in Quantity Supplied
Price Entire supply curve shifts rightward when: • price of input ↑ • price of alternate good ↑ • number of firms ↓ • expected price ↑ • unfavorable weather
Summary: Factors That Shift The Supply Curve
The short list of shift-variables for supply that we
have discussed is far from exhaustive In some cases, even the threat of such events can cause serious effects on production Basic principle is always the same
– Anything that makes sellers want to sell more or less of a good at any given price will shift supply curve
respectively – At point where supply and demand curves cross 42 . will remain constant • Unless and until supply curve or demand curve shifts The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes. once achieved.Equilibrium: Putting Supply and Demand Together When a market is in equilibrium – Both price of good and quantity bought and sold have settled into a state of rest – The equilibrium price and equilibrium quantity are values for price and quantity in the market but.
00 H Excess Demand 4. .00 J D 1. causes the price to rise .00 per bottle an excess demand of 50. . 3. . At a price of $1.000 Number of Bottles per Month 43 . 1. shrinking the excess demand . S E $3. until price reaches its equilibrium value of $3.000 50.000 75.00 . . 25.000 bottles .Figure 7: Market Equilibrium Price per Bottle 2. . .
Excess Demand Excess demand – At a given price. the excess of quantity demanded over quantity supplied Price of the good will rise as buyers compete with each other to get more of the good than is available 44 .
000 50.Figure 8: Excess Supply and Price Adjustment Price per Bottle 1. shrinking the excess supply .000 bottles .000 65.000 Number of Bottles per Month 45 . D 35. Excess Supply at $5.00 3.00 S $5. 3.00. . . K E L 4. .00 2. until price reaches its equilibrium value of $3. . causes the price to drop.00 per bottle an excess supply of 30. At a price of $5.
Excess Supply Excess Supply – At a given price. the excess of quantity supplied over quantity demanded Price of the good will fall as sellers compete with each other to sell more of the good than buyers want 46 .
P is the price of the good. is quantity demanded. Supply is given by Q S 80 5P where Q s is quantity supplied.Solve for Equilibrium Algebraically Suppose that demand is given by the equationQ 140 10 P . What is the equilibrium price and quantity? D QD where 47 .
Income Rises: What Happens When Things Change Income rises. causing an increase in demand – Rightward shift in the demand curve causes rightward movement along the supply curve – Equilibrium price and equilibrium quantity both rise Shift of one curve causes a movement along the other curve to new equilibrium point 48 .
and equilibrium quantity increases too. An increase in demand . .00 E F' D2 D1 5. .Figure 9 Price per Bottle 4. . $4.00 3. moves us along the supply curve . Equilibrium price increases 3.000 Number of Bottles of Maple Syrup per Period 49 . . to a new equilibrium. S 2. 1. 50.000 60.
An Ice Storm Hits: What Happens When Things Change An ice storm causes a decrease in supply – Weather is a shift variable for supply curve • Any change that shifts the supply curve leftward in a market will increase the equilibrium price – And decrease the equilibrium quantity in that market 50 .
00 E D 35.Figure 10: A Shift of Supply and A New Equilibrium Price per Bottle $5.00 S2 E' S1 3.000 50.000 Number of Bottles 51 .
Using Supply and Demand: The Invasion of Kuwait Why did Iraq’s invasion of Kuwait cause the price of oil to rise? – Immediately after the invasion. United States led a worldwide embargo on oil from both Iraq and Kuwait – A significant decrease in the oil industry’s productive capacity caused a shift in the supply curve to the left • Price of oil increased 52 .
Figure 12: The Market For Oil Price per Barrel of Oil S2 S1 E' P2 P1 E D Q2 Q1 Barrels of Oil 53 .
the price of natural gas rose 54 .Using Supply and Demand: The Invasion of Kuwait Why did the price of natural gas rise as well? – Oil is a substitute for natural gas – Rise in the price of a substitute increases demand for a good – Rise in price of oil caused demand curve for natural gas to shift to the right • Thus.
Figure 13: The Market For Natural Gas Price per Cubic Foot of Natural Gas S F' P4 F P3 D1 D2 Q3 Q4 Cubic Feet of Natural Gas 55 .
. S2002 S2003 1. 2. . An increase in supply . 4.45 3. and quantity decreased as well. and a decrease in demand . $500 B A $400 5.Figure 11: Changes in the Market for Handheld PCs Price per Handheld PC 3. . moved the market to a new equilibrium. . . Price decreased .33 D2002 D2003 Millions of Handheld PCs per Quarter 56 . 2. .
Both Curves Shift When just one curve shifts (and we know the direction of the shift) we can determine the direction that both equilibrium price and quantity will move When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantity—but not both – Direction of the other will depend on which curve shifts by more 57 .
The Three Step Process Key Step 1—Characterize the Market – Decide which market or markets best suit problem being analyzed and identify decision makers (buyers and sellers) who interact there Key Step 2—Find the Equilibrium – Describe conditions necessary for equilibrium in the market. and a method for determining that equilibrium Key Step 3—What Happens When Things Change – Explore how events or government polices change market equilibrium 58 .
Demand & Supply Diagram Equilibrium P & Q Why $1000 can not be equilibrium? Effects from a tornado destroying some apartments. rent($) 800 1000 1200 1400 quantity demanded 30 25 22 19 quantity supplied 10 14 17 19 1600 1800 17 15 21 22 59 . chapter 3 in textbook.Example: rental apartment Example: problem 4.
Demand for two bedroom rental apartment 60 .
and give examples of each. or both. Explain the difference between a change in demand (shift of the curve) and a change in quantity demanded (movement along the curve). Use a demand schedule and a demand curve to demonstrate the law of demand. you will be able to Characterize a market. Similar analysis for supply side.Summaries Through the study of the chapter. Explain what will happen in a competitive market after a shift in the supply curve. Explain how equilibrium price and quantity are determined in a competitive market. the demand curve. Describe the three steps economists take to answer almost any question about the economy. 61 . List the factors that will lead to a change in demand.
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