Markets and Competition. Markets and Competition. The Market Forces of Supply and Demand. Demand

4 The Market Forces of Supply and Demand In this chapter, look for the answers to these questions:  What factors affect buyers’ demand for goods? ...
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4

The Market Forces of Supply and Demand

In this chapter, look for the answers to these questions:  What factors affect buyers’ demand for goods?

PRINCIPLES OF

 What factors affect sellers’ supply of goods?  How do supply and demand determine the price of

ECONOMICS

a good and the quantity sold?

FOURTH EDITION

 How do changes in the factors that affect demand

N. G R E G O R Y M A N K I W

or supply affect the market price and quantity of a good?

Premium PowerPoint® Slides by Ron Cronovich 2008 update Modified by Joseph Tao-yi Wang

 How do markets allocate resources? CHAPTER 4

© 2008 South-Western, a part of Cengage Learning, all rights reserved

Markets and Competition

Markets and Competition  A perfectly competitive market:

 A market is a group of buyers and sellers of a

• all goods exactly the same • buyers & sellers so numerous that no one can

particular product.

 A competitive market is one with many buyers and sellers, each has a negligible effect on price.

 In modern economics,  A market is a group of buyers and sellers of a

 In modern economics,

and sellers so you can always “switch”

• No one can affect market price – each is a “price taker” (since others can always “switch”)

 A competitive market is one where buyers and

 In this chapter, we assume markets are perfectly

sellers have a negligible effect on price because there are substitutes on either side. THE MARKET FORCES OF SUPPLY AND DEMAND

affect market price – each is a “price taker”

• There are perfect substitutes for both buyers

particular product trading under certain “rules”.

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competitive. 2

3

The Demand Schedule

Demand  The quantity demanded of any good is the

 Demand schedule:

amount of the good that buyers are willing and able to purchase.

A table that shows the relationship between the price of a good and the quantity demanded.

 Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal

 Example: Helen’s demand for lattes.

 Notice that Helen’s preferences obey the Law of Demand. CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

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THE MARKET FORCES OF SUPPLY AND DEMAND

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Price Quantity of of lattes lattes demanded $0.00

16

1.00

14

2.00

12

3.00

10

4.00

8

5.00

6

6.00

4

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Helen’s Demand Schedule & Curve

Market Demand versus Individual Demand

Price Quantity of of lattes lattes demanded

Price of Lattes

$6.00

$0.00

16

1.00

14

$4.00

2.00

12

$3.00

3.00

10

$5.00

4.00

$2.00

0 CHAPTER 4

5

 Suppose Helen and Ken are the only two buyers in

4

Quantity 15 of Lattes

10

6

THE MARKET FORCES OF SUPPLY AND DEMAND

Price

Helen’s Qd

$0.00

16

+

8

=

24

1.00

14

+

7

=

21

2.00

12

+

6

=

18

3.00

10

+

5

=

15

4.00

8

+

4

=

12

5.00

6

+

3

=

9

6.00

4

+

2

=

6

The Market Demand Curve for Lattes P

Qd (Market)

$0.00

24

$5.00

1.00

21

$4.00

2.00

18

$3.00

3.00

15

4.00

12

5.00

9

6.00

6

P $6.00

$2.00 $1.00 $0.00

(Qd = quantity demanded)

the Latte market.

6

6.00

$0.00

the quantities demanded by all buyers at each price.

8

5.00

$1.00

 The quantity demanded in the market is the sum of

Ken’s Qd

Market Qd

Demand Curve Shifters  The demand curve shows how price affects quantity demanded, other things being equal.

 These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).

 Changes in them shift the D curve…

Q 0

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5

10

15

20

25

THE MARKET FORCES OF SUPPLY AND DEMAND

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Demand Curve Shifters: # of buyers

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THE MARKET FORCES OF SUPPLY AND DEMAND

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Demand Curve Shifters: # of buyers

 Increase in # of buyers

Suppose the number of buyers increases. Then, at each P, Qd will increase (by 5 in this example).

P

increases quantity demanded at each price, shifts D curve to the right.

$6.00 $5.00 $4.00 $3.00 $2.00 $1.00

Q

$0.00 0 CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

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Demand Curve Shifters: income

Demand Curve Shifters:

 Demand for a normal good is positively related

prices of related goods

 Two goods are substitutes if

to income.

an increase in the price of one causes an increase in demand for the other.

• Increase in income causes increase in quantity demanded at each price, shifts D curve to the right.

 Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.

(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)

 Other examples: laptops and desktop computers, compact discs and music downloads, • In the news: Fresh and Frozen Vegetables after a typhoon

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THE MARKET FORCES OF SUPPLY AND DEMAND

Demand Curve Shifters:

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THE MARKET FORCES OF SUPPLY AND DEMAND

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Demand Curve Shifters: tastes

prices of related goods

 Anything that causes a shift in tastes toward a

 Two goods are complements if

good will increase demand for that good and shift its D curve to the right.

an increase in the price of one causes a fall in demand for the other.

 Example:

 Example: computers and software.

The organic diet became popular recently, caused an increase in demand for organic food, shifted the organic demand curve to the right.

If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.

 Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon



In the news: gasoline and cars

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

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Demand Curve Shifters: expectations

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

Summary: Variables That Affect Demand

 Expectations affect consumers’ buying

Variable

decisions.

• If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.

• If the economy turns bad and people worry about their future job security, demand for new autos may fall now.

THE MARKET FORCES OF SUPPLY AND DEMAND

16

A change in this variable…

Price

…causes a movement along the D curve

No. of buyers

…shifts the D curve

Income

…shifts the D curve

Price of related goods

…shifts the D curve

Tastes

…shifts the D curve

Expectations

…shifts the D curve

 Examples:

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15

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THE MARKET FORCES OF SUPPLY AND DEMAND

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ACTIVE LEARNING

1:

ACTIVE LEARNING

Demand curve

1:

A. price of iPods falls

Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

Music Music downloads downloads and and iPods iPods are are complements. complements. A A fall fall in in price price of of iPods iPods shifts shifts the the demand demand curve curve for for music music downloads downloads to to the the right. right.

Price of music downloads

A. The price of iPods falls

P1

B. The price of music downloads falls D2

D1

C. The price of compact discs falls

Q2

Q1

Quantity of music downloads

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1: B. price of music downloads falls

ACTIVE LEARNING

Price of music downloads

Price of music downloads

ACTIVE LEARNING

The The D D curve curve does does not not shift. shift. Move Move down down along along curve curve to to aa point point with with lower lower P, P, higher higher Q. Q.

P1 P2

CDs CDs and and music music downloads downloads are are substitutes. substitutes. A A fall fall in in price price of of CDs CDs shifts shifts demand demand for for music music downloads downloads to to the the left. left.

P1

D1 Q1

Q2

1:

C. price of CDs falls

D1

D2 Q2

Quantity of music downloads

Q1

Quantity of music downloads

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The Supply Schedule

Supply

 Supply schedule:

 The quantity supplied of any good is the

A table that shows the relationship between the price of a good and the quantity supplied.

amount that sellers are willing and able to sell.

 Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal

 Example: Starbucks’ supply of lattes.

 Notice that Starbucks’ supply schedule obeys the Law of Supply. CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

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Price of lattes

Quantity of lattes supplied

$0.00

0

1.00

3

2.00

6

3.00

9

4.00

12

5.00

15

6.00

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Starbucks’ Supply Schedule & Curve P $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00

Market Supply versus Individual Supply

Price of lattes

Quantity of lattes supplied

$0.00

0

1.00

3

2.00

6

3.00

9

4.00

12

5.00

15

6.00

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 The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.

 Suppose Starbucks and Jitters are the only two sellers in this market.

Q 0

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10

15 24

THE MARKET FORCES OF SUPPLY AND DEMAND

(Qs = quantity supplied) Market Qs

Price

Starbucks

Jitters

$0.00

0

+

0

=

1.00

3

+

2

=

5

2.00

6

+

4

=

10

3.00

9

+

6

=

15

4.00

12

+

8

=

20

5.00

15

+

10

=

25

6.00

18

+

12

=

30

0

Supply Curve Shifters

The Market Supply Curve P $6.00

P

QS (Market)

$0.00

0

1.00

5

2.00

10

$4.00

3.00

15

$3.00

4.00

20

$2.00

5.00

25

6.00

30

$5.00

$1.00

 The supply curve shows how price affects quantity supplied, other things being equal.

 These “other things” are non-price determinants of supply.

 Changes in them shift the S curve…

Q

$0.00 0 CHAPTER 4

5

10 15

20 25 30

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Supply Curve Shifters: input prices

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THE MARKET FORCES OF SUPPLY AND DEMAND

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Supply Curve Shifters: input prices

 Examples of input prices:

Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example).

P

wages, prices of raw materials.

$6.00

 A fall in input prices makes production

$5.00

more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.

$4.00 $3.00 $2.00 $1.00

Q

$0.00 0 CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

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Supply Curve Shifters: technology

Supply Curve Shifters: # of sellers

 Technology determines how much inputs are

 An increase in the number of sellers increases

required to produce a unit of output.

the quantity supplied at each price,

 A cost-saving technological improvement has

shifts S curve to the right.

the same effect as a fall in input prices, shifts S curve to the right.

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THE MARKET FORCES OF SUPPLY AND DEMAND

30

Variable

Example: • Events in the Middle East lead to expectations of higher oil prices. • In response, owners of Texas oilfields reduce supply now, save some inventory to sell later at the higher price. • S curve shifts left. supply*

In general, sellers may adjust when their expectations of future prices change. (*If good not perishable.) THE MARKET FORCES OF SUPPLY AND DEMAND

ACTIVE LEARNING

32

2:

31

A change in this variable…

Price

…causes a movement along the S curve

Input prices

…shifts the S curve

Technology

…shifts the S curve

No. of sellers

…shifts the S curve

Expectations

…shifts the S curve

CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

33

A C T I V E L E A R N I N G 2: A. fall in price of photo imaging software

Supply curve Draw a supply curve for photo imaging software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost.

THE MARKET FORCES OF SUPPLY AND DEMAND

Summary: Variables That Affect Supply

Supply Curve Shifters: expectations

CHAPTER 4

CHAPTER 4

Price of photo imaging software

S1

P1 P2

S S curve curve does does not not shift. shift. Move Move down down along along the the curve curve to to aa lower lower P P and and lower lower Q. Q.

Picture source: Wikipedia

Q2 Q1

C. Professional photoshops raise the price of the services they provide. 34

Quantity of photo imaging software

35

2: B. fall in cost of producing the software

2: C. professional photoshops raise their price

ACTIVE LEARNING

Price of photo imaging software

S1

Q2

Price of photo imaging software

S S curve curve shifts shifts to to the the right: right: at at each each price, price, Q Q increases. increases.

S2

P1

Q1

ACTIVE LEARNING

Quantity of photo imaging software

P

D

S

$5.00 $4.00 $3.00 $2.00

Equilibrium: P has reached the level where quantity supplied equals quantity demanded

P

Q

QS

$5.00

$0

24

0

$4.00

1

21

5

$3.00

2

18

10

3

15

15

4

12

20

5

9

25

6

6

30

$2.00 $1.00

$0.00

$0.00

Q 5

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Equilibrium quantity: The quantity supplied and quantity demanded at the equilibrium price P D S $6.00 D S P

Q

Q

24

0

$5.00

$4.00

1

21

5

$4.00

$3.00

2

18

10

$3.00

3

15

15

4

12

20

5

9

25

$1.00

6

6

30

$0.00

$1.00

Q 0

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THE MARKET FORCES OF SUPPLY AND DEMAND

and QS = 25 lattes resulting in a surplus of 16 lattes Q 0

40

39

then QD = 9 lattes

$2.00

10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND

10 15 20 25 30 35

Surplus: when quantity supplied is greater than quantity demanded P Example: D Surplus S $6.00 If P = $5,

$0

$2.00

5

CHAPTER 4

$5.00

$0.00

Q 0

THE MARKET FORCES OF SUPPLY AND DEMAND

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Equilibrium price: The price that equates quantity supplied with quantity demanded P D S $6.00 D

$1.00

0

This This shifts shifts the the demand demand curve curve for for photo photo imaging imaging software, software, not not the the supply supply curve. curve.

Quantity of photo imaging software

36

Supply and Demand Together

$6.00

S1

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Surplus: when quantity supplied is greater than quantity demanded P D Surplus S Facing a surplus, $6.00 sellers try to increase $5.00 sales by cutting price.

Surplus: when quantity supplied is greater than quantity demanded P D Surplus S Facing a surplus, $6.00 sellers try to increase $5.00 sales by cutting price.

$4.00

This causes QD to rise and QS to fall…

$4.00

…which reduces the surplus.

$2.00

$3.00 $2.00 $1.00 $0.00 5

CHAPTER 4

Prices continue to fall until market reaches equilibrium.

$1.00 $0.00

Q 0

This causes QD to rise and QS to fall.

$3.00

10 15 20 25 30 35

Q 0

THE MARKET FORCES OF SUPPLY AND DEMAND

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5

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10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND

Shortage: when quantity demanded is greater than quantity supplied P Example: D S $6.00 If P = $1, $5.00 then $4.00 QD = 21 lattes and $3.00 QS = 5 lattes $2.00 resulting in a $1.00 shortage of 16 lattes

Shortage: when quantity demanded is greater than quantity supplied P Facing a shortage, D S $6.00 sellers raise the price,

$0.00

$0.00

Shortage 0

5

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Q

10 15 20 25 30 35 44

Shortage: when quantity demanded is greater than quantity supplied P Facing a shortage, D S $6.00 sellers raise the price,

$2.00 $1.00

$2.00 $1.00

Shortage

Q

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5

10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND

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To To determine determine the the effects effects of ofany anyevent, event, 1. 1. Decide Decide whether whetherevent eventshifts shifts SScurve, curve, DDcurve, curve,or orboth. both. 2. 2. Decide Decide in in which which direction direction curve curve shifts. shifts.

Prices continue to rise until market reaches equilibrium.

$3.00

$3.00

Three Steps to Analyzing Changes in Eq’m

causing QD to fall and QS to rise.

$4.00

causing QD to fall and QS to rise, …which reduces the shortage.

$4.00

0

THE MARKET FORCES OF SUPPLY AND DEMAND

$5.00

$5.00

43

3. 3. Use Use supply-demand supply-demand diagram diagram to to see see how the shift changes eq’m P how the shift changes eq’m Pand and Q. Q.

Shortage

$0.00

Q 0

CHAPTER 4

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10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND

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CHAPTER 4

THE MARKET FORCES OF SUPPLY AND DEMAND

47

EXAMPLE:

The Market for Hybrid Cars

EXAMPLE 1: A Change in Demand EVENT TO BE ANALYZED:

P

price of hybrid cars

P

Increase in price of gas.

S1

STEP 1:

D curve shifts because STEP 2: price of gas affects demand for D shifts right hybrids. because high gas STEP 3: does S curve not price makes hybrids The shift causes an shift, more because attractiveprice increase in price of gas does not relative to other cars. and quantity affect cost of of hybrid cars. producing hybrids.

P1

D1 Q

Q1

quantity of hybrid cars CHAPTER 4

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THE MARKET FORCES OF SUPPLY AND DEMAND

CHAPTER 4

D2

D1

Q

Q1 Q2

• occurs when a non-price determinant of supply

S1

changes (like technology or costs)

 Change in the quantity supplied:

P2

a movement along a fixed S curve • occurs when P changes

P1

 Change in demand: a shift in the D curve

• occurs when a non-price determinant of

D2

D1

demand changes (like income or # of buyers) Q

Q1 Q2

 Change in the quantity demanded: a movement along a fixed D curve • occurs when P changes 50

THE MARKET FORCES OF SUPPLY AND DEMAND

EXAMPLE 2: A Change in Supply

EXAMPLE 3: A Change in Both Supply

EVENT: New technology P reduces cost of producing hybrid cars.

EVENTS: price of gas rises AND new technology reduces production costs

and Demand

S1

S2

STEP 1:

S curve shifts because STEP 2: event affects P1 cost of production. P2 S shifts right D curve does not because event STEPbecause 3: shift, reduces cost, The shift causes production technology makes production price to fallof the is not one more profitable at and quantity to rise. factors thatprice. affect any given demand. CHAPTER 4

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THE MARKET FORCES OF SUPPLY AND DEMAND

 Change in supply: a shift in the S curve

P

Always be careful to distinguish b/w a shift in a curve and a movement along the curve.

P1

Terms for Shift vs. Movement Along Curve

EXAMPLE 1: A Change in Demand Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.

CHAPTER 4

S1

P2

STEP 1:

Both curves shift.

P S1

S2

P2 P1

STEP 2:

Both shift to the right. STEP 3:

D1 Q1 Q2

THE MARKET FORCES OF SUPPLY AND DEMAND

Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises.

Q

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D1 Q1

Q2

THE MARKET FORCES OF SUPPLY AND DEMAND

D2 Q

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3: Changes in supply and demand

EXAMPLE 3: A Change in Both Supply

ACTIVE LEARNING

and Demand

EVENTS: price of gas rises AND new technology reduces production costs STEP 3, cont.

But if supply increases more than demand, P falls.

P S1

Event A: A fall in the price of compact discs

P1

Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.

P2 D2

D1 Q1

CHAPTER 4

Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.

S2

Q

Q2

Event C: Events A and B both occur.

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THE MARKET FORCES OF SUPPLY AND DEMAND

3:

ACTIVE LEARNING

A. fall in price of CDs P

ACTIVE LEARNING

B. fall in cost of royalties

The market for music downloads S1

STEPS

1. D curve shifts

P1

2. D shifts left

P2

55

P

The market for music downloads S1

STEPS

3. P and Q both fall. D2 Q2 Q1

3:

1. S curve shifts (royalties are part 2. S shifts right of sellers’ costs) 3. P falls, Q rises.

D1

S2

P1 P2

Q

D1 Q1 Q2

56

Q

57

CONCLUSION:

3: C. fall in price of CDs AND fall in cost of royalties ACTIVE LEARNING

How Prices Allocate Resources

 One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.

STEPS STEPS 1. 1. Both Both curves curves shift shift (see (see parts parts AA && B). B).

 In market economies, prices adjust to balance

2. 2. D D shifts shifts left, left, SS shifts shifts right. right.

supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.

3. 3. PP unambiguously unambiguously falls. falls. Effect Effect on on Q Q is is ambiguous: ambiguous: The The fall fall in in demand demand reduces reduces Q, Q, the increase in supply the increase in supply increases increases Q. Q.

58

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CHAPTER SUMMARY  A competitive market has many buyers and

CHAPTER SUMMARY  Besides price, demand depends on buyers’

sellers, each of whom has little or no influence on the market price.

incomes, tastes, expectations, the prices of substitutes and complements, and # of buyers. If one of these factors changes, the D curve shifts.

 Economists use the supply and demand model to

 The upward-sloping supply curve reflects the Law

analyze competitive markets.

of Supply, which states that the quantity sellers supply depends positively on the good’s price.

 The downward-sloping demand curve reflects the Law of Demand, which states that the quantity buyers demand of a good depends negatively on the good’s price.

CHAPTER 4

 Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve. 60

THE MARKET FORCES OF SUPPLY AND DEMAND

CHAPTER SUMMARY  The intersection of S and D curves determine

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THE MARKET FORCES OF SUPPLY AND DEMAND

CHAPTER SUMMARY  We can use the supply-demand diagram to analyze the effects of any event on a market: First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one.

the market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded.

 If the market price is above equilibrium, a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise.

 In market economies, prices are the signals that guide economic decisions and allocate scarce resources.

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Seeing the Invisible Hand

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THE MARKET FORCES OF SUPPLY AND DEMAND

Seeing the Invisible Hand

Seeing the Invisible Hand

Seeing the Invisible Hand

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10 9

10

8 7

8

Demand

Price

Price

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5

Supply

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3 2

2

1 0

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quantity

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Seeing the Invisible Hand

Seeing the Invisible Hand

Seeing the Invisible Hand Seeing the Invisible Hand

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Price

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Quantity

Seeing the Invisible Hand

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Price

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Quantity

Summary • Supply, Demand, and Equilibrium • Step 1: Identify which curve shifts (or both) • Step 2: Identify what direction did it shift • Step 3: Use the S/D graph to find how equilibrium price and quantity change • Homework: Mankiw, p. 85-87, Problem 4, 7, 8, 12, 13

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