Download Module 3

Demand, Supply & Market
Equilibrium
P
ECO 2013
Chapter 3
Prof M. Mari
Fall 2007
S
D
Q
Demand

A relation between the price of a good and the
quantity that consumers are willing and able
to buy during a given period, other things
constant.


Willing: you want to buy the product
Able: you can afford the buy the product
Demand Schedule and Curve

Demand curve:


a curve showing the
relation between the
price of a good and
quantity demanded
during a given period,
other things constant.
Suppose we are making
pizza.
Price of Quantity
Good
Demand
ed
$3
200
$4
150
$5
100
$6
75
$7
50
Law of Demand




States that a quantity of a good demanded
during a given period relates inversely to its
price, other things constant.
Price increases  Quantity Demanded
decreases
Price decreases  Quantity demanded
increases
Creates a downward sloping demand curve
Why?

Substitution Effect



Unlimited wants/scarce resources
When the price of a good falls, consumers
substitute that good for other goods, which
become relatively more expensive.
Reverse also holds true
Why?

Income Effect



Money income: is simply the number of dollars
received per period
Real income: your income measured in terms of
what it can buy.
A fall in the price of a good increases consumers’
real income making consumers more able to
purchase goods; for a normal good, the quantity
demanded increases.
Demand Curve
A curve showing the relation between
the price of a good and the quantity
demanded.
Price
$6
$5
Point on the line that matches the schedule
Every point on the line matches the schedule.
It is a price/quantity demanded that consumers
are willing and able to buy.
$4
$3
0
50
75
100 150
Demand
Quantity
200
Movement Along the Demand Curve

Caused by a change in price



Only a change in price
Move from one point to another on the same
graph
Called a

Change in quantity demanded.
Movement along the Demand Curve
Price
B
$6
$5
A
Demand
0
75
100
Quantity
Demand

Individual demand


The demand of an individual consumer
Market demand

Sum of individual demands of all consumers in
the market
Shifts in the Demand Curve


A demand curve isolates the relation between
prices of a good and quantities demanded
when other factors that could affect demand
remain unchanged.
Factors called assumptions or determinants
Determinants of Demand





Changes in consumer income
Changes in prices of related goods
Changes in consumer expectations
Changes in the number or composition of
consumers
Changes in consumer tastes
Changes in determinants



Results in changes to the RELATIONSHIP
BETWEEN PRICE AND QUANTITY
DEMANDED.
At each and every price a DIFFERENT
quantity is demanded.
Results in a shift in the demand curve

New curve must be drawn
Changes in Demand

Increase in demand


P
At each and every price
MORE of the good is
Price
demanded
Shifts to the right
Qd1 Qd2
$4 150
$5
A
B
D2
200
$5 100
150
$6 75
100
D1
100
150
Quantity
Causes of Increase in Demand

Increase in consumer
income



Causes consumers to
buy more of the product
at each and every price.
Normal goods
Inferior goods
Change in consumer income

Normal goods


A good for which demand
increases as consumer
income rise
Inferior goods

A good which demand
increases as consumer
income falls
Changes in Price of Related Goods

Substitutes



Goods that are not
consumed jointly
Goods that are related in
such a way that an increase
in the price of one shifts the
demand curve for the other
rightward.
Increase in price of Coke
leads to increase in
demand for Pepsi
Changes in Price of Related Goods

Substitutes

Suppose that the price of Coke rises from $1 to
$1.50, then the demand for Pepsi will decrease
from 75 to 100.
$1
D2
D1
75
100
Changes in the price of related goods

Complements



Goods that are
related in a such a
way that an increase
in the price of one
shifts the demand of
the other leftward
Two goods that are
consumed jointly.
An decrease in the
price of one will
increase demand
for the other
Changes in Price of Related Goods

Complements


An decrease in the
price of DVD players,
increases the demand
for DVDs
Suppose that DVD
players decrease in
price from $145 to
$100, now the
demand for DVDs
will decrease from
750 at $20 to 900.
$20
D2
D
750
900
Changes in Consumer Expectations

Such as expectations in



Prices and income
Affect how consumers
spend their money and
their demand
If product cheaper
today than tomorrow,
then increase in demand
Changes in consumer tastes


Consumer preferences
likes and dislikes in
consumption assumed to
be constant along a given
demand curve assumed
constant along a given
demand curve
Changes in taste will
cause a shift in the
demand curve as different
quantities are demanded
at each and every price.
Changes in taste


Consumers
prefer platform
shoes.
At $50, demand
increases from
100 to 200.
$50
D
100
200
D2
Change in the number and composition
of consumers


The market demand curve is the sum of the
individual demand curves.
If the number of consumers falls then the sum
will be smaller thus shifting the demand curve
Changes in Demand

Decrease in demand


P
At each and every price
Less of the good is
Price
demanded
Shifts to the Left
Qd1 Qd2
$4 150
B
$5
D1
110
$5 100
90
$6 75
60
D2
90
100
Quantity
Causes of Decrease in Demand

Decrease in consumer
income

Causes consumers to
buy less of the product
at each and every price.
Changes in Price of Related Goods

Substitutes



Goods that are not
consumed jointly
Goods that are related in
such a way that an increase
in the price of one shifts the
demand curve for the other
rightward.
Decrease in price of Coke
leads to Decrease in
demand for Pepsi
Changes in Price of Related Goods

Substitutes

Suppose that the price of Coke drops from $1 to
$0.50, then the demand for Pepsi will decrease
from 100 to 75.
$1
D
D2
75
100
Changes in the price of related goods

Complements



Goods that are
related in a such a
way that an increase
in the price of one
shifts the demand of
the other leftward
Two goods that are
consumed jointly.
An increase in the
price of one will
decrease demand
for the other
Changes in Price of Related Goods

Complements


An decrease in the
price of DVD players,
increases the demand
for DVDs
Suppose that DVD
players increase in
price from $100 to
$145, now the
demand for DVDs
will decrease from
900 at $20 to 750.
$20
D1
D2
750
900
Changes in Consumer Expectations

Such as expectations in



Prices and income
Affect how consumers
spend their money and
their demand
If product more
expensive today than
tomorrow, then
decrease in demand
Changes in consumer tastes


Consumer preferences
likes and dislikes in
consumption assumed to
be constant along a given
demand curve assumed
constant along a given
demand curve
Changes in taste will
cause a shift in the
demand curve as different
quantities are demanded
at each and every price.
Change in the number and composition
of consumers


The market demand curve is the sum of the
individual demand curves.
If the number of consumers falls then the sum
will be smaller thus shifting the demand curve
Review of Demand





A change in quantity demanded is not a change in
demand
Change in quantity demanded is caused by a change
in price
Change in quantity demanded is a movement along
the demand curve
Change is demand is caused by a change in the
determinants
Change in demand shifts the demand curve
Supply


Producer’s side
A relation between the price of a good and the
quantity that the producers are willing and
able to offer for sale during a given period,
other things constant.
Law of Supply




The quantity of a good supplied during a
given period is usually directly related to the
price of the good
Increase in price leads to increase in quantity
supplied
Decrease in price leads to decrease in quantity
supplied.
Creates upward sloping supply curve
Supply Curve
Price
Price of
Good
Quantity
Demanded
6
$3
50
$4
75
$5
100
$6
150
$7
200
Supply
5
Quantity
Movement along the supply curve

A change in price and only in price
Causes a movement along the supply curve

Called a Change in Quantity Supplied

Supply
$6
B
$4
A
100
150
Supply

Individual supply


The supply of an individual producer
Market supply

The sum of individual supplies of all producers in
the market
Determinants for the Supply Curve





Changes in technology
Changes in prices of relevant resources
Changes in the prices of alternative goods
Changes in Producer Expectations
Changes in the number of producers
Changes in Supply




Caused by changes in the determinants to
the supply curve
Results in changes to the relationship
between the price and quantity supplied
At each and every price a different
quantity is supplied
New supply curve - shift in supply
Increase in Supply

At each and every price more of the good
is supplied
S1
$6
300
400
S2
Causes of increase in Supply


Improvements in Technology
Changes in relevant resources



Changes in price of alternative goods


Decrease in the price of resources
Lowers costs
If price of alternative good increases, supply of
the good increases
Changes in producers expectations
Changes in technology

Technology is the economy’s stock of
knowledge about how to combine resources
efficiently
Changes in Technology

Improvements in technology


Causes an increase in supply
More of the product is available at all prices
S1
$6
300
400
S2
Changes in Relevant Resources

Decrease in
resource prices

Increases the
supply of the
good at each and
every price.
S1
$6
300
400
S2
Changes in prices of Alternative Goods

Alternative goods


Other goods that use
some or all of the same
resources as the good in
question
Beef and leather.

If the price of beef
increases, producers
will supply more beef
thus increasing the
supply of leather.
Price
S1
S2
$6
Q Leather
300
400
Above is the market for the
supply of leather
Changes in Producers Expectations

Expectation of future prices of resources or
their own product can cause producers to
change what they offer at each individual
price
Changes in the Number of Producers


As the number of
producers change so
does the supply of the
product
A decrease in the number
of producers will lead to
a decrease in supply
Decrease in Supply

At each and every price LESS of the good is
supplied
5
S2
400 600
S1
Causes of Decrease in Supply


Backward movement in Technology
Changes in relevant resources



Changes in price of alternative goods


Increase in the price of resources
Raises costs
If price of alternative good decreases, supply of
the good decreases
Changes in producers expectations
Changes in Relevant Resources


$9
S2
500 600
S1
Are those employed in
the production of the
good in question
Increase in price of
resources


Results in decrease in
supply
Less of the good is
available at all prices
Changes in prices of Alternative Goods

Alternative goods


Other goods that use
some or all of the same
resources as the good in
question
Beef and leather.

If the price of beef
decreases, producers
will supply less beef
thus decreasing the
supply of leather.
Price
S1
$6
Q Leather
300
400
Above is the market for the
supply of leather
Producer’s Expectation

Nationalization

Expropriation
Supply Review

Change in Quantity Supplied



Caused by a change in the price of the product
Movement along the supply curve
Change in Supply


Caused by change in the determinants
Results in a shift in the supply curve
Market Equilibrium

Market



Includes all the
arrangements used to
buy and sell
Reduce transaction
costs
The place where
buyers and sellers
meet to determine
price and quantity
Equilibrium


At specific price where:
Quantity demanded = Quantity supplied
Equilibrium price –


market clearing price
Equilibrium quantity –

D=S
Equilibrium

At specific
price where:
Quantity
demanded
Equals
Quantity
Supplied
P
S
$5
Equilibrium
D
Q
150
Reaching Equilibrium
P

Surplus
S

$6

$5

D
100 150 200
Q
If market price is
ABOVE equilibrium
Qs > QD
Economy is at a
SURPLUS
Market price will
fall
Reaching Equilibrium




If the market
price is BELOW
the equilibrium
price
QD > Qs
Shortage exists
Market price rises
to equilibrium
P
S
$5
$4
D
Shortage
100 150 200
Q
Shifts in Demand

Demand increases


Equilibrium price
increases
Equilibrium
quantity increases
P
S
$6
$4
B
A
D1
D
100 150 200
Q
Shifts in Demand
P

S
Decrease in demand

$6
B
$5

A
D1
D
100
200
Q
decrease in price
decrease in equilibrium
Shifts in Supply

Increase in supply

Price
S1
S2
$6
$5
Q Leather
300 400

Decrease in
equilibrium price
Increase in quantity
Shifts in Supply

Decrease in supply


Price increases
Quantity decreases
Simultaneous Shifts in Supply and
Demand

The change in equilibrium price and quantity
depends on which curve shifts the most.
S
S1
5
A
B
4
D
200
300
D1
Simultaneous Changes
Change in
Supply
Change in
Demand
Increase
Decrease
Increase
Decrease
Increase
Increase
Effect on
Effect on
Equilibrium Equilibrium
Price
Quantity
Decrease
Indeterminate
Increase
Indeterminate
Indeterminate Increase
Decrease
Decrease
Indeterminate
Decrease
Government Intervention



Government enters
the economy
Price Setting
Subsidies

Government payments
to reduce the cost of
product or to limit
production.
Price Floors


A minimum
legal price
below which a
good or service
cannot be sold
If above
equilibrium
causes surplus
Surplus
S
$7
$6
D
100 150 200
Q
Price Ceilings

P
S
$5

D

Shortage
100 150 200
Q
A maximum legal
price above which
a good or service
cannot be sold
Below equilibrium
price
Shortage occurs