Demand and Supply. Chapter 4, pages Chapter 5, pages

Demand  and  Supply   Chapter  4,  pages  99-­‐122     Chapter  5,  pages  125-­‐148     Theories  and  [email protected]   •  We  need  to  be  able  to  ...
Author: Philip Preston
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Demand  and  Supply   Chapter  4,  pages  99-­‐122     Chapter  5,  pages  125-­‐148    

Theories  and  [email protected]   •  We  need  to  be  able  to  predict  the   consequences  of     –  [email protected]  policies,  and   –  events  that  may  be  outside  our  control  

•  The  mental  tool  we  use  to  make  such   [email protected]  is  called  a  theory   •  A  theory  is  of  no  use  if  its  [email protected]  are   inaccurate   SUPPLY  AND  DEMAND  

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We  need  a  theory  of  prices   •  The  theory  of  demand  and  supply  is  a  simple   example  of  an  economic  theory   •  It  can  be  used  to  make  [email protected]  about  the   price  and  [email protected]  of  some  commodity   •  In  a  free-­‐market  economy,  most  economic   decisions  are  guided  by  prices   •  Therefore,  without  a  reliable  theory  of  prices,   you  will  get  nowhere  in  economic  analysis   SUPPLY  AND  DEMAND  

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Assume  perfect  [email protected]@on   •  The  theory  of  supply  and  demand  assumes  that   [email protected]  are  traded  in  perfectly  [email protected]@ve   markets   •  A  perfectly  compe--ve  market  is  a  market  in   which   –  there  are  many  buyers   –  many  sellers   –  and  all  sellers  sell  the  exact  same  product  

•  As  a  result,  each  buyer  and  seller  has  a  negligible   impact  on  the  market  price   SUPPLY  AND  DEMAND  

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Demand   •  Quan%ty  demanded  is  the  amount  of  a  good   that  buyers  are  willing  and  able  to  purchase   •  Demand  is  a  full  [email protected]  of  how  the   [email protected]  demanded  changes  as  the  price  of   the  good  changes.  

SUPPLY  AND  DEMAND  

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Catherine’s  Demand  Schedule  and   Demand  Curve   Price  of Ice-­‐Cream  Cone $3.00 2.50 1.  A  decrease   in  price  ...

2.00 1.50 1.00 0.50 6 7 8 9 10 11 12 Quan%ty  of Ice-­‐Cream  Cones 2.   ... increases  [email protected]   of  cones  demanded.

0 1 2 3 4 5

SUPPLY  AND  DEMAND  

Copyright  ©  2004    South-­‐Western  

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Market  Demand  is  the  Sum  of  Individual   Demands  

SUPPLY  AND  DEMAND  

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Law  of  Demand   •  The  law  of  demand  states  that     –  the  quan%ty  demanded  of  a  good  falls  when  the   price  of  the  good  rises,  and  vice  versa,  provided   all  other  factors  that  affect  buyers’  decisions  are   unchanged  

SUPPLY  AND  DEMAND  

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“provided  all  other  factors  …  are   unchanged”   •  That’s  an  important  phrase  in  the  wording  of  the  Law  of   Demand   •  The  [email protected]  demanded  of  a  consumer  good  such  as    ice   cream  depends  on   –  –  –  –  –  – 

The  price  of  ice  cream   The  prices  of  related  goods   Consumers’  incomes   Consumers’  tastes   Consumers’  [email protected]  about  future  prices  and  incomes   Number  of  buyers,  etc  

•  The  Law  of  Demand  says  that  the  [email protected]  demanded  of  a   good  is  inversely  related  to  its  price,  provided  all  other  factors   are  unchanged   SUPPLY  AND  DEMAND  

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Why  Might  Demand  Increase?   Quantity Demanded Price Situation A

0.00 0.50 1.00 1.50 2.00 2.50 3.00

12 10 8 6 4 2 0

Situation B

20 16 12 8 6 4 2

•  How  can  we  explain  the   difference  in   Catherine’s  behavior  in   [email protected]  A  and  B?   •  Why  does  she  consume   more  in  [email protected]  B  at   every  possible  price?  

SUPPLY  AND  DEMAND  

Price  

10   [email protected]  Demanded  

Shi]s  in  the  Market  Demand  Curve   •  …  are  caused  by  changes  in:  

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–  Consumer  income   –  Prices  of  related  goods   –  Tastes   –  [email protected],  say,  about  future  prices  and   prospects   –  Number  of  buyers  

SUPPLY  AND  DEMAND  

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Shi]s  in  the  Demand  Curve   Price  of Ice-­‐Cream Cone Increase in  demand

Decrease in  demand

Demand  curve,   D 3 0 SUPPLY  AND  DEMAND  

Demand curve,   D 1

Demand curve,   D 2

Quan%ty  of Ice-­‐Cream  Cones

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Shi]s  in  the  Demand  Curve   •  Consumer  Income  

–  As  income  increases  the  demand  for  a  normal  good   will  increase   –  As  income  increases  the  demand  for  an  inferior  good   will  decrease  

•  Prices  of  Related  Goods  

–  When  a  fall  in  the  price  of  one  good  reduces  the   demand  for  another  good,  the  two  goods  are  called   subs-tutes   –  When  a  fall  in  the  price  of  one  good  increases  the   demand  for  another  good,  the  two  goods  are  called   complements   SUPPLY  AND  DEMAND  

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The  Law  of  Demand—[email protected]     •  There  are  two  ways  to  explain  the  Law  of   Demand   –  [email protected]@on  effect   –  Income  effect  

SUPPLY  AND  DEMAND  

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[email protected]@on  Effect   •  When  the  price  of  a  good  decreases,   consumers  [email protected]  that  good  instead  of   other  [email protected]  ([email protected])  goods  

1.  When  the  price  of  Coke   decreases…  

Clothes  

Coke  

2.  Consump%on  of   Pepsi  decreases…  

Books  

Movies  

SUPPLY  AND  DEMAND  

3.  Consump%on  of   Coke  increases  

Pepsi   15  

Income  Effect   •  A  decrease  in  the  price  of  a  commodity  is   [email protected]  equivalent  to  an  increase  in   consumers’  income  

SUPPLY  AND  DEMAND  

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Lower  Prices  =  Higher  Income   Situation A Price of an Apple

$1.00

Price of an Orange

$2.00

Income

$10.00

If  prices  fall,  [email protected]  A   becomes  [email protected]  C.    

If  income  rises,  [email protected]  A   becomes  [email protected]  B.    

Situation B Price of an Apple

$1.00

Price of an Orange

$2.00

Income

$20.00

Situation C Price of an Apple

$0.50

Price of an Orange

$1.00

Income

$10.00 SUPPLY  AND  DEMAND  

Q:  Which  change  is  befer?   A:  They  are  both  equally   desirable.  A  fall  in  prices  is   equivalent  to  an  increase  in   income.  

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Income  Effect   •  Consumers  respond  to  a  decrease  in  the  price  of  a   commodity  as  they  would  to  an  increase  in  income   •  They  increase  their  [email protected]  of  a  wide  range  of   goods,  including  the  good  that  had  a  price  decrease  

1.  When  the  price  of  Coke   decreases…  

Clothes  

Coke  

2.  Consumers   feel  richer…  

Books  

Movies  

SUPPLY  AND  DEMAND  

3.  Consump%on  of  Coke  and   other  goods  increases  

Pepsi   18  

SUPPLY   •  Quan-ty  supplied  is  the  amount  of  a  good  that   sellers  are  willing  and  able  to  sell   •  Supply  is  a  full  [email protected]  of  how  the  [email protected]   supplied  of  a  commodity  responds  to  changes   in  its  price  

SUPPLY  AND  DEMAND  

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Ben’s  supply  schedule  and  supply  curve   Price  of    Ice-­‐Cream   Cones     $3.00   Price  of   Ice-­‐cream  cone  

[email protected]  of   Cones  supplied  

$0.00   0.50   1.00   1.50   2.00   2.50   3.00  

0  cones   0   1   2   3   4   5  

2.50   2.00   1.50   1.00  

Supply  curve   1.  An  increase   in  price  .  .  .  

2.  .  .  .  increases  [email protected]   of  cones  supplied.  

0.50   0   1   2   3   4   5   6   7   8   9   10  11   12   [email protected]  of  Ice-­‐Cream  Cones    

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Market  supply  and  individual   supplies   Price  of  ice-­‐cream  cone  

Ben    

$0.00   0.50   1.00   1.50   2.00   2.50   3.00  

0   0   1   2   3   4   5  

Jerry     +  

0   0   0   2   4   6   8  

Market     =  

0   0   1   4   7   10   13  

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Market supply and individual supplies Price  of    Ice   Cream   Cones   $3.00  

Ben’s   supply  

+  

SBen  

Price  of    Ice   Cream   Cones   $3.00  

Jerry’s   supply  

=  

Price  of    Ice   Cream   Cones  

SJerry  

$3.00  

2.50  

2.50  

2.50  

2.00  

2.00  

2.00  

1.50  

1.50  

1.50  

1.00  

1.00  

1.00  

0.50  

0.50  

0.50  

0   1   2   3   4   5   6   7   8   9   10  11   12   [email protected]  of  Ice-­‐Cream  Cones    

0   1   2   3   4   5   6   7   [email protected]  of    Ice-­‐Cream  Cones    

Market   supply  

SMarket  

0   2   4   6   8   10  12  14  16   18   [email protected]  of  Ice-­‐Cream  Cones     22  

Law  of  Supply   •  The  law  of  supply  states  that,  the  quan%ty   supplied  of  a  good  rises  when  the  price  of  the   good  rises,  as  long  as  all  other  factors  that   affect  suppliers’  decisions  are  unchanged  

SUPPLY  AND  DEMAND  

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Law  of  Supply—[email protected]     •  How  can  we  make  sense  of   the  numbers  in  Ben’s  supply   schedule?   •  The  best  guess  is  that  his   costs  must  be  something  like   the  cost  schedule  below.   A specific icecream cone

It’s cost ($)

1st

0.75

2nd

1.35

3rd

1.75

4th

2.30

5th

2.85

6th

3.10

In  this  way,  the  Law  of  Supply   follows  from  the  assump%on  of   Increasing  Costs  (or,  Diminishing   Returns)  

SUPPLY  AND  DEMAND  

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Shi]s  in  the  Supply  Curve:  What  causes  them?   Price  of Ice-­‐Cream Cone

Supply  curve,   S 3

Decrease in  supply

Supply curve,   S 1

Supply curve,   S 2

Increase in  supply

0 SUPPLY  AND  DEMAND  

Quan%ty  of Ice-­‐Cream  Cones 25  

Supply  Shi]   •  How  could  Ben’s  supply   have  increased?   Ice-cream cone

It’s cost ($) Before

After

1st

0.75

0.45

2nd

1.35

0.85

3rd

1.75

1.45

4th

2.30

1.95

5th

2.85

2.45

6th

3.10

2.90

Ben’s Supply Schedule Price ($)

Quantity Supplied Before

After

0.00

0

0

0.50

0

1

1.00

1

2

1.50

2

3

2.00

3

4

2.50

4

5

3.00

5

6

Anything  that  reduces   produc%on  costs,  shiOs   supply  to  the  right.   SUPPLY  AND  DEMAND  

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Shi]s  in  the  Supply  Curve…     •  …  are  caused  by  changes  in   –  Input  prices   –  Technology   –  Number  of  sellers  (short  run)  

•  The  market  supply  will  shi]  right  if   –  Raw  materials  or  labor  becomes  cheaper   –  The  technology  becomes  more  efficient   –  Number  of  sellers  increases   SUPPLY  AND  DEMAND  

27  

Equilibrium:  [email protected]  of  demand  and  supply   •  We  have  seen  what  demand  and  supply  are   •  We  have  seen  why  demand  and  supply  may   shi]   •  Now  it  is  @me  to  say  something  about  how   buyers  and  sellers  [email protected]  determine  the   market  outcome   •  To  do  this,  we  assume  equilibrium   •  Law  of  supply  and  demand   –  The  price  of  any  good  adjusts  to  bring  the  quan-ty   supplied  and  the  quan-ty  demanded  for  that  good  into   balance   SUPPLY  AND  DEMAND  

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Equilibrium     •  We  assume  that  the  price  will  [email protected]   reach  a  level  at  which  the  [email protected]  demanded   equals  the  [email protected]  supplied  

SUPPLY  AND  DEMAND  

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SUPPLY  AND  DEMAND  TOGETHER   Demand Schedule

Supply Schedule

At  $2.00,  the  [email protected]  demanded  is   equal  to  the  [email protected]  supplied!   SUPPLY  AND  DEMAND  

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Equilibrium  of  supply  and  demand   Price  of    Ice-­‐Cream   Cones     $3.00   2.50   2.00  

Supply   Equilibrium   price  

Equilibrium  

1.50   1.00   0.50  

Equilibrium   [email protected]  

Demand  

0   1   2   3   4   5   6   7   8   9   10  11   12   [email protected]  of  Ice-­‐Cream  Cones    

31  

Equilibrium   •  Can  we  [email protected]  the  [email protected]  of  equilibrium?  

32  

Markets  Not  in  Equilibrium   (a)  Excess  Supply Price  of Ice-­‐Cream Cone

Supply Surplus

$2.50 2.00

Demand

0

4 [email protected] demanded

7

10 [email protected] supplied

SUPPLY  AND  DEMAND  

Quan%ty  of Ice-­‐Cream Cones 33  

Markets  Not  in  Equilibrium   •  Surplus   –  When  price  exceeds  equilibrium  price,  then   [email protected]  supplied  is  greater  than  [email protected]   demanded   •  There  is  excess  supply  or  a  surplus   •  Suppliers  will  lower  the  price  to  increase  sales,  thereby   moving  toward  equilibrium  

SUPPLY  AND  DEMAND  

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Markets  Not  in  Equilibrium   (b)  Excess  Demand Price  of Ice-­‐Cream Cone

Supply

$2.00 1.50 Shortage Demand

0

4 [email protected] supplied

7

10 [email protected] demanded

SUPPLY  AND  DEMAND  

Quan%ty  of Ice-­‐Cream Cones 35  

Markets  Not  in  Equilibrium   •  Shortage   –  When  price  is  less  than  equilibrium  price,  then   [email protected]  demanded  exceeds  the  [email protected]  supplied   •  There  is  excess  demand  or  a  shortage   •   Suppliers  will  raise  the  price  due  to  too  many  buyers   chasing  too  few  goods,  thereby  moving  toward   equilibrium  

SUPPLY  AND  DEMAND  

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