The model of supply and demand is the economics profession’s greatest contribution to human understanding because it explains the operation of the markets on which we depend for nearly everything that we eat, drink, or consume. The model is so powerful and so widely used that to many people it is economics. This chapter explains how the model works and how it can explain both the quantities that are bought and sold in markets as well as the prices at which they trade.
03 Demand,Supply,andMarketEquilibrium McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved Markets Interaction between buyers and • sellers Markets may be • Local • National • International • Price is discovered in the interactions of buyers and sellers LO1 3-2 Demand • Schedule or curve • Amount consumers are willing and • • • LO1 able to purchase at a given price Other things equal Individual demand Market demand 3-3 Law of Demand • Other things equal, as price falls the quantity demanded rises, and as price rises the quantity demanded falls • Reasons • Common sense • Law of diminishing marginal utility • Income effect and substitution effects LO1 3-4 The Demand Curve P P Qd $5 10 20 35 55 Price (per bushel) 80 LO1 D 10 20 30 40 50 60 70 80 Q Quantity Demanded (bushels per week) 3-5 Changes in Demand P Change in Demand Price (per bushel) Change in Quantity Demanded D2 D1 D3 10 12 14 16 18 Q Quantity Demanded (bushels per week) LO1 3-6 Determinants of Demand Determinants of Demand: Factors That Shift the Demand Curve Determinant Examples Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones Change in the number of buyers A decline in the birthrate reduces the demand for children’s toys Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods) Change in consumer expectations Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans LO1 3-7 Supply • Schedule or curve • Amount producers are willing and • • LO2 able to sell at a given price Individual supply Market supply 3-8 Law of Supply • Other things equal, as the price rises • LO2 the quantity supplied rises, and as the price falls the quantity supplied falls Reasons • Price acts as an incentive to producers • At some point, costs will rise 3-9 The Supply Curve P Price per Bushel Qs per Week $5 60 50 35 20 Price (per bushel) Supply of Corn S 10 20 30 40 50 60 70 Q Quantity supplied (bushels per week) LO2 3-10 Changes in Supply P $6 Change in Quantity S3 Supplied S1 Price (per bushel) S2 Change in Supply 10 12 14 16 Q Quantity supplied (thousands of bushels per week) LO2 3-11 Determinants of Supply Determinants of Supply: Factors That Shift the Supply Curve Determinant Examples Change in resource prices A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline Change in technology The development of more effective wireless technology increases the supply of cell phones Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education Change in prices of other goods An increase in the price of cucumbers decreases the supply of watermelons Change in producer expectations An expectation of a substantial rise in future log prices decreases the supply of logs today Change in the number of suppliers An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games LO2 3-12 Market Equilibrium • Equilibrium occurs where the demand • • curve and supply curve intersect Surplus and shortage Rationing functions of prices • The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent LO3 3-13 Market Equilibrium Qd $5 2,000 4,000 7,000 11,000 16,000 Price (per bushel) P 6,000 Bushel Surplus S 33 7,000 Bushel Shortage 67 10 D 12 14 16 P Qs $5 12,000 10,000 7,000 4,000 1,000 18 Bushels of Corn (thousands per week) LO3 3-14 ` Changes in Demand and Equilibrium D increase: P ,Q D decrease: P ,Q P P S S D2 D3 D1 0 Increase in demand LO4 D4 Decrease in demand 3-15 ` Changes in Demand and Equilibrium Changes in Supply and Equilibrium S increase: P ,Q S decrease: P ,Q P P S1 S4 S2 D D 0 Increase in supply LO4 S3 Decrease in supply 3-16 GovernmentSet Prices • Price Ceilings • Set below equilibrium price • Rationing problem • Black markets • Example: Rent control LO5 3-17 GovernmentSet Prices P $3.50 P0 S Ceiling 3.00 PC D Shortage Qs LO5 Q0 Qd Q 3-18 GovernmentSet Prices • Price Floors • Prices are set above the market • LO5 price • Chronic surpluses Example: Minimum wage laws 3-19 GovernmentSet Prices P S Surplus Floor $3.00 Pf 2.00 P0 D Q Qd LO5 Q0 Qs 3-20 ... (thousands per week) LO3 3-1 4 ` Changes in Demand and Equilibrium D increase: P ,Q D decrease: P ,Q P P S S D2 D3 D1 0 Increase in demand LO4 D4 Decrease in demand 3-1 5 ` Changes in Demand and Equilibrium. .. willing and • • • LO1 able to purchase at a given price Other things equal Individual demand Market demand 3-3 Law of Demand • Other things equal, as price falls the quantity demanded rises, and. .. women’s professional basketball games LO2 3-1 2 Market Equilibrium • Equilibrium occurs where the demand • • curve and supply curve intersect Surplus and shortage Rationing functions of prices