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Supply and Demand: An Introduction Principles of Macroeconomics Dr. Gabriel X. Martinez Ave Maria University Supply and Demand: An Introduction How do consumers get the goods and services they want in the right quantities and qualities? – Some goods and services are allocated by the market forces of supply and demand. Economic forces are necessary reactions to scarcity and opportunity costs. Market forces are economic forces acting through the market. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 2 Buyers and Sellers in Markets A Market – Consists of all buyers and sellers of a good or service What do you think? – What determines the price of pizza, gasoline, a car wash, or other goods and services? Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 8 Buyers and Sellers in the Market The Price of a good is determined by – the interaction between – the value that consumers give to the good – and the cost of producing it. – Value is studied with the demand curve. – Cost is studied with the supply curve – Market Equilibrium happens when value equals cost. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 9 Buyers and Sellers in Markets The Demand Curve – A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price. Demand reflects people’s willingness to pay a given price for a given quantity of a good or service. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 10 Buyers and Sellers in Markets A Property of Demand – As price of a good or service goes down the quantity consumers wish to buy will increase. P ↓ QD ↑ – Therefore, the demand curve is downwardsloping. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 11 The Yearly Demand Curve for Cell phones Price ($ per phone) 4 3 2 Demand 8 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 12 16 Chapter 3 - Supply and Demand: An Introduction Quantity (million of phones per year) 12 Buyers and Sellers in Markets The Supply Curve – A curve or schedule showing the quantity of a good that sellers wish to sell at each price. Question –Will the opportunity cost of producing additional cell phones increase or decrease as you produce more cell phones? Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 13 Buyers and Sellers in Markets The Supply Curve – Sellers must receive a higher price to produce additional units of a product to cover the higher opportunity costs of each additional unit. P ↓ QS ↓ Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 14 Buyers and Sellers in Markets Supply reflects the cost of producing a given quantity of a good or service. Price must be equal to (or higher than) cost for the seller to supply the good or service. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 15 The Yearly Supply Curve of Cell phones Price ($ per phone) Supply 4 3 2 8 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 12 16 Chapter 3 - Supply and Demand: An Introduction Quantity (million of phones per year) 16 Market Equilibrium Equilibrium – A system is in equilibrium when there is no tendency for it to change. The forces in the system are balanced. Market Equilibrium – Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price. The economic forces are balanced. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 17 The Equilibrium Price and Quantity of Cell phones Price ($ per phone) Supply Equilibrium at $3 Quantity Demanded = Quantity Supplied 4 3 2 Demand 8 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 12 16 Chapter 3 - Supply and Demand: An Introduction Quantity (millions of phones per year) 18 Market Equilibrium Equilibrium Price and Equilibrium Quantity – The values of price and quantity for which quantity supplied and quantity demanded are equal Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 19 Market Equilibrium What Do You Think? – Would buyers prefer a lower price than the equilibrium price? – Would sellers prefer a higher price than the equilibrium price? Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 20 Market Equilibrium What Do You Think? – If prices are lower than the equilibrium price, there will be excess demand. – If prices are higher than the equilibrium price, there will be excess supply. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 21 Excess Supply Excess supply = 8 million phones per year Price ($ per phone) Supply 4 Excess supply causes prices to fall 3 2 Demand 8 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 12 16 Chapter 3 - Supply and Demand: An Introduction Quantity (millions of phones per year) 22 Excess Demand Price ($ per phone) Supply 4 Excess demand = 12 million phones per year 3 Excess demand causes prices to rise 2 Demand 6 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 18 Chapter 3 - Supply and Demand: An Introduction Quantity (million phones per year) 23 Market Equilibrium What Do You Think? – Is the market equilibrium always an ideal outcome for all market participants? Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 26 Predicting and Explaining Changes in Prices and Quantities Distinguishing Between – A change in the quantity demanded… A movement along the demand curve that occurs in response to a change in price We often see this when the supply curve shifts and the market equilibrium changes. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 27 Predicting and Explaining Changes in Prices and Quantities … And – A change in demand A shift of the entire demand curve – Caused by anything besides price, for example Changes in people’s preferences, Changes in incomes or population, Changes in prices of other goods. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 28 An Increase in Quantity Demanded vs. an Increase in Demand Price ($/can) 6 D Increase in quantity demanded 5 4 3 2 1 0 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. D 2 4 6 8 12 Chapter 3 - Supply and Demand: An Introduction Quantity (1000s of cans/day) 29 An Increase in Quantity Demanded vs. an Increase in Demand Price ($/can) 6 D D’ 5 4 3 Increase in demand 2 1 0 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. D 12 Chapter 3 - Supply and Demand: An Introduction D’ 14 Quantity (1000s of cans/day) 30 Predicting and Explaining Changes in Prices and Quantities Change in the quantity supplied – A movement along the supply curve that occurs in response to a change in price. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 31 Predicting and Explaining Changes in Prices and Quantities Change in supply – A shift of the entire supply curve. Caused by anything besides price, for example – Changes in the cost of labor (wages), – Changes in the cost of other factors of production, – Changes in the technology of production. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 32 An Increase in Quantity Supplied vs. an Increase in Supply Price ($/can) S 6 5 Increase in quantity supplied 4 3 2 S 1 0 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 2 4 6 8 10 Chapter 3 - Supply and Demand: An Introduction Quantity (1000s of cans/day) 33 An Increase in Quantity Supplied vs. an Increase in Supply Price ($/can) 6 S S’ 5 4 3 Increase in supply 2 1 S’ S 0 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 2 4 6 8 10 Chapter 3 - Supply and Demand: An Introduction Quantity (1000s of cans/day) 34 Demand, Supply, and Market Equilibrium Four Rules for Figuring out the Effects of Shifts of Demand and Supply – If Quantity Rises, And Prices Rise, Demand has increased. – That is, demand has shifted out. And Prices Fall, Supply has increased. – If Quantity Falls, And Prices Fall, Demand has shifted in. – That is, demand has decreased. And Prices Rise, Supply has shifted in. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction 35 Four Rules Governing the Effects of Supply and Demand Shifts: I Price An increase in demand will lead to an increase in both the equilibrium price and quantity S Increase in Demand D ↑ P ↑ QD ↑ P’ Movement along Supply curve P ↑ QS ↑ P D Q Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. D’ Q’ Chapter 3 - Supply and Demand: An Introduction Quantity 36 Four Rules Governing the Effects of Supply and Demand Shifts: II Price A decrease in demand will lead to a decrease in both the equilibrium price and quantity S Decrease in Demand D ↓ P ↓ QD ↓ P Movement along Supply curve P ↓ QS ↓ P’ D’ Q’ Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. D Quantity Q Chapter 3 - Supply and Demand: An Introduction 37 Four Rules Governing the Effects of Supply and Demand Shifts: III An increase in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity Price S S’ P P’ D Q Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Q’ Chapter 3 - Supply and Demand: An Introduction Increase in Supply S ↑ P ↓ QS ↑ Movement along Demand curve P ↓ QD ↑ Quantity 38 Four Rules Governing the Effects of Supply and Demand Shifts: IV Price An decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity S’ P’ P D Q’ Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Decrease in S Supply S ↓ P ↑ QS ↓ Movement along Demand curve P ↑ QD ↓ Quantity Q Chapter 3 - Supply and Demand: An Introduction 39 Reasons for changes in Q High Quantity due to High Demand Price ($/ticket) S PS PW DS DW QW Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. QS Chapter 3 - Supply and Demand: An Introduction 1000s of tickets 40 Reasons for changes in Q Price ($/bushel) High Quantity due to High Supply SW SS PS PW D QW Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. QS Chapter 3 - Supply and Demand: An Introduction Millions of bushels 41 The Effects of Simultaneous Shifts in Supply and Demand Q falls because D shifts more than S. Price ($/bag) S S’ P S’ after reduction in cost of production D’ after fall in willingness to buy P’ D D’ Q’ Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Q Chapter 3 - Supply and Demand: An Introduction Millions of bags per month 42 The Effects of Simultaneous Shifts in Supply and Demand Price ($/bag) Q rises because D shifts less than S. S S’ P D’ after fall in willingness to buy P’ D’ D Q Q’ Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. S’ after reduction in cost of production Chapter 3 - Supply and Demand: An Introduction Millions of bags per month 43