The Economics Department, UMR Presents:

Supply and Demand: Price and Quantity Determination in Competitive Markets

Starring ‹

Demand

‹

Supply

Equilibrium and Disequilibrium ‹

Featuring ‹The Law of Demand ‹D = D(PENTE) ‹The Tendency of Supply ‹S = S(PENT) ‹Equilibrium/Disequilibrium

In Three Parts Demand Supply Equilibrium/Disequilibrium

Part 1

What is Demand? ‹It is the relationship between

quantity demanded and price, c.p., within a specific period ‹Or, it is the relationship between the maximum willingness to pay in return for something of value

Individual vs. Market Demand ‹Market demand is the

horizontal sum of individual demands ‹It is market demand that commands our interest

But Start with Individual Demand ‹Consider your demand for

peanuts per semester (This is called “Quantity Demanded, qd”) ‹We will first look at this information in a table called a “Demand Schedule”

Your Demand Schedule Demand Schedule - a table showing the relationship between the price of a good and the quantity demanded per period of time, ceteris paribus. Peanuts are measured in pounds.

Price of Peanuts ($) Quantity Demanded per semester

Your Demand Schedule P ($)

qd

$2.00

5

Your Demand Schedule P ($)

qd

$2.00

5

$1.50

7

Your Demand Schedule P ($)

qd

$2.00

5

$1.50

7

$1.00 10

15

Law of Demand ‹The price (willingness to pay) of

a product, service, or activity is inversely related to the quantity demanded, ceteris paribus. ‹Applies to Market Demand (but notice your demand for peanuts obeyed the law)

Demand Schedules and Curves ‹Demand Curve - a graph of

the demand schedule showing the relationship between the price of a good and the quantity demanded per period of time, ceteris paribus.

Individual Demand Curve P($) Note: ALWAYS label your axes!

qd per semester

Individual Demand Curve P($) 2.00 1.50 1.00 0.50 0

5

10

15

qd per semester

Individual Demand Curve P($) 2.00

A

1.50 1.00 0.50 0

5

10

15

qd per semester

Individual Demand Curve P($)

A

2.00

B

1.50 1.00 0.50 0

5

7

10

15

qd per semester

Individual Demand Curve P($) 2.00

A B

1.50

C

1.00 0.50 0

5

7

10

15

qd per semester

Individual Demand Curve P($) 2.00

A B

1.50

C

1.00

d

0.50 0

qd per semester 5

7

10

15

Market Demand Curve ‹The demand curve we just

drew was the Demand for Peanuts by one person. ‹We want an aggregate measure of the price, quantity demanded relationship--a market demand

Two Views of Demand ‹WTP - Maximum

willingness to pay for a given unit of a good (marginal WTP) or for a number of units of a good ‹The Law of Demand - P, Qd relationship

WTP and the Law of Demand The max. WTP for the 23rd unit is $1.50. The quantity demanded at $2.00 is 15 units per period

P

$2.00 $1.50

D 15

23

Qd/t

Market Demand Schedule ‹Market Demand Schedule - a

table showing the relationship between the price of a good and the total quantity demanded by all consumers in the market per period of time, ceteris paribus.

Market Demand Schedule ‹Market Demand is obtained

by summing horizontally the quantity demanded by each person at each price

Market Demand Schedule P($) 5

Mary’s qd 3

10

2

15

1

Market Demand Schedule P($) 5

Mary’s John’s qd qd 3 12

10

2

8

15

1

3

Market Demand Schedule P($) 5

Mary’s John’s qd qd 3 12

Ling’s qd 7

10

2

8

5

15

1

3

4

Market Demand Schedule P($) 5

Mary’s John’s qd qd 3 12

Ling’s Market qd Qd 7 22

10

2

8

5

15

15

1

3

4

8

Demand Curve P

Note: the linear demand is used for convenience

$15 $10 $5

D 8

15

22

Qd/t

Change in D vs. Change in Qd ‹ Change in Demand - a change in a factor

that effects demand other than the price of the good, thus there is a change in quantity demanded at EVERY price. ‹ Change in Quantity Demanded - a movement along a given demand curvedue only to a change in the price of the good itself

Change in Demand ‹Increase in demand - demand

curve shifts to the right (or up an increase in WTP) ‹Decrease in demand - demand curve shifts to the left (or down - a decrease in WTP)

Increase in Demand P

D

D’ Qd/t

Increase in Qd P($) A

B D Qd/t

Behind the Demand Curve ‹A

demand curve is drawn under the assumption of ceteris paribus all other important factors remaining unchanged ‹Factors to be considered may be remembered by D = D(PINTE)

Factors affecting market demand, PINTE ‹P =

Prices ‹I = income ‹N = number of buyers ‹T = tastes or preferences ‹E = expectations about future prices and market conditions

Price of Other Goods ‹The price of substitutes ‹The price of complements

Price of Substitutes ‹What would happen to the

demand for Peanuts if the price of pretzels fell? ™ The demand for Peanuts would probably

fall since people would buy pretzels instead.

‹There is a positive relationship

between the demand for a good and the price of its substitutes

Price of Substitutes ‹Thus an increase in the price

of a substitute will increase the demand for the good ‹And a decrease in the price of a substitute will decrease the demand for the good

Price of Complements ‹Complementary goods are

goods used together ‹What if the price of beer goes up? What ought to happen to the demand for Peanuts?

™ It ought to go down, since people want

beer to drink with Peanuts. If the price of beer rises, the demand for Peanuts will fall.

Price of Complements ‹Thus an increase in the price

of a complement will decrease the demand for the good ‹And a decrease in the price of a complement will increase the demand for the good

Price of Other Goods Summary

‹Thus, either of the following

will increase Demand • •

Price of a substitute good increases Price of a complement good decreases

‹And either of the following

will decrease Demand • •

Price of a substitute good decreases Price of a complement good increases

Income ‹ For most goods there is a

positive relationship between income and demand. These are defined as normal goods.

‹For inferior goods, there is an

inverse relationship between income and demand.

Normal and Inferior Goods ‹Are Peanuts a normal good?

Are they for you? If they are, upon graduation and a higher salary you would buy more peanuts. ‹The question is empirical how do people react?

Normal and Inferior Goods ‹What about Spam?

Is the relationship between income and demand positive or negative, c.p.? ‹Cheaper food products are examples of inferior goods

Number of Buyers ‹A positive relationship - the greater

the number of buyers, the larger the total quantity demanded of the good at a given price. Demand increases, or the demand curve shifts to the right. ‹Likewise, if there are fewer buyers in the market there is less quantity demanded at every price, so demand has decreased.

Tastes and Preferences ‹If we find out Peanuts improves

our attractiveness to others, our willingness to pay for Peanuts would increase (an upward shift of the demand curve) ‹If we find out Peanuts are unhealthy the demand for the good decreases (a leftward shift of the curve)

Expectations ‹If we were to hear a new

story about how Peanut prices were going to go up would you stock up? ‹If you expect your employer to begin downsizing would you reduce your demand for goods now?

Demand Reminders ‹ Demand curves downward and to the

right. ‹ Changes in only the price of a good cause changes in the quantity demanded. ‹ The only demand factor that cannot cause a change in the demand of a good is a change in its own price. ‹PINTE factors may alone or jointly

change the demand for a good.

The End

Continue to: Supply