Download The Basics of Supply and Demand

Markets:
Supply and
Demand
Prof. Bryson, Marriott School
I.
Elements of
Market Theory
Understanding Market Forces
Markets
1. What is a market?
A place? A store? A bank?
A medium through which
transactions occur.
Markt am Marienplatz, Munich
Understanding Market Forces
Markets
2. Why are markets important?
•
Markets are an expression of
freedom,
•
They function with
automaticity and without
prejudice (except against lack
of money).
Markt am Marienplatz, Munich
Demand
3. Who are the players?
Buyers and sellers
4. What is demand? Is it a quantity? A function?
A schedule of the quantity demanded at each
possible price.
Demand
5. What actually determines quantity purchased?
a. Price and
b. Non-price variables:
tastes, population, money incomes, distribution
of incomes, prices of related (sub/comp) goods
Demand Curves and Schedules
(For T Shirts, Not nasal tobacco)
• P
Q
P,$
$8.00
1,000
7.50
1,200
7.00
1,400
6.50
1,600
6.00
1.800
5.50
2,000
A “change in quantity
demanded” is the result of a
price change. One moves to
a new position in the
schedule or on the D curve.
7.50
6.00
Demand
0
1,200
1,800
Quantity
Demand continued
7. What is the ceteris paribus assumption?
All other things remain the same when you change the
price.
8. Price vs. non-price variables for a demand curve.
9. Shift vs. movement on the curve.
Demand Curves and Schedules
If the market increases greatly in size (number of buyers) or
all the buyers have greater incomes over time, we have a change
in demand. The entire schedule and
P,$
• P Q
curves must be redrawn.
$8.00
1,500
1,000
7.50
1,700
1,200
7.00
1,900
1,400
6.50
1,600
2,100
6.00
1.800
2,300
5.50
2,000
2,500
D
0
Quantity
We call this an “increase in demand” when the schedule is
rewritten and the curve shifts out to the right.
D’
Supply
10. What is supply?
11. What are elements of the Supply side? (What determines
the quantity actually sold?)
a. Price (the “focus” variable) and
b. The “underlying” or “non-price” variables:
technology, the number of suppliers, attitudes and
expectations or mood of sellers (business spirits), costs of
factors of production , prices of other related goods or
services.
12. Supply as a schedule, or function, and a curve.
13. Shift vs. movement along Supply curve.
This is precisely analogous to changes in demand and in the
quantity demanded.
Supply Curves and Schedules
(For T Shirts, Not nasal tobacco)
• P
Q
$8.00
$4,000
2,000
7.50
1,800
3,600
7.00
1,600
3,200
6.50
1,400
2,800
6.00
1.200
2,400
5.50
1,000
2,000
P,$
S
S’
Why does S slope
up to the right?
0
Quantity
If the price changes, we change positions in the schedule or on
the curve. If a non-price variable changes, we rewrite the
schedule and shift the curve.
II.
How Markets
Function
How markets function
Combine Demand and Supply as a whole market.
What causes a shortage?
$
At a price above the
equilibrium level, the
quantity supplied
S exceeds the quantity
demanded, so a
surplus (“glut”)
exists.
Sellers reduce the price
and reduce the quantity
D they offer towards
equilibrium.
0
Q
How markets function
Combine Demand and Supply as a whole market.
What causes a shortage?
$
S
At a price below the
equilibrium level, the
quantity demanded
exceeds the quantity
supplied, so a
shortage exists.
Sellers increase the quantity
supplied, but also raise the
D price toward equilibrium.
0
Q
The Price Equilibrium: Review
Where the price is
set above market
equilibrium, there
will be a surplus,
since the quantity
supplied exceeds
the quantity
demanded.
Suppliers will
reduce their output
and the price as
inventories build
Surplus
Qd
Qs
The Price Equilibrium
Where the price is set
below the market
equilibrium, there will
be a shortage, since the
quantity demanded
exceeds the quantity
supplied.
Suppliers will increase
their output and the
price as new orders
come in.
Shortage
Qs
Qd
Short-run Adjustments
A short-run change in tastes from root beer to
ginger ale will cause demand curves to shift.
Ginger Ale
Root Beer
D’
D
D’
D
Long-run Adjustments
In the long run, there is a supply response.
Resources flow to the strong demand market
from the weaker one. The supply adjustment
moderates price changes that can be quite
dramatic in the short run.
S
D’
D
D’ D
Resources flow
Long-run Adjustments
Final equilibrium, after labor, capital, etc. flow to
ginger ale, is at the pink price lines, with
prices close to their original levels.
S
S’
S’
S
D’
D
D’ D
III.
Political
Interference
with Markets
Price Freezes
Say that price increases in
rental housing inspire
legislators to impose a
price freeze on rents.
As demand continues to
increase…
a shortage will soon
appear
D’
D
Price Freezes
Market forces would
cause a price increase to
accommodate the
increased demand
automatically,…
but price increases are
now illegal, so the
shortage (in pink) will
persist.
D’
D
Price Freezes
But shortages can increase
profits without price
increases.
Tighten terms of credit
Eliminate guarantees,
Cease delivery
Slacken quality control
Reduce quality in other
ways.
D’
D
Price Freezes
If the quantity available is
limited by rent controls…
Pi
buyers would be willing to
pay an illegally high price,
Pi, as indicated by the
demand curve.
D’
D
Qs
Price Freezes
The higher price allows
black market sellers to
collect economic rents,
as shown by the orange
block.
D’
D
Qs
Price Floors: The Labor Market
• When the minimum
wage is above the
market
Wmin
equilibrium,..
• the quantity of
Wmkt
labor supplied
exceeds the quantity
demanded. Result?
Unemployment
Unemployment
IV.
Consumer and
Producer
Surplus
Consumer Surplus
What the consumer would pay rather than go without
-What the consumer actually does pay
= Consumer Surplus
Quantity
D(Would Pay) Minus P(Does Pay) = Cons. Surplus
1
$5
$2
$3
2
4
2
2
3
3
2
1
4
2
2
0
$6
Consumer Surplus
$5
$2
0
P
Q
The whole shaded area is what individual 1 would
be willing to pay rather than go without. ($5)
This is what consumer 1 actually does pay ($2)
This is consumer surplus for individual 1 ($3)
Consumer Surplus
$4
$2
0
P
Q
The whole shaded area is what individual 2 would
be willing to pay rather than go without. ($4)
This is what consumer 2 actually does pay ($2)
This is consumer surplus for individual 2 ($2)
Consumer Surplus
$3
$2
0
P
Q
The whole shaded area is what individual 3 would
be willing to pay rather than go without. ($3)
This is what consumer 3 actually does pay ($2)
This is consumer surplus for individual 3 ($1)
Consumer Surplus
$2
0
P
Q
The whole shaded area is what individual 4 would
be willing to pay rather than go without. ($2)
This is what consumer 4 actually does pay ($2)
THERE IS NO CONSUMER SURPLUS
FOR CONSUMER 4
Consumer Surplus
$2
0
P
Q
This area represents total expenditures
This area represents consumer surplus ($6)
Consumer
Surplus
$2
Price
D
0
Q
In general, Consumer Surplus is the area
below the demand curve and above the
price line
Consumer
Surplus
Notice that when the price goes up or
down, consumer surplus is lost or gained.
This much consumer surplus…
is lost when the price goes up.
Producer Surplus
• Producer Surplus is the
difference between what
sellers would be willing to
sell for, should the market P
require it, and what they
actually do sell the product
for.
• It is the area above the
supply curve and below
the price line.
S
Q