Chapter 3 - Demand, supply, and market equilibrium. 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.
Chapter Demand, Supply, and Market Equilibrium McGrawHill/Irwin Copyright © 2009 by The McGrawHill Companies, Inc. All rights reserved Chapter Objectives • Demand and its determinants • Supply and its determinants • Supply, demand, & market equilibrium • Changes in supply and demand • Government-set prices 3-2 A Market • Interaction between buyers and sellers • Buyers demand goods • Sellers supply goods • Assumptions – Standardized good – Competitive market 3-3 Demand • Schedule or curve • Amount consumers willing and able to purchase at a given price • Other things equal • Individual demand • Market demand 3-4 Law of Demand • Other things equal, as price falls quantity demanded rises • Explanations: – Diminishing marginal utility – Income effect – Substitution effect 3-5 Individual Demand P P Qd $5 10 Price (per bushel) 4 20 35 55 1 80 D 10 20 30 40 50 60 70 80 Q Quantity Demanded (bushels per week) 3-6 Determinants of Demand • Factors that shift the demand curve • Cause more or less to be bought at any possible price • Increase or decrease in demand • Tastes • Number of buyers 3-7 Determinants of Demand • Income – Normal goods – Inferior goods • Price of related goods – Substitute good – Complementary good – Unrelated goods • Consumer expectations 3-8 Individual Demand P P Qd $5 10 20 35 55 80 Price (per bushel) D2 D1 D3 10 12 14 16 18 Q Quantity Demanded (bushels per week) 3-9 Individual Demand P Change in Demand P Qd $5 10 20 35 55 80 Price (per bushel) Change in Quantity Demanded D2 D1 D3 10 12 14 16 18 Q Quantity Demanded (bushels per week) 3-10 Supply • Schedule or curve • Amount producers willing and able to sell at a given price • Individual supply • Market supply 3-11 Law of Supply • Other things equal, as price rises the quantity supplied rises • Explanations: – Revenue implications – Marginal cost 3-12 Individual Supply P S1 P Qs $5 60 Price (per bushel) 4 50 35 20 1 10 20 30 40 50 60 70 Quantity Supplied (bushels per week) Q 3-13 Determinants of Supply • • • • • • Resource prices Technology Taxes and subsidies Prices of other goods Producer expectations Number of sellers 3-14 Individual Supply P S3 P Qs $5 60 Price (per bushel) S1 S2 4 50 35 20 1 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3-15 Individual Supply P P Qs $5 60 50 35 Price (per bushel) S3 S1 Change in Quantity Supplied S2 Change in Supply 20 1 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3-16 Market Equilibrium • Equilibrium price and quantity • Surplus and shortage • Rationing function of price • Efficient allocation – Productive efficiency – Allocative efficiency 3-17 Market Equilibrium Qd $5 2,000 4,000 7,000 11,000 16,000 Price (per bushel) P 6,000 Bushel Surplus S $4 Price Floor $2 Price Ceiling 7,000 Bushel Shortage 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) 3-18 Market Equilibrium • Change in demand – Shift of the demand curve • Change in supply – Shift of the supply curve • Change in equilibrium price and quantity 3-19 Market Equilibrium Price Quantity • Supply increase; Demand decrease • Supply decrease; Demand increase • Supply increase; Demand increase • Supply decrease; Demand decrease ? ? ? ? 3-20 Government-Set Prices • Price ceilings on gasoline – Rationing problem – Black markets • Rent controls • Price floors on wheat – Optimal allocation of resources 3-21 A Market for Human Organs • Waiting list for transplants • Demand for organs • Supply of organs—two possibilities • Market eliminates shortage • Moral objections • Legalize and regulate? 3-22 A Market for Human Organs S1 P S2 Supply of Organs P1 At Price P1 the Shortage is Reduced By Q1 – Q2 P0 Demand for Organs D1 Q1 Q2 Q3 Q 3-23 Key Terms • • • • • • • • • • • • • • demand demand schedule law of demand diminishing marginal utility income effect substitution effect demand curve determinants of demand normal goods inferior goods substitute good complementary good change in demand change in quantity demanded • • • • • • • • • • • • • supply supply schedule law of supply supply curve determinants of supply change in supply change in quantity supplied equilibrium price equilibrium quantity surplus shortage price ceiling price floor 3-24 Next Chapter Preview… The U.S Economy: Public and Private Sectors 3-25 ... sellers 3- 14 Individual Supply P S3 P Qs $5 60 Price (per bushel) S1 S2 4 50 35 20 1 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3- 15 Individual Supply P P Qs $5 60 50 35 Price... implications – Marginal cost 3- 12 Individual Supply P S1 P Qs $5 60 Price (per bushel) 4 50 35 20 1 10 20 30 40 50 60 70 Quantity Supplied (bushels per week) Q 3- 13 Determinants of Supply • •... effect – Substitution effect 3- 5 Individual Demand P P Qd $5 10 Price (per bushel) 4 20 35 55 1 80 D 10 20 30 40 50 60 70 80 Q Quantity Demanded (bushels per week) 3- 6 Determinants of Demand •