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1 Economics 6th edition Chapter 3 Where Prices Come From: The Interaction of Demand and Supply Copyright © 2017 Pearson Education, Inc. All Rights Reserved Ch. 2 Class Quiz Birds/Day Mice/Day Cinder 2 4 Flounder 8 4 What is Cinder’s opportunity cost/day for producing a bird? 4 Mice/day / 2 Birds/day = 2 mice What is Flounder’s opportunity cost/day for producing a mouse? 8 Birds/day / 4 Mice/day = 2 birds Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 2 of 64 3 Chapter Outline 3.1 The Demand Side of the Market 3.2 The Supply Side of the Market 3.3 Market Equilibrium: Putting Demand and Supply Together 3.4 The Effect of Demand and Supply Shifts on Equilibrium Copyright © 2017 Pearson Education, Inc. All Rights Reserved 4 Early High-Tech Gadgets 1992 Copyright © 2017 Pearson Education, Inc. All Rights Reserved 5 Smart Watch Copyright © 2017 Pearson Education, Inc. All Rights Reserved 6 What determines the price of a smartwatch? Demand for smartwatches – How many smartwatches do consumers want to buy? – Factors affecting demand price of the smartwatches other factors, such as prices of other goods Supply of smartwatches – How many smartwatches are producers willing to sell? – Factors affecting demand price of the smartwatches other factors, such as prices of other goods Copyright © 2017 Pearson Education, Inc. All Rights Reserved 7 Our model of a smartwatch market To analyze the market for smartwatches, we need a model how buyers and sellers behave. Perfectly competitive market (1) many buyers and sellers (2) all firms selling identical products (3) no barriers to new firms entering the market While these assumptions are quite restrictive, the model is still useful for analyzing many markets. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 8 3.1 The Demand Side of the Market List and describe the variables that influence demand We begin our analysis of where prices come from by investigating how buyers behave. • We refer to this as market demand, the demand by all the consumers of a given good or service. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 9 Figure 3.1 A demand schedule and a demand curve (1 of 3) Demand schedule: A table that shows the relationship between the price of a product and the quantity of the product demanded. Demand curve: A curve that shows the relationship between the price of a product and the quantity of the product demanded. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 10 Figure 3.1 A demand schedule and a demand curve (2 of 3) When drawing the demand curve, we assume ceteris paribus. Ceteris paribus (“all else equal”) condition: The requirement that when analyzing the relationship between two variables—such as price and quantity demanded—other variables must be held constant. Copyright © 2017 Pearson Education, Inc. All Rights Reserved Figure 3.1 A demand schedule and a demand curve (3 of 3) Quantity demanded: The amount of a good or service that a consumer is willing and able to purchase at a given price. Law of Demand: A rule that states that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 11 12 What explains the law of demand? When the price of a good falls, two effects take place: 1. Consumers substitute toward the newly less-expensive good. 2. Consumers have more purchasing power, which is like an increase in income. We call these the substitution effect and the income effect: Substitution effect: The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes. Income effect: The change in the quantity demanded of a good that results from the effect of a change in the good’s price on a consumers’ purchasing power. Copyright © 2017 Pearson Education, Inc. All Rights Reserved Change in Price move along the demand curve Change in quantity demanded! Copyright © 2017 Pearson Education, Inc. All Rights Reserved 13 14 Figure 3.2 Shifting the demand curve (1 of 2) A change in something other than price that affects demand, causes the entire demand curve to shift. A shift to the right (D1 to D2) is an increase in demand. A shift to the left (D1 to D3) is a decrease in demand. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 15 Figure 3.2 Shifting the demand curve (2 of 2) As the demand curve shifts, the quantity demanded will change, even if the price doesn’t change. The quantity demanded changes at every possible price. P1 Q3 Copyright © 2017 Pearson Education, Inc. All Rights Reserved Q1 Q2 16 What factors influence market demand? Income – Increase in income increases demand if product is normal, decreases demand if product is inferior. Prices of related goods – Increase in price of related good increases demand if products are substitutes, decreases demand if products are complements. Tastes Population and demographics Expected future prices Copyright © 2017 Pearson Education, Inc. All Rights Reserved 17 Changes in income of consumers Normal goods: Goods for which the demand increases as income rises and decreases as income falls. Examples: Clothing (new) Restaurant meals Vacations Inferior goods: Goods for which the demand increases as income falls, and decreases as income rises. Examples: Second-hand clothing Ramen noodles Copyright © 2017 Pearson Education, Inc. All Rights Reserved 18 Effects of changes in income An increase in income would increase the demand for new clothing, ceteris paribus. However the same increase in income would likely decrease the demand for second-hand clothing. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 19 Changes in the price of related goods Substitutes: Goods and services that can be used for the same purpose. Examples: Big Mac and Whopper Ford F-150 and Dodge Ram iPhone and Galaxy Complements: Goods and services that are used together. Examples: Big Mac and McDonald’s fries Hot dogs and hot dog buns Cars and motor oil Copyright © 2017 Pearson Education, Inc. All Rights Reserved 20 Effects of changes in the price of related goods Substitutes An increase in the price of a Big Mac would increase the demand for Whoppers. Complements However the same increase in the price of a Big Mac would decrease the demand for McDonald’s fries. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 21 Making the Connection: Are smartwatches substitutes for smartphones? Smartwatches like the new Apple Watch are not perfect substitutes for smartphones; they do not fulfill identical purposes. Many people already own a smartphone; will they see enough benefit from a smartwatch to make that purchase as well? Copyright © 2017 Pearson Education, Inc. All Rights Reserved 22 Changes in tastes Tastes If consumers’ tastes change, they may buy more or less of the product. Example: If consumers become more concerned about eating healthily, they might decrease their demand for fast food. Copyright © 2017 Pearson Education, Inc. All Rights Reserved End of the “Soft Drink Era?” Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 23 of 64 End of the “Soft Drink Era?” Other than changes in Taste, what other issues might be affected demand for soda? Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 24 of 64 25 Changes in population/demographics Demographics: The characteristics of a population with respect to age, race, and gender. Increases in the number of people buying something will increase the amount demanded. Example: An increase in the elderly population increases the demand for medical care. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 26 Changes in expectations about future prices Consumers decide which products to buy and when to buy them. • Future products are substitutes for current products. • An expected increase in the price tomorrow increases demand today. • An expected decrease in the price tomorrow decreases demand today. Example: If you found out the price of gasoline would go up tomorrow, you would increase your demand today. Copyright © 2017 Pearson Education, Inc. All Rights Reserved Making the Connection: Apple’s policy on product speculation Apple strongly discourages its employees from speculating about when a new model will appear. Why? Suppose a customer learns that a new iPad model will be available next month. • The new model is a potential substitute for the current model. • The price of the current model will likely fall next month. • Both effects decrease current demand (bad for Apple!). Copyright © 2017 Pearson Education, Inc. All Rights Reserved 27 28 Change in demand vs. change in quantity demanded A change in the price of the product being examined causes a movement along the demand curve. • This is a change in quantity demanded. Any other change affecting demand causes the entire demand curve to shift. • This is a change in demand. Copyright © 2017 Pearson Education, Inc. All Rights Reserved The dot represents a point on the individual’s yearly demand curve for rock concerts. Which of the following interpretations of the dot on this graph is correct? B a. The dot shows that this individual spends $125 on five rock concerts each year. b. When a rock concert costs $125, this individual goes to five of them per year. c. When five concerts cost a total of $125, this individual goes to up to five per year. d. At $125, the quantity of concerts demanded equals the quantity supplied. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 29 of 64 Which of the following refers to consumers buying other goods when the price of the good in question rises? a. The law of demand. b. The substitution effect. c. The income effect. d. The term ceteris paribus. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. B 30 of 64 When analyzing the relationship between the price of a good and quantity demanded, other variables must be held constant. Which term best describes such an assumption? a. The law of demand. b. The substitution effect. c. The income effect. d. The term ceteris paribus. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. D 31 of 64 Each graph refers to the demand for pizza. Assuming that a pizza is a normal good, which of the graphs best describes the impact of an increase in income? a. The graph on the left. b. The graph on the right. c. Both graphs. d. Neither graph. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. A 32 of 64 Each graph refers to the demand for pizza. Which of the graphs best describes the impact of an increase in the price of beer (at the pizza restaurant)? a. The graph on the left. b. The graph on the right. c. Both graphs. d. Neither graph. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. B 33 of 64 Each graph refers to the demand for pizzas. Which of the graphs best describes the impact of an decrease in the price of a substitute good? a. The graph on the left. b. The graph on the right. c. Both graphs. d. Neither graph. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. B 34 of 64 Which of the following moves best describes what happens when a change in something other than the price of a concert ticket affects market demand? a. A move from A to B. b. move from A to C. c. Either move from A to B or A to C. d. None of the above. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. B 35 of 64 36 3.2 The Supply Side of the Market List and describe the variables that influence supply There are some similarities, and some important differences, between the demand and supply sides of the market. In this section we examine the market supply, i.e. the decisions of (generally) firms about how much of a product to provide at various prices. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 37 Figure 3.4 A supply schedule and supply curve (1 of 2) Supply schedule: A table that shows the relationship between the price of a product and the quantity of the product supplied. Supply curve: A curve that shows the relationship between the price of a product and the quantity of the product supplied. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 38 Figure 3.4 A supply schedule and supply curve (2 of 2) Quantity supplied: The amount of a good or service that a firm is willing and able to supply at a given price. The law of supply: The rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 39 Figure 3.5 Shifting the supply curve (1 of 2) A change in something other than price that affects supply causes the entire supply curve to shift. • A shift to the right (S1 to S3) is an increase in supply. • A shift to the left (S1 to S2) is a decrease in supply. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 40 Figure 3.5 Shifting the supply curve (2 of 2) As the supply curve shifts, the quantity supplied will change, even if the price doesn’t change. P1 The quantity supplied changes at every possible price. Q2 Copyright © 2017 Pearson Education, Inc. All Rights Reserved Q1 Q3 41 What factors influence market supply? Prices of inputs Technological change Prices of substitutes in production Number of firms in the market Expected future prices Copyright © 2017 Pearson Education, Inc. All Rights Reserved 42 Change in prices of inputs Inputs are things used in the production of a good or service. For a smartwatch, inputs include the computer processor, plastic, and labor. An increase in the price of an input decreases the profitability of selling the good, causing a decrease in supply. A decrease in the price of an input increases the profitability of selling the good, causing an increase in supply. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 43 Technological change A firm may experience a positive or negative change in its ability to produce a given level of output with a given quantity of inputs. We call this a technological change. Examples: A new, more productive variety of wheat would increase the supply of wheat. Governmental restrictions on land use for agriculture might decrease the supply of wheat. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 44 Prices of related goods in production Many firms can produce and sell alternative products. Example: An Illinois farmer can plant corn or soybeans. If the price of soybeans rises, he will plant (supply) less corn. Sometimes, two products are necessarily produced together. Example: Cattle provide both beef and leather. An increase in the price of beef encourages more cattle farming, and hence increases the supply of leather. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 45 Number of firms and expected future prices More firms in the market will result in more product available at a given price (greater supply). Fewer firms → supply decreases. If a firm anticipates the price of its product will be higher in the future, it might decrease its supply today in order to increase it in the future. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 46 Making the Connection: Release timing of Collateral Damage The Arnold Schwarzenegger film Collateral Damage was originally scheduled to be released on October 5, 2001. • The film contained plot elements about terrorist attacks. The production company (Warner Bros.) decided the movie would have higher demand if it did not show immediately after 9/11, so it was delayed until February 2002. • i.e. current supply of the film decreased because the (relative) expected future price increased. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 47 Figure 3.6 A change in supply versus a change in quantity supplied A change in the price of the product being examined causes a movement along the supply curve. • This is a change in quantity supplied. Any other change affecting supply causes the entire supply curve to shift. • This is a change in supply. Copyright © 2017 Pearson Education, Inc. All Rights Reserved Which of the following defines a supply curve? C a. The quantity of a good or service that a firm is willing to supply at a given price. b. A table that shows the relationship between the price of a product and the quantity of the product supplied. c. A curve that shows the relationship between the price of a product and the quantity of the product supplied. d. A curve that shows combinations of price and quantity for which quantity supplied equals quantity demanded. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 48 of 64 Which of the following best describes the law of supply? a. Supply shifts are caused not by a single variable but most likely by a number of different variables. b. An increase in price causes an increase in the quantity supplied, and a decrease in price cause decrease in the quantity supplied. c. A change in price causes a shift of the supply curve. d. All of the above. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. B 49 of 64 The graphs depict the supply of rock concerts in the United States. Which of the graphs best describes the impact of an increase in the price of an input? a. The graph on the left. b. The graph on the right. c. Both graphs. A d. Neither graph. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 50 of 64 The graphs depict the supply of rock concerts in the United States. Which of the graphs best describes the impact of an increase in the expected future price of concert tickets? a. The graph on the left. b. The graph on the right. c. Both graphs. d. Neither graph. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. A 51 of 64 Which of the following moves best describes a change in supply? D a. b. c. d. A move from A to B. A move from A to C. Either the move from A to B or from A to C. A move from B to C. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 52 of 64 Supply Questions Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 53 of 64 In economics for simplicity, we often assume every firm supplies the same quantity as every other firm at a given price. Is this always true? What factor(s) might cause the quantity of smartphones supplied by different firms to be different at a particular price? Not necessarily. Firms may have different costs of producing smartphones and, therefore, supply different quantities at the same price. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 54 of 64 Name two different variables that would cause the quantity supplied of UGG boots to change from 2014 to 2015 as indicated in the table above. The supply of UGG boots decreased from 2014 to 2015. The supply decrease could be caused by an increase in the price of sheepskin (UGG boots are sheepskin boots) or an increase in the price of the machines used to assembly the boots, an increase in the price of other types of boots that UGG could produce. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 55 of 64 Explain and demonstrate graphically the difference between a change in supply and a change in quantity supplied. • A change in supply is a shift in the supply curve and is caused by a change in at least one of the factors of supply (i.e. price of inputs, technological change, prices of substitutes in production, number of firms in the market and expected future prices). • A change in quantity supplied is a movement along the supply curve and is caused by a change in price of the specific good. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 56 of 64 Demand Questions Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 57 of 64 a. What is meant by the term ceteris paribus? The requirement that when analyzing the relationship between two variables – such as price and quantity demanded – other variables must be held constant. b. Give an example of when it would be necessary to use ceteris paribus. Suppose we wanted to determine the effect of a price decrease for a iPhone. We would have to hold all other variables constant to determine the effect of the price decrease. a. If we wanted to determine the effect on demand from a population increase, identify some things we would have to hold constant. Income, tastes and preferences, substitute goods are just a few examples. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 58 of 64 a. In your own words, state the “law of demand.” The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease. a. How do the substitution effect and income effect both explain this law? For a normal good, as the price of a product increases both the income and substitution effects work together to reduce the quantity of the product demanded. a. Give an example. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 59 of 64 For each of the following pairs of products, state which are complements, which are substitutes, and which are unrelated a. New cars and used cars b. French Fries and Catsup c. Fishing pole and boat d. Hamburger and taco Substitutes Complements Complements Substitutes e. Golf shoes and basketballs Not related f. Houses and washing machines Complements Create your own example(s) of complements, substitutes and unrelated products. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 60 of 64 Let’s do an local example of demand. Consider the demand for off-campus student apartments in Corvallis. a. Identify factors that would potentially cause an increase in demand for student apartments. Examples might include rising student population and higher incomes. Also, a rising population throughout the city might make other housing options more difficult ( or expensive) to find and, consequently, increase the population of students looking for student specific housing. b. Identify factors that would potentially cause an increase in the quantity demanded for student apartments. Lower rent Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 61 of 64 What effect will each of the following, ceteris paribus, have on the demand for hot dogs in Corvallis? Demonstrate in words and graphically. a movement along the demand curve for hot dogs in Corvallis or a shift of the demand curve? a. The price of hot dogs declines. ↑ in qty Demanded b. It’s a home game for the Beavers today. ↑ Demand c. Taco Time is offering free tacos today with the order of any beverage. ↓ Demand Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 62 of 64 What effect will each of the following, ceteris paribus, have on the demand for hot dogs in Corvallis? Demonstrate in words and graphically. a movement along the demand curve for hot dogs in Corvallis or a shift of the demand curve? a. You get a free drink if you order a hot dog. ↑ Demand b. The Gazette-Times just published an article about a Salmonella outbreak originating from hot dogs. ↓ Demand c. The U.S. economy enters a period of rapid growth in incomes. ↑ Demand Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 63 of 64 A) State whether each of the following events will result in a movement along the demand curve for McDonald’s Big Mac hamburgers or whether it will cause the curve to shift. B) if the demand curve shifts indicate which direction it will shift C) Identify which ↓ Demand, price variable caused this change. of substitute 1. The price of a Burger King’s Whopper hamburger declines. decreased 2. McDonald’s distributes coupons for $1.00 off the purchase of a Big ↑ qty Demanded, decrease in price of good Mac. 3. Because of a shortage of potatoes, the price of French fries ↓ Demand, price of complement increased increases. ↓ Demand, change in 4. The USDA warns people not to eat fast food. tastes 5. The U.S. economy enters a period of rapid growth in incomes. ↑ Demand, Increase in income Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 64 of 64 65 Chapter 3 Outline – DAY 2 3.1 The Demand Side of the Market 3.2 The Supply Side of the Market 3.3 Market Equilibrium: Putting Demand and Supply Together 3.4 The Effect of Demand and Supply Shifts on Equilibrium Copyright © 2017 Pearson Education, Inc. All Rights Reserved Review of Supply – Supply of econ textbooks at LBCC store How can each of the following examples be illustrated – i.e. a movement along the supply curve or a shift of the supply curve for economics textbooks at the LBCC bookstore? Demonstrate graphically. a. The price of an economics textbook rises. supplied Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 66 of 64 Review of Supply – Supply of econ textbooks at LBCC store How can each of the following be illustrated – i.e. a movement along the supply curve or a shift of the supply curve for economics textbooks at the LBCC bookstore? Demonstrate graphically. a. There is an increase in minimum wage benefiting most of your employees. Review of Supply – Supply of econ textbooks at LBCC store Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 67 of 64 How can each of the following be illustrated – i.e. a movement along the supply curve or a shift of the supply curve for economics textbooks at the LBCC bookstore? Demonstrate graphically. a. A second bookstore opens at LBCC. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 68 of 64 How can each of the following be illustrated – i.e. a movement along the supply curve or a shift of the supply curve for economics textbooks at the LBCC bookstore? Demonstrate graphically. a. A recent report predicts that the market price for textbooks will double next week. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 69 of 64 70 3.3 Market Equilibrium: Putting Demand and Supply Together Use a graph to illustrate market equilibrium Market equilibrium is a situation in which quantity demanded equals quantity supplied. Recall that markets with many buyers and sellers are perfectly competitive markets; a market equilibrium in one of these markets is called a competitive market equilibrium. There are ~25 firms selling smartwatches; we will assume this is enough to generate competitive behavior in the market for smartwatches. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 71 Figure 3.7 Market equilibrium At a price of $350, • consumers want to buy 5 million smartwatches, and • producers want to sell 5 million smartwatches. We say the equilibrium price in this market is $350, and the equilibrium quantity is 5 million smarwatches per week. Since buyers and sellers want to trade the same quantity at the price of $350, we do not expect the price to change. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 72 Figure 3.8 The effect of surpluses and shortages on the market price (1 of 2) What if the price were $400 instead? At a price of $400, • consumers want to buy 4 million smartwatches, while • producers want to sell 6 million. This gives a surplus of 2 million smartwatches: a situation in which quantity supplied is greater than quantity demanded. Prediction: sellers will compete amongst themselves, driving the price down. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 73 Figure 3.8 The effect of surpluses and shortages on the market price (2 of 2) Now what if the price were $250? At a price of $250, • consumers want to buy 7 million smartwatches, while • producers want to sell 3 million. This gives a shortage of 4 million smartwatches: a situation in which quantity demanded is greater than quantity supplied. Prediction: sellers will realize they can increase the price and still sell many smartphones, so the price will rise. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 74 Demand and supply both count • Price is determined by the interaction of buyers and sellers. • Neither group can dictate price in a competitive market (i.e. one with many buyers and sellers). • However changes in supply and/or demand will affect the price and quantity traded. Copyright © 2017 Pearson Education, Inc. All Rights Reserved Rent Control – Effect of Ceiling on Supply & Dem. Rental price ceiling set at $3.00/sq ft by Govt Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 75 of 64 Minimum Wage–Effect of Floor on Supply & Dem. Wage floor set at $3.00/hr by Govt Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 76 of 64 77 3.4 The Effect of Demand and Supply Shifts on Equilibrium Use demand and supply graphs to predict changes in prices and quantities • Predictions about price and quantity in models require us to know supply and demand curves. • Typically, we know price and quantity, but do not know the curves that generate them. • The power of the demand and supply model is in its ability to predict directional changes in price and quantity traded. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 78 Figure 3.9 The effect of an increase in supply on equilibrium (1 of 2) The graph shows the market for smartwatches before Apple enters the market. When Apple enters, more smartphones are supplied at any given price—an increase in supply from S1 to S2. • Equilibrium price falls from P1 to P2. • Equilibrium quantity rises from Q1 to Q2. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 79 Figure 3.9 The effect of an increase in supply on equilibrium (2 of 2) By how much will price fall? By how much will quantity rise? We cannot say, without knowing more information. For now, we can only predict that price will fall and quantity traded will rise. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 80 Figure 3.10 The effect of an increase in demand on equilibrium Suppose incomes increase. What happens to the equilibrium in the smartwatch market? Smartwatches are a normal good, so as income rises, demand shifts to the right (D1 to D2). • Equilibrium price rises (P1 to P2). • Equilibrium quantity rises (Q1 to Q2). Copyright © 2017 Pearson Education, Inc. All Rights Reserved 81 Practice – Try This Suppose you are working at a local wine distributor. You noticed that the price of for Pinot Noir wine has recently increased and the equilibrium quantity seems to have decreased. Ceteris paribus, would this likely be caused by a shift in the demand curve or supply curve for Pinot Noir wine? Explain and use a graph to illustrate your conclusions. Copyright © 2017 Pearson Education, Inc. All Rights Reserved Practice – Try This Last year, the Oregonian reported that “For the third consecutive year, Oregon holds on to the No. 1 spot as the “Top Moving Destination” in United Van Lines’ 39th Annual National Movers Study, which tracks customers’ state-to-state migration patterns over the past year.” Use a supply and demand model to predict how this will affect real estate prices in Oregon in 2016. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 82 83 Practice – Try This 2006 2016 Why did gas prices fall? Copyright © 2017 Pearson Education, Inc. All Rights Reserved 84 Practice – Try This 2006 2016 Why did gas prices fall? Copyright © 2017 Pearson Education, Inc. All Rights Reserved 85 Table 3.3 How shifts in demand and supply affect equilibrium price (P) and quantity (Q) (1 of 2) The table summarizes what happens when the demand curve shifts or the supply curve shifts, with the other curve remaining unchanged. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 86 Making the Connection: The falling price of Blu-ray players (1 of 2) From 2006 to 2013, the price of Blu-ray players fell from about $800 to about $95, while the number of Blu-ray players traded increased dramatically. What best explains this change? A. Increase in demand B. Decrease in demand C. Increase in supply D. Decrease in supply Can you show this change on a supply-and-demand diagram? Copyright © 2017 Pearson Education, Inc. All Rights Reserved 87 Making the Connection: The falling price of Blu-ray players (2 of 2) Supply increased as additional firms started manufacturing Blu-ray players and input costs fell. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 88 Figure 3.11 Shifts in demand and supply over time (1 of 3) Over time, it is likely that both demand and supply will change. For example, as new firms enter the market for smartwatches and incomes increase, we expect: • The supply of smartwatches will shift to the right, and • The demand for smartwatches will shift to the right. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 89 Figure 3.11 Shifts in demand and supply over time (2 of 3) What does our model predict? S↑ ( P↓ and Q↑ ) D↑ ( P↑ and Q↑ ) So we can be sure equilibrium quantity will rise; but the effect on equilibrium price is not clear. This panel shows demand shifting more than supply: equilibrium price and quantity both rise. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 90 Figure 3.11 Shifts in demand and supply over time (3 of 3) This panel shows supply shifting more than demand: quantity rises, but equilibrium price falls. Without knowing the relative size of the changes, the effect on equilibrium price is ambiguous. It is possible, but unlikely, that the equilibrium price will remain unchanged. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 91 Table 3.3 How shifts in demand and supply affect equilibrium price (P) and quantity (Q) (2 of 2) We can now fill in the rest of Table 3.3. The cell in red is the example that we just did. Copyright © 2017 Pearson Education, Inc. All Rights Reserved 92 Shifts of a curve vs. movements along a curve Suppose an increase in supply occurs. We now know: • Equilibrium quantity will increase, and • Equilibrium price will decrease. It is tempting to believe the decrease in price will cause an increase in demand. But this is incorrect. • The decrease in price will cause a movement along the demand curve, but not an increase in demand. • Why? The demand curve already describes how much of the good consumers want to buy, at any given price. • When the price change occurs, we just look at the demand curve to see what happens to how much consumers want to buy, a.k.a. the “quantity demanded”. Copyright © 2017 Pearson Education, Inc. All Rights Reserved If the magnitude of an increase in supply is greater than the magnitude of an increase in demand, what happens to equilibrium price and quantity in the market? a. b. c. d. Equilibrium price will rise and quantity will rise. Equilibrium price will rise and quantity will fall. Equilibrium price will fall and quantity will rise. Equilibrium price will fall and quantity will fall. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 93 of 64 If the magnitude of an increase in demand is greater than the magnitude of an increase in supply, what happens to equilibrium price and quantity in the market? a. b. c. d. Equilibrium price will rise and quantity will rise. Equilibrium price will rise and quantity will fall. Equilibrium price will fall and quantity will rise. Equilibrium price will fall and quantity will fall. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 94 of 64 a. Draw a supply and demand curve for bananas. b. Identify the equilibrium price and quantity on your graph. c. Demonstrate graphically what happens if the current price of bananas is above the equilibrium price. Explain. d. Assuming the banana market is unregulated, explain what is likely to happen in the long run (i.e. if the current price of bananas is above the equilibrium price). Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 95 of 64 Briefly explain whether you agree with the following statement: “When there is a shortage of a good, consumers eventually give up trying to buy it, so the demand for the good declines, and the price falls until the market is finally in equilibrium.” Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 96 of 64 It was recently reported that the supply of milk has fallen due to unusually dry conditions affecting the availability of feed for dairy cows and the demand for milk has also fallen due to consumers choosing to drink other beverages such as soy milk and orange juice. a. Can we use this information to be certain whether the equilibrium quantity of milk will increase or decrease? b. Can we use this information to be certain whether the equilibrium price of milk will increase or decrease? c. Use a supply and demand model to demonstrate your conclusions to a. and b. above. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 97 of 64 The following are four graphs and four market scenarios for cabbage. Match each scenario with the appropriate graph: a. A new fertilizer capable of doubling cabbage yield. b. A fall in the price of lettuce. c. A fungus outbreak which reduces cabbage yields. d. An increase in the population of buyers. Copyright © 2017 Pearson Education, Inc. All Rights Reserved © 2015 Pearson Education, Inc. 98 of 64