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Lecture 6: Market Equilibrium, Demand and Supply Shifts Session ID: DDEE EC101 DD & EE / Manove Supply & Demand p1 EC101 DD & EE / Manove Clicker Question p2 Market Equilibrium A competitive market is in equilibrium if the quantity supplied equals the quantity demanded at the market price. At the market equilibrium, the price is called the equilibrium price, … …and the quantities supplied and demanded are called the equilibrium quantity. In equilibrium, the price and quantity have no tendency to change (more later). In general, a system is in equilibrium when there is no tendency for change. EC101 DD & EE / Manove Supply & Demand>Market Equilibrium p3 Example: The Market for Milk In the market for milk described previously, market supply and demand are as follows. Price ($) 0.20 0.40 0.60 0.80 1.00 1.20 Market Market Supply Demand (Qts/day) (Qts/day) 300 600 1200 1800 2400 3600 3200 2000 1200 600 200 100 The market equilibrium is described by a $.60 price and a traded quantity of 1200 quarts. EC101 DD & EE / Manove Supply & Demand>Market for Milk>Equilibrium p4 Equilibrium in the Market for Milk on a Graph Market Supply & Demand for Milk P QS 1.40 QD 300 3200 1.20 0.40 600 2000 1.00 0.60 1200 1200 0.80 1800 600 1.00 2400 200 1.20 3600 100 Price 0.20 0.80 0.60 0.40 0.20 0.00 0 1000 2000 Quantity 3000 EC101 DD & EE / Manove Supply & Demand>Market for Milk>Graph>Equilibrium 4000 p5 Movement towards Market Equilibrium If the price is above the equilibrium price, quantity supplied > quantity demanded, excess supply. Sellers cannot sell as much as they want, so they will tend to offer buyers a lower price. Therefore, the price will tend to move downwards towards the equilibrium price. EC101 DD & EE / Manove Supply & Demand>Excess Supply p6 If the price is below the equilibrium price, quantity demanded > quantity supplied excess demand, buyers will not be able to buy all they want to buy, so they will tend to offer sellers a higher price. Therefore, the price will tend to move upwards towards the equilibrium price. EC101 DD & EE / Manove Supply & Demand>Excess Demand p7 EC101 DD & EE / Manove Clicker Question p8 Movement Towards Equilibrium in the Market for Milk Market Supply & Demand for Milk 1.40 P QS QD 300 3200 1.20 0.40 600 2000 1.00 0.60 1200 1200 0.80 1800 600 1.00 2400 200 1.20 3600 100 Price 0.20 Excess Supply 0.80 0.60 0.40 0.20 Excess Demand 0.00 0 1000 2000 Quantity 3000 4000 EC101 DD & EE / Manove Supply & Demand>Movement Towards Equilibrium p9 The Effect of Price Changes Price ($) 6 If Price changes, a buyer will MOVE ALONG his original demand curve, … D 5 Price 4 A …because the same demand curve yields the quantity demanded at B 3 2 1 0 Quantity 40 60 D 120 every reasonable price. Quantity Likewise, if price changes, a seller will MOVE ALONG her original supply curve, because the same supply curve yields the quantity supplied at every reasonable price. EC101 DD & EE / Manove Supply & Demand>Price Changes p 10 Demand-Curve Shifts Changes in some demand-related factors affect the quantities demanded at every price: Consumer preferences Income Prices of other goods Expectations about the future Such changes can affect demand in general,… …and they can change the position of the entire demand curve. EC101 DD & EE / Manove Supply & Demand>Demand-Curve Changes p 11 Changes in Consumer Preferences Consumer preferences change for many reasons. New information Fashion Experience These changes can shift demand. EC101 DD & EE / Manove Supply & Demand>Demand-Curve Changes p 12 Example: Preference for Milk New evidence emerges that milk… Price _____ milk demanded at every price. 8 6 S D’ D B 4 New market equilibrium: A 2 0 10 20 30 40 Quarts of Milk EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Baldness p 13 Example 2: Preference for Milk New evidence shows that milk… Price 8 D D’ 6 4 2 0 Slope increases because of narrow range of desirable quantities 10 S D’ Another possibility A In new equilibrium: ??? B 20 (but that depends on where the curves cross) 30 40 Quantity EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Complexion p 14 EC101 DD & EE / Manove Clicker Question p 15 Income and Demand Demand is affected by a person’s income. Normal goods: demand increases as income rises. Inferior goods: demand increases as income falls. EC101 DD & EE / Manove Elasticity of Demand>Income p 16 Example: Apartments and Income in Washington DC Government salaries increase. Price 8 S 6 D’ D Apartments are normal goods,… but the supply curve is almost vertical,… B because it takes a long time to build more apartments. 4 A 2 0 10 20 In new equilibrium: 30 40 Apartments EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Apartments p 17 Substitutes Two goods are substitutes if you can use one of them instead of the other. Demand for a good (chicken) increases when the price of a substitute (hamburger) rises,… because consumers want to buy less of the substitute,… and consume more of the first good instead —at every price. Supply DD & Demand>Demand-Curve Shifts>Substitutes EC101 & EE / Manove p 18 Example: Car rentals and Airfares Airfares are rising sharply. (And the quality of air travel is falling.) Price 8 6 Road travel is a substitute for air travel, so demand for rental cars will increase. D’ D S B In new equilibrium: 4 A 2 0 10 20 30 40 Car Rentals EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Car Rentals p 19 Complements Two goods are complements if you normally use both of them together. Demand for a good decreases when the price of a complement rises,… because if the complement is too expensive, the first good is less useful. EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Complements p 20 Example: Motel Rooms and Gasoline Prices Price Gasoline prices increase. 80 S D 60 D’ A Motel rooms and gasoline are complements. In new equilibrium: 40 B 20 0 100 200 300 400 Rooms rented EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Motel Rooms p 21 Supply-Curve Changes Changes in some supply-related factors will affect the quantities supplied at every price: Prices of Inputs Technology Economic Environment Changes in these factors affect supply in general,… …and they can shift the entire supply curve. EC101 DD & EE / Manove Supply & Demand>Supply-Curve Changes p 22 Example: Supply of Milk and Mad Cows Mad-cow disease kills many cows. Price 8 D S’ S In new equilibrium: 6 B A 4 2 0 100 200 300 400 Quarts of Milk EC101 DD & EE / Manove Supply & Demand>Supply-Curve Shifts>Cows p 23 Example: Supply of Milk and Hormones BST is discovered. Price 8 D S 6 S’ Causes each cow to give much more milk. A In new equilibrium: B 4 2 0 100 200 300 400 Quarts of Milk EC101 DD & EE / Manove Supply & Demand>Supply-Curve Shifts>Hormones p 24 Example: Opium and the Taliban Price 80 D 60 S S’ restrictions on opium production were relaxed. A B 40 In 2001, after the Afghan Taliban regime fell,... In new equilibrium: 20 0 100 200 300 400 Opium Output EC101 DD & EE / Manove Supply & Demand>Supply-Curve Shifts>Opium p 25 EC101 DD & EE / Manove Clicker Question p 26 End of File EC101 DD & EE / Manove End of File p 27