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Lecture The Market Forces of Supply and Demand MICROECONOMICS Overview Market and Competition Demand Supply Equilibrium Price and Resource Allocation Market Forces - Supply & Demand Supply and Demand are the two words that economists use most often Supply and Demand are the forces that make market economies work! Modern microeconomics is about supply, demand, and market equilibrium Markets and Competition Market A group of buyers and sellers of a particular good or service Can be highly organized E.g.: agricultural commodities Can be less organized E.g.: ice cream Buyers determine demand Sellers determine supply Market: any institution, mechanism, or arrangement which facilitates exchange Market Structures Perfectly Competitive: Homogeneous Products Buyers and Sellers are Price Takers Monopoly: One Seller, controls price Oligopoly: Few Sellers, not aggressive competition Monopolistic Competition: Many Sellers, differentiated products Monopsony: Only one buyer Quick Quiz! What is a market? Identify two characteristics of a perfectly competitive market Identify examples of noncompetitive markets Overview Market and Competition Demand Supply Equilibrium Price and Resource Allocation Demand Quantity demanded: Amount of a good Buyers are willing and able to purchase Law of demand Other things equal When the price of the good rises, quantity demanded of a good falls Demand Relationship between Price of a good (P) and Quantity demanded (QD) can be shown: Demand schedule - a table: a table that shows the quantity demanded at each price Demand curve - a graph: illustrates how the quantity demanded of the good changes as its price varies slopes downward Demand function: QD= f (P) Figure Catherine’s demand schedule and demand Price of curve Ice-Cream Cones $3.00 Price of Ice-cream cone Quantity of Cones demanded $0.00 0.50 1.00 1.50 2.00 2.50 3.00 12 cones 10 A decrease in price 2.50 2.00 increases quantity of cones demanded 1.50 1.00 Demand curve 0.50 10 11 12 Quantity of Ice-Cream Cones 10 Quick Quiz List the determinants of the supply for pizza Give an example of a supply schedule for pizza Give an example of something that would shift the supply curve Overview Market and Competition Demand Supply Equilibrium Price and Resource Allocation Supply and Demand Together Equilibrium - a situation Market price has reached the level : Quantity supplied = quantity demanded Equilibrium price - the price: Balances quantity supplied and quantity demanded Equilibrium quantity Quantity supplied and the quantity demanded at the equilibrium price 34 Figure The equilibrium of supply and demand Price of Ice-Cream Cones $3.00 2.50 2.00 Supply Equilibrium price Equilibrium 1.50 1.00 0.50 Equilibrium quantity Demand 10 11 12 Quantity of Ice-Cream Cones 35 Supply and Demand Together Surplus Quantity supplied > quantity demanded Excess supply Downward pressure on price Shortage Quantity demanded > quantity supplied Excess demand Upward pressure on price 36 Figure Markets not in equilibrium (a) Excess Supply Price of Ice Cream Cones Surplus Supply (b) Excess demand Price of Ice Cream Cones Supply $2.50 2.00 $2.00 Demand Quantity demanded Quantity supplied 1.50 Demand Quantity supplied Shortage Quantity demanded 10 10 Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones In panel (a), there is a surplus Because the market price of $2.50 is above the equilibrium price, the quantity supplied (10 cones) exceeds the quantity demanded (4 cones) Suppliers try to increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level In panel (b), there is a shortage Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied (4 cones) With too many buyers chasing too few goods, suppliers can take advantage of the shortage by raising the price Hence, in both cases, the price adjustment moves the market toward the equilibrium of supply and demand37 Supply and Demand Together • Law of supply and demand – The price of any good adjusts • Bring the quantity supplied and the quantity demanded into balance – In most markets • Surpluses and shortages are temporary 38 Supply and Demand Together • Three steps to analyzing changes in equilibrium Decide: the event shifts the supply curve, the demand curve, or both curves Decide: curve shifts to right or to left Use supply-and-demand diagram • • Compare initial and new equilibrium How the shift affects equilibrium price and quantity 39 Figure 10 How an increase in demand affects the equilibrium Price of Ice-Cream Cones Supply Hot weather increases the demand for ice cream …resulting in higher price $2.50 New equilibrium 2.00 Initial equilibrium D1 D2 …and a higher quantity sold 10 Quantity of Ice-Cream Cones An event that raises quantity demanded at any given price shifts the demand curve to the right The equilibrium price and the equilibrium quantity both rise Here an abnormally hot summer causes buyers to demand more ice cream The demand curve shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to rise from to 10 cones 40 Figure 11 How a decrease in supply affects the equilibrium Price of An increase in the price of sugar reduces the supply of ice cream Ice-Cream Cones …resulting in higher price S2 S1 $2.50 New equilibrium 2.00 Initial equilibrium Demand …and a smaller quantity sold Quantity of Ice-Cream Cones An event that reduces quantity supplied at any given price shifts the supply curve to the left The equilibrium price rises, and the equilibrium quantity falls Here an increase in the price of sugar (an input) causes sellers to supply less ice cream The supply curve shifts from S to S2, which causes the equilibrium price of ice cream to rise from $2.00 to $2.50 and the 41 equilibrium quantity to fall from to cones Figure 12 A shift in both supply and demand Price of (a) Price Rises, Quantity Rises Ice Cream New equilibrium S2 S Cones Large P2 increase in demand in demand Small decrease in supply Initial equilibrium Q1 D2 Quantity of Ice-Cream Cones Large decrease in supply P1 D2 Initial equilibrium D1 Q2 S1 New equilibrium P2 P1 Price of (b) Price Rises, Quantity Falls Ice S2 Cream Small Cones increase D1 Q2 Q1 Quantity of Ice-Cream Cones Here we observe a simultaneous increase in demand and decrease in supply Two outcomes are possible In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2 In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2 42 Table What happens to price and quantity when supply or demand shifts? No change In Supply An increase In Supply A decrease In supply No change In demand P same Q same P down Q up P up Q down An increase In demand P up Q up P ambiguous Q up P up Q ambiguous A decrease In demand P down Q down P Down Q ambiguous P ambiguous Q down 43 Overview Market and Competition Demand Supply Equilibrium Price and Resource Allocation Concluding Thoughts Market economies harness the forces of supply and demand Supply and Demand together determine the prices of the economy’s different goods and services Prices in turn are the signals that guide the allocation of resources LECTURE SUMMARY What are demand determinants? What are supply determinants? What is excess demand? What is excess supply? ... the market toward the equilibrium of supply and demand3 7 Supply and Demand Together • Law of supply and demand – The price of any good adjusts • Bring the quantity supplied and the quantity demanded... quantity of cones demanded 1.50 1.00 Demand curve 0.50 10 11 12 Quantity of Ice-Cream Cones 10 Demand Individual demand: Demand of one individual Market demand Sum of all individual demands... $2.00, Catherine demands ice-cream cones, and Nicholas demands ice-cream cones The quantity demanded in the market at this price is cones 12 Figure Market demand as the sum of individual Catherine’s
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