Download Document

ECN202: Macroeconomics
S&D
Supply & Demand
Think of how important markets are in your life? Stories
about them fill the news, as you can see in some
headlines. Markets determine the price you pay for
food, phones, and air travel, which affects what you eat,
what phone you buy, and if you travel by plane. They
also affect the wages you earn or the interest you pay
on a loan or the value of the US $. In this unit we will
look at the model economists use to explain
movements in price so you will be able to explain past
moves and forecast future moves. We start with some
examples of how prices can be really wrong. Like the
housing bubble we just experienced, and the one China
may be in right now. Then we get some practice with
those curves.
What are the major stories of prices?
One group of stories about prices are about
disequilibrium prices and shortages and
surpluses that are associated with those prices.
There is a shortage of tickets to the finals of the
NFL playoff game at the current price?
The second, and more frequent, group of stories
is about price changes driven by shocks to the
market. This is the type we spend the most time
on in this course.
What are the primary drivers of price
changes?
1. Demand shocks
2. Supply shocks
3. Changes in market power (competition)
4. Government intervention
How should you approach these questions
about prices and markets?
Follow these steps one-by-one.
Cookbook approach
1. Identify the market
2. Identify the participants
3. Identify the determinants of behavior
4. Identify the type of problem
1.disequilibrium - wrong price
2.comparative static - price change
5. Identify the appropriate curves
Some Practice: What is the market?
Identify the market in these headlines
1. “The ageing of baby-boomers casts doubt
over asset prices”
2. “Race to satisfy caviar craving”
3. “A love affair with SUVs begins to cool”
Write it down and then read on
What is the market?
Identify the market in the headlines
1. “The ageing of baby-boomers casts doubt
over asset prices” (Market for assets such
as stocks or homes)
2. “Race to satisfy caviar craving” (Market for
caviar)
3. “A love affair with SUVs begins to cool”
(Market for SUVs)
Determinants of demanders’ behavior
Make a list of factors that affect demand for some
product and then see if you missed anything.
1.
2.
3.
4.
5.
Ability to pay (income )
Number (demographics )
Preferences (fads, fashions, habits)
Expectations (bubbles )
Price of other things (complements &
substitutes)
6. Price of product
Headline: “A love affair with SUVs begins to cool”
Market: SUVs
What affects demand for SUVs?
• Ability to pay – an increase in income or wealth
would increase demand
• Number – an increase in the number of driving
age population would increase demand
• Preferences – increased advertising expenses
will increase demand
• Price of other things – increase in price of gas
will reduce demand
• Price of product – increase in price of SUVs will
reduce quantity demanded
Determinants of suppliers’ behavior
1. Number of suppliers
2. Costs of production
1. Price of inputs / resources
2. Productivity / efficiency of resources
3. Price of product
Headline: “Race to satisfy caviar craving”
Market: domestic grown caviar
What affects supply domestic grown caviar?
• Number of suppliers - an increase in the
number of fish farms increases supply
• Costs of production
– Price of inputs – an increase in feed costs
raises cost, which decreases supply
– Productivity – new harvesting technique
reduces harvesting costs = increases supply
• Price of product – increases in price = increase
quantity supplied
Now let’s look closely at those S&D
curves
We will use a simple numerical
example, so get out that pad of paper
Demand Curve
Relationship between Price and Quantity
(amount) demanded.
Nature of relationship: As price rises demand
falls.
Price
$2
$4
Quantity
20
15
Picture of relationship: Plot these points on
the following graph before moving on.
Demand Curve
“Picture” of
Buyers / demanders
Oil Market
Now plot those
points from the table
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
Demand Curve
Here is what it should look like
Oil Market
Price
@ price of $4
demand is 15
$40
P
$30
$4
@ price of $2
demand is 20
$20
$2
$10
$0
-
8,00015
20
16,000
Q1s
24,000 Q
Quantity
What can change demand?
Short answer: Change in any of the factors that
affect demand
Longer answer: There are two “Types” of factors
1.price change –if the price changes then this
causes a change in quantity demanded
2.Change in ANYTHING else –if any factor other
than price changes then this causes a change in
demand
Decrease in quantity demanded
______
Increase
in quantity demanded
Oil Market
When P falls to $2 demand rises to 20
Movement ALONG demand curve
$40
P
$30
$4
$20
$2
$10
D
$0
-
8,00015
20
16,000
Q1s
24,000 Q
INCREASE in demand
______
Increase
Oil Market
in demand
When income of buyers increase
@ each price demand
is now higher
$40
P
$30
$4
$20
$2
$10
D
$0
-
8,00015
20
16,000
Q1s
24,000 Q
INCREASE in demand
______
Increase
Oil Market
in demand
When income of buyers increase
@ each price demand
is now higher
$40
P
$30
$4
$20
$2
$10
D
$0
-
8,00015
20
16,000
Q1s
24,000 Q
Supply Curve
Relationship between Price and Quantity
(amount) supplied.
Nature of relationship: As price rises supply rises.
Price
$2
$4
Quantity
18
22
Picture of relationship: Plot these points on
the following graph before moving on.
Demand Curve
“Picture” of
Sellerss
Oil Market
Now plot those
points from the table
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
Supply Curve
Here is what it should look like
Oil Market
Price
@ price of $4
supply is 22
$40
P
$30
$4
@ price of $2
supply is 18
$20
$2
$10
$0
-
8,000 18
22
16,000
24,000 Q
Quantity
What can change supply?
Short answer: Change in any of the factors that
affect demand
Longer answer: There are two “Types” of factors
1.price change –if the price changes then this
causes a change in quantity supplied
2.Change in ANYTHING else –if any factor other
than price changes then this causes a change in
supply
Supply Curve
Increase in quantity supplied
When P rises to $4 supply rises to 22
Movement ALONG supply curve
Oil Market
Price
$40
P
$30
$4
$20
$2
$10
$0
-
8,000 18
22
16,000
24,000 Q
Quantity
Supply Curve
Increase in supply
When productivity increases
@ each price supply
Oil Market
is now higher
Price
$40
P
$30
$4
$20
$2
$10
$0
-
8,000 18
22
16,000
24,000 Q
Quantity
Supply Curve
Increase in supply
When productivity increases
@ each price supply
Oil Market
is now higher
Price
$40
P
$30
$4
$20
$2
$10
$0
-
8,000 18
22
16,000
24,000 Q
Quantity
Summary
A curve shifts – something other than the price
shocks the market
•Increase in demand – demand curve shifts OUT
•Increase in supply– supply curve shifts OUT
No curve shifts when the price changes – this is just a
movement along a curve.
Hint
The most common mistake is to shift two curves.
•Most shocks only directly affect either buyers or
sellers so we have only one shift.
Example1: How do we show higher incomes on
demand for Toyota cars? – it is the buyers’ income
that changes so it will be demand that changes – so
supply does not shift. Demanders of cars feel
wealthier and will buy more cars and this increases
demand – the D curve shifts out. NO shift in S.
Hint
The most common mistake is to shift two curves.
•Most shocks only directly affect either buyers or
sellers so we have only one shift.
Example2: How do we show higher jet fuel prices on
market for airplane travel? – you never wake up and
think about jet fuel prices and neither do other
travelers – so demand does not shift. Suppliers of
seats, however, do care about jet fuel prices and this
raises costs so it reduces supply – the S curve shifts in.
NO shift in D.
Supply & Demand Curves
Disequilibrium prices
Equilibrium price
Price
$2
$3
$4
Picture of market
Supply
18
19
22
Demand
20
19
15
Demand Curve
“Picture” of
Buyers & Sellers
Oil Market
Now plot those
points from the table
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
Supply & Demand Curves
Here is what it should look like
@ price of $4 supply is 22 & demand is 15 = surplus
Oil Market
Price
$40
P
$30
$4
$20
$2
$10
$0
-
8,000 18
22
16,000
24,000 Q
@ price of $2 supply is 18 & demand is 20 = shortage
What will happen?
• If price is $2 then the shortage will prompt sellers to
raise the price and as the price rises the shortage
falls as quantity supplied increases and quantity
demanded decreases.
• If price is $4 then the surplus will prompt sellers to
lower the price and as the price falls the surplus falls
as quantity supplied decreases and quantity
demanded increases.
• So prices keep moving until at some price S = D. We
call it the equilibrium price and that happens where
the S&D curves intersect.
Equilibrium
@ price of $2.5 supply = demand = 19 = equilibrium
Oil Market
Price
$40
P
$30
$20
$2.5
$10
$0
-
8,000
19
16,000
24,000 Q
Now let’s look at some examples to see how
well you have mastered this.
On the next two slides think about how we
show the impact of the shock on the market –
and use the cookbook approach. Do it before
you move on.
How will China’s economic rise affect the
price of oil in the US?
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
How will China’s economic rise affect the
price of labor in the US?
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
How will China’s economic rise affect the
price of oil in the US?
1. Identify the market – oil market
2. Identify the participants – demanders (us),
suppliers (oil companies)
3. Identify the determinants of behavior- China is a
demander of oil
4. Identify the type of problem
comparative static - price change from shock
5. Identify the appropriate curves - China’s growth
increases demand for oil = demand curve shifts
outward
How will China’s economic rise affect the
price of oil in the US?
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
How will China’s economic rise affect the price of
labor in the US?
1. Identify the market – US labor market
2. Identify the participants – demanders (US firms),
suppliers (US workers)
3. Identify the determinants of behavior- China is a
substitute for US workers as firms move to China
4. Identify the type of problem
comparative static - price change from shock
5. Identify the appropriate curves - China’s growth
decreases demand for US workers by US firms =
demand curve shifts inward
How will China’s economic rise affect the
price of labor in the US?
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
Questions
Use a S&D graph to demonstrate the Impact on oil
market of _____.
a.
US increases in mileage standards on automobiles
b.
Nigeria revolt upsets oil supply
c.
New technology finds new oil in old wells
d.
Rise in smart phones behind drop in computer
sales
a. US increases in mileage standards on
automobiles
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
b. Nigeria revolt upsets oil supply
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
c. New technology finds new oil in old wells
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
d. Rise in smart phones behind drop in
computer sales
Oil Market
$40
P
$30
$20
$10
$0
-
8,000
16,000
24,000 Q
Questions
Use a S&D graph to demonstrate the Impact on oil
market of _____.
a. US increases in mileage standards on automobiles –
if costs rise this will decrease Supply
b. Nigeria revolt upsets oil supply
– Nigeria is supplier = decrease in supply
c. New technology finds new oil in old wells
– New tech increases supply
d. Rise in smart phones behind drop in computer sales
– People buying a smartphone instead of computer =
decrease in demand
Generalization: Single Shift
Fill in the table again – see if it is easier now
Price
Demand Demand - 
Supply -
Supply - 
Quantity
Questions
What will happen to the price of marijuana if it is
legalized? Do this before you move on
Price
0
0
Quantity
Marijuana legalized
•Reduces social cost of getting caught increases demand = DP, Q
•Reduces cost of transportation –
increase supply= SP, Q
•Combined effect - Q, not forecast
change in Q
Questions
What will happen to the price of marijuana if it is
legalized? Big increase in D
Price
0
0
Quantity
Questions
What will happen to the price of marijuana if it is
legalized? Big increase in S
Price
0
0
Quantity
Double shift
When we have two curves shifting it s only possible
to predict either price or quantity change, but not
both. I suggest always trying to figure out what
happens to price and you are done.
Example: Increase S&D
•increase in D pushes prices higher
•Increase in supply pushes prices lower
•Can’t predict price
•Both increase in D & S push quantity higher
Generalizations: Double Shift
Fill in the table again – see if it is easier now
Price
Demand increase
Supply increase
Demand increase
Supply decrease
Demand decrease
Supply increase
Demand decrease
Supply decrease
Quantity