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Chapter 1 Supply, Demand, and Equilibrium Steven Landsburg, University of Rochester Copyright ©2005 by Thomson South-Western, a part of the Thomson Corporation. All rights reserved. Introduction • Economic consequences of bad weather • Interplay of supply and demand • Supply and demand analysis – Consumers – Producers – Responsiveness of prices and quantities to variety of changes in economic environment Landsburg, Price Theory and Applications, 6th edition 2 Law of Demand • Observation that when price of a good goes up, people will buy less of that good • Leads to a downward sloping demand curve Landsburg, Price Theory and Applications, 6th edition 3 Demand versus Quantity Demanded • Quantity Demanded – the amount of a good that a given individual or group of individuals will choose to consume at a given price – Change in price means a change in quantity demanded • Movement along the demand curve • Demand – A family of numbers that lists the quantity demanded corresponding to each possible price – Refers to the curve itself Landsburg, Price Theory and Applications, 6th edition 4 Demand Curves • Graph illustrating demand, with prices on the vertical axis and quantities demanded on the horizontal • Representation of the demand schedule Landsburg, Price Theory and Applications, 6th edition 5 Changes in Demand • A change in price does not lead to a change in demand • If rule for how you make purchases changes, then demand changes • Entire curve shifts Landsburg, Price Theory and Applications, 6th edition 6 Changes in Demand • Fall in Demand – Decision made by demanders to a buy a smaller quantity at each given price – Leftward shift of demand curve • Rise in Demand – Decision made by demanders to a buy a larger quantity at each given price – Rightward shift of demand curve Landsburg, Price Theory and Applications, 6th edition 7 EXHIBIT 1.2 Shifting The Demand Curve Landsburg, Price Theory and Applications, 6th edition 8 Sales Tax Example • Impose a tax to be paid by consumers directly to the government • Less desirable to buy the taxed good or service at every given price • Demand shifts left and downward Landsburg, Price Theory and Applications, 6th edition 9 EXHIBIT 1.3 The Effect of a Sales Tax on Demand Landsburg, Price Theory and Applications, 6th edition 10 Market Demand • Quantity associated with a given price is the total number of that good or service that the group members would demand • Slopes downward as the individual demand curve does Landsburg, Price Theory and Applications, 6th edition 11 Shape of the Demand Curve • Steeply-sloped demand curve means a small change in price will lead to a small change in quantity demanded • Flat demand curve means a small change in price will lead to a large change in the quantity demanded • Important to producers of goods Landsburg, Price Theory and Applications, 6th edition 12 Econometrics • Statistical techniques used by economist to resolve questions about slopes of various demand curves • Based on direct observations in marketplace – Ex. Demand for murder – Ex. Demand for reckless driving • Wide scope of economics – Allows for other investigations as well Landsburg, Price Theory and Applications, 6th edition 13 Law of Supply • Observation that when the price of a good goes up, the quantity supplied goes up • Leads to a upward sloping supply curve Landsburg, Price Theory and Applications, 6th edition 14 Supply versus Quantity Supplied • Quantity Supplied – The amount of a good that suppliers will provide at a given price – Changes if the price changes • Movement along the curve • Supply – Family of numbers giving the quantities supplied at each price – Changes in anything other than price changes supply • Shifts entire curve Landsburg, Price Theory and Applications, 6th edition 15 Changes in Supply • Rise in Supply – Increase in quantities that supplier will provide at each price – Rightward shift of supply • Fall in Supply – Decrease in quantities that supplier will provide at each price – Leftward shift of supply Landsburg, Price Theory and Applications, 6th edition 16 EXHIBIT 1.5 The Supply of Coffee Landsburg, Price Theory and Applications, 6th edition 17 Excise Tax Example • Impose a tax to be paid by producers directly to the government • Less desirable to produce the taxed good or service at every given price • Supply shifts left and upward Landsburg, Price Theory and Applications, 6th edition 18 EXHIBIT 1.6 Effect of an Excise Tax Landsburg, Price Theory and Applications, 6th edition 19 Equilibrium • Actual prices determined by interaction between demanders and suppliers • Demanders cannot purchase more than suppliers willing to sell them • Suppliers cannot sell more than demanders willing to buy Landsburg, Price Theory and Applications, 6th edition 20 Equilibrium Point • Point where supply and demand curves intersect • Price where quantity demanded equals quantity supplied • Demanders and suppliers satisfied – Able to behave as one wants to, taking market prices as given Landsburg, Price Theory and Applications, 6th edition 21 EXHIBIT 1.7 Equilibrium in the Market for Cement Landsburg, Price Theory and Applications, 6th edition 22 Changes in the Equilibrium Point • Never look at price and quantity • Look at effect change has on demand curve and supply curve • Common mistakes arise as look at equilibrium – Supply, demand, and equilibrium misused at times – Check validity of information Landsburg, Price Theory and Applications, 6th edition 23 EXHIBIT 1.8 The Effects of Supply and Demand Shifts Landsburg, Price Theory and Applications, 6th edition 24 Effect of Sales Tax • Sales tax of x¢ per item causes equilibrium price to fall by some amount less than x¢ per item • Price to suppliers not same as price to demanders (price plus sales tax) Landsburg, Price Theory and Applications, 6th edition 25 Effect of Excise Tax • Excise tax of x¢ per item causes the equilibrium price to rise by some amount less than x¢ per item • Price to suppliers (price minus excise tax) not same as price to demanders Landsburg, Price Theory and Applications, 6th edition 26 Comparing Two Taxes • Economic Incidence – the division of a tax burden according to who actually pays the tax • Legal Incidence – the division of a tax burden according to who is required under the law to pay the tax • The economic incidence of a tax independent of its legal incidence • Ex. Social Security tax Landsburg, Price Theory and Applications, 6th edition 27 EXHIBIT 1.10 A Sales Tax versus an Excise Tax Landsburg, Price Theory and Applications, 6th edition 28