Download Chapter 02

Chapter Two
Supply and Demand
Chapter 1 Concepts and Related
Concepts
 Definition of Economics
 Microeconomics versus
Macroeconomics
 Positive versus Normative Economics
 Mainstream Neoclassical Economics
© 2009 Pearson Addison-Wesley. All rights reserved.
2-2
Chapter 2 Outline
1.
2.
3.
4.
5.
Demand.
Supply.
Market Equilibrium.
Shocking the Equilibrium.
Effects of Government
Interventions.
6. When to Use the Supply-andDemand Model.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-3
Demand: determinants of demand.
 The following factors determine the
demand for a good:
 Price of the good
 Tastes
 Information
 Prices of related goods
 Complements and substitutes
 Income
 Government rules and regulations
 Other
© 2009 Pearson Addison-Wesley. All rights reserved.
2-4
Demand: the demand curve
 Quantity demanded - the amount of a
good that consumers are willing to buy
at a given price, holding constant the
other factors that influence purchases.
 Demand curve - the quantity demanded
at each possible price, holding constant
the other factors that influence
purchases
© 2009 Pearson Addison-Wesley. All rights reserved.
2-5
p, $ per kg
Figure 2.1 A Demand Curve
14.30
Demand curve for pork, D1
Law of Demand
consumers demand
more of a good the
lower its price, holding
constant all other
factors that influence
consumption
4.30
3.30
2.30
0
200 220 240
286
Q, Million kg of pork per year
© 2009 Pearson Addison-Wesley. All rights reserved.
2-6
p, $ per kg
Figure 2.2 A Shift of the
Demand Curve
Effect of a 60¢ increase in the price of beef
3.30
D2
D1
0
176
© 2009 Pearson Addison-Wesley. All rights reserved.
220
232
Q, Million kg of pork per year
2-7
The Demand Function
 The processed pork demand function is:
Q = D(p, pb, pc, Y)
 where Q is the quantity of pork demanded
(millions of kg)
 p is the price of pork (dollars per kg)
 pb is the price of beef (dollars per kg)
 pc is the price of chicken (dollars per kg)
 Y is the income of consumers (thousand
dollars)
© 2009 Pearson Addison-Wesley. All rights reserved.
2-8
From the Demand Function to the
Demand Curve

Estimated demand function for pork:
Q = 171−20p + 20pb + 3pc + 2Y

Using the values pb = 4, pc = 3.33 and Y =
12.5, we have (direct demand)
Q = 286−20p

which is the linear demand function for pork.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-9
From the Demand Function to the
Demand Curve
p, $ per kg
Q = 286−20p
14.30
If
$3.30
pincreases
= 0, then by
In general,
IfIfppIfp=
decreases
(to(to
$4.30)
Demand curve for pork,
by
$1
Qthen,
=p286
DDQ = -20
D$1
then, then,
Q =$2.30)
220
200
QQ==240
1
4.30
3.30
2.30
0
200 220 240
286
Q, Million kg of pork per year
Demand curve or inverse demand
P = (286/20) – (1/20)Q
© 2009 Pearson Addison-Wesley. All rights reserved.
2-10
Demand Function
Q  D( p, pb , pc, Y )
q  171  20 p  20 pb  3 pc  2 y
Dq / Dpb  20, Dq / Dpc  3, Dq / Dy  2
If pb  4, pc  3, Y  13
Then q  286  20 p
© 2007 Pearson Addison-Wesley. All rights reserved.
2–15
Inverse Demand Function
(Demand Curve)
 How much consumers are willing to buy
as a function of price
Q  286  20 p
(Inverse demand) p  14.30  0.05Q
Dp / DQ  .05
© 2007 Pearson Addison-Wesley. All rights reserved.
2–16
Terminology
 Demand function
 The quantity demanded as a function of the
important independent variables
 Direct demand
 The quantity demanded as solely a function
of price given the values of the independent
variables
 Demand curve
 The inverse of direct demand
 The values of the independent variables
are given
© 2009 Pearson Addison-Wesley. All rights reserved.
2-17
The price of beef increases from $4.00
to $5.50.
 Given Q = 171 – 20p + 20pb + 3pc + 2Y
 How does the demand curve shift and
what is the magnitude of the shift?
 ∆Q/ ∆pb= 20
 ∆Q = 20 ∆pb = 20*1.50 = 30
 ∆Q is equal to the horizontal shift in the
demand curve
© 2007 Pearson Addison-Wesley. All rights reserved.
2–18
p, $ per kg
A Shift of the Demand Curve
Effect of a $1.50 increase in the price of beef
3.30
D2
D1
0
176
© 2009 Pearson Addison-Wesley. All rights reserved.
220
250
Q, Million kg of pork per year
2-19
The price of beef increases from
$4.00 to $5.50.
What is the equation for the new demand curve?
Given initial values
Q  171  20 p  20 pb  3 pc  2Y
1
Q  171  20 p  20(4)  3(3 )  2(12.5)
3
Q  286  20 p
p  14.5  .05Q
Price of beef increases from $4.00 to $5.50
1
Q  171  20 p  20(5.5)  3(3 )  2(12.5)
3
Q  316  20 p
p  15.8  .05Q
DQ / Dpb  20
DQ  20Dpb  20(1.5)  30
© 2009 Pearson Addison-Wesley. All rights reserved.
2-20
Market Demand
Market Demand is the horizontal sum of
the individual demand curves
Q  Q1  Q 2
Q  D ( p)  D ( p)
1
© 2007 Pearson Addison-Wesley. All rights reserved.
2
2–21
Application: Aggregating the
Demand for Broadband Service
© 2009 Pearson Addison-Wesley. All rights reserved.
2-22
Horizontally summing demand curves
Inverse Demand Curve 1
p  120  Q1
Inverse Demand Curve 2
p  120 - 2Q 2
Market Demand Function
Q  Q1  Q2
Q1  120  p
Q2  60  .5 p
QM  120  60  p  .5 p  180  1.5 p
Market Demand Curve
applies when both quantities are positive
p  120 - .67Q M
© 2007 Pearson Addison-Wesley. All rights reserved.
2–23
Market Demand
© 2009 Pearson Addison-Wesley. All rights reserved.
2-24
Supply: determinants of supply.
 The following factors determine the
supply for a good:
 Price of the good
 Costs
 Government rules and regulations
© 2009 Pearson Addison-Wesley. All rights reserved.
2-25
Supply: the demand curve
 Quantity supplied - the amount of a
good that firms want to sell at a given
price, holding constant other factors that
influence firms’ supply decisions, such
as costs and government actions
 Supply curve - the quantity supplied at
each possible price, holding constant
the other factors that influence firms’
supply decisions
© 2009 Pearson Addison-Wesley. All rights reserved.
2-26
p, $ per kg
Figure 2.3 A Supply Curve
An increase in the
price…
Supply curve, S1
5.30
3.30
causes a movement
along the curve….
0
176
220
and a decrease in the
quantity supplied….
© 2009 Pearson Addison-Wesley. All rights reserved.
300
Q, Million kg of pork per year
2-27
p, $ per kg
Figure 2.4 A Shift of a Supply
Curve
A $0.25 increase in the
price of hogs…..
shifts the supply curve
to the left
S2
S1
3.30
reducing the quantity
supplied at the previous
price.
0
176
205
© 2009 Pearson Addison-Wesley. All rights reserved.
220
Q, Million kg of po rk per year
2-28
The Supply Function
 The processed pork supply function is:
Q = S(p, ph)
 where Q is the quantity of pork supplied
 p is the price of pork (dollars per kg)
 ph is the price of a hog (dollars per kg)
© 2009 Pearson Addison-Wesley. All rights reserved.
2-29
From the Supply Function to the
Supply Curve

Estimated demand function for pork:
Q = 178 + 40p−60ph

Using the values ph = $1.50 per kg
Q = 88 + 40p.

What happens to the quantity supplied if the
price of processed pork increases by Δp =
p2−p1?
© 2009 Pearson Addison-Wesley. All rights reserved.
2-30
Supply Function
Qs  S ( p, pb )
Qs  178  40 p  60 ph
ph  $1.50
Qs  88  40 p
DQs
 40,
Dp
© 2007 Pearson Addison-Wesley. All rights reserved.
DQs
 60
Dph
2–31
Figure 2.5 Total Supply: The Sum
of Domestic and Foreign Supply
© 2009 Pearson Addison-Wesley. All rights reserved.
2-32
Solved Problem 2.2
 How does a quota set by the United
States on foreign steel imports of Q
affect the total American supply curve
for steel given the domestic supply, Sd in
panel a of the graph, and foreign supply,
Sf in panel b?
© 2009 Pearson Addison-Wesley. All rights reserved.
2-33
Solved Problem 2.2
© 2009 Pearson Addison-Wesley. All rights reserved.
2-34
Market Equilibrium
 Equilibrium - a situation in which no
one wants to change his or her
behavior.
 excess demand the amount by which the
quantity demanded exceeds the quantity
supplied at a specified price.
 excess supply the amount by which the
quantity supplied is greater than the
quantity demanded at a specified price
© 2009 Pearson Addison-Wesley. All rights reserved.
2-35
p, $ per kg
Figure 2.6 Market Equilibrium
At a price above
equilibrium….
Excess supply
= 39
Market equilibrium
point!
S
3.95
e
3.30
2.65
Excess demand = 39
D
At a price below
equilibrium….
0
176
is below the quantity
is below the quantity
supplied
demanded
194
207
the quantity
supplied….
the quantity
demanded….
© 2009 Pearson Addison-Wesley. All rights reserved.
220
233
246
Q, Million kg of pork per year
2-36
Using Math to Determine the
Equilibrium
 Demand: Qd = 286 − 20p
 Supply: Qs = 88 + 40p
 Equilibrium:
Qd = Qs
286 − 20p = 88 + 40p
60p = 198
P = $3.30
Q = 286 – 20(3.3) = 220
© 2009 Pearson Addison-Wesley. All rights reserved.
2-37
Equilibrium: Practice Problem
 The demand function for a good is
Q = a−bp, and the supply function is
Q = c + ep, where a, b, c, and e are
positive constants. Solve for the
equilibrium price and quantity in
terms of these four constants.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-38
Market Equilibrium
Qd  286  20 p
Qs  88  40 p
Qd  Qs
286  20 p  88  40 p
p  $3.30
q  220
© 2007 Pearson Addison-Wesley. All rights reserved.
2–39
Shocking the Equilibrium
The equilibrium changes only if a shock
occurs that shifts the demand curve or the
supply curve. These curves shift if one of
the variables we were holding constant
changes.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-40
Figure 2.7a Equilibrium Effects of a
Shift of a Demand Curve
p, $ per kg
A $0.60 increase in the price of
beef shifts the demand outward
e2
3.50
3.30
Which puts an
upward pressure in
the price to a new
equilibrium.
S
D2
e1
D1
At the original price
there is now an
excess demand….
Excess demand = 12
0
176
220
228 232
Q, Million kg of pork per year
© 2009 Pearson Addison-Wesley. All rights reserved.
2-41
p, $ per kg
Figure 2.7b Equilibrium Effects of a
Shift of a Supply Curve
A $0.25 increase in the price of hogs
shifts the supply curve to the left
Which puts an upward
pressure in the price to
a new equilibrium.
S2
S1
e2
3.55
3.30
e1
D
At the original price
there is now an
excess demand….
Excess demand = 15
0
176
205
215 220
Q, Million kg of pork per year
© 2009 Pearson Addison-Wesley. All rights reserved.
2-42
Solved Problem 2.3
 Mathematically, how does the
equilibrium price of pork vary as the
price of hogs changes if the variables
that affect demand are held constant at
their typical values?
© 2009 Pearson Addison-Wesley. All rights reserved.
2-43
Solved Problem 2.3: Solution
1. Solve for the equilibrium price of pork in
terms of the price of hogs.
Qd = 286−20p
Qs = 178 + 40p−60ph
286−20p = 178 + 40p−60ph
60p = 108 + 60ph
p = 1.8 + ph
2. Show how the equilibrium price of pork varies
with the price of hogs.

Since Δp = Δph, any increase in the price of hogs
causes an equal increase in the price of
processed pork.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-44
Solved Problem 2.4 – Mad Cow Disease
 There is an outbreak of mad cow disease
in the U.S. Japan bans imports of U.S. beef
 In the first few weeks after the U.S. ban,
the quantity of beef sold in Japan fell
substantially, and the price rose. In
contrast, three weeks after the first
discovery, the U.S. price in January 2004
fell by about 15% and the quantity sold
increased by 43% over the last week in
October 2003. Use supply-and-demand
diagrams to explain why these events
occurred.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-45
Figure 2.5 Total Supply: The Sum
of Domestic and Foreign Supply
© 2009 Pearson Addison-Wesley. All rights reserved.
2-46
p, Price of r ice per pound
Figure 2.8 A Ban on Rice Imports
Raises the Price in Japan
–
S (ban)
p2
A ban on rice imports
shifts the total supply of
rice in Japan…
S (no ban)
e2
p1
which causes the
equilibrium to change
and the price to
increase.
e1
D
Q2
© 2009 Pearson Addison-Wesley. All rights reserved.
Q1
Q, Tons of rice per year
2-47
Solved Problem 2.4
Decrease in supply
© 2009 Pearson Addison-Wesley. All rights reserved.
Increase in supply and
decrease in demand
2-48
Solved Problem 2.5
 What is the effect of a United States
quota on steel on the equilibrium in the
U.S. steel market? Hint: The answer
depends on whether the quota binds (is
low enough to affect the equilibrium).
© 2009 Pearson Addison-Wesley. All rights reserved.
2-49
Solved Problem 2.2
© 2009 Pearson Addison-Wesley. All rights reserved.
2-50
Solved Problem 2.5
© 2009 Pearson Addison-Wesley. All rights reserved.
2-51
p, $ per gallon
Figure 2.9 Price Ceiling on
Gasoline
Supply shifts to the
left….
S1
S2
but gas stations
must continue to
charge a price of
P1…..
e1
p1 = p–p1
Price ceiling
D
which creates an
excess demand.
Q1= Qd
Qs
Excess demand
© 2009 Pearson Addison-Wesley. All rights reserved.
Q, Gallons of gasoline per month
2-52
Figure 2.10 Minimum Wage
© 2009 Pearson Addison-Wesley. All rights reserved.
2-53
Solve for Excess Demand or Supply
 Simply insert price into demand and
supply functions
Qd  286  20 p
Qs  88  40 p
Qd  Qs
p  $3.30
q  220
At $3 find excess demand or supply
Qd  286  20(3)  226
Qs  88  40(3)  208
Excess demand Qd  Qs  18
© 2009 Pearson Addison-Wesley. All rights reserved.
2-54
Demand Shifts (Supply Constant)
2-55
Supply Shifts (Demand Constant)
2-56
Simultaneous Shifts
 When demand & supply shift
simultaneously
 Can predict either the direction in which
price changes or the direction in which
quantity changes, but not both
 The change in equilibrium price or quantity
is said to be indeterminate when the
direction of change depends on the relative
magnitudes by which demand & supply
shift
2-57
Simultaneous Shifts: (D, S)
P
S
S’
S’’
B
P’
P
P’’
A
•
•
•C
D’
D
Q
Q
Q’
Q’’
Price may rise or fall; Quantity rises
2-58
Simultaneous Shifts: (D, S)
P
S
S’
S’’
A
•
P
B
P’
•
•C
P’’
D
D’
Q
Q’ Q
Q’’
Price falls; Quantity may rise or fall
2-59
Simultaneous Shifts: (D, S)
P
S’’
S’
P’’
•
S
C
B
•
P’
A
•
P
D’
D
Q
Q’’
Q Q’
Price rises; Quantity may rise or fall
2-60
Simultaneous Shifts: (D, S)
P
S’’
S’
S
P’’
P
P’
•C
A
•
B
•
D
D’
Q’’
Q
Q’
Q
Price may rise or fall; Quantity falls
2-61
Why Supply Need Not Equal Demand
 The quantity that firms want to sell and
the quantity that consumers want to buy
at a given price need not equal the
actual quantity that is bought and sold.
 Example: price ceiling.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-62
Perfectly competitive markets
 Everyone is a price taker.
 Firms sell identical products.
 Everyone has full information about the
price and quality of goods.
 Costs of trading are low.
© 2009 Pearson Addison-Wesley. All rights reserved.
2-63
Figure 2A.1 Regression
© 2009 Pearson Addison-Wesley. All rights reserved.
2-64