Sep, 2016

Demand, Supply, and Equilibrium

Economic Department, Saint Louis University
Instructor: Xi Wang
What happens in a market? What is a Market?

• You walked into a farmers' market

• There stand a lot of buyers and sellers

• Trading happens, Cash only!

How do Buyer Behave?

• We assume that these buyers are price-takers: they treat the market price
as a take-it-or-leave-it offer;

• No bargaining happens

• Why? Since there are a lot of buyers! You are not the only one:(
How do Buyer Behave?

• Buyer are price taker!

• At a given price, the amount of the good or service that buyers are willing
to purchase is called the quantity demanded.
• How is quantity demanded related to Goods Price?
• Positive? Negative?No relationship?
• Example: For example, if gas prices rise, I might bike to school instead of
driving. Or I have an Upass, I can take the bus.
How do Buyer Behave?

• So the amount of gas I will demand is negatively related to the price of

gasoline.(holding all else equal)
• Since I will drive less if the price of gas is higher. Like this graph:
How do Buyer Behave?

• Demand curve plots the relationship between prices and quantity

demanded (holding all else equal)
Why do Buyer Behave in this way?

• Demand curve has an important property: Downward sloping (Law of

Demand)
• Why is it downward sloping?
• Since here is St.louis, Not mexico, Mango here is not very good!
• I miss Mango icecream I onced had in Mexico city, Question! How much I
would like to pay for one Mango icrecream now?

• OK, I am willing to pay $10!

How do Buyer Behave, Willing to Pay(Intro method)

• What if I have already had one, How much I am willing to pay one more?
• E.... $5?
• What if I have already had two, how much I am willing to pay one more?
• Gosh! You should pay me
• Willingness to pay is the highest price that a buyer is willing to pay for an extra unit of a
good.
• Did you see? As you consume more of a good, your willingness to pay for an additional
unit declines (diminishing marginal benefit)
• i.e you will get tired of pizza, when you just finish a whole piece of 12inch Pizza!
• When you get tired of something, the willingness to pay will decrease, right?
From Individual Demand Curves to Aggregate
From Individual Demand Curves to Aggregate, When we have more people

Note that (1)this demand curve is not a straight line

(2)Demand curves can exhibit this negative

relationship without being straight lines
Demand Curve, another Example
# of People wage cost # of consumer can Revenue Net Optim
to hire ($10/person) be served $10/person Benifit al ?
0 0 0 0 0

1 10 3 30 20

2 20 5 50 30

3 30 6.6 66 36

4 40 7.5 75 35

5 50 8 79 29

6 60 8.5 82 22
Demand Curve, another Example, what if wage changes?

# of People wage cost # of consumer can Revenue Net Optim

to hire ($6/person) be served $10/person Benifit al ?
0 0 0 0 0

1 6 3 30 24

2 12 5 50 38

3 18 6.6 66 48

4 24 7.5 75 51

5 30 8 79 49

6 36 8.5 82 46
Demand Curve, another Exercise
# of People wage cost # of consumer can Revenue Net Optim
to hire ($4/person) be served $10/person Benifit al ?
0 0

1 3

2 5

3 6.6

4 7.5

5 8

6 8.5
Demand Curve, another Exercise
# of People wage cost # of consumer can Revenue Net Optim
to hire ($4/person) be served $10/person Benifit al ?
0 0 0 0 0

1 4 3 30 26

2 8 5 50 42

3 12 6.6 66 44

4 12 7.5 75 57

5 20 8 79 59

6 24 8.5 82 58
Demand Curve, another Exercise
# of People to wage cost Marginal Cost Revenue Net Benifit Margin
hire ($4/person) $10/person al
Benifit

0 0 --- 0 0 ---

1 4 4 30 26 30

2 8 4 50 42 20

3 12 4 66 44 16

4 12 4 75 57 9

5 20 4 79 59 4

6 24 4 82 58 3
Billiken way to think about Demand Curve

• Every one propose a maximum amount of money he/she is willing to pay

• Say A diamond

• There are 5 people, whose Propose are

• $1000, $900, $800, $1200, $1100

Billiken way to think about Demand Curve

• What if I ask $850 as price?

• $1000, $900, $800, $1200, $1100

• What if I ask $ 950?

• $1000, $900, $800, $1200, $1100

Downward Sloping!!!!!
• What if I ask $ 1050?

• $1000, $900, $800, $1200, $1100

Shifting Demand Curve: Several Factors
The demand curve shifts when these five major factors change;

• Tastes and preferences

• Income and wealth

• Availability and prices of related goods, iphone 6s v.s 6

• Number and scale of buyers, Immigriant;

• Buyers’ beliefs about the future:

Shifting Demand Curve
Shifting Demand Curve: Preference

The demand curve shifts when these five major factors change

• Tastes and preferences, you are a green fighter! Hate global warming!

• Or you like the diamond or not?

• Income and wealth: Let's set ourselves in such a setting:

If my annual income is $10000, then I will not go to bid the diamond. So put in another
way, my propose would be pretty low.

Say I am only willing to pay $500 for this diamond. Why?

Shifting Demand Curve: Income

• Income and wealth: Let's set ourselves in such a setting:

If my annual income is $10000, then I will not go to bid the diamond. So put in another
way, my propose would be pretty low.

Say I am only willing to pay $500 for this diamond. Why?

Since My annual living cost would be around $7000. other entertainment cost would be
$2000, I do not have too much left. $ 500 means 50 meals for me. If I pay too much for this
diamond, I may have to stay hungry for someday.

Does homeless buy diamond? Iphone 6S?

Shifting Demand Curve

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Shifting Demand Curve: Income

• Normal good, an increase in income causes the demand curve to shift to the right.
Normal goods is the kind of good, you would like to have but cannot afford it now. For me,
say Tesla

• If rising income shifts the demand curve for a good to the left, then the good is called an
inferior good.

• For example, $1 burger. Homeless tends to have this as their main food. When he has
more budge balance, he will switch to, say Big Mac ($3.5).
Shifting Demand Curve: Other Goods

• Availability and prices of related goods, Iphone 6 v.s Sumsung Galaxy 5, prices are pretty
similar

• Think about it, if you are deciding which one you would choose, there comes a promotion
deal on Sumsung note, say $100 less. Which one will you choose? I will choose Sumsung
notes

• Two goods are said to be substitutes when the fall in the price of one leads to a left
shift in the demand curve for the other.

• Two goods are said to be complement when the fall in the price of one leads to a right
shift in the demand curve for the other. Say Coffee and Milk.
Shifting Demand Curve: Other Goods

• In English: Substitues means you only need to have one of these two(i.e they have
very similar function)

• Say iphone 6 and Samsung Galaxy 5

• Honda civic v.s Ford Focus

• Complementary pair means you must have them together

• Coffee and Milk

• Left shoe and Right Shoe

Shifting Demand Curve: Other Goods
Shifting Demand Curve: Other Goods
Shifting Demand Curve and Moving along the curve
Shifting Demand Curve: Number of People and Belief

• Number and scale of buyers, Immigriant; Or more people give me propose?

• Buyers’ beliefs about the future: What if you are expecting price is to increase?
How do sellers Behave?

• At a given price, the amount of the good or service that sellers are willing to supply is
called the quantity supplied

• ExxonMobil, An oil campany

• Holds several Drilling points, Some oil is easy to get. But Some oil is in deep-water
locations where the ocean depth is 2 miles and the oil is another 8 miles below the
seafloor.

• Because of the enormous expense, such wells are only drilled when the price of oil is over
$70 per barrel. We will see why.

• The higher the price of oil goes, the more drilling locations become profitable for
ExxonMobil.
How do sellers Behave?

• Supply curve plots the quantity supplied at different prices.

• Property?

• Willingness to accept is the lowest price that a seller is willing to get paid to sell an extra
unit of a good.

• Law of Supply: In almost all cases, the quantity supplied rises when the price rises
(holding all else equal).
How do sellers Behave?
Why is Supply curve upward-sloping?

• As we have talked about, The only behavior of an economic agent is to choose.

• What is the Choice of Seller here?

• (1) to Choose a optimal supply amount given the the price---Level Optimization

• (2) Or given the price is he/she willing to supply one more unit of goods?---Marginal
Optimization
Why is Supply curve upward-sloping

• For example, Oil company A has 8 Oil Well Drillings, and each one of them can produce
one gallon of gasoline per day. And the daily operation cost of these oil well is 1, 2, 3, 4,
5,6,7,8; Why Shall I order in this way?

• How about their daily operation cost is 6 7 8 5 3 1 2 4

• Ok if I operate the one with daily cost 6, it will cost me $6 and I will get 1 unit of oil in
return
Why is Supply curve upward-sloping

• List of Drilling points: 6 7 8 5 3 1 2 4

• Given price of is $10 dollar

• And which one you would like to operate if I only allow you to operate one drilling point?

• 67853124

• What if you can operate two drilling point?

• 67853124

• Three piont?

• 67853124
Why is Supply curve upward-sloping
Four pionts?

• 67853124

• Five pionts?

• 67853124

• Six piont?

• 67853124

• Seven piont?

• 67853124

• Eight piont?

• 67853124
Why is Supply curve upward-sloping
# Of drilling Total Cost Benefit Net Benefit Marginal Cost Marginal Benifit
Points to Operate （$5/ unit）

0 0 0 0 --- ---

1 1 5 5-1=4 1 5

2 3 10 10-3=7 2 5

3 6 15 15-6=9 3 5

4 10 20 20-10=10 4 5

5 15 25 25-15=10 5 5

6 21 30 30-21=9 6 5

7 28 35 35-28=7 7 5

8 36 40 40-36=4 8 5
Why is Supply curve upward-sloping
# Of drilling Total Cost Benefit Net Benefit Marginal Cost Marginal Benifit
Points to Operate （$7/ unit）

0 0 0 0 --- ---

1 1 7 1 7

2 3 14 2 7

3 6 21 3 7

4 10 28 4 7

5 15 35 5 7

6 21 42 6 7

7 28 49 7 7

8 36 56 8 7
Why is Supply curve upward-sloping, Marginal Cost is increasing

Why Marginal cost is 1 2 3 4 5 6 7 8?

• Since which one you will choose to be the first one to operate? The one with Cost $1

• Conditional on you have already operated one project. Then which one you will choose as
the extra one if I give you a opportunity to choose another one? The one with cost $2

• Conditional on you have already operated two projects. Then which one you will choose
as the extra one if I give you a opportunity to choose another one? The one with cost $3

• Conditional on you have already operated three projects. Then which one you will choose
as the extra one if I give you a opportunity to choose another one? The one with cost $4
Marginal Cost is increasing: Another Example
• What will be your new sequence of Marginal Cost if your project have daily cost 2 4.5 5 3.2 6.1 0.8 1.4?

• Since which one you will choose to be the first one to operate? The one with Cost $0.8

• Conditional on you have already operated one project. Then which one you will choose as the extra one if I give
you a opportunity to choose another one? The one with cost $1.4

• Conditional on you have already operated two projects. Then which one you will choose as the extra one if I
give you a opportunity to choose another one? The one with cost $2

• Conditional on you have already operated three projects. Then which one you will choose as the extra one if I
give you a opportunity to choose another one? The one with cost $3.2

• Since We always use our favorate first.

Marginal Cost is increasing v.s Diminishing Utility

• Since We always use our favorate first.

• Think in another way, Think about it, Now your favorite Fruit are (Cherry) >(Avacado) >(Watermelon)
>(Orange) >(Apple) >(Grape)
• Ok say, we have 6 cups of Juice, with corresponding favor.
• Which one you are going to have if I tell you that you can only have one?
• Cherry
• Conditional on you have already had Cherry Juice, which one you are to have if I tell you that you
can have an extra one?
• Acacado......
• Watermelon.....
• See- Your next one is always worse than current one
Why is Supply curve upward-sloping, Marginal Cost

• As we have talked about, in last example.

• What is the shape of Supply curve?

• Extend it:(Practice Quiz:)

• For example, Oil company A has 12 Oil Well Drillings, and each one of them can produce
one gallon of gasoline per day. And the daily operation cost of these oil well is 1, 2,
3, ...,12; Why Shall I order in this way?

• How about their daily operation cost is 6 12 8 9 10 1 3 4.....

• Say Now Market Price is 10, what is the optimal supply amount?
From Individual Supply to Aggregate Supply
Supply Shift

The supply curve shifts when these variables change:

• Prices of inputs used to produce the good

• Technology used to produce the good

• Number and scale of sellers

• Sellers’ beliefs about the future

Supply Shift
Supply Shift: Shift factors

The supply curve shifts when these variables change:

• Prices of inputs used to produce the good(If operating cost decrease)

• Technology used to produce the good: Why? Since these will change seller's Marginal
Cost(operating cost decrease)

• Number and scale of sellers, Of couse! It changes the amount of individual supply curve
to add up!

• Sellers’ beliefs about the future. For example, Groupon will expire tomorrow
Supply and Demand in Equilibrium

• How do buyers and sellers interact?

• What determines the market price at which they trade?

• What determines the quantity of goods bought by buyers and sold by sellers?

• Demand And Supply Analysis!

Supply and Demand in Equilibrium
Supply and Demand in Equilibrium， Some concepts

• This crossing point is defined to be the competitive equilibrium

• The price at the crossing point is referred to as the competitive equilibrium price

• The quantity at the crossing point is referred to as the competitive equilibrium quantity.

• Why do we name them to be “equilibrium XX”?

• Imagin what happen if the price or quantity is not at equilibrium price or quantity
Supply and Demand in Equilibrium

Excess Supply

Is it optimal to
supply more than
demand?
Supply > Demand
• Is the situation at Eq?
• Say price is at P
Everyone stays at their
Optimum; In another word,
they do not want to change But you can always
their decision. Earn 0 profit if you
do nothing

• Supply > Demand means what?

• Some of the firm cannot sell their product!

• Cannot sell product= Zero Revenue but positive cost!------Negative Profit!!

Supply and Demand in Equilibrium

Excess Demand

Is it optimal to
supply less than
demand?
Supply < Demand

• Is the situation at Eq?

• Say price is at P

• Supply < Demand means what?

• Means you can sell it when you set a higher price!

• Everyone knows it! Then every one is going to ask for a higher price!
What Would Happen If Price is fixed then?
Supply and Demand in Equilibrium

what would happen if a major oil

exporter suddenly stopped
production, as Libya did in 2011?
This causes a left shift of the
supply curve.
Then?
Equilibrium Changes
Supply and Demand in Equilibrium

what would happen if a Huge

amount electric cars are adopted?
This causes a left shift of the
Demand curve of Oil.
Then?
Equilibrium Changes
Supply and Demand in Equilibrium
How to model Price Control?

• What Would Happen If the Government Tried to Dictate the Price of Gasoline?

• Market will also work, but by another way

 Reading Assignment and Practice Question

Read Ch3-4

Recommended Question: Ch3-Problem 3, 4

Ch4-Problem 1, 5