Lecture 2 Part II. Supply and Demand

Lecture 2 – Part II Supply and Demand Theory of Supply • A thought experiment with the following assumptions: – All apartments are identical – Each ...
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Lecture 2 – Part II Supply and Demand

Theory of Supply • A thought experiment with the following assumptions: – All apartments are identical – Each apartment has a different owner – There are 10 owners interested in selling their apartments – Owners are intelligent, well-informed people; they weigh the costs and benefits of their actions – Owners care only about their own monetary interests (self-interested rational behavior) – They are only interested in price, but they have different ideas about what is an acceptable price

Theory of Supply • Supply schedule A table showing the quantity of a good or service that would be offered by the sellers at each possible price • Supply curve Shows the same information in a graph A Supply Schedule for Apartments Price ($1000s) 100 99 98 97 96 95 94 93 92 91 90 Quantity of Apartments Supplied 10 9 8 7 6 5 4 3 2 1 0

A Supply Schedule for Apartments Price ($1000s) 100 99 98 97 96 95 94 93 92 91 90 Quantity of Apartments Supplied 10 9 8 7 6 5 4 3 2 1 0

Theory of Supply • Change in quantity supplied Movement along a supply curve in response to a price change • Change in supply A shift of the supply curve in response to a determinant other than price • Ceteris paribus «All else constant» or «other things equal» • Market supply The supply from all sellers in the market • Individual supply The supply from one individual seller

When does the supply curve shift to the right (outward)?

When does the supply curve shift to the left (inward)? 100

S2

S1

Price of Belts ($)

80

60

40

20

0

10

20

30

Quantity of Belts (number per month)

40

50

Nonprice determinants of supply 1. 2. 3. 4.

Available technology of production Resource prices The number of producers Producer expectations about future prices and technology 5. Prices of related goods and services

Theory of Demand • Assumptions: – 10 potential buyers for these apartments – They are well-informed – They make decisions based on rational selfinterest – They regard $100,000 as too high, but some of them are willing to buy the apartments as price falls

Theory of Demand • Demand schedule A table showing the quantity of a good or service that buyers are willing to purchase at each possible price • Demand curve Shows the same information in a graph

A Demand Schedule for Apartments Price ($1000s) Quantity of Apartments Demanded

100 99 98 97 96 95 94 93 92 91 0 1 2 3 4 5 6 7 8 9

90 10

A Demand Schedule for Apartments Price ($1000s) Quantity of Apartments Demanded

100 99 98 97 96 95 94 93 92 91 0 1 2 3 4 5 6 7 8 9

90 10

Theory of Demand • Change in quantity demanded Movement along a demand curve in response to a price change • Change in demand A shift of the demand curve in response to some determinant other than price • Effective demand The desire for a product combined with a purchasing ability on side of the consumer • Market demand The demand from all buyers in the market • Individual demand The demand from one individual buyer • Derived demand Demand for an input based on demand for the output it will help to produce

When does the demand curve shift to the right (outward)?

When does the demand curve shift to the left (inward)?

50

Price of Tables ($)

45 40 35

30

D1

25

D2 0

5

10

15

20

Quantity of Tables (number per month)

25

Nonprice determinants of demand 1. Tastes and preferences 2. Incomes and/or available assets 3. Availability and prices of related goods and services 4. Consumer expectations about future prices and incomes 5. The number of consumers

The theory of market adjustment Combined Supply and Demand Schedules for Apartments Price ($1000s) Quantity of Apartments Supplied Quantity of Apartments Demanded

100 99 98 97 96 95 94 93 92 91 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9

90 0 10

Market adjustment • Surplus A situation in which the quantity that sellers wish to sell at the stated price is greater than the quantity that buyers will buy at that price • Shortage A situation in which the quantity that buyers wish to buy at the stated price is greater than the quantity that sellers are willing to sell at that price • Equilibrium A situation that has reached a resting point, where there are no forces that create change

Market adjustment • Market-clearing equilibrium A situation in which the quantity supplied is equal to the quantity demanded • Theory of market adjustment The theory that market forces will tend to make price and quantity to move toward the equilibrium point • Market disequilibrium A situation of either shortage or surplus

Market clearing equilibrium

Market adjustment • Static model A model that ignores time, implicitly assuming that all adjustments occur anonymously • Dynamic model A model that takes into account the passage of time required for changes to occur

Shifts in Supply Supply and Demand Schedules After an Increase in Supply (Only) Price ($1000s) Quantity of Apartments Supplied Quantity of Apartments Demanded

100 99 98 97 96 95 94 93 92 91 12 11 10 9 8 7 6 5 4 3 0 1 2 3 4 5 6 7 8 9

90 2 10

Shifts in Demand Supply and Demand Schedules After an Increase in Demand (Only) Price ($1000s) Quantity of Apartments Supplied Quantity of Apartments Demanded

100 99 98 97 96 95 94 93 92 91 10 9 8 7 6 5 4 3 2 1 4 5 6 7 8 9 10 11 12 13

90 0 14

Summary of the Effects of Shifts in Supply and Demand Effect on Equilibrium Price

Effect on Equilibrium Quantity

Increase in Supply

fall

rise

Decrease in Supply

rise

fall

Increase in Demand

rise

rise

Decrease in Demand

fall

fall

Price

1981

2006 1979 1974 1978

1973

1986

1996

1995

2001

Quantity

Year

Quantity (millions of barrels per day)

Price (2000 dollars per barrel)

Explaining real-world prices and quantities

1981 2006

Price (2000 dollars per barrel)

1980

1979 1985

2004 1978

1996 1969

1986

1995

Quantity (millions of barrels per day)

Can the empirical data from the year 2006 be represented as an equilibrium in the oil market? Or is it a disequilibrium?

Oil market: 1979-1981

Oil market: 1995-1996

Price floor A law or agreement that puts a lower limit on prices

Price ceiling A law or agreement that puts a upper limit on prices