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eStudy.us Market Demand, Supply and Equilibrium copyright © michael [email protected] 2010, All rights reserved eStudy.us Markets and Competition Market – a group of buyers and sellers of a good or service • Can be highly organized (Corn, Wheat) • Can be less organized (Television) Competitive market • Many buyers and many sellers • Each has a negligible impact on market price copyright © michael [email protected] 2010, All rights reserved eStudy.us Demand Quantity demanded – the amount of a good buyers are willing and able to purchase Law of demand – other things equal, when the price of the good rises the quantity demanded of a good falls Demand schedule – a table illustrating the relationship between a price of a good and quantity demanded Demand curve – a graph illustrating the relationship between price of a good and quantity demanded Individual demand – Demand of one individual copyright © michael [email protected] 2010, All rights reserved eStudy.us demand schedule – a table that shows the quantity demanded at each price. Price of hamburgers $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 Demand schedule and demand curve Price Quantity of hamburgers demanded $3.00 12 10 8 6 4 2 0 $2.00 Hamburger Demand Curve decrease in price $2.50 increases quantity of hamburgers demanded. $1.50 $1.00 Demand curve $0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity demand curve – illustrates how the quantity demanded of the good changes as its price varies. Because a lower price increases the quantity demanded, the demand curve slopes downward. copyright © michael [email protected] 2010, All rights reserved eStudy.us Market Demand Schedule Market demand – the sum of all individual demand schedules for a good or service Price of hamburger Bob $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 12 10 8 6 4 2 0 Sam + 7 6 5 4 3 2 1 Market = 19 16 13 10 7 4 1 The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price. Thus, the market demand curve is found by adding horizontally the individual demand curves. At a price of $2.00 Bob demands 4 hamburgers, and Sam demands 3. The quantity demanded in the market at this price is 7 hamburgers. copyright © michael [email protected] 2010, All rights reserved eStudy.us Bob’s demand + Price $3.00 DBob Market Demand Curve Sam’s demand = Market demand Price Price $3.00 $3.00 DSam 2.50 2.50 2.00 2.00 2.00 1.50 1.50 1.50 1.00 1.00 1.00 0.50 0.50 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity 0 2.50 1 2 3 4 5 6 7 Quantity 0 DMarket 2 4 6 8 10 12 14 16 18 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand – Consumer Income • Normal good – an increase in income will cause an increase in demand, all else equal • Inferior good – an increase in income a decrease in demand, all else equal Hamburger Market Hamburger? Inferior Steak? Price Normal For Hamburger increase in income (D1) decrease in income (D2) P0 D0 D1 0 Q1 Q0 D2 Q2 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand – Prices of related goods • Substitutes an increase in the price of one leads to an increase in the demand for the other • Complements an increase in the price of one leads to a decrease in the demand for the other Hamburger Market Compliments buns, cheese & soda Price Increase in bun price (D1) Substitutes chicken, steak & fish P0 D0 D1 Increase in chicken price (D2) 0 Q1 Q0 D2 Q2 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand – Tastes • News story • Advertisement • Diets Oprah “all burgers are evil”, Mad cow (D1) Beef, It’s What’s for Dinner Adkins Diet (D2) Hamburger Market Price P0 D0 D1 0 Q1 Q0 D2 Q2 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand – Expectations about future prices, quality and availability • Leaner, healthier, meat announcement (D1) • New tax on hamburgers next month to promote health (D2) Hamburger Market Price P0 D0 D1 0 Q1 Q0 D2 Q2 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand – Consumer Income • Normal good – an increase in income will cause an increase in demand, all else equal • Inferior good – an increase in income causes a decrease in demand, all else equal – Prices of related goods • Substitutes an increase in the price of one leads to an increase in the demand for the other • Complements an increase in the price of one leads to a decrease in the demand for the other – Tastes – Expectations about future prices, quality and availability – Number of buyers copyright © michael [email protected] 2010, All rights reserved eStudy.us Demand Terminology Change in Demand is a shift in the demand curve resulting from a change in one of the determinants of demand Price Change in Quantity Demanded is a movement along a given demand curve caused by a change in own price Price $4.00 B $2.00 $2.00 D0 D1 0 10 A 20 Quantity As incomes increase, the demand curve for hamburger shifts to the left. Note the left graph: the demand curve shifts from D0 to D1. At price of $2.00, the quantity demanded falls from 20 to 10 hamburgers. D0 0 12 20 Quantity An increase in the price of hamburgers causes a movement to a different point on a given demand curve. Note the right graph: when the price rises from $2.00 to $4.00, the quantity demanded falls from 20 to 12 hamburgers, as reflected by the movement from point A to point B. copyright © michael [email protected] 2010, All rights reserved eStudy.us Demand Terminology Increase in demand – any change that increases the quantity at every price • Demand curve shifts right (D1) Decrease in demand – any change that decreases the quantity at every price • Demand curve shifts left (D1) Price Increase in Demand Decrease in Demand D0 D2 0 D1 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Demand Review Variable A Change in This Variable . . . Change in Quantity Demanded Price of the good itself Movement along the demand curve Change in Demand Income Prices of related goods Tastes Expectations Number of buyers Shift in demand curve Shift in demand curve Shift in demand curve Shift in demand curve Shift in demand curve copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply Quantity supplied – the amount of a good sellers are willing and able to sell Law of supply – other things equal, when the price of the good changes quantity supplied of a good moves in the same direction Increase in Supply – when the price of the good rises quantity supplied of a good go up Decrease in Supply – when the price of the good falls quantity supplied of a good drops copyright © michael [email protected] 2010, All rights reserved eStudy.us supply schedule – a table that shows the quantity supplied at each price. Supply schedule and supply curve Price Supply curve $3.00 Price of hamburger $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 Quantity of hamburger supplied 0 0 1 2 3 4 5 $2.50 increase in price $2.00 $1.50 $1.00 increases quantity of hamburger supplied $0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity supply curve – a graphic representation of the relationship between price of a good and quantity supplied, higher price increases the quantity supplied, so the supply curve slopes upward. copyright © michael [email protected] 2010, All rights reserved eStudy.us Market Supply Market supply – sum of the supply schedules of all sellers for a good or service Price of hamburger Jan $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 0 0 1 2 3 4 5 Al + 0 0 0 2 4 6 8 Market = 0 0 1 4 7 10 13 The quantity supplied in a market is the sum of the quantities supplied by all the sellers at each price. Thus, the market supply curve is found by adding horizontally the individual supply curves. At a price of $2.00, Bob supplies 3 hamburgers, and Al supplies 4 hamburgers. The quantity supplied in the market at this price is 7 hamburgers. copyright © michael [email protected] 2010, All rights reserved eStudy.us Jan’s supply Market supply + Price Al’s supply = Market supply Price Price $3.00 $3.00 $3.00 2.50 2.50 2.50 2.00 2.00 2.00 1.50 1.50 1.50 1.00 1.00 1.00 0.50 0.50 0.50 SJan 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity 0 SAl 1 2 3 4 5 6 7 Quantity 0 SMarket 2 4 6 8 10 12 14 16 18 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Shifts in Supply Shift in Supply or “Change in Supply” – Increase in supply: any change that increases the quantity supplied at every price • Supply curve shifts right – Decrease in supply: any change that decreases the quantity supplied at every price • Supply curve shifts left copyright © michael [email protected] 2010, All rights reserved eStudy.us Price Supply curve, S2 Shifts in Supply Supply curve, S0 Supply curve, S1 Decrease in supply ` 0 Increase in Supply Quantity Any change that raises the quantity that sellers wish to produce at any given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at any given price shifts the supply curve to the left. copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Supply Variables that can shift the supply curve – Input Prices (negatively related to increased prices of inputs) – Technology (positively related to improved technology) – Expectations about future – Price of other goods being produced (negatively related to increased prices of other goods) – Number of sellers copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand Variables that can shift the supply curve – Input Prices (negatively related to increased prices of inputs) Employees always want a wage increase. How will a wage increase impact the market for Hamburger? (S1) Hamburger Price S1 S0 S2 P0 A wage decrease? (S2) 0 Q1 Q0 Q2 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Determinants of Demand Variables that can shift the supply curve – Price of other goods being produced (negatively related to increased prices of other goods) In economic recession households demand more cats and fewer dogs ― Cats (inferior goods) Cat food prices increase Dog Food Price S2 S0 P0 ― Dogs (normal goods) 0 Q2 Q0 Quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply Review Variables that influence sellers Variable Change in Quantity Supplied of the good itself Change in Supply Input prices Technology Expectations Number of sellers A Change in This Variable . . . movement along the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve copyright © michael [email protected] 2010, All rights reserved eStudy.us Equilibrium Equilibrium – where market price achieves the condition quantity supplied equals quantity demand Price Supply $3.00 2.50 Equilibrium Equilibrium price 2.00 1.50 Equilibrium price is $2.00. At this price, 7 hamburgers are supplied, and 7 hamburgers are demanded. 1.00 Demand 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity Equilibrium quantity 25 copyright © michael [email protected] 2010, All rights reserved eStudy.us Equilibrium Excess Supply Excess Demand Price Price Supply Surplus Supply $2.50 $2.00 $2.00 Demand $1.50 Demand Shortage 0 4 7 10 Quantity 0 4 7 10 Quantity Suppose market price is $2.50, the quantity supplied (10 burgers) exceeds the quantity demanded (4 burgers). Suppliers will increase sales by cutting the price which causes an increase in quantity demand and moves the price toward its equilibrium level. Suppose market price is $1.50, the quantity demanded (10 burgers) exceeds the quantity supplied (4 burgers). With more buyers and goods available, suppliers take advantage of the shortage by raising the price. The price adjustment moves the market toward the equilibrium. copyright © michael [email protected] 2010, All rights reserved eStudy.us Equilibrium • Surplus (Excess supply) – Quantity supplied > quantity demanded – Downward pressure on price • Shortage (Excess demand) – Quantity demanded > quantity supplied – Upward pressure on price copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Law of supply and demand – states that price of any good adjusts bringing the quantity supplied and the quantity demanded into balance In most markets surpluses and shortages are temporary copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Three steps to analyzing changes in equilibrium 1. Decide if the event shifts the supply curve, the demand curve, or both curves 2. Decide if curve shifts to right or to left 3. Use supply-and-demand diagram • Compare initial and new equilibrium • How the shift affects equilibrium price and quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Example: A change in market equilibrium due to a shift in demand A cool summer effect on the hamburger market 1. Cool weather - demand curve (tastes) 2. Demand curve shifts to the left (down) 3. Lower equilibrium price; lower equilibrium quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand 1. Cool weather decreases the demand for hamburger . . . Price Supply 2. resulting in a lower price . . . $2.50 New equilibrium 2.00 D0 D1 3. …and a lower quantity sold. 0 7 10 Quantity An abnormally cool summer causes buyers to demand less hamburger (less grilling). The demand curve shifts from D0 to D1, which causes the equilibrium price to lower from $2.50 to $2.00 and the equilibrium quantity to lower from 10 to 7 hamburgers copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Example: A change in market equilibrium due to a shift in supply – Technology improves hamburger processing 1. Change in technology impacts the supply curve 2. Supply curve shifts to the right 3. Lower equilibrium price; higher equilibrium quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Price 1. an improvement in Technology S0 2. results in a lower price S1 $2.50 2.00 New equilibrium Demand 3. and a higher quantity sold 0 4 7 Quantity A technology improvement causes sellers to supply more hamburger. The supply curve shifts from S0 to S1, which causes the equilibrium price of hamburger to lower from $2.50 to $2.00 and the equilibrium quantity to increase from 4 to 7 hamburgers 33 copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Example: A change in market equilibrium due to a shift in supply – Labor wages increase – Effect on the market for hamburger? 1. Change in input price impacts the supply curve 2. Supply curve - shifts to the left 3. Higher equilibrium price; lower equilibrium quantity copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Price 1. an increase in labor wages S1 2. results in a higher price S0 $2.50 New equilibrium 2.00 Demand 3. a smaller quantity sold 0 4 7 Quantity An increase in labor wages (an input price) causes sellers to supply less hamburger. The supply curve shifts from S0 to S1, which causes the equilibrium price of hamburger to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 hamburgers copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Example: shifts in both supply and demand – Increase in labor wages and increase in fish price 1. Higher fish price shifts demand curve for hamburger to the right 2. Higher labor wages will shift supply to the left 3. Equilibrium price raises 4. Equilibrium quantity depends on relative shifts in demand and supply – If demand increases substantially while supply falls just a little: equilibrium quantity rises – If supply falls substantially while demand rises just a little: equilibrium quantity falls copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand Price Rises, Quantity Rises Price Large increase in demand New equilibrium Price Rises, Quantity Falls Price Small increase in demand S1 S 0 P1 S0 New equilibrium P1 Small decrease in supply P0 D1 Large decrease in supply P0 D1 D0 D0 0 S1 Q0 Q1 Quantity of Hamburgers 0 Q1 Q 0 Quantity of Hamburgers Observe a simultaneous increase in demand and decrease in supply with two possibly outcomes. • To the left, equilibrium price rises from P0 to P1, and the equilibrium quantity rises from Q0 to Q1. • To the right, equilibrium price again rises from P0 to P1, but the equilibrium quantity falls from Q0 to Q1. copyright © michael [email protected] 2010, All rights reserved eStudy.us Supply and Demand What happens to price and quantity when supply or demand shifts? No change In Supply An increase In Supply A decrease In supply No change In demand P same Q same P down Q up P up Q down An increase In demand P up Q up P ambiguous Q up P up Q ambiguous A decrease In demand P down Q down P Down Q ambiguous P ambiguous Q down copyright © michael [email protected] 2010, All rights reserved