Download Chapter 3 - McGraw Hill Higher Education

Chapter 3
Supply and Demand
Intertwined
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Learning Objectives
• How do supply and demand determine
prices?
• What is equilibrium?
• What is surplus?
• What is shortage?
• What is the effect of a change in demand?
• What is the effect of a change in supply?
3-2
When Supply and Demand Intersect
•
•
•
•
At $0.45:
Consumers want 12,000
apples.
Firms want to produce
12,000 apples.
Quantity demanded
= Quantity supplied.
Supply and demand
intersect.
= Equilibrium
$P
Quantity
demanded at
0.45
Supply
.45
Quantity
supplied at
0.45
Demand
12,000
Quantity of Apples
3-3
Surplus
•
•
•
•
At $0.70:
Consumers want 10,000
apples.
Firms want to produce
14,600 apples.
Quantity supplied
> quantity demanded
= Surplus.
Price will fall.
Quantity
demanded at
0.70
$P
Supply
.70
Quantity
supplied at
0.70
Demand
10,000
14,600
Quantity of Apples
3-4
Shortage
•
•
•
•
At $0.25:
Firms want to produce
9,000 apples.
Consumers want 15,000
apples.
Quantity supplied
< quantity demanded
= Shortage.
Price will rise.
$P
Quantity
supplied at
0.25
Supply
Quantity
demanded at
0.25
.25
Demand
9,000
15,000
Quantity of Apples
3-5
Equilibrium
• A market at equilibrium is stable unless
disturbed by shift of supply or demand
curves.
• A market not at equilibrium moves towards
equilibrium with change in price.
3-6
Equilibrium
Price
Demand
Price above
equilibrium
= Surplus.
Fall in price
Price below
equilibrium
= Shortage.
Rise in price
Supply
Equilibrium
price
Equilibrium
Equilibrium
quantity sold
Quantity
3-7
Do You Know?
• When does a surplus arise?
When price is above equilibrium where
quantity supplied exceeds quantity
demanded.
• When does a shortage arise?
When price is below equilibrium where
quantity demanded exceeds quantity
supplied.
3-8
Moving Towards New Equilibrium
An increase in supply:
• A new equilibrium at a
lower price and a
higher quantity.
Price
Old
equilibrium
Old
Supply
New
Supply
New
equilibrium
Demand
Quantity
3-9
Moving Towards New Equilibrium
An increase in
demand:
• A new equilibrium at a
lower price and a
higher quantity.
New
equilibrium
Price
Supply
Old
equilibrium
New
Demand
Old
Demand
Quantity
3-10
Moving Towards New Equilibrium
A decrease in supply:
• A new equilibrium at a
higher price and a
lower quantity.
Price
New
equilibrium
New
Supply
Old
Supply
Old
equilibrium
Demand
Quantity
3-11
Moving Towards New Equilibrium
A decrease in
demand:
• A new equilibrium at a
higher price and a
lower quantity.
Old
equilibrium
Price
Supply
New
equilibrium
Old
Demand
New
Demand
Quantity
3-12
Market Forces in a Fictional Tale
•
•
•
•
In anticipation of the blockade…
Increase in demand for food and hence its price.
Smuggler transports food rather than luxury
goods.
After the blockade…
With higher food prices, the smuggler is willing
to take the risk of shipping food.
After government control over food prices…
No incentive for the smuggler to ship food.
3-13
Invisible Hand
• Invisible hand of the market pushes
self-interested people to act for the
good of society.
“It is not from the benevolence of the
butcher, the brewer or the baker, that
we expect our dinner, but from their
regard to their own interest.”
3-14
Markets in Times of Crisis
• Pets destroy wheat
crop.
• Increase in demand
for a substitute, i.e.
fish.
• Increase in price of
fish.
• Fishermen catch
more fish.
New
equilibrium
Price
Supply
Old
equilibrium
$7
Demand
after
$4
Demand
before
600
800
Quantity of fish
3-15
Markets in Times of Crisis
• War in the Middle
East reduces supply
of oil.
• Price of oil rises.
• Higher price causes
people to use less oil.
• Market offers the best
solution among all the
alternatives.
$Price
New
equilibrium
Supply
after
Supply
before
150
Old
equilibrium
70
Demand
Quantity of oil
3-16
Markets in Times of Crisis
Hurricane damage affects the supply and
demand for bottled water.
• Decrease in supply
• Increase in demand
How will it affect new equilibrium price?
How will it affect new equilibrium quantity?
Only one can be determined, the other is
ambiguous.
3-17
Hurricane Damage
Increase in demand
> Decrease in supply.
• Higher price
• Higher quantity
Price
Increase in demand
< Decrease in supply.
• Higher price
• Lower quantity
Demand
after
Demand
before
Price
Supply
after
Supply
before
Quantity of bottled water
Demand Demand
before
after
Supply
after
Supply
before
Quantity of bottled water
3-18
Markets in Times of Crisis
Price gouging:
• Increase in price as a result of market
reaction to increase in demand or
decrease in supply.
• It provides incentive to firms to sell more.
• It provides incentive to consumers to
conserve the good short in supply.
3-19
Diamonds vs. Water
Why do markets
place higher value on
diamonds than on
precious water?
Price
Water
demand
Diamond
demand
Water
Supply
Diamond
supply
Diamond
Equilibrium
• Water is in much
greater supply than
diamonds.
Water
Equilibrium
Quantity
3-20
Diamonds vs. Water
• A good’s price is influenced by its marginal value
to consumers.
• Marginal value = additional benefit received from
the last unit of the good consumed.
• Consumers receive less marginal value from a
good the more they have of it.
• At the equilibrium in market for water, so much
water is consumed that marginal value is very
low.
3-21
Market for Developable Land
Government passes
anti-development law:
• Decrease in supply of
developable land.
• Higher price and
lower quantity of
traded developable
land.
Price
New
Equilibrium
Supply
after
Supply
before
Old
Equilibrium
Demand
Quantity of developable land
3-22
Market for Newly Built Homes
Increase in price of
developable land
increases cost of
production.
• Decrease in supply of
newly built homes.
• Higher price and
lower quantity sold of
newly built homes.
Price
New
Equilibrium
after higher
land prices
New
Supply
Old
Supply
Old
Equilibrium
before higher
land prices
Demand
Quantity of newly built homes sold
3-23
Market for Previously Occupied Homes
• Newly built and
previously occupied
homes are substitutes.
Higher price of newly built
homes:
• Increase in demand for
previously occupied
homes
• Higher price and higher
quantity sold of previously
occupied homes
Price
Old
Equilibrium
before higher
prices of new
homes
New
Equilibrium
before higher
prices of new
homes
Supply
New
Demand
Old Demand
Quantity sold of previously built homes
3-24
Do You Know?
• Do markets move to new equilibrium
instantaneously?
No. It takes time. How long depends on the type
of market. It can be from a few seconds to a few
months.
• What are some examples of forces that disturb
market equilibrium?
Any changes that effect demand or supply
disturb market equilibrium, e.g., change in input
prices, future expectations, change in price of
substitutes, innovations.
3-25
Do You Know?
• What is Adam Smith’s Invisible Hand?
Market forces guide self-interested people as if
by an invisible hand to act for the good of
society.
• How does marginal value relate to the price of
water?
A good’s price is influenced by its marginal value
to consumers. The marginal value of water is
very low since lots of water is consumed.
3-26
Summary
• Equilibrium = When quantity demanded
meets quantity supplied.
• Surplus = When quantity supplied exceeds
quantity demanded.
• Shortage = When quantity demanded
exceeds quantity supplied.
• A market not at equilibrium moves towards
equilibrium with change in price.
3-27
Summary
• A good’s price is determined by
intersection of demand and supply.
• A change in demand or supply shifts the
market to a new equilibrium.
• Market forces offer the best solution to any
changes in the society.
3-28
Coming Up
By how much does quantity
change when there is a change in
price?
3-29