Download Demand, Supply, and Market Equilibrium

Economics
NINTH EDITION
Chapter 4
Demand, Supply,
and Market
Equilibrium
Prepared by Brock Williams
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Learning Objectives
4.1 Describe and explain the law of demand.
4.2 Describe and explain the law of supply.
4.3 Explain the role of price in reaching a market equilibrium.
4.4 Describe the effect of a change in demand on the
equilibrium price.
4.5 Describe the effect of a change in supply on the
equilibrium price.
4.6 Use information on price and quantity to determine what
caused a change in price.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
DEMAND, SUPPLY, AND MARKET
EQUILIBRIUM
The model of demand and supply explains how a perfectly
competitive market operates.
•Perfectly competitive market
•
A market with many buyers and sellers of a homogeneous product and
no barriers to entry.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.1 THE DEMAND CURVE
(1 of 5)
• Quantity demanded
The amount of a product that consumers are willing and able to buy.
• Demand schedule
A table that shows the relationship between the price of a product and the quantity
demanded, ceteris paribus.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.1 THE DEMAND CURVE
(2 of 5)
Here is a list of the variables that affect an individual consumer’s decision, using
the pizza market as an example:
• The price of the product (for example, the price of a pizza)
• The consumer’s income
• The price of substitute goods (for example, the prices of tacos or sandwiches or
other goods that can be consumed instead of pizza)
• The price of complementary goods (for example, the price of lemonade or other
goods consumed with pizza)
• The consumer’s preferences or tastes and advertising that may influence
preferences
• The consumer’s expectations about future prices
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.1 THE DEMAND CURVE
(3 of 5)
The Individual Demand Curve and the Law of Demand
• Individual demand curve
A curve that shows the relationship between the price of a good and quantity demanded
by an individual consumer, ceteris paribus.
• Law of demand
There is a negative relationship between price and quantity demanded, ceteris paribus.
• Change in quantity demanded
A change in the quantity consumers are willing and able to buy when the price changes;
represented graphically by movement along the demand curve.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.1 THE DEMAND CURVE
(4 of 5)
The Individual Demand Curve and
the Law of Demand
According to the law of demand, the higher the
price, the smaller the quantity demanded,
everything else being equal. Therefore, the
demand curve is negatively sloped: When the
price increases from $6 to $8, the quantity
demanded decreases from seven pizzas per
month (point c) to four pizzas per month (point b).
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.1 THE DEMAND CURVE
(5 of 5)
From Individual Demand to
Market Demand
The market demand equals the sum of the
demands of all consumers. In this case, there
are only two, so at each price the market
quantity demanded equals the quantity
demanded by Al plus the quantity demanded by
Bea.
At a price of $8, Al’s quantity is four pizzas (point
a) and Bea’s quantity is two pizzas (point b), so
the market quantity demanded is six pizzas
(point c).
Each consumer obeys the law of demand, so
the market demand curve is negatively sloped.
• Market demand curve
A curve showing the relationship between
price and quantity demanded by all
consumers, ceteris paribus.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
APPLICATION 1
THE LAW OF DEMAND FOR YOUNG SMOKERS
APPLYING THE CONCEPTS #1: What is the Law of Demand?
• As price decreases and we move downward along the market demand for cigarettes, the
quantity of cigarettes demanded increases for two reasons. First, people who smoked
cigarettes at the original price respond to the lower price by smoking more. Second,
some people start smoking.
• A change in cigarette taxes in Canada illustrates the second effect, the new-smoker
effect. In 1994, several provinces in eastern Canada cut their cigarette taxes and the
price of cigarettes in the provinces decreased by roughly 50 percent. Researchers
tracked the choices of 591 youths from the Waterloo Smoking Prevention Program, and
concluded that the lower price increased the smoking rate by roughly 17 percent.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE (1 of 8)
Suppose you ask the manager of a firm, “How much of your product are you willing to
produce and sell?” The manager’s decision about how much to produce depends on many
variables, including the following, using pizza as an example:
• The price of the product (for example, the price per pizza)
• The wage paid to workers
• The price of materials (for example, the price of dough and cheese)
• The cost of capital (for example, the cost of a pizza oven)
• The state of production technology (for example, the knowledge used in making
pizza)
• Producers’ expectations about future prices
• Taxes paid to the government or subsidies (payments from the government to firms
to produce a product)
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(2 of 8)
The Individual Supply Curve and the Law of Supply
• Quantity supplied
The amount of a product that firms are willing and able to sell.
• Supply schedule
A table that shows the relationship between the price of a product and quantity supplied,
ceteris paribus.
• Individual supply curve
A curve showing the relationship between price and quantity supplied by a single firm,
ceteris paribus.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(3 of 8)
The Individual Supply Curve and
the Law of Supply
The supply curve of an individual supplier is
positively sloped, reflecting the law of
supply.
As shown by point a, the quantity supplied is
zero at a price of $2, indicating that the
minimum supply price is just above $2.
An increase in price increases the quantity
supplied to 100 pizzas at a price of $4, to
200 pizzas at a price of $6, and so on.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(4 of 8)
The Individual Supply Curve and the Law of Supply
• Law of supply
There is a positive relationship between price and quantity supplied, ceteris paribus.
• Change in quantity supplied
A change in the quantity firms are willing and able to sell when the price changes;
represented graphically by movement along the supply curve.
• Minimum supply price
The lowest price at which a product will be supplied.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(5 of 8)
Why Is the Individual Supply Curve Positively Sloped?
MARGINAL PRINCIPLE
Consistent with the Law of Supply, increase the level of an activity as long
as its marginal benefit exceeds its marginal cost. Choose the level at which
the marginal benefit equals the marginal cost.
From Individual Supply to Market Supply
• Market supply curve
A curve showing the relationship between the market price and quantity supplied by all
firms, ceteris paribus.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(6 of 8)
From Individual Supply to
Market Supply
The market supply is the sum of the
supplies of all firms. In Panel A, Lola is a
low-cost producer who produces the first
pizza once the price rises above $2 (shown
by point a).
Panel B, Hiram is a high-cost producer who
doesn’t produce pizza until the price rises
above $6 (shown by point f ).
To draw the market supply curve, we sum
the individual supply curves horizontally. At
a price of $8, market supply is 400 pizzas
(point m), equal to 300 from Lola (point d)
plus 100 from Hiram (point g).
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(7 of 8)
From Individual Supply to Market
Supply
The market supply is the sum of the
supplies of all firms.
The minimum supply price is $2 (point a),
and the quantity supplied increases by
10,000 for each $2 increase in price to
10,000 at a price of $4 (point b), to
20,000 at a price of $6 (point c), and so
on.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.2 THE SUPPLY CURVE
(8 of 8)
Why Is the Market Supply Curve Positively Sloped?
To explain the positive slope, consider the two responses by firms to an increase in price:
• Individual firm. As we saw earlier, a higher price encourages a firm to increase its output by
purchasing more materials and hiring more workers.
• New firms. In the long run, new firms can enter the market and existing firms can expand their
production facilities to produce more output.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
APPLICATION 2
LAW OF SUPPLY AND WOOLYMPICS
APPLYING THE CONCEPTS #2: What is the Law of Supply?
• In the 1990s, the world price of wool decreased by about 30 percent, and prices have
remained relatively low since then. Based on the law of supply, we would expect the
quantity of wool supplied in New Zealand and other exporters to decrease, and that’s
what happened. Land that formerly grew grass for wool-producing sheep has been
converted into other uses, including dairy products, forestry, and the domestication of
deer.
• There have been several attempts to revive the wool industry by boosting the demand
for wool and thus increase its price. The United Nations General Assembly declared
2009 as the International Year of Natural Fibers, with the objective “to raise awareness
and stimulate demand for natural fibers.” In 2012, the Federated Farmers of New
Zealand proposed that sheep shearing be added to the Commonwealth Games and
Olympics as a demonstration sport. Of course, it’s not obvious that Olympic shearing
would increase the demand for wool, and then there is the problem of what to do with all
the sheared wool. Extreme knitting?
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.3 MARKET EQUILIBRIUM: BRINGING
DEMAND AND SUPPLY TOGETHER (1 of 2)
• Market equilibrium
A situation in which the quantity demanded equals the quantity supplied at the prevailing
market price.
Excess Demand Causes the Price to Rise
• Excess demand (shortage)
A situation in which, at the prevailing price, the quantity demanded exceeds the quantity
supplied.
Excess Supply Causes the Price to Drop
• Excess supply (surplus)
A situation in which the quantity supplied exceeds the quantity demanded at the
prevailing price.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.3 MARKET EQUILIBRIUM: BRINGING
DEMAND AND SUPPLY TOGETHER (2 of 2)
At the market equilibrium (point a,
with price = $8 and quantity =
30,000), the quantity supplied
equals the quantity demanded.
At a price below the equilibrium
price ($6), there is excess
demand—the quantity demanded at
point c exceeds the quantity
supplied at point b.
At a price above the equilibrium
price ($12), there is excess
supply—the quantity supplied at
point e exceeds the quantity
demanded at point d.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
APPLICATION 3
SHRINKING WINE LAKES
APPLYING THE CONCEPTS #3: What are the consequences of a price above the
equilibrium price?
• Under the Common Agricultural Policy (CAP) the European Union uses a number of policies to
support the agricultural sectors of its member countries.
• Under a minimum-price policy the government sets a price above the market-equilibrium price. The
EU guarantees farmers minimum prices for products such as grain, dairy products, and wine. This
policy causes artificial excess supply: if the minimum price exceeds the market-equilibrium price, the
quantity supplied will exceed the quantity demanded.
• To support the minimum prices, the EU purchases any output that a farmer cannot sell at the
guaranteed price and stores the excess supply in facilities labeled by the European press as “butter
mountains” and “wine lakes.”
• In recent years the EU has reformed its agriculture policy by reducing and in some cases eliminating
minimum prices. As a result, the butter mountains and wine lakes are shrinking.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.4 MARKET EFFECTS OF CHANGES IN
DEMAND (1 of 6)
Change in Quantity Demanded
versus Change in Demand
(A) A change in price causes a change in
quantity demanded, a movement along a
single demand curve. For example, a
decrease in price causes a move from point
a to point b, increasing the quantity
demanded.
•
(B) A change in demand caused by
changes in a variable other than the price of
the good shifts the entire demand curve.
For example, an increase in demand shifts
the demand curve from D1 to D2.
•
• Change in demand
A shift of the demand curve caused by a
change in a variable other than the price
of the product.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.4 MARKET EFFECTS OF CHANGES IN
DEMAND (2 of 6)
Increases in Demand Shift the Demand Curve
• Normal good
A good for which an increase in income increases demand.
• Inferior good
A good for which an increase in income decreases demand.
• Substitutes
Two goods for which an increase in the price of one good increases the demand for the
other good.
• Complements
Two goods for which a decrease in the price of one good increases the demand for the
other good.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.4 MARKET EFFECTS OF CHANGES IN
DEMAND (3 of 6)
Increases in Demand Shift the Demand Curve
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.4 MARKET EFFECTS OF CHANGES IN
DEMAND (4 of 6)
Increases in Demand Shift the
Demand Curve
An increase in demand shifts the demand curve
to the right: At each price, the quantity
demanded increases.
At the initial price ($8), there is excess demand,
with the quantity demanded (point b) exceeding
the quantity supplied (point a).
The excess demand causes the price to rise,
and equilibrium is restored at point c.
To summarize, the increase in demand
increases the equilibrium price to $10 and
increases the equilibrium quantity to 40,000
pizzas.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.4 MARKET EFFECTS OF CHANGES IN
DEMAND (5 of 6)
Decreases in Demand Shift the
Demand Curve
A decrease in demand shifts the demand curve
to the left: At each price, the quantity demanded
decreases.
At the initial price ($8), there is excess supply,
with the quantity supplied (point a) exceeding
the quantity demanded (point b).
The excess supply causes the price to drop, and
equilibrium is restored at point c.
To summarize, the decrease in demand
decreases the equilibrium price to $6 and
decreases the equilibrium quantity to 20,000
pizzas.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.4 MARKET EFFECTS OF CHANGES IN
DEMAND (6 of 6)
Decreases in Demand Shift the Demand Curve
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
APPLICATION 4
CHINESE DEMAND AND PECAN PRICES
APPLYING THE CONCEPTS #4: How does a change in demand affect the equilibrium
price?
• Between 2006 and 2009, Chinese imports of US pecans increased from 9 million
pounds per year to 88 million pounds.
• The increase in demand from China is roughly 30 percent of the total annual crop. The
increase in demand was caused in part by widespread reports in the Chinese media that
pecans promote brain and cardiovascular health.
• As a result of the increase in demand, the equilibrium price of pecans increased by
about 50 percent, increasing the price of pecan pie, a holiday favorite.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.5 MARKET EFFECTS OF CHANGES IN
SUPPLY (1 of 6)
Change in Quantity Supplied versus
Change in Supply
(A) A change in price causes a change in quantity
supplied, a movement along a single supply curve.
For example, an increase in price causes a move
from point a to point b.
(B) A change in supply (caused by a change in
something other than the price of the product) shifts
the entire supply curve. For example, an increase in
supply shifts the supply curve from S1 to S2. For any
given price (for example, $6), a larger quantity is
supplied (25,000 pizzas at point c instead of 20,000
at point a). The price required to generate any given
quantity decreases. For example, the price required
to generate 20,000 pizzas drops from $6 (point a) to
$5 (point d ).
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.5 MARKET EFFECTS OF CHANGES IN
SUPPLY (2 of 6)
Increases in Supply Shift the Supply Curve
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.5 MARKET EFFECTS OF CHANGES IN
SUPPLY (3 of 6)
An Increase in Supply Decreases
the Equilibrium Price
An increase in supply shifts the supply
curve to the right: At each price, the quantity
supplied increases.
At the initial price ($8), there is excess
supply, with the quantity supplied (point b)
exceeding the quantity demanded (point a).
The excess supply causes the price to drop,
and equilibrium is restored at point c.
To summarize, the increase in supply
decreases the equilibrium price to $6 and
increases the equilibrium quantity to 36,000
pizzas.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.5 MARKET EFFECTS OF CHANGES IN
SUPPLY (4 of 6)
Decreases in Supply Shift the Supply Curve
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.5 MARKET EFFECTS OF CHANGES IN
SUPPLY (5 of 6)
A Decrease in Supply Increases
the Equilibrium Price
A decrease in supply shifts the supply curve to
the left. At each price, the quantity supplied
decreases.
At the initial price ($8), there is excess demand,
with the quantity demanded (point a) exceeding
the quantity supplied (point b). The excess
demand causes the price to rise, and equilibrium
is restored at point c.
To summarize, the decrease in supply increases
the equilibrium price to $8 and decreases the
equilibrium quantity to 24,000 pizzas.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.5 MARKET EFFECTS OF CHANGES IN
SUPPLY (6 of 6)
Simultaneous Changes in Demand and
Supply
(A) Larger increase in demand. If the increase in demand
is larger than the increase in supply (if the shift of the
demand curve is larger than the shift of the supply
curve), both the equilibrium price and the equilibrium
quantity will increase.
(B) Larger increase in supply. If the increase in supply is
larger than the increase in demand (if the shift of the
supply curve is larger than the shift of the demand
curve), the equilibrium price will decrease and the
equilibrium quantity will increase.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
APPLICATION 5
THE HARMATTAN AND THE PRICE OF CHOCOLATE
APPLYING THE CONCEPTS #5: How does a change in supply affect the
equilibrium price?
•
•
•
Every year around harvest time for the cocoa crop in West Africa, the harmattan, a dry
dusty wind from the Sahara desert, sweeps through cocoa plantations in Ghana and
Ivory Coast, drying the pods and reducing yields.
In 2015, the harmattan was longer than usual (14 days compared to the usual 5
days), so crop yields were lower than usual.
The decrease in supply from the long harmattan was one factor n the large increase
in the world price of cocoa prices in 2015.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
4.6 PREDICTING AND EXPLAINING
MARKET CHANGES
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
APPLICATION 6
WHY LOWER DRUG PRICES?
APPLYING THE CONCEPTS #6: What explains a decrease in price?
• Ted Koppel, host of the ABC news program Nightline, once said, "Do you know what's
happened to the price of drugs in the United States? The price of cocaine, way down,
the price of marijuana, way down. You don't have to be an expert in economics to know
that when the price goes down, it means more stuff is coming in. That's supply and
demand." According to Koppel, the price of drugs dropped because the government's
efforts to control the supply of illegal drugs had failed. In other words, the lower price
resulted from an increase in supply.
• Is Koppel's economic detective work sound? In Table4.5, Koppel’s explanation of lower
prices is the third case--Increase in supply. This is the correct explanation only if along
with a decrease we experience an increase in the equilibrium quantity. But according to
the U.S. Department of Justice, the quantity of drugs consumed actually decreased
during the period of dropping prices. Therefore, the correct explanation of lower prices is
the second case--Decrease in demand. Lower demand—not a failure of the
government's drug policy and an increase in supply—was responsible for the decrease
in drug prices.
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved
KEY TERMS
Change in demand
Law of demand
Change in quantity demanded
Law of supply
Change in quantity supplied
Market demand curve
Change in supply
Market equilibrium
Complements
Market supply curve
Demand schedule
Minimum supply price
Excess demand (shortage)
Normal good
Excess supply (surplus)
Perfectly competitive market
Individual demand curve
Quantity demanded
Individual supply curve
Quantity supplied
Inferior good
Substitutes
Supply schedule
Copyright © 2017, 2015, 2012 Pearson Education, Inc. All Rights Reserved