Download Demand

Macroeconomics
Unit 3
Supply and Demand
The Top 5
©2007, 2005 by E.H. McKay III
Some images ©2004, 2003 www.clipart.com
Markets
There are two types of markets where factors of production
(land, labor ,capital, entrepreneurship) and products are bought
and sold.
Factor Market – A factor market is any place where the factors
of production are bought and sold.
Examples of factor markets include the labor market, the real
estate market or the market for machinery used to produce
manufactured goods.
Consumers provide labor and land to businesses in the factor
market. Capital goods are also purchased in factor markets by
businesses.
Markets
The second type of market is called a product market. A
product market is any place where finished goods and
services are bought and sold. Examples of product markets
include department stores, grocery stores, accounting
services, and new car dealers.
In product markets consumers purchase goods and services
from businesses.
Concept 1: The Circular Flow
The circular flow model is an economic model designed to
represent the relationship between product markets and factor
markets.
It illustrates the interaction between consumers, business firms,
government entities, and international participants.
The Circular Flow Model
International
Goods and services
demanded
Consumers
Product
Markets
Governments
Factors of
production supplied
International
Participants
Factor
Markets
Participants
Goods and services
supplied
Businesses
Factors of
production demanded
Concept 1: The Circular Flow
Within the circular flow model, consumers supply the factors of
production to the factor markets, which produce the goods and
services demanded in the product markets by consumers.
International participants also supply factors of production to
the factor markets and demand products and services in the
product markets.
Concept 1: The Circular Flow
The role of government entities within the circular flow is to
obtain resources in the factor markets (similar to a business),
and supply services to both consumers and businesses.
Governmental entities also provide the operating framework by
establishing standards, regulations, and oversight in both the
factor and product markets.
Concept 2: Demand
Demand is the ability and willingness to buy specific quantities
of a good at alternative prices in a given time period, ceteris
paribus.
When we discuss demand, we are specifically examining
consumer demand for goods and services in the product
markets.
Our demand for a good or service is affected by its opportunity
cost – what do we have to give up in order to obtain a particular
good/service. It is also affected by the cost of the product and
other factors known as determinants of demand.
Concept 2: Demand
The demand for products and services can be examined on an
individual basis.
Demand can also be examined by looking at the total demand
for a product or service. This is known as the market demand.
Market demand can be defined by geographic location (for
example the demand for gasoline in the state of Michigan), by
group (senior citizens, etc.) or as the total demand for a good or
service.
Concept 2: Demand
Frequently when we examine individual demand, an individual
demand schedule is developed.
A demand schedule illustrates the quantities of a good or
service a consumer is willing and able to buy at alternative
prices in a given time period, ceteris paribus.
The next page illustrates a demand schedule.
Fred’s Demand Schedule for CDs
Price per CD
Quantity of CDs Demanded
$25
1
$20
2
$15
3
$10
5
$7.50
8
Demand Schedule
Fred’s demand schedule reflects his interest in music and his
desire to add to his CD music collection compared with other
needs and desires Fred has.
It also reflects Fred’s interest in purchasing more CDs when
the price drops or fewer CDs when the price rises.
A demand schedule does not tell us why Fred will buy
different quantities of CDs – it just tells us what Fred is willing
and able to purchase at different price levels.
Demand Curve
We can take the information from a demand schedule and draw
a simple graph.
The graph of the demand schedule indicates the quantity
demanded at each price level.
Demand curves are usually drawn with the price on the y –
axis, and the quantity demanded on the x – axis.
Demand Curve for CDs
$30.00
$25.00
Price
$20.00
$15.00
$10.00
$5.00
$0.00
1
2
3
Quantity
5
8
Demand Curve
The demand curve illustrates Fred’s current demand schedule
for CDs.
When a price change occurs, there is movement along the
existing curve. For example if the price of CDs falls, there is
movement down along the demand curve in response to the
price change.
If the previous price was $20 and the new price is $15, the
quantity demanded changes from 2 to 3.
Demand Curves and Demand
Demand curves and schedules represent consumer buying
intentions, not actual purchases.
Demand curves have a downward slope indicating that as the
price falls, more quantities will be purchased.
The Law of Demand states that the quantity of a good
demanded in a given time period increases as its price falls,
ceteris paribus. This means that as the price falls or increases,
the quantity demanded will increase or fall (an inverse
relationship).
Concept 2: Determinants of Demand
The demand curve can also shift in response to a change in
tastes (desire), income, the availability of other goods, or a
change in expectations associated with income, prices, and
tastes.
The factors which cause the demand curve to shift are known
as determinants of market demand.
Let’s examine each determinant and look at the definitions and
examples for each one.
Concept 2: Determinants of Demand
Taste is the desire for a particular product
compared to other products. Our desire for
a particular product can change over time.
For example, if you are thirsty your desire for
a soft drink may be high, but after you have
consumed the soft drink, you may no longer
be thirsty and so your desire for a soft drink
is much lower.
Concept 2: Determinants of Demand
The next determinant of demand is income. Income refers to
the amount of income the consumer has.
Changes in consumer income can affect the amount and type
of consumer purchases.
For example if a consumer receives an increase in his/her
salary, the consumer has more money to spend on goods and
services thereby affecting the demand for goods and services
by this consumer.
Concept 2: Determinants of Demand
Another determinant of demand is called Other Goods. This
determinant is defined as the availability and price of substitute
and complementary goods.
A substitute good is a good that can substitute for another
good.
A complementary good is a good that is frequently consumed
with another good.
Concept 2: Determinants of Demand
If you prefer one particular brand of soda pop and it is not
available but another brand is, you may consume that brand
instead.
This is an example of a substitute good. Substitute goods are
goods that can substitute for each other.
The relationship between substitute goods in terms of price is
that if the price of your favorite soda pop rises above other
drink choices you may have, you will start purchasing the less
expensive soda pop.
Concept 2: Determinants of Demand
Another type of good is called a
complementary good. A complementary
good is a good that is frequently consumed
in combination with another good.
An example of two complementary goods
is milk and cereal. They are frequently
consumed together. If the price of cereal
rises, the demand for milk will fall, ceteris
paribus.
Concept 2: Determinants of Demand
The next determinant of demand is called Expectations. This
is defined as the consumer’s expectation for income, prices,
and any changes in taste.
Income expectation refers to a consumer’s expectation for
changes in income. If a consumer expects to receive a salary
increase, spending may increase immediately.
If a consumer expects to be laid off from his/her job, spending
may immediately decline.
Concept 2: Determinants of Demand
Expectations for prices refers to anticipated changes in the
prices of goods and services.
If prices are expected to fall, consumers will delay purchasing
many goods and services in the hope that prices will decline.
If prices are expected to rise, consumers may purchase goods
and services immediately rather than wait for an actual need for
those items.
Concept 2: Determinants of Demand
Finally the last determinant is Number of Buyers. Number of
buyers refers to the number of consumers seeking to purchase
a good or service, and the availability of the product.
Goods or services in high demand by buyers may result in
inventory depletion which will leave many potential buyers
without an opportunity to purchase the product.
Concept 2: Changes in Demand
The determinants of demand can change over time.
Any change in tastes, income, other goods, expectations, and
the number of buyers will affect the demand schedule and
curve.
A shift in demand occurs when there is a change in the
quantity demanded at every price level – a change has
occurred in one or more of the determinants of demand.
A shift in demand produces a new demand curve.
Concept 2: Changes in Demand
If the price of a good or service changes, and there has been
no change in the determinants of demand, then we will have
movement along the existing demand curve.
Movement along the curve indicates that if the price has
decreased, consumption will increase; or if the price has
increased, consumption will decrease.
Concept 2: Changes in Demand
When the demand curve shifts to the right, there is an increase
in the demand for a good or service. A determinant of demand
has changed – perhaps consumers prefer a product more than
before or there may have been an increase in income.
When the demand curve shifts to the left, there is a decrease in
the demand for a good or service. A determinant of demand
has changed – perhaps consumers expect to lose their jobs or
consumers may believe that prices will fall for a good in the
future.
Movements vs. Shifts
Price
$20.00
15.00
10.00
7.50
5.00
4.00
3.00
2.00
1.00
0
Shift in
demand
C
A
Movement
along curve
B
increased
demand
initial demand
2
4
6
8
10
12
14
16
18
20
22
Quantity
Movements vs. Shifts
If we have a change in the quantity demanded, it means we
have movement along a given demand curve, in response to
a price change (from point A to point B on the graph).
If we have a change in demand, it means the demand curve
has shifted due to changes in the determinants of demand:
tastes, income, other goods, expectations, number of buyers
(from point A to point C on the graph).
Concept 2: Market Demand
Market demand is the total quantity of a good or service
people are willing and able to buy at alternative prices in a
given time period.
Takes each consumer’s individual demand for a good or
service and combines it into an overall demand schedule and
curve.
Market demand is affected by the number of buyers and their
tastes, incomes, other goods, and expectations.
Concept 2: Market Demand
To construct a market demand schedule or curve, you combine
each consumer demand schedule into one schedule.
Using the new market demand schedule, you plot the curve.
The procedure for constructing the market demand schedule
and curve is similar to the individual demand schedule and
curve, except you are adding each consumer’s demand at
various price points together for a total.
Market Demand Schedule for CDs
Price
Fred
Jane
Sam
Kim
Market
Demand
$25
1
0
1
1
3
$20
2
1
1
2
6
$15
3
2
2
4
11
$10
5
3
4
6
18
$7.50
8
4
6
8
26
Market Demand Curve for CDs
$30.00
$25.00
Price
$20.00
$15.00
$10.00
$5.00
$0.00
3
6
11
Quantity
18
26
Concept 3: Supply
Supply is defined as the ability
and willingness to sell specific
quantities of a good or service at
alternative prices in a given time
period, ceteris paribus.
When we discuss supply we are
examining the behavior of
businesses and their willingness
to sell their products and services
at different price levels.
Concept 3: Supply
Market Supply is the total quantities of a good or service that
all sellers are willing and able to sell at alternative prices in a
given time period, ceteris paribus.
Similar to demand, there are determinants of market supply.
The determinants of market supply are Technology, Factor
Costs, Other Goods, Taxes and Subsidies, Expectations,
Number of Sellers.
Concept 3: Determinants of Supply
The first determinant, Technology, refers to the availability and
use of technology. Technology when properly installed and
implemented can lower the cost of producing a good or service.
This may make a business more competitive and perhaps
lower the cost of the product to the consumer.
The second determinant, Factor Costs, refers to the cost of
labor, capital and land. As the prices change for these factor
costs, the ability of a business to produce and sell a product or
service for a profit changes too.
Concept 3: Determinants of Supply
The third determinant of supply, Other Goods, refers to the
prices and profits available for producing other products or
services. The business will evaluate the sales and profits of the
current product against alternative pursuits,
The fourth determinant is called Taxes and Subsidies. It
refers to the level of taxation on corporate profits and the
availability of government subsidies for producing specific
goods or services. Items produced that are subject to
additional taxation may not be as attractive as other items that
are eligible for government subsidies.
Concept 3: Determinants of Supply
The fifth determinant of supply is Expectations. Expectations
refers to future predictions for sales, profits, and economic
conditions. If future sales are expected to decline, the product
line may be discontinued.
The final determinant of supply is Number of Sellers. This
determinant is concerned with the level of competition and the
potential for profit. Higher levels of competition can produce
lower profits per unit and discourage some sellers from
remaining in the market.
Concept 3: Law of Supply
The Law of Supply states that the quantity of a good or service
supplied in a given time period increases as its price increases,
ceteris paribus.
The market supply schedule and curve reflects the sellers’
intentions and not actual sales.
Supply curves are upward sloping indicating that as price
increases, the quantity available for sale will increase.
In most situations there are more than one seller so our
discussion revolves around market supply not individual supply.
Market Supply Schedule for CDs
Price
The CD
Hut
CD
World
CD
Palace
Cheap
CDs
Market
Supply
$25
100
150
150
200
600
$20
75
100
125
190
490
$15
50
75
100
175
400
$10
25
50
75
150
300
$7.50
5
15
50
125
195
Market Supply Curve for CDs
$30.00
$25.00
$20.00
$15.00
$10.00
$5.00
$0.00
195
300
400
490
600
Market Supply Schedule and Curve
The market supply curve and schedule reflects sellers’
intentions, not actual sales.
As the price rises, sellers become more interested in
selling more products/services.
This is the opposite of a demand schedule and curve
which indicates that as price falls demand increases.
Buyers and sellers react to price changes differently.
Concept 3: Supply - Movements vs. Shifts
If only the price changes, then we have movement along
the existing supply curve, but no shifts. This causes a
change in the quantity supplied.
If there is a change in supply, then we have a change in one or
more of the determinants of supply (technology, factor costs,
other goods, taxes and subsidies, expectations, number of
sellers). Changes in supply produce shifts of the supply curve.
Concept 3: Supply Shifts
When the supply curve shifts to the left, this indicates a
reduction in supply due to a change in one or more
determinants. For example, an increase in factor costs may
cause the supply curve to shift to the left.
When the supply curve shifts to the right, there is an increase in
supply due to a change in one or more determinants. For
example, improvements in technology which result in lower
costs per unit may cause an increase in the willingness of
sellers to sell more units at the existing price.
Shift of Supply Curve
$30.00
Supply increases
when it shifts to the
right
$25.00
Price
$20.00
$15.00
$10.00
$5.00
$0.00
0
100
200
300
400
500
Quantity
600
700
800
900
Concept 4: Equilibrium
At some point buyers and sellers will agree on a price and
quantity demanded. This location is known as the market
equilibrium price and quantity.
The market equilibrium price is the price at which the quantity
of a good or service demanded in a given time period equals
the supply.
The market equilibrium price changes when the determinants of
demand or supply change, or when the price changes.
Market Equilibrium
$30.00
$25.00
Equilibrium occurs at a price
of $10 and a quantity of 18
Price
$20.00
$15.00
$10.00
$5.00
$0.00
0
10
20
30
Quantity
40
50
60
Concept 4: Equilibrium
At equilibrium if the demand curve shifts to the right, demand
increases but price also rises. When the demand curve shifts
to the left, demand and price declines.
At equilibrium if the supply curve shifts to the right, supply
increases and price falls. If the supply curve shifts to the left,
supply declines and prices rise.
Concept 5: Surpluses and Shortages
A market surplus can occur when the quantity supplied
exceeds the quantity demanded. The surplus amount is the
difference between the quantity supplied and the quantity
demanded.
In surplus situations, business owners will need to get rid of
excess inventory by usually reducing the price or slowing down
production.
Concept 5: Surpluses and Shortages
A market shortage can occur when the quantity of a good or
service demanded exceeds the quantity supplied.
If supply is not increased to meet demand, then the price will
increase and the market equilibrium will occur at a higher price.
The next graph depicts market shortages and surpluses.
Market Shortages and Surpluses
$30.00
$25.00
Price
$20.00
A
$15.00
Surplus
B
$10.00
C
Shortage
D
$5.00
$0.00
0
10
20
30
Quantity
40
50
60
Concept 5: Market Shortages and Surpluses
At point A on the preceding graph, the demand for CDs equals
10 units at $15.00. However the supply at this price level is
equal to 25 (point B). In this situation, a market surplus exists.
If sellers wish to sell more CDs they must reduce the price.
At point C on the graph, the supply of CDs equals 10 units at a
price of $7.50. However the demand for CDs at this price
equals 26 units. In this situation, a market shortage exists. If
sellers do not increase supply, the price will rise.
Supply and Demand Issues
The equilibrium price and quantity will change whenever supply
or demand shifts or there is a change in price (movement along
the demand or supply curve).
Price ceilings imposed by the government will usually cause a
shortage of supply if they are imposed at a price level lower
than the market equilibrium price. Effective price ceilings are
implemented at output levels where the market equilibrium can
be maintained.
Summary
The major concepts from this unit are:
• Circular flow
• Demand and its determinants
• Supply and its determinants
• Equilibrium
• Shortages and Surpluses