Download P1 - UTA Economics

© 2010 Jane Himarios, Ph.D.
Lesson 3
Chapter 3: Supply and Demand
Markets bring buyers and sellers together so they can interact and transact with
each other. There are two sides to each market: the demand side and the supply
side.
Prices communicate a lot of information. Our market economy is called the price
system.
Demand
Demand = the maximum amount of a good or service that buyers are willing and
able to offer to buy at each and every price during a specific time period, ceteris
paribus
Here is a demand curve. Notice that each price is associated with a different
quantity demanded.
Price of this good
P1
P2
Demand
Q1
Q2
Quantity demanded of this good
If the price of this good changes then the “quantity demanded” of this good will
also change, but nothing will happen to the “demand” for this good.
The Law of Demand: Ceteris paribus, as price increases, quantity demanded
falls, and as price decreases, quantity demanded rises. (This is because people
will substitute towards relatively cheaper products.)
When the price of this good changes we slide along the existing demand curve—
notice that demand doesn’t change.
Determinants of Demand: Ceteris paribus, when a determinant of demand
changes, the position of the demand curve shifts. This is called a change in
demand.
The determinants of demand are listed in columns 3 and 4 below:
© 2010 Jane Himarios, Ph.D.
Your job is to learn to define and show on a graph (1) an increase in
demand, (2) a decrease in demand, (3) an increase in quantity demanded,
and (4) a decrease in quantity demanded. You have to learn to identify the
things that cause (1) an increase in demand, (2) a decrease in demand, (3)
an increase in quantity demanded, and a (4) decrease in quantity
demanded:
An increase in
quantity demanded
is caused by a
decrease in the price
of the good in the
current market
period
A decrease in
quantity demanded
is caused by an
increase in the price
of the good in the
current market period
An increase in
demand is caused by
one of the following:
A decrease in demand
is caused by one of the
following:
An increase in the
number of buyers
A decrease in the
number of buyers
An increase in tastes or
preferences
A decrease in tastes or
preferences
An increase in the price
of a substitute good
A decrease in the price
of a substitute good
A decrease in the price
of a complementary
good
An increase in the price
of a complementary
good
A change in consumer
expectations about
future conditions that
cause them to want to
buy more today
A change in consumer
expectations about
future conditions that
cause them to want to
buy less today
An increase in income if
this is a normal good
or
A decrease in income if
this is an inferior good
A decrease in income if
this is a normal good
or
An increase in income if
this is an inferior good
© 2010 Jane Himarios, Ph.D.
Supply
Supply = the maximum amount of a good or service that sellers are willing and
able to offer to provide at each and every price during a specific time period,
ceteris paribus
Here is a supply curve. Notice that each price is associated with a different
quantity supplied.
Price of this good
Supply
P2
P1
Q1
Q2
Quantity supplied of this good
If the price of this good changes then the “quantity supplied” of this good will also
change, but nothing will happen to the “supply” for this good.
The Law of Supply: Ceteris paribus, as price increases, quantity supplied rises,
and as price decreases, quantity supplied falls. (This is because the higher the
price, the greater the potential for higher profits and thus the greater the incentive
for firms to produce and sell more products.)
When the price of this good changes we slide along the existing supply curve—
notice that supply doesn’t change.
Determinants of Supply: Ceteris paribus, when a determinant of supply
changes, the position of the supply curve shifts. This is called a change in supply.
The determinants of supply are listed in columns 3 and 4 below:
© 2010 Jane Himarios, Ph.D.
Your job is to learn to define and show on a graph (1) an increase in
supply, (2) a decrease in supply, (3) an increase in quantity supplied, and
(4) a decrease in quantity supplied. You have to learn to identify the things
that cause (1) an increase in supply, (2) a decrease in supply, (3) an
increase in quantity supplied, and a (4) decrease in quantity supplied:
An increase in
quantity supplied is
caused by an
increase in the price
of the good in the
current market
period
A decrease in
quantity supplied
is caused by a
decrease in the
price of the good in
the current market
period
An increase in supply
is caused by one of the
following:
A decrease in supply is
caused by one of the
following:
An improvement in
production technology
A decrease in production
technology
A decrease in the price
of a resource used to
produce this good
An increase in the price of
a relevant resource used
to produce this good
A decrease in the price
of another good that
sellers can produce
An increase in the price of
another good that sellers
can produce
A change in
expectations about
future conditions that
cause sellers to supply
more today
A change in
expectations about
future conditions that
cause sellers to supply
less today
An increase in the
number of sellers
A decrease in the number
of sellers
An increase in
subsidies to producers
A decrease in subsidies to
producers
A decrease in taxes on
producers
An increase in taxes on
producers
A decrease in
government restrictions
(not in your text)
An increase in
government restrictions
(not in your text)
© 2010 Jane Himarios, Ph.D.
Economic profit = Total Revenue – Total Costs + Subsidies – Taxes
Remember that economic profits sends signals to producers, telling them how
much to produce. When economic profit rises, the supply curve will shift
rightward, and vice versa.
Technology: The knowledge of how to use resources to produce the good being
graphed. If technology improves then total costs will fall. This will increase economic
profits, sending producers the signal to produce more.
Subsidy to producer: A payment, per unit of production, from the government to the
producer
Subsidies increase economic profits, sending producers the signal to produce more.
Tax on producer: A payment, per unit of production, from the producer to the
government
Taxes decrease economic profits, sending producers the signal to produce less.
Government restrictions: rules or laws that the government makes firms comply with.
Since compliance is costly, an increase in government restrictions decreases economic
profits, sending producers the signal to produce less. Examples: quotas, licensing
requirements
Market Equilibrium versus Market Disequilibrium
Market Equilibrium: Markets that are in equilibrium tend to remain there,
ceteris paribus.
Price
Supply
P* = equilibrium
price
Demand
Q* = equilibrium
quantity traded
Quantity traded
At P* the quantity demanded by buyers equals the quantity supplied by sellers.
All market participants are happy. There are no shortages or surpluses so there
is no signal for anyone to change their behavior.
Market Disequilibrium: Markets that are in disequilibrium will not remain in
disequilibrium. Markets tend to move towards equilibrium.
© 2010 Jane Himarios, Ph.D.
1.
What happens when a surplus exists?
Surplus = excess supply. A surplus occurs when the price is above the
equilibrium price, and quantity supplied exceeds the quantity demanded.
The surplus is a signal telling market participants that the current price is too
high.
Participants will respond by offering to buy or sell at some lower price. Notice that
the price starts to fall. We see the market respond with an increase in quantity
demanded and a decrease in quantity supplied. That is, we see movement along
the demand curve and movement along the supply curve!! This process
continues until the surplus is eliminated. Draw this on the graph below.
Price
Phigher than equil. price
Supply
Demand
Quantity traded
© 2010 Jane Himarios, Ph.D.
2.
What happens when a shortage exists?
Shortage = excess demand. A shortage occurs when the price is below the
equilibrium price, and quantity demanded exceeds the quantity supplied.
The shortage is a signal telling market participants that the current price is too
low.
Participants will respond by offering to buy or sell at some higher price. Notice
that the price starts to rise. We see the market respond with a decrease in
quantity demanded and an increase in quantity supplied. That is, we see
movement along the demand curve and movement along the supply curve!! This
process continues until the shortage is eliminated. Draw this on the graph below.
Price
Plower than equil. price
Supply
Demand
Quantity traded
© 2010 Jane Himarios, Ph.D.
Moving to a New Equilibrium: Changes in Supply and Demand
Why doesn’t a market, once it has achieved equilibrium, stay at that equilibrium
point forever? It doesn’t stay in equilibrium forever because market forces move
the equilibrium point.
Your job is to learn to predict what will happen when one curve shifts:
1. When demand increases, P* will _______ and Q* will _______.
2. When demand decreases, P* will _______ and Q* will _______.
3. When supply increases, P* will _______
and Q* will _______.
4. When supply decreases, P* will _______ and Q* will _______.
© 2010 Jane Himarios, Ph.D.
You also have to learn to predict what will happen when more than one
curve shifts:
Shifts in the same direction: quantity will change in that same direction, price will
change in the direction of the largest shift (think of which side wins the “tug of
war”)
D↑ → P↑Q↑
S↑ → P↓Q↑
D↓ → P↓Q↓
S↓ → P↑Q↓
Shifts in opposing directions: price will change in that same direction that
demand and supply both shift, quantity will change in the direction of the largest
shift
D↑ → P↑Q↑
S↓ → P↑Q↓
D↓ → P↓Q↓
S↑ → P↓Q↑