THE MARKET FORCES OF SUPPLY AND DEMAND. J. Mao

THE MARKET FORCES OF SUPPLY AND DEMAND J. Mao Markets ¨  A market is a group of buyers and sellers of a particular good or service ¤  Buyers as ...
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THE MARKET FORCES OF SUPPLY AND DEMAND J. Mao

Markets ¨ 

A market is a group of buyers and sellers of a particular good or service ¤  Buyers

as a group determine demand ¤  Sellers as a group determine supply ¨ 

Examples: farmers market, stock market, ebay, taobao

Markets ¨ 

Markets take many forms. ¤  Some

are highly organized. Buyers and sellers meet at a specific time and place, where an auctioneer helps set prices and arrange sales. ¤  Many are less organized.

Markets and Competition Monopoly: one seller (seller controls price) ¨  Oligopoly: few sellers (not always aggressive competition) ¨  Competitive market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price ¨ 

Perfect Competition ¨ 

Homogeneous good ¤  All

¨ 

products are exactly the same

Numerous buyers and sellers so that each has no influence over price ¤  Buyers

¨ 

and sellers are price takers

Perfect information

Examples

Monopolistic Competition Many sellers ¨  Slightly differentiated products ¨  Each seller may set price for its own product ¨ 

Markets and Competition ¨ 

Most markets fall between monopoly and perfect competition

Demand Quantity demanded: amount buyers are willing and able to purchase. ¨  Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded ¨ 

68

Individual Demand

PART II

Figure

HOW MARKETS WORK

1

The demand schedule is a table that shows the quantity demanded at each price. The demand curve, which graphs the demand schedule, illustrates how the quantity demanded of the good changes as its price varies. Because a lower price increases th quantity demanded, the demand curve slopes downward.

Catherine’s Demand Schedule and Demand Curve

Catherine’s Demand ¨  Schedule and Demand Curve Price of Ice-Cream Cone

Quantity of Cones Demanded

$0.00 0.50 1.00 1.50 2.00 2.50 3.00

12 cones 10 8 6 4 2 0

Price of Ice-Cream Cone $3.00 2.50 1. A decrease in price . . .

2.00 1.50 1.00

Demand curve

0.50 0

1

2

9 10 11 12 Quantity of Ice-Cream Cones 2. . . . increases quantity of cones demanded. 3

4

5

6

7

8

Figure

The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price. Thus, the market demand curve is found by adding horizontally the individual demand curves. At a price of $2.00, Catherine demands 4 ice-cream cones, and Nicholas demands 3 ice-cream cones. The quantity demanded in the market at this price is 7 cones.

Market Demand

Price of Ice-Cream Cone

Catherine

$0.00 0.50 1.00 1.50 2.00 2.50 3.00

12 10 8 6 4 2 0 Catherine's Demand

Nicholas +

7 6 5 4 3 2 1

+

19 cones 16 13 10 7 4 1

Nicholas's Demand

=

Market Demand

Price of Ice-Cream Cone

Price of Ice-Cream Cone

Price of Ice-Cream Cone

$3.00

$3.00

$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

DCatherine 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones

0.50

Market Demand as the Sum of Individual Demands

Market =

DNicholas 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones

2

DMarket

0.50 0

2

4

6 8 10 12 14 16 18 Quantity of Ice-Cream Cones

Change in Quantity Demanded versus Change in Demand ¨ 

Change in Quantity Demanded ¤  Movement

along the demand curve. ¤  Caused by a change in the price of the product ¨ 

Change in Demand ¤  A

shift in the demand curve, either to the left or right. ¤  Caused by a change in a determinant other than price.

Demand Shifters Any change that increases the quantity demanded at every price shifts the demand curve to the right and is called an increase in demand. ¨  Any change that reduces the quantity demanded at every price shifts the demand curve to the left and is called a decrease in demand. ¨ 

Demand Shifters

Demand Shifters 1. 

Number of buyers

Demand Shifters ¨ 

¨ 

Increase in # of buyers increase quantity demanded at each price Population growth, immigration, etc.

Demand Shifters 1.  2. 

Number of buyers Income

Demand Shifters ¨ 

How will your demand for a good change when your income goes fro $10,000 to $100,000?

Normal and Inferior Goods Normal good: other things equal, increase in income leads to increase in demand ¨  Inferior good: other things equal, increase in income leads to decrease in demand ¨ 

Examples of normal goods

Examples of inferior goods

Normal and Inferior Goods ¨ 

Note: goods can be normal for some ranges of income and inferior for other ranges

Demand Shifters 1.  2.  3. 

Number of buyers Income Price of related goods

Demand Shifters ¨  ¨ 

Suppose that the price of milk increases What will happen to the demand for soy milk?

Demand Shifters ¨ 

¨ 

Demand for soy milk should increase, because people will substitute at least part of their consumption of milk by soy milk Milk and Soy milk are substitute goods, or substitutes.

Demand Shifters ¨ 

What if the price of cereal increases?

Demand Shifters ¨ 

¨ 

Demand for both milk/soy milk should decrease, because cereal is usually consumed together with milk/soy milk They are complementary goods, or complements

Demand Shifters ¨ 

Substitutes: two goods for which the demand for one rises when the price of the other increases ¤  Coffee

and Tea ¤  Pork and Beef ¤  Toyota and Honda

Demand Shifters ¨ 

Complements: two goods for which the demand for one falls when the price of the other increases ¤  Printers

and ink cartridges ¤  Car and gas ¤  Computers and software

Demand Shifters 1.  2.  3.  4. 

Number of buyers Income Price of related goods Tastes/needs

Demand Shifters ¨ 

¨ 

If medical research shows that drinking coffee has significant health benefits, demand for coffee will increase If the weather becomes hotter, demand for airconditioner will increase

Demand Shifters 1.  2.  3.  4.  5. 

Number of buyers Income Price of related goods Tastes/needs Expectations

Demand Shifters ¨ 

Expectations affect consumers’ buying decisions. ¤  If

people expect their incomes to rise, their demand for meals at expensive restaurants may increase now. ¤  If the economy sours and people worry about their future job security, demand for new autos may fall now.

Shifts in the demand curve

Demand curve shifts to the right Price of substitute good rises ¨  Price of complementary good falls ¨  Income level rises (normal good) ¨  Increase in number of buyers ¨  People like the good more ¨ 

Shifts in the demand curve

Demand curve shifts to the left Price of substitute good falls ¨  Price of complementary good increases ¨  Income level rises (inferior good) ¨  Decrease in number of buyers ¨  People like the good less ¨ 

Corn and Oil Corn is the main feedstock used for producing ethanol fuel in the U.S. ¨  Ethanol and gasoline are substitutes in fuel consumption ¨ 

Corn and Oil There is a strong connection between price of corn and price of oil as both are substitute ways to fuel a car ¨  Other things are also changing. Importantly, countries like China and India are getting richer and there is an increase demand for both commodities, contributing to the upward pressure on corn and oil prices ¨ 

Two Ways to Reduce Smoking

Two Ways to Reduce Smoking

Supply Quantity supplied: amount that sellers are willing and able to sell. ¨  Supply schedule: a table that shows the relationship between the price of a good and the quantity supplied. ¨ 

Individual Supply ¨ 

Ben’s Supply Schedule and Supply Curve

Market Supply

Supply Shifters 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 supply curve ¨ 

Supply Shifters The supply curve shows how the price of a good affects its quantity supplied, other things being equal. ¨  These “other things” are determinants of supply other than the price of the good. Changes in them shift the supply curve ¨ 

Supply Shifters Any change that raises quantity supplied at every price shifts the supply curve to the right and is called an increase in supply. ¨  Any change that reduces the quantity supplied at every price shifts the supply curve to the left and is called a decrease in supply. ¨ 

Supply Shifters

Supply Shifters 1. 

Number of sellers ¤ 

Trade liberalization → supply↑

Supply Shifters 1.  2. 

Number of buyers Input Prices ¤ 

Milk price ↑ → Ice cream supply ↓

Supply Shifters 1.  2.  3. 

Number of buyers Input Prices Technology ¤ 

Invention of the assembly line → manufactured goods supply ↑

Supply Shifters 1.  2.  3.  4. 

Number of buyers Input Prices Technology Expectations ¤ 

Expectations of higher corn prices next year → corn supply this year ↓

Market Equilibrium ¨ 

¨ 

¨ 

Market equilibrium is determined by the intersection of the supply and demand curves Supply and demand together determine the prices of the economy’s goods and services. For now, we focus on the analysis of equilibrium of perfectly competitive markets.

Supply and Demand Together Demand Schedule

Price $0.00 0.50 1.00 1.50 2.00 2.50 3.00

Quantity 19 16 13 10 7 4 1

Supply Schedule

Price $0.00 0.50 1.00 1.50 2.00 2.50 3.00

Quantity 0 0 1 4 7 10 13

At $2.00, the quantity demanded is equal to the quantity supplied!

Equilibrium of Supply and Demand

Price of Ice-Cream Cone

Supply

$3.00

Equilibrium

2.50 2.00 1.50 1.00

Demand

0.50 0

1 2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

Market Equilibrium At the equilibrium price, quantity demanded = quantity supplied ¨  The equilibrium price is also called the marketclearing price ¨ 

Excess Supply Price of Ice-Cream Cone

Surplus

$3.00

Supply

2.50 2.00 1.50 1.00 Demand

0.50 0

1 2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

Excess Demand Price of Ice-Cream Cone

Supply $2.00 $1.50

Shortage

0

1

2

3

4

5 6

7

Demand

8 9 10 11 12 13 Quantity of Ice-Cream Cones

How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone

1. Hot weather increases the demand for ice cream...

Supply $2.50

New equilibrium

2.00 2. ...resulting in a higher price...

Initial equilibrium

D2

D1 0

3. ...and a higher quantity sold.

7

10

Quantity of Ice-Cream Cones

How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone

S2

1. An earthquake reduces the supply of ice cream...

S1 New equilibrium

$2.50 2.00

Initial equilibrium

2. ...resulting in a higher price...

Demand

0

1 2 3 4

7 8 9 10 11 12 13 3. ...and a lower quantity sold.

Quantity of Ice-Cream Cones

What Happens to Price and Quantity When Supply or Demand Shifts?

No Change In Demand An Increase In Demand A Decrease In Demand

No Change In Supply

An Increase In Supply

A Decrease In Supply

P Q P Q P Q

P Q P Q P Q

P Q P Q P Q

same same up up down down

down up ambiguous up down ambiguous

up down up ambiguous ambiguous down

Market Equilibrium ¨ 

In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources. ¤  Who

gets to live on the beachfront? ¤  Who joins the army? ¤  What coordinates the actions of billions of people?

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