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Supply and demand model Single most useful tool of economic analysis. Explains how price of goods and the quantity bought and sold are determined in (certain kinds of) markets. Remember: The point is to be able to make conditional predictions: How will price and quantity for a particular good be affected if “X” occurs? Market: The buyers and sellers of a particular good or service. Competitive market: A market in which there are many buyers and many sellers so that each has a negligible impact on the market price. Perfectly competitive market: In addition to “many buyers and sellers,” the goods offered for sale are all the same. In a competitive market: Sellers and buyers don’t “set” price . . . instead they “take” price as given. “Price takers.” Price is determined “by the market” (through the interaction of buyers and sellers). Quantity demanded: The amount of a good that buyers are (or a buyer is) willing and able to purchase. “Desired purchases” Desired purchases not necessarily the same as actual purchases. Quantity demanded always has a time dimension. Let’s first consider individual demand for a particular good (desired purchases by a single household). What factors influence the quantity of a good that a given household would be willing and able to purchase? Determinants of demand: (Own) price: Law of demand: Other things equal, when the price of a good rises, the quantity demanded of the good falls. Income: Normal good: Other things equal, an increase in income leads to an increase in quantity demanded. Inferior good: Other things equal an increase in income leads to a decrease in quantity demanded. Prices of related goods: Substitutes: Two goods for which an increase in the price of one, other things equal, leads to an increase in the quantity demanded of the other. Complements: Two goods for which an increase in the price of one, other things equal, leads to a decrease in the quantity demanded of the other. Other determinants of demand include: Tastes (not everyone likes the same things) Expectations (about future prices, for example) Demand curve: A graph of the relationship between the price of a good and the quantity demanded, other things equal. price ($/lb.) An individual consumer’s demand for apples. p1 p2 q1 q2 quantity (lbs./yr.) Law of demand says that the demand curve slopes down. Price on the vertical axis; quantity on the horizontal axis? Individual demand vs. market demand. Individual demands are added horizontally to get market demand. Consumer 1 demand price ($/lb.) Consumer 2 demand price ($/lb.) Market demand price ($/lb.) 0.65 0.45 14 22 10 30 quantity (lbs./yr.) 24 52 Change in quantity demanded resulting from a ceteris paribus change in own price -price ($/lb.) Market demand for apples p1 p2 Q1 Q2 quantity (lbs./yr.) -- movement along a demand curve. Change in quantity demanded resulting from a ceteris paribus change in a demand determinant other than own price -price ($/lb.) p1 D2 D Q1 Q2 1 quantity (lbs/yr.) -- shift of demand. (Rightward shift is called “an increase in demand.”) A leftward shift in demand is called “a decrease in demand”: price ($/lb.) p1 D1 D2 Q2 Q1 quantity (lbs./yr.) Now redo everything for the case of supply (a little more quickly this time): Quantity supplied: The amount of a good that sellers are willing and able to sell. “Desired sales” Desired sales not necessarily the same as actual sales. Quantity supplied always has a time dimension. Individual supply vs. market supply Determinants of supply: (Own) price: Law of supply: Other things equal, when the price of a good rises, the quantity supplied of the good rises. Input prices Technology Expectations Supply curve: A graph of the relationship between the price of a good and the quantity supplied, other things equal. price ($/bu.) An individual producer’s supply of soybeans. p2 p1 q1 q2 quantity (bu./yr.) Law of supply says that the supply curve slopes up. Going from individual supply to market supply? -- horizontal summation again. (Add up individual quantities supplied at each price to get market quantity supplied at that price.) Very(!) important to distinguish between two different kinds of changes in quantity supplied: Those represented by - movements along a supply curve. - shifts of a supply curve. Change in quantity supplied resulting from a ceteris paribus change in own price -price ($/bu.) Market supply of soybeans p1 p2 Q2 Q1 quantity (bu./yr.) -- movement along a supply curve. Change in quantity supplied resulting from a ceteris paribus change in a supply determinant other than own price -S1 price ($/bu.) S2 p1 Q1 Q2 quantity (bu./yr.) -- shift of supply. (Rightward shift is called “an increase in supply.”) A leftward shift in supply is called “a decrease in supply”: S2 price ($/bu.) S1 p1 Q2 Q1 quantity (bu./yr.) Caution! Caution! Caution! A rightward shift in supply (from S1 to S2) . . . price ($/bu.) S1 S2 quantity (bu./yr.) . . . can also be thought of as a downward shift in supply. But it’s an increase (not decrease) in supply!!!