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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.