Economics NINTH EDITION Chapter Demand, Supply, and Market Equilibrium Prepared by Brock Williams Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved Learning Objectives 4.1 Describe and explain the law of demand 4.2 Describe and explain the law of supply 4.3 Explain the role of price in reaching a market equilibrium 4.4 Describe the effect of a change in demand on the equilibrium price 4.5 Describe the effect of a change in supply on the equilibrium price 4.6 Use information on price and quantity to determine what caused a change in price Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved DEMAND, SUPPLY, AND MARKET EQUILIBRIUM The model of demand and supply explains how a perfectly competitive market operates •Perfectly competitive market • A market with many buyers and sellers of a homogeneous product and no barriers to entry Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.1 THE DEMAND CURVE • (1 of 5) Quantity demanded The amount of a product that consumers are willing and able to buy • Demand schedule A table that shows the relationship between the price of a product and the quantity demanded, ceteris paribus Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.1 THE DEMAND CURVE (2 of 5) Here is a list of the variables that affect an individual consumer’s decision, using the pizza market as an example: • The price of the product (for example, the price of a pizza) • The consumer’s income • The price of substitute goods (for example, the prices of tacos or sandwiches or other goods that can be consumed instead of pizza) • The price of complementary goods (for example, the price of lemonade or other goods consumed with pizza) • The consumer’s preferences or tastes and advertising that may influence preferences • The consumer’s expectations about future prices Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.1 THE DEMAND CURVE (3 of 5) The Individual Demand Curve and the Law of Demand • Individual demand curve A curve that shows the relationship between the price of a good and quantity demanded by an individual consumer, ceteris paribus • Law of demand There is a negative relationship between price and quantity demanded, ceteris paribus • Change in quantity demanded A change in the quantity consumers are willing and able to buy when the price changes; represented graphically by movement along the demand curve Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.1 THE DEMAND CURVE (4 of 5) The Individual Demand Curve and the Law of Demand According to the law of demand, the higher the price, the smaller the quantity demanded, everything else being equal Therefore, the demand curve is negatively sloped: When the price increases from $6 to $8, the quantity demanded decreases from seven pizzas per month (point c) to four pizzas per month (point b) Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.1 THE DEMAND CURVE (5 of 5) From Individual Demand to Market Demand The market demand equals the sum of the demands of all consumers In this case, there are only two, so at each price the market quantity demanded equals the quantity demanded by Al plus the quantity demanded by Bea At a price of $8, Al’s quantity is four pizzas (point a) and Bea’s quantity is two pizzas (point b), so the market quantity demanded is six pizzas (point c) Each consumer obeys the law of demand, so the market demand curve is negatively sloped • Market demand curve A curve showing the relationship between price and quantity demanded by all consumers, ceteris paribus Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved APPLICATION THE LAW OF DEMAND FOR YOUNG SMOKERS APPLYING THE CONCEPTS #1: What is the Law of Demand? • As price decreases and we move downward along the market demand for cigarettes, the quantity of cigarettes demanded increases for two reasons First, people who smoked cigarettes at the original price respond to the lower price by smoking more Second, some people start smoking • A change in cigarette taxes in Canada illustrates the second effect, the new-smoker effect In 1994, several provinces in eastern Canada cut their cigarette taxes and the price of cigarettes in the provinces decreased by roughly 50 percent Researchers tracked the choices of 591 youths from the Waterloo Smoking Prevention Program, and concluded that the lower price increased the smoking rate by roughly 17 percent Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.2 THE SUPPLY CURVE (1 of 8) Suppose you ask the manager of a firm, “How much of your product are you willing to produce and sell?” The manager’s decision about how much to produce depends on many variables, including the following, using pizza as an example: • The price of the product (for example, the price per pizza) • The wage paid to workers • The price of materials (for example, the price of dough and cheese) • The cost of capital (for example, the cost of a pizza oven) • The state of production technology (for example, the knowledge used in making pizza) • Producers’ expectations about future prices • Taxes paid to the government or subsidies (payments from the government to firms to produce a product) Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.4 MARKET EFFECTS OF CHANGES IN DEMAND Increases in Demand Shift the Demand Curve Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (3 of 6) 4.4 MARKET EFFECTS OF CHANGES IN DEMAND Increases in Demand Shift the Demand Curve An increase in demand shifts the demand curve to the right: At each price, the quantity demanded increases At the initial price ($8), there is excess demand, with the quantity demanded (point b) exceeding the quantity supplied (point a) The excess demand causes the price to rise, and equilibrium is restored at point c To summarize, the increase in demand increases the equilibrium price to $10 and increases the equilibrium quantity to 40,000 pizzas Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (4 of 6) 4.4 MARKET EFFECTS OF CHANGES IN DEMAND Decreases in Demand Shift the Demand Curve A decrease in demand shifts the demand curve to the left: At each price, the quantity demanded decreases At the initial price ($8), there is excess supply, with the quantity supplied (point a) exceeding the quantity demanded (point b) The excess supply causes the price to drop, and equilibrium is restored at point c To summarize, the decrease in demand decreases the equilibrium price to $6 and decreases the equilibrium quantity to 20,000 pizzas Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (5 of 6) 4.4 MARKET EFFECTS OF CHANGES IN DEMAND Decreases in Demand Shift the Demand Curve Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (6 of 6) APPLICATION CHINESE DEMAND AND PECAN PRICES APPLYING THE CONCEPTS #4: How does a change in demand affect the equilibrium price? • Between 2006 and 2009, Chinese imports of US pecans increased from million pounds per year to 88 million pounds • The increase in demand from China is roughly 30 percent of the total annual crop The increase in demand was caused in part by widespread reports in the Chinese media that pecans promote brain and cardiovascular health • As a result of the increase in demand, the equilibrium price of pecans increased by about 50 percent, increasing the price of pecan pie, a holiday favorite Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.5 MARKET EFFECTS OF CHANGES IN SUPPLY Change in Quantity Supplied versus Change in Supply (A) A change in price causes a change in quantity supplied, a movement along a single supply curve For example, an increase in price causes a move from point a to point b (B) A change in supply (caused by a change in something other than the price of the product) shifts the entire supply curve For example, an increase in supply shifts the supply curve from S1 to S2 For any given price (for example, $6), a larger quantity is supplied (25,000 pizzas at point c instead of 20,000 at point a) The price required to generate any given quantity decreases For example, the price required to generate 20,000 pizzas drops from $6 (point a) to $5 (point d ) Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (1 of 6) 4.5 MARKET EFFECTS OF CHANGES IN SUPPLY Increases in Supply Shift the Supply Curve Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (2 of 6) 4.5 MARKET EFFECTS OF CHANGES IN SUPPLY An Increase in Supply Decreases the Equilibrium Price An increase in supply shifts the supply curve to the right: At each price, the quantity supplied increases At the initial price ($8), there is excess supply, with the quantity supplied (point b) exceeding the quantity demanded (point a) The excess supply causes the price to drop, and equilibrium is restored at point c To summarize, the increase in supply decreases the equilibrium price to $6 and increases the equilibrium quantity to 36,000 pizzas Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (3 of 6) 4.5 MARKET EFFECTS OF CHANGES IN SUPPLY Decreases in Supply Shift the Supply Curve Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (4 of 6) 4.5 MARKET EFFECTS OF CHANGES IN SUPPLY A Decrease in Supply Increases the Equilibrium Price A decrease in supply shifts the supply curve to the left At each price, the quantity supplied decreases At the initial price ($8), there is excess demand, with the quantity demanded (point a) exceeding the quantity supplied (point b) The excess demand causes the price to rise, and equilibrium is restored at point c To summarize, the decrease in supply increases the equilibrium price to $8 and decreases the equilibrium quantity to 24,000 pizzas Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (5 of 6) 4.5 MARKET EFFECTS OF CHANGES IN SUPPLY Simultaneous Changes in Demand and Supply (A) Larger increase in demand If the increase in demand is larger than the increase in supply (if the shift of the demand curve is larger than the shift of the supply curve), both the equilibrium price and the equilibrium quantity will increase (B) Larger increase in supply If the increase in supply is larger than the increase in demand (if the shift of the supply curve is larger than the shift of the demand curve), the equilibrium price will decrease and the equilibrium quantity will increase Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved (6 of 6) APPLICATION THE HARMATTAN AND THE PRICE OF CHOCOLATE APPLYING THE CONCEPTS #5: How does a change in supply affect the equilibrium price? • Every year around harvest time for the cocoa crop in West Africa, the harmattan, a dry dusty wind from the Sahara desert, sweeps through cocoa plantations in Ghana and Ivory Coast, drying the pods and reducing yields • In 2015, the harmattan was longer than usual (14 days compared to the usual days), so crop yields were lower than usual • The decrease in supply from the long harmattan was one factor n the large increase in the world price of cocoa prices in 2015 Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.6 PREDICTING AND EXPLAINING MARKET CHANGES Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved APPLICATION WHY LOWER DRUG PRICES? APPLYING THE CONCEPTS #6: What explains a decrease in price? • Ted Koppel, host of the ABC news program Nightline, once said, "Do you know what's happened to the price of drugs in the United States? The price of cocaine, way down, the price of marijuana, way down You don't have to be an expert in economics to know that when the price goes down, it means more stuff is coming in That's supply and demand." According to Koppel, the price of drugs dropped because the government's efforts to control the supply of illegal drugs had failed In other words, the lower price resulted from an increase in supply • Is Koppel's economic detective work sound? In Table4.5, Koppel’s explanation of lower prices is the third case Increase in supply This is the correct explanation only if along with a decrease we experience an increase in the equilibrium quantity But according to the U.S Department of Justice, the quantity of drugs consumed actually decreased during the period of dropping prices Therefore, the correct explanation of lower prices is the second case-Decrease in demand Lower demand—not a failure of the government's drug policy and an increase in supply—was responsible for the decrease in drug prices Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved KEY TERMS Change in demand Law of demand Change in quantity demanded Law of supply Change in quantity supplied Market demand curve Change in supply Market equilibrium Complements Market supply curve Demand schedule Minimum supply price Excess demand (shortage) Normal good Excess supply (surplus) Perfectly competitive market Individual demand curve Quantity demanded Individual supply curve Quantity supplied Inferior good Substitutes Supply schedule Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved ... of 5) The Individual Demand Curve and the Law of Demand • Individual demand curve A curve that shows the relationship between the price of a good and quantity demanded by an individual consumer,... graphically by movement along the demand curve Copyright © 2017, 2015, 2012 Pearson Education, Inc All Rights Reserved 4.1 THE DEMAND CURVE (4 of 5) The Individual Demand Curve and the Law of Demand... Demand to Market Demand The market demand equals the sum of the demands of all consumers In this case, there are only two, so at each price the market quantity demanded equals the quantity demanded