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Chapter 3-continued
Demand
Normal Good & Inferior Goods
• Normal goods: Goods for which demand
goes up when income is higher and for
which demand goes down when income is
lower.
• Inferior goods: Goods for which demand
falls when income rises.
Normal Good & Inferior Goods
Example
• When income rises, what will happen to
inferior good and normal good?
• Figure 3.4 (a)
Substitutes & complements
• Substitutes: Goods that can serve as
replacements for one another; when the
price of one increases, demand for the other
goes up
– Perfect substitutes are identical products.
• Complements: goods that “go together”;
when the price of one increases, demand for
the other goes down.
Substitutes & complements
Example
• Figure 3.4 (b)
From household to market
demand
• Demand for a good or service can be
defined for an individual household, or for a
group of households that make up a market.
• Market demand: the sum of all the
quantities of a good or service demanded
per period by all the households buying in
the market for that good or service.
Quantity demand of households
and market --example
•
Price
$5.00
A
1
B
0
C
2
Mkt
3
$3.50
4
0
4
8
$1.50
8
3
9
20
Quantity demand of households
and market --example
• Figure 3.5
Chapter 3
Supply
Supply in output markets
• A firm’s decision about what quantity of a
product to supply depends on a number of
factors:
– Price of the product
– Cost of producing the product
• Prices of required inputs
• Technologies used to produce the product
– Prices of related products
Supply in output markets
• Profit: the difference between revenues and
costs.
• The best method of production is the one
that minimizes cost, thus maximizing profit.
Quantity supply
• The number of units of a product that a firm
would be willing and able to offer for sale at
a particular price during a given time
period.
Consider a supply curve
• supply curve: a graph illustrating how much
of a product a firm will supply at different
prices.
price
Supply curve
quantity
The law of supply
• There is a positive, or direct, relationship
between the quantity of good supplied and
its price.
• This means that supply curves typically
have a positive slope.
An example of supply curve
• Table 3.3
• Figure 3.6
Changes in Quantity supply vs.
changes in supply
• Changes in quantity supply imply
movement along a curve.
• Changes in supply imply a shift in entire
supply curve.
Return to the example
• Table 3.4
• Figure 3.7
Shift vs. Movement of supply
curve
• Change in price of a good or service leads
to change in quantity supply (movement
along the supply curve).
• Change in costs, input prices, technology, or
prices of related goods or services leads to
change in supply (shift of supply curve).
Shift of supply curve--supply of CDROM players, used in personal computers.
•
price
Supply curve
Suppose technological
improvement leads lower
production costs.
What will happen to the
supply of the players?
quantity
Shift of supply curve
price
Supply curve
s1
s2
Shift right
quantity
Shift of supply curve—supply of CDROM players, used in personal computers.
•
price
Supply curve
Suppose the price of
stereos doubles because of
a change in consumer
tastes and preferences.
What will happen to the
supply of the players?
quantity
Shift of supply curve
price
Shift left
s2
Supply curve
s1
quantity
From individual firm to market
supply
• The supply of a good or service can be defined for
an individual firm, or for a group of firms that
make up a market or an industry.
• The sum of all the quantities of a good or service
supplied per period by all the firms selling in the
market for that good or service.
– As with market demand, market supply is the horizontal
summation of the individual firm’s supply curves
Example of Market supply
• Figure 3.8
Chapter 3
Market equilibrium
Equilibrium
• Equilibrium: the condition that exists when
quantity supplied and quantity demanded
are equal.
– At equilibrium, there is no tendency for price to
change.
– This can only occur when
• Quantity demanded (QD)=Quantity supplied (QS)
Excess demand & Excess supply
• Excess demand or shortage: the condition
that exists when quantity demand exceeds
quantity supplied at the current price.
• Excess supply or surplus: the condition that
exists when quantity supplied exceeds
quantity demanded at the current price.
Example-coffee demand
Price QD
QS
$7.00 1,000 9,000
price
$7.00
$6.50
$6.00
$5.50
$5.00
$6.50
$6.00
$5.50
$5.00
2,000
3,000
4,000
5,000
8,000
7,000
6,000
5,000
$3.50
$4.50 6,000 4,000
$4.00 7,000 3,000
$3.50 8,000 2,000
$3.00
$3.00 9,000 1,000
$4.50
$4.00
Demand curve
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Example-coffee supply
Supply curve
price
$7.00
Price QD
QS
$7.00 1,000 9,000
$6.50
$6.00
$5.50
$5.00
$6.50
$6.00
$5.50
$5.00
2,000
3,000
4,000
5,000
8,000
7,000
6,000
5,000
$3.50
$4.50 6,000 4,000
$4.00 7,000 3,000
$3.50 8,000 2,000
$3.00
$3.00 9,000 1,000
$4.50
$4.00
Demand curve
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Example-equilibrium point
Supply curve
price
$7.00
Price QD
QS
$7.00 1,000 9,000
$6.50
$6.00
$5.50
$5.00
$6.50
$6.00
$5.50
$5.00
2,000
3,000
4,000
5,000
8,000
7,000
6,000
5,000
$3.50
$4.50 6,000 4,000
$4.00 7,000 3,000
$3.50 8,000 2,000
$3.00
$3.00 9,000 1,000
$4.50
$4.00
Demand curve
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Example-excess demand (shortage)
•Suppose that the price for coffee were $3.50
•QS=2,000 and QD=8,000 (QD>QS)
price
$7.00
Price
QD
QS
$7.00
1,000
9,000
$6.50
2,000
8,000
$6.00
$6.00
3,000
7,000
$5.50
$5.50
4,000
6,000
$5.00
$5.00
5,000
5,000
$4.50
$4.50
6,000
4,000
$4.00
$4.00
7,000
3,000
$3.50
$3.50
8,000
2,000
$3.00
9,000
1,000
Supply curve
$6.50
Shortage
(excess demand)Demand curve
$3.00
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Example-excess demand (shortage)
• Like an auction, these consumers will bid
up the price in order to get coffee
• As the price is bid up some consumers drop
out of the bidding (QD decrease)
• And coffee grower put more of their
product on the market (QS increase)
• when QS=QD, reaches the equilibrium
price!
Example-excess demand (shortage)
price
$7.00
Supply curve
Price
QD
QS
$6.50
$7.00
1,000
9,000
$6.00
$6.50
2,000
8,000
$6.00
3,000
7,000
$5.50
4,000
6,000
$5.00
5,000
5,000
$4.50
6,000
4,000
$4.00
$4.00
7,000
3,000
$3.50
$3.50
8,000
2,000
$3.00
9,000
1,000
$5.50
$5.00
$4.50
Shortage
(excess demand)Demand curve
$3.00
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Example-excess supply (surplus)
Supply curve
price
$7.00
surplus
Excess supply
$6.50
Price QD
QS
$7.00 1,000 9,000
$6.50
$6.00
$5.50
$5.00
$6.00
$5.50
$5.00
2,000
3,000
4,000
5,000
8,000
7,000
6,000
5,000
$3.50
$4.50 6,000 4,000
$4.00 7,000 3,000
$3.50 8,000 2,000
$3.00
$3.00 9,000 1,000
$4.50
$4.00
Demand curve
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Example-excess supply (surplus)
• At the price of $6.00, QS=7,000 and
QD=3,000 (QD>QS)
• Coffee growers would like to sell more
coffee than consumers whish to buy..
• At $6.00 some coffee growers are not able
to sell all they wish to
• Some growers will want to sell more and to
do so will cut prices
Example-excess supply (surplus)
• As price are decreased, consumers will wish
to buy more ( QD increases)
• Some coffee growers will take their product
off the market (QS decreases)
• This will continue until all the growers are
able to sell all they wish to
• Only when QS=QD can this occur.
Equilibrium price!!
Example-excess supply (surplus)
Supply curve
price
$7.00
surplus
Excess supply
$6.50
Price QD
QS
$7.00 1,000 9,000
$6.50
$6.00
$5.50
$5.00
$6.00
$5.50
$5.00
2,000
3,000
4,000
5,000
8,000
7,000
6,000
5,000
$3.50
$4.50 6,000 4,000
$4.00 7,000 3,000
$3.50 8,000 2,000
$3.00
$3.00 9,000 1,000
$4.50
$4.00
Demand curve
0
1
2
3
4
5
6
7
8
9 10
Quantity demanded & supplied
of Coffee (in thousands)
Changes in equilibrium
Shifts in demand and supply
curves
Example-shift of demand
• If the price of tea ( a substitute good)
increases, consumers will want more coffee
(increase in demand)
Example-shift of demand
Supply curve
price
$7.00
New equilibrium
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
D2
$3.50
$3.00
0
1
2
3
4
5
6
Demand curve
7 8 9 10 Quantity demanded & supplied
of Coffee (in thousands)
Example-shift of demand
• The increase in demand causes both
equilibrium price and quantity to go up:
increase in Income for normal goods,
decrease in price of a complementary good,
expected higher prices in the future, more
consumers, increase in preferences for the
good.
Example-shift of supply
• Suppose the price of land (for growing
coffee) decreases
• The decline in the price of an input will
increase the profitability of coffee growers
who will want to produce more..
• Increase in supply
Example-shift of supply
Supply curve
price
$7.00
S2
$6.50
$6.00
$5.50
New equilibrium
$5.00
$4.50
$4.00
$3.50
$3.00
0
1
2
3
4
5
6
Demand curve
7 8 9 10 Quantity demanded & supplied
of Coffee (in thousands)
Example-shift of supply
• The increase in supply causes an increase in
equilibrium quantity and decrease in
equilibrium price: an increase in technology,
a fall in the price of other goods that can be
produced, expected fall in future price, and
more firms producing the good, a fall in
taxes or an increase in subsidies
Example-shift of supply
• Suppose a hurricane destroys a fair amount
of coffee crop in Central America…
• Supply of coffee would have to reduced
• Which will shift the supply curve to the left
Example-shift of supply
Supply curve
price
$7.00
$6.50
New equilibrium
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
0
1
2
3
4
5
6
Demand curve
7 8 9 10 Quantity demanded & supplied
of Coffee (in thousands)
Review questions
• Understand the examples in class clearly
• Use the knowledge of class to analysis the
movement and shift of demand and supply
curves and equilibrium
• What is market supply (demand)?
• The factors affect demand (supply).
• Complements and substitutes.
• Normal goods and inferior goods.