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Chapter 3 - Markets. In this chapter you will learn: Characteristics of a competitive market, how to construct a demand curve, shift in vs. a movement along the demand curve, how to construct a supply curve, shift in supply vs. movement along supply curve, how demand and supply interact to bring markets to equilibrium, how changes in supply and demand influence equilibrium price and quantity.
Chapter 3 Markets © 2014 by McGraw‐Hill Education What will you learn in this chapter? Characteristics of a competitive market How to construct a demand curve Shift in vs. a movement along the demand curve How to construct a supply curve Shift in supply vs. movement along supply curve How demand and supply interact to bring markets to equilibrium • How changes in supply and demand influence equilibrium price and quantity • • • • • • © 2014 by McGraw‐Hill Education Markets • A market refers to the buyers and sellers who trade a particular good or service – Markets can be located locally, globally, or even virtually • One special class of markets is the competitive market • Four characteristics of perfectly competitive markets Standardized good Full information No transaction costs Participants are price takers • In this chapter, markets are assumed to be perfectly competitive © 2014 by McGraw‐Hill Education Demand • As a group, consumers determine the demand for a product • The quantity demanded is the amount of a particular good or service that buyers are willing and able to purchase at a given price • The law of demand states that the lower the price, the higher the quantity demanded, all otherthingsequal â2014byMcGrawHillEducation Thedemandschedule ã Ademandschedule displaysthequantities demandedatvarious prices ã This demand schedule provides the quantity of cellphones demanded at specific prices • Notice that as price falls, the quantity demanded increases Cell phones Price (millions) ($) 30 180 60 160 90 140 120 120 150 100 180 80 210 60 240 40 270 20 © 2014 by McGraw‐Hill Education The demand curve The demand curve illustrates the relationship between the quantity demanded and the price of the good, holding all of the other non‐price determinants constant Price ($) 220 Cell phones 200 Price (millions) ($) 30 180 60 160 90 140 120 120 100 150 100 80 180 80 60 210 60 40 240 40 20 270 20 180 1. As the price decreases… 160 140 2. …the quantity demand increases 120 30 60 90 120 © 2014 by McGraw‐Hill Education 150 180 210 240 270 Quantity of cell phones (millions) Active Learning: Constructing demand Use the following demand schedule to construct the demand curve Price Quantity P 280 260 240 220 200 180 160 140 140 160 180 200 220 240 260 280 300 â2014byMcGrawHillEducation Q Changesindemand ã The five most important non‐price determinants of demand are: Preferences Number of buyers Incomes Expectations Price of related goods • What happens when one of the non‐price determinants changes? – If positive influence, demand increases – If negative influence, demand decreases © 2014 by McGraw‐Hill Education Shifting the demand curve Price ($) 240 200 160 120 DB 80 DA 40 DC 0 60 120 180 Quantityofcellphones(millions) â2014byMcGrawHillEducation 240 ã Whendemand increases,the demandcurveshifts to the right • When demand decreases, the demand curve shifts to the left Shifts versus movements There is an important difference between a shift in the demand curve and a movement along the demand curve Price ($) 240 Price ($) 240 200 200 160 160 120 120 DB 80 80 DA 40 D 40 DC 60 120 180 Quantity of cell phones (millions) 240 If a non‐price determinant changes, then the demand curve shifts with changes in the quantity demanded at every price 240 60 120 180 Quantity of cell phones (millions) If the price decreases, then quantity demanded increases and there is a movement along the demand curve. © 2014 by McGraw‐Hill Education 10 Active Learning: Shifts vs. movements Indicate whether a shift or movement occurs in the market for cellphones when each of the following determinants changes – Advertising causes individuals to prefer cellphones over home phones – Cellphonesgoonsale Cellphonecallingplansbecomemoreexpensive â2014byMcGrawHillEducation 11 Supply ã Asagroup,producers determinethesupply of a product • The quantity supplied is the amount of a particular good that producers are willing and able to purchase at a given price • The law of supply states that the higher the price, the higher the quantity supplied, all other things equal © 2014 by McGraw‐Hill Education 12 The supply schedule • A supply schedule displays the quantities supplied at various prices • This supply schedule provides the quantity of cellphones supplied at specific prices • Notice that as price increases, the quantity supplied increases Cell phones Price (millions) ($) 270 180 240 160 210 140 180 120 150 100 120 80 90 60 60 40 30 20 © 2014 by McGraw‐Hill Education 13 The supply curve Price ($) 200 Cell phones 180 Price (millions) ($) 270 180 240 160 210 140 180 120 150 100 120 80 90 60 60 40 30 20 As price increases… 160 quantity supplied increases… 140 120 100 80 60 40 20 30 60 90 120 150 180 210 240 270 Quantity of cell phones (millions) © 2014 by McGraw‐Hill Education 14 Active Learning: Constructing supply Use the following supply schedule to construct the supply curve Price Quantity P 130 260 390 520 650 780 910 1040 © 2014 by McGraw‐Hill Education 140 160 180 200 220 240 260 280 300 Q 15 Changes in supply • The five most important non‐price determinants of supply are: Technology Number of producers Price of Inputs Expectations Price of related goods • What happens when one of the non‐price determinants changes? – If positive influence, supply increases – If negative influence, supply decreases © 2014 by McGraw‐Hill Education 16 Shifting the supply curve Price ($) 240 SC 200 SA 160 SB • When supply increases, the supply curve shifts to the right • When supply decreases, the supply curve shifts to the left 120 80 40 0 60 120 180 240 Quantity of cell phones (millions) 300 © 2014 by McGraw‐Hill Education 17 Shifts versus movements There is an important difference between a shift in the supply curve and a movement along the supply curve Price ($) 240 SC Price ($) 240 200 SA 200 160 SB 160 SA 120 120 80 80 40 40 240 60 120 180 Quantity of cell phones (millions) 300 If a non‐price determinant changes, then the supply curve shifts with changes in the quantity supplied at every price © 2014 by McGraw‐Hill Education 240 60 120 180 Quantity of cell phones (millions) 300 If the price decreases, then quantity supplied decreases and there is a movement along the supply curve. 18 Active Learning: Shifts vs. movements • Indicate whether a shift or movement occurs in the market for cellphones when each of the following determinants change – A new Chinese cellphone manufacturer enters the market – Producers expect cellphones prices to rise ThepriceofcallingovertheInternet(e.g.Skype) decreases â2014byMcGrawHillEducation 19 Marketequilibrium ã Theequilibriumiswhere thesupplycurve intersectsthedemand curve Price ($) 200 S 150 – At this point, consumers are willing to buy exactly what producers are willing to sell 100 50 D 50 100 150 200 250 300 Quantity of cell phones (millions) • The equilibrium price is $100 • The equilibrium quantity is 150 M © 2014 by McGraw‐Hill Education 20 Active Learning: Finding equilibrium 1) Graph the supply and demand curve and find the equilibrium 2) Circle the market equilibrium price and quantity in the schedule Price QS QD P 130 280 260 260 390 240 520 220 650 200 780 180 910 160 1040 140 © 2014 by McGraw‐Hill Education 140 160 180 200 220 240 260 280 300 Q 21 Disequilibrium • What happens when the market is not in equilibrium? • If the market price is not equal to the equilibrium price, then quantity demanded is not equal to quantity supplied – If the price is too high, excess supply occurs and there is a surplus of the good or service • A lower price alleviates the surplus – If the price is too low, excess demand occurs and there is a shortage of the good or service • A higher price alleviates the shortage © 2014 by McGraw‐Hill Education 22 A surplus Price ($) 200 Surplus (excess supply) S 160 Price is too high 120 80 40 QD D QS 240 300 60 120 180 Quantity of cell phones (millions) • A surplus provides incentives for the price to decrease. • As the price decreases… 1) The quantity supplied decreases 2) The quantity demanded increases • The price continues to decrease until QS = QD = Q* © 2014 by McGraw‐Hill Education 23 A shortage Price ($) 200 S 160 120 80 Price is too low 40 ShortageQ QS(excess D demand) D 240 60 120 180 Quantity of cell phones (millions) © 2014 by McGraw‐Hill Education 300 • A shortage provides incentives for the price to increase. • As the price increases… 1) The quantity supplied increases 2) The quantity demanded decreases • The price continues to increase until QS = QD = Q* 24 Active Learning: Excess supply 1) Find the quantity demanded and quantity supplied at a price of $3 2) Quantify the excess supply (surplus) P QS QD 130 280 260 260 390 240 520 220 650 200 780 180 910 160 1040 140 © 2014 by McGraw‐Hill Education 25 Active Learning: Excess demand 1) Find the quantity demanded and quantity supplied at a price of $1 2) Quantify the excess demand (shortage) P QS QD 130 280 260 260 390 240 520 220 650 200 780 180 910 160 1040 140 â2014byMcGrawHillEducation 26 Changesinmarketequilibrium ã Theequilibriumpriceandquantityaredeterminedbythe intersectionofthedemandandsupplycurves ã If a non‐price factor changes, this affects the market equilibrium • To determine the effect on market equilibrium, there are three questions that must be answered: – Does the change affect demand? If so, how? – Does the change affect supply? If so, how? – Whathappenstoequilibriumpriceandquantity? â2014byMcGrawHillEducation 27 Shiftsindemand Supposethepriceoflandlineservicesuddenly skyrockets ã Marketforcellphonesis in equilibrium • More expensive substitute causes the demand to increase • The demand curve shifts right • The market equilibrium changes Price ($) 200 S2 180 160 140 120 100 80 60 D2 40 20 D1 0 30 60 90 120 150 180 210 240 Quantity of cell phones (millions) 270 300 – Equilibrium price increases – Equilibrium quantity increases © 2014 by McGraw‐Hill Education 28 Active Learning: Equilibrium effects from shifts in demand Suppose the demand curve shifts outward by 60 units. Update the demand schedule and find the new equilibrium price and quantity P QS QD 270 30 240 60 210 90 180 120 150 150 120 180 90 210 60 240 Q’D © 2014 by McGraw‐Hill Education 29 Shifts in supply Suppose there is a breakthrough in battery technology Price ($) 200 • Market for cellphones is initially in equilibrium • Increased technology causes the supply to increase • The supply curve shifts right • The market equilibrium changes S1 180 160 S2 140 120 100 80 60 40 20 D1 0 30 60 90 120 150 180 210 240 Quantity of cell phones (millions) © 2014 by McGraw‐Hill Education 270 300 – Equilibrium price decreases – Equilibrium quantity increases 30 10 Active Learning: Equilibrium effects from shifts in supply Suppose the cost of sugar, an input for making ice cream, increases. Identify whether supply, demand, or both shift(s) and the new equilibrium price and quantity for ice cream P Ice Cream Market S P* D Q* Q © 2014 by McGraw‐Hill Education 31 Shifts in demand or supply When either demand or supply changes, there is an unambiguous effect on equilibrium price and quantity Curve Change Supply Decrease Supply Increase Demand Decrease Demand Increase Price change Quantity change © 2014 by McGraw‐Hill Education 32 Shifts in both demand and supply • It is possible for non‐price factors that influence both demand and supply at the same time • This leads to shifts in both demand and supply • The new equilibrium occurs at the new intersection • Suppose that landline phone service prices increase and an input price to make cellphones decreases – Demand increases – Supply increases • What happens to equilibrium price and quantity? – It depends on whether the demand or supply curve shifts out more © 2014 by McGraw‐Hill Education 33 11 Shifts in both demand and supply (A) Demand increases more (B) Supply increases more Price ($) Price ($) 200 200 180 S1 180 160 S2 160 140 140 120 E2 E1 100 120 E1 100 80 D2 60 40 40 20 20 D1 30 60 90 120 150 180 210 240 270 300 Quantity of cell phones (millions) E2 S2 80 60 S1 D2 D1 30 60 90 120 150 180 210 240 270 Quantity of cell phones (millions) New equilibrium New equilibrium – Quantity increases – Quantity increases – Price decreases – Price increases Conclusion: Quantity increases Price may increase or decrease (ambiguous) © 2014 by McGraw‐Hill Education 34 Shifts in demand and supply When both supply and demand shift and the magnitudes of change are unknown, the effect on either price or quantity is known, but not both Supply change Demand change Decrease Decrease Increase Increase Price change Quantity change Decrease Increase Increase Decrease â2014byMcGrawHillEducation 35 Summary ã Amarket isthegroupofbuyersandsellers whotrade Acompetitivemarketexistsifalargenumberof buyersandsellerstradestandardizedgoodsand services Modeledusingsupplyanddemand â2014byMcGrawHillEducation 36 12 Summary ã Demand demonstrates consumers’ highest willingness to pay for a given quantity • The law of demand states that the quantity demanded increases as the price decreases – The demand curve has a negative slope • When one of the non‐price determinants of demandchanges,theentiredemandcurve shiftstotheleftortheright â2014byMcGrawHillEducation 37 Summary ã Supplydemonstratesproducerslowestprice thattheymustreceivetosellagivenquantity ã Thelawofsupplystatesthatthequantity supplied increasesasthepriceincreases Thesupplycurvehasapositiveslope ã Whenoneofthenonpricedeterminantsof supply changes,theentiresupplycurveshifts totheleftortheright â2014byMcGrawHillEducation 38 Summary • The equilibrium price and quantity are identified when quantity supplied equals quantity demanded. At this point: – Producers sell all they desire at the equilibrium price – Consumers buyalltheydesireattheequilibriumprice ã Ifthemarketpriceisnotequaltotheequilibrium price,thenasurplusorshortageexists,andthe priceadjustsuntilquantitydemandedisequalto quantitysupplied â2014byMcGrawHillEducation 39 13 Summary • When a non‐price determinant changes, the effect on equilibrium price and quantity can be evaluated by: – Determining whether supply, demand, or both are affected – Determining the direction supply, demand, or both shift(s) – Comparing the new equilibrium to the initial equilibrium to identify the effect on price and quantity © 2014 by McGraw‐Hill Education 40 14