Download supply and demand maximizing behavior the circular flow the two

MAXIMIZING BEHAVIOR
Consumers maximize their utility (satisfaction)
given limited resources.
 Businesses try to maximize profits by using
resources efficientlyy in producingg ggoods.
 Government maximizes general welfare of
society.
 The basic goals of utility maximization, profit
maximization, and welfare maximization
explain most market activity.

Chapter 3
SUPPLY AND DEMAND
2
THE CIRCULAR FLOW
ECONOMIC INTERACTIONS WITH OTHERS OCCUR BECAUSE:

We can’t produce all of the goods we need or
desire.

 Consumers
 Even
if we could produce all our own goods and
service, it still makes sense to specialize.

Four different groups participate in our
economy:
 Business
We have limited time, energy, and resources to
produce things we could make for ourselves.
firms
 Government
 Foreigners
3
4
THE TWO MARKETS
THE TWO MARKETS
Factor markets are any place where factors of
production (e.g., land, labor, capital) are bought
and sold.
 Product Markets are any place where finished
goods and services (products) are bought and
sold.


5
Foreigners both buy and sell in both product
and factor markets.
Governments buy resources from factor
markets and provides services to
businesses and consumers.
 The consumer is the final recipient of all
goods and services produced.

6
SUPPLY AND DEMAND
THE CIRCULAR FLOW

Goods and services
demanded
Consumers
Product
markets
Governments
Factors of
production supplied
International
participants
Factor
markets
International
participants
There must be a buyer and a seller in every
market transaction.
 The
Goods and services
supplied
 The
Business
Firms

Factors of
production demanded

seller is on the supply side of the market.
buyer is on the demand side of the market.
Supply is the ability and willingness to sell (produce)
specific quantities of a good at alternative prices in a
given time period, ceteris paribus.
Demand is the ability and willingness to buy specific
quantities of a good at alternative prices in a given
time period, ceteris paribus.
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7
INDIVIDUAL DEMAND
A demand exists only if someone is willing and
able to pay for a good.
 A demand schedule is a table showing the
quantities of a good a consumer is willing and
able to buy at alternative prices in a given time
period, ceteris paribus.
 A demand curve is a curve describing the
quantities of a good a consumer is willing and
able to buy at alternative prices in a given time
period, ceteris paribus.
DEMAND SCHEDULE AND CURVE
Demand Schedule
Quantity
Price
Demanded
$5.00
1
4 0
4.50
2
4.00
3
3.50
5
3.00
7
2.50
9
2.00
12
1.50
15
1.00
20

9
PRICE
$5.00
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
A
B
C
D
E
F
G
H
I
2 4 6 8 10 12 14 16 18 20
Quantity Of Typing Demanded
INDIVIDUAL DEMAND
DETERMINANTS OF DEMAND
“Demand” is an expression of consumer buying
intentions – of a willingness to buy – not a
statement of actual purchases.
 According to law of demand,
demand the quantity of a
good demanded in a given time period
increases as its price falls, ceteris paribus.


11
10
Determinants of market demand include:
 Tastes
— desire for this and other goods.
— of the consumer.
 Other goods — their availability and price.
price
 Expectations — for income, prices, tastes.
 Number of buyers.
 Income
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OTHER GOODS

SHIFTS IN DEMAND
Substitute goods substitute for each other.
A demand curve (schedule) is valid only so long
as the underlying determinants of demand
remain constant.
 A shift in demand is a change in the quantity
demanded at any (every) given price.
 The entire demand curve shifts to the right
when income goes up.

 When
the price of good x rises, the demand for
good y increases, ceteris paribus.

Complementary goods are frequently
consumed in combination.
 When
the price of good x rises, the demand for
good y falls, ceteris paribus.
 An
increase in taste (desire) also shifts the
demand curve to the right.
13
MOVEMENTS VS. SHIFTS
14
MOVEMENTS VS. SHIFTS
Changes in quantity demanded – movements
along a demand curve, in response to price
changes for that good.
 Changes in demand – shifts of the demand
curve due to changes in tastes, income, other
goods, or expectations.

PRICE
$4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
Shift in
demand
d2
d1
g1
Movement
along curve
D2 increased
demand
D1
initial demand
2
4
6
8
10
12
14
16
18
20
22 Quantity
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MARKET DEMAND
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CONSTRUCTION OF THE MARKET DEMAND CURVE
Market demand is the total quantities of a good
or service people are willing and able to buy at
alternative prices in a given time period.
 The separate demands of individual consumers
is added up to determine the total quantity
demanded at any given price.

Tom’s demand
curve
George’s
demand curve
Lisa’s
demand
curve
$5
My demand
curve
Price
4
3
+
2
+
+
=
1
0
4 8 12 16
0 4 8 12 16 20 24 28
0 4 8 12
0 4 8 12
See Page 54
17
18
CONSTRUCTION OF THE MARKET DEMAND
CURVE
SUPPLY
Market supply is the total quantities of a good
that sellers are willing and able to sell at
alternative prices in a given time period, ceteris
paribus.
 The determinants of market supply include:

The market demand curve
$5
A
B
=
Price
4
C
D
3
E
F
2
G
H
1
0
4
12
20
28
I
Quantity Demanded
36

Factor costs

Taxes and subsidies

Technology

Expectations

Other goods

Number of sellers
20
19
LAW OF SUPPLY
MARKET SUPPLY
According to the law of supply, the quantity of a
good supplied in a given time period increases
as its price increases, ceteris paribus.
 Market supply is an expression of sellers
sellers’
intentions – an offer to sell – not a statement
of actual sales.

Quantity Supplied By:
Price (per page)
Ann
Bob
Cory
Market
j
$5.00
94
35
19
148
i
4.50
93
33
14
140
h
4.00
90
30
10
130
g
3.50
86
28
0
114
f
3.00
78
12
0
90
e
2.50
53
9
0
62
d
2.00
32
7
0
39
c
1.50
20
0
0
20
b
1.00
10
0
0
10
21
SHIFTS OF SUPPLY
MARKET SUPPLY
Price
$5.00
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
22
Changes in the quantity supplied —
movements along the supply curve.
 Changes in supply — shifts in the supply curve.

j
i
Quantity supplied
increases as price rises
h
g
f
e
d
c
b
10 20 30 40 50 60 70 80 90 100 110 120 Quantity Supplied
23
24
EQUILIBRIUM
MARKET CLEARING
The equilibrium price is the price at which the
quantity of a good demanded in a given time
period equals the quantity supplied.
 Only one price and quantity are compatible with
the existing intentions of both the buyers and
the sellers.


An equilibrium doesn’t imply that everyone is
happy with the prevailing price or quantity.
 Although not everyone gets full satisfaction
from the market equilibrium
equilibrium, that unique
outcome is efficient.
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EQUILIBRIUM PRICE
Price Quantity Supplied
$5.00
148
4.50
140
4 00
4.00
130
3.50
114
3.00
90
2.50
62
2.00
39
1.50
20
1.00
10
26
EQUILIBRIUM PRICE
surplus
surplus
surplus
surplus
surplus
surplus
equilibrium
shortage
shortage
Price
$5.00
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
Quantity Demanded
5
8
11
16
22
30
39
47
57
0
Market demand
Market supply
At equilibrium price, quantity demanded
equals quantity supplied
Equilibrium price
25
39
50
75
100
125 Quantity
27
28
THE INVISIBLE HAND
MARKET SURPLUS
The market mechanism is the use of market
prices and sales to signal desired outputs (or
resource allocations).
 Adam Smith characterized this market
mechanism as the invisible hand.

A market surplus is the amount by which the
quantity supplied exceeds the quantity
demanded at a given price – excess supply.
 A market surplus is created when the seller
seller’ss
asking prices are too high.

29
30
MARKET SHORTAGE
SURPLUS AND SHORTAGE
A market shortage is the amount by which the
quantity demanded exceeds the quantity
supplied at a given price – excess demand.
 A market shortage is created when the seller
seller’ss
asking prices are too low.
Price
$50
45
40
35
30
25
20
15
10
5

Market demand
0
Market supply
S l
Surplus
x
y
Shortage
25
39
50
75
100
125 Quantity
31
32
SELF-ADJUSTING PRICES
SELF-ADJUSTING PRICES
A market surplus will emerge when the market
price is above the equilibrium price.
 A market shortage will emerge when the
market price is below the equilibrium price.
price



To overcome a surplus or shortage, buyers and
sellers will change their behavior.
Only at the equilibrium price will no further
adjustments be required.
33
CHANGES IN EQUILIBRIUM
SURPLUS AND SHORTAGE
Price
$50
45
40
35
30
25
20
15
10
5
0
34
No equilibrium price is permanent.
The equilibrium price will change whenever the
supply or demand curve shifts.
 Changes
Ch g iin supply
l and
dd
demand
d occur when
h th
the
determinants of supply and demand change.

Market demand
Market supply

S l
Surplus
x
y
Equilibrium price
 Should
the demand curve shift, the result will be a
change in equilibrium price and quantity.
 Should the supply curve shift, the result will be a
change in equilibrium price and quantity.
Shortage
25
39
50
75
100
125 Quantity
35
36
CHANGES IN EQUILIBRIUM
CHANGES IN EQUILIBRIUM
Price
$50
Price
$50
Market supply
Market supply
40
40
E3
E2
30
30
New demand
E1
20
10
0
10
Initial demand
25
E1
20
50
75
100
Quantity
0
Initial demand
25
50
75
100
Quantity
38
37
ELECTRIC SHOCK: ENERGY-PRICE SPIKES
MARKET OUTCOMES

The market mechanism resolves the basic
economic questions:
People are often upset with the market
outcome.
 In a market-driven economy, electricity prices
are set by the forces of supply and demand.
demand
 Electricity prices increased in California
because of an increase in demand and a
decrease in supply.

 WHAT
we produce is determined by the equilibrium
of the markets.
 HOW we produce is determined by profit seeking
behavior and using resources efficiently.
 FOR WHOM we produce is determined by those
willing and able to pay the equilibrium price.
 The
demand curve shifted rightward.
 The supply curve shifted leftward.
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DISEQUILIBRIUM PRICING
The California legislature put a price ceiling on
retail electricity prices.
 A price ceiling is the upper limit imposed on the
price of a good.
good
 Price ceilings have three predictable effects:
40
PRICE CEILINGS CREATE SHORTAGES
1996 -> 2001

the quantity demanded.
 Decrease the quantity supplied.
 Create a market shortage.
35
Price Of Ele
ectricity
(cent per kilow
watt-hour)
 Increase
40
30
D1 Old
demand
D2 New
demand
S2 New
supply
E2
S1 Old
supply
shift in
supply
25
shift in
demand
20
15
shortage
10
E1
Price ceiling
5
0
41
qsc
qe2
qdc
Quantity Of Electricity
(megawatts per hour)
42
PRICE CEILINGS CREATE SHORTAGES

PRICE FLOOR
Letting prices rise would have:
Setting a price below which prices cannot go is
called a price floor.
 Price floors have three predictable effects,
opposite of price ceilings:

Reduced the quantity demanded.
Increased the quantity supplied.
 Alleviated the market shortage.


 Decrease
the quantity demanded.
the quantity supplied.
 Create a market surplus.
 Increase
43
End of Chapter 3
SUPPLY AND DEMAND
44