Download Chapter 2 – Supply and Demand

Chapter 2 – Supply and Demand
Overview: In this chapter, we will cover the following
topics.
1. Demand and Supply Analysis.
 Determinants of Demand and Supply.
 Equilibrium Quantity and Price.
 Adjustment to Equilibrium.
2. Taxes.
1. Demand and Supply Analysis.
Demand and Supply Analysis: is a basic
tool for analyzing market outcomes, i.e.
price and quantity.
 Required Conditions:

◦ Need a “well defined” market.
 Simple Definition: A market consists of the buyers
and sellers of a good or service.
◦ Perfect Information.
1. Demand and Supply Analysis.

Demand Curve.
◦ Describe the relationship between price and
quantity demanded (from the buyer’s
perspective).
◦ (Most of the time is) downward sloping.
 Law of Demand: The quantity demanded rises as the
price of the product falls.
 What types of products that exhibit upward sloping
demand curves?
 Giffen Good (Inferior Goods that have no close substitute)
 Luxury (Veblen) Good (perception of high status products)
1. Demand and Supply Analysis.

Determinants of Demand – Factors that Shift the
Demand Curve
◦ Incomes – Positive relationship Income
Elasticity of Demand.
◦ Tastes/Preference. – Positive relationship.
◦ Ex: major research study discovers that drinking coffee
daily reduce chance of getting cancer by ½.
◦ Prices of Substitutes and Complements  Cross
Price Elasticity of Demand
 Substitutes: Negative relationship.
 Ex: A Safeway’s flyer shows that Fuji Apple is 30% off normal
price. What happens to the demand for Gala Apples at Safeway.
 Complements: Positive relationship.
1. Demand and Supply Analysis.

Determinants of Demand – Factors that Shift
the Demand Curve.
◦ Expectations – Positive relationship.
◦ Ex: It’s about a month away from Black Friday,
BestBuy will have huge door crash event. Many
electronic products will be on sale.
◦ Population – Positive relationship.
1. Demand and Supply Analysis.

Supply Curve.
◦ Describe the relationship between price and
quantity supplied (from the seller’s
perspective).
◦ Upward sloping.
 Law of Supply: the quantity supplied rises as the
price of a product rises..
1. Demand and Supply Analysis.

Determinants of Supply.
◦ Technology –Positive relationship.
◦ Weather – Positive relationship.
◦ Factor Prices – Negative relationship.
 Ex: Price of raw peanut goes up due to a long dry
summer that hammers raw peanut production.
What will happen to the supply of peanut butter?
◦ Number of Suppliers – Positive relationship.
I. Demand and Supply Analysis.
Consumer Surplus (CS):
the difference between
consumers’ willingness to
pay and what they actually
pay.
CS
Equilibrium
PS
Producer Surplus (PS):
the difference between the
product’s market price and
the cost of producing
them.
Social Surplus (SS): is the
Sum of CS and PS.
I. Demand and Supply Analysis.

Market Equilibrium.
◦ The most efficient market allocation (Pareto
efficient).
 Example: Problem 5 p.50
 Using diagrams, show what changes in equilibrium price and
quantity exchanged in the following markets in the
situations described.
 Crude Oil: Petroleum reserves decreases.
 Air Travel: Worries about air travel safety.
 Milk: A drop in milk production costs.
I. Demand and Supply Analysis.

Market Equilibrium
◦ Any intervention (rent control, price ceiling,
price floor, tax, etc.) may result in efficiency
loss or deadweight loss (DWL).
I. Demand and Supply Analysis.
Excess
Supply
Price Floor
CS
PS
D
W
L
Equilibrium
Price Ceiling
Excess
Demand
2. Tax and other Interventions.

Consider the case of Constant Unit Tax (or
constant tax per unit of output or excise tax).
◦ Seller’s share of the tax:
◦ Buyer’s share of the tax: tb = 1 – ts
◦ In general, the tax burden depends on the shapes of
the supply and demand schedule.
◦ The effect of the tax on the equilibrium quantity and
price is insensitive to whom the tax is applied.
Tax
2. Tax and other Interventions.

Examples: Problem 7 p.51
◦ Suppose demand for seats at Winless University
football games is given by P=1900 -1/5Q and supply is
fixed at Q=9000 seats.
 Find the equilibrium price and quantity of seats for a football
game.
 Suppose a new govt. policy prohibits selling college football
ticket more than $50 (price ceiling). How large is excess
demand?
 Suppose the next game is a major rivalry, and so demand
jumps to P = 2100 – 1/5Q. How large is the excess demand
for this game?
 How do the distortions of this price ceiling differ from the
more typical case of upward sloping supply curve?