CHAPTER MARKET FORCES: DEMAND AND SUPPLY Objectives: Explain the laws of demand and supply, and identify factors that cause demand and supply to shift Calculate consumer surplus and producer surplus, and describe what they mean Explain price determination in a competitive market, and show how equilibrium changes in response to changes in determinants of demand and supply Explain and illustrate how excise taxes, ad valorem taxes, price floors, and price ceilings impact the functioning of a market Apply supply and demand analysis as a qualitative forecasting tool to see the “big picture” in competitive markets Chapter Outline Chapter Overview • Demand – Factors that change quantity demanded and factors that change demand – The demand function – Consumer surplus • Supply – Factors that change quantity supplied and factors that change supply – The supply function – Producer surplus • Market equilibrium • Price restrictions and market equilibrium – Price ceilings – Price floors • Comparative statics – Changes in demand – Changes in supply – Simultaneous shifts in supply and demand 2-2 Demand Demand 2-3 Demand Demand • Market demand curve – Illustrates the relationship between the total quantity and price per unit of a good all consumers are willing and able to purchase, holding other variables constant • Law of demand – The quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises) 2-4 Demand Market Demand Curve Price ($) $40 $30 $20 $10 Demand 20 40 60 80 Quantity (thousands per year) 2-5 Changes in Quantity Demanded Demand • Changing only price leads to changes in quantity demanded – This type of change is graphically represented by a movement along a given demand curve, holding other factors that impact demand constant • Changing factors other than price lead to changes in demand – These types of changes are graphically represented by a shift of the entire demand curve 2-6 Changes in Demand Demand Price Increase in demand A Decrease in demand B D1 D2 D0 Quantity 2-7 Demand Shifters Demand • Income – Normal good: A good for which an increase (decrease) in income leads to an increase (decrease) in the demand for that good – Inferior good: A good for which an increase (decrease) in income leads to a decrease (increase) in the demand for that good • • • • • Prices of related goods Advertising and consumer tastes Population Consumer expectations Other factors 2-8 Demand Shifters Demand • Income • Prices of related goods – Substitute goods: Goods for which an increase (decrease) in the price of one good leads to an increase (decrease) in the demand for the other good – Complement goods: Goods for which an increase (decrease) in the price of one good leads to a decrease (increase) in the demand for the other good • • • • Advertising and consumer tastes Population Consumer expectations Other factors 2-9 Demand Advertising and the Demand for Clothing Price of high-style clothing Due to an increase in advertising $50 $40 D2 D1 50,000 60,000 Quantity of high-style clothing 2-10 Supply The Market Supply Curve International Oil Market Price Supplyoil (Dollars per Barrel) $140 $100 $60 $20 80 160 240 Quantity (Millions of Barrels) 2-55 Change in Quantity Supplied Supply International Oil Market Price Supplyoil (Dollars per Barrel) $65 $60 Increase in quantity supplied $20 80 90 Quantity (Millions of Barrels) 2-56 Change in Supply in Action Supply International Oil Market Price (Dollars per Barrel) Supplyoil2 Decrease in supply Supplyoil1 $140 $100 $50 $20 100 160 180 240 Quantity (Millions of Barrels) 2-57 Market Equilibrium Competitive Market Equilibrium I International Oil Market Price (Dollars per Barrel) Supplyoil Surplus 160 million barrels $140 Forces of demand and supply put downward pressure on price Competitive market equilibrium Qd(Pe) = Qs(Pe) Forces of demand and supply put upward pressure on price Shortage Demandoil 160 million barrels $120 Pe = $80 $40 $20 40 Qe = 120 200 280 Quantity (Millions of Barrels) 2-58 Price Restrictions and Market Equilibrium Price Ceiling in Action I International Oil Market Price Supplyoil (Dollars per Barrel) Lost social welfare Nonpecuniary price $140 Pf = $120 Competitive market equilibrium Qd(Pe) = Qs(Pe) Pe = $80 Priceceiling Pc = $40 Shortage 160 million barrels $20 40 Qe = 120 Demandoil 200 280 Quantity (Millions of Barrels) 2-59 Comparative Statics Note: Changes in Demand • Increase in demand only – Increase equilibrium price – Increase equilibrium quantity • Decrease in demand only – Decrease equilibrium price – Decrease equilibrium quantity • Example of change in demand – Suppose that worldwide demand for automobiles is projected to decrease by 30% next year What is the impact on the international crude oil market? 2-60 Comparative Statics Change in Demand in Action International Oil Market Price Supplyoil (Dollars per Barrel) $140 Pe1 = $80 Pe2 = $54 Demandoil2 $20 Qe2 = 68 Qe1 = 120 Demandoil1 280 Quantity (Millions of Barrels) 2-61 Comparative Statics Note: Changes in Supply • Increase in supply only – Decrease equilibrium price – Increase equilibrium quantity • Decrease in supply only – Increase equilibrium price – Decrease equilibrium quantity • Example of change in supply – Suppose that war breaks out in a major oilproducing country in the Middle East What is the impact on the international crude oil market? 2-62 Comparative Statics Change in Supply in Action International Oil Market Price Supplyoil2 (Dollars per Barrel) Supplyoil1 $140 Pe2 = $100 Pe1 = $80 Demandoil $20 Qe2 = 80 Qe1 = 120 280 Quantity (Millions of Barrels) 2-63 Comparative Statics Simultaneous Shifts in Supply and Demand • Suppose that simultaneously the following two events occur: – worldwide demand for automobiles is projected to decrease by 30% next year – war breaks out in a major oil-producing country in the Middle East • What is the combined impact on the international crude oil market? 2-64 Comparative Statics Simultaneous Shifts in Supply and Demand in Action International Oil Market Price Supplyoil2 (Dollars per Barrel) Supplyoil1 $140 The equilibrium price increases or decreases depending on the magnitude of the demand and supply changes Pe1 = $80 Pe2 = $65 $20 Demandoil2 Qe2 = 10 Qe1 = 120 Demandoil1 280 Quantity (Millions of Barrels) 2-65 Practice Use the accompanying graph next slide to answer these questions • A Suppose demand is D and supply is S ! If a price ceiling of $6 is imposed, what are the resulting shortage and full economic price? • B Suppose demand is D and supply is S ! If a price floor of $12 is imposed, what is the resulting surplus? What is the cost to the government of purchasing any and all unsold units? • C Suppose demand is D and supply is S ! so that the equilibrium price is $10 If an excise tax of $6 is imposed on this product, what happens to the equilibrium price paid by consumers? The price received by producers? The number of units sold? • D Calculate the level of consumer and producer surplus when demand and supply are given by D and S ! respectively • E Suppose demand is D and supply is S ! Would a price ceiling of $2 benefit any consumers? Explain Copyright © 2014 by the McGraw-Hill Companies, Inc All rights reserved 2-66 Practice Copyright © 2014 by the McGraw-Hill Companies, Inc All rights reserved 2-67 Practice Consider a market where supply and demand are ' , given by 𝑄! =-10 +𝑃! and 𝑄! = 56 - 2Px Suppose the government imposes a price floor of $25, and agrees to purchase any and all units consumers not buy at the floor price of $25 per unit • Determine the cost to the government of buying firms’ unsold units • Compute the lost social welfare (deadweight loss) that stems from the $25 price floor Copyright © 2014 by the McGraw-Hill Companies, Inc All rights reserved 2-68 Practice • Consider a market where supply and demand are given by QXS = -16 + PX and QXd = 92 - 2PX Suppose the government imposes a price floor of $40, and agrees to purchase and discard any and all units consumers not buy at the floor price of $40 per unit • a Determine the cost to the government of buying firms’ unsold units • b Compute the lost social welfare (deadweight loss) that stems from the $40 price floor Copyright © 2014 by the McGraw-Hill Companies, Inc All rights reserved 2-69 ... in demand – Changes in supply – Simultaneous shifts in supply and demand 2- 2 Demand Demand 2- 3 Demand Demand • Market demand curve – Illustrates the relationship between the total quantity and. .. inferior good? 2- 15 Inverse Demand Function Demand • By setting