Download Supply and Demand

Demand & Supply
1
On Modeling
 Models
may seem very simplistic at
times - but many good models are.
 Proof of pudding is in how well the
model stands up to empirical scrutiny.
 Two pitfalls to avoid:
– the fallacy of composition
– post hoc ergo propter hoc mistakes
 positive
vs. normative analysis
2
Supply and Demand




The supply and demand model is a basic workhorse
of economics.
We will consider each of its pieces.
Then, we will use it to answer some basic questions.
Note: When employing supply and demand we are
considering perfectly competitive markets. For now
that simply means all buyers and sellers are
assumed to be price takers.
3
Demand Concepts
 The
demand function for X:
XD = f(PX, Ps, Pc, I, T&P, Pop)
Where:
XD = quantity demanded
PX = X’s price
Ps = the price of substitutes
Pc = the price of complements
I=income
T&P=tastes and preferences
Pop=population in market or market size
4
The Demand Curve (Verbal)
 The
demand curve, a.k.a. demand, describes
the relation between a good’s price and the
maximum quantity that consumers are willing
and able to buy at that price, ceteris paribus.
– Ceteris paribus means holding all the other
demand function variables constant at some given
level.
5
The Demand Curve (Verbal)




The Law of Demand states that the relationship
between a good’s price and the quantity demanded
of that good is negative.
Example: when the price of a good falls from 25 to
10, the quantity demanded rises from 15 to 30.
This is referred to as a “change in quantity
demanded” and in this case an “increase in quantity
demanded.”
Own-price changes cause movements along a given
demand curve.
6
Movements vs. Shifts
 A movement
along the demand curve
for X would be caused by a change in
Px.
 A shift of the entire demand curve
would be caused by a change in one of
the “ceteris paribus” demand variables.
– This would be referred to as an increase or
decrease in demand.
7
Increase in Demand
 When
demand increases, the quantity
demanded by consumers increases at
every price.
 Example: when demand increases, the
quantity demanded at a price of 25
rises from 15 to 25.
8
Decrease in Demand
 When
demand decreases, the quantity
demanded by consumers falls at every
price.
 Example: when demand decreases, the
quantity demanded at a price of 25 falls
from 15 to 10.
9
The Demand Curve (Table)

The quantity
demanded is a
declining
function of the
price, as the
table to the right
illustrates.
Price
0
5
10
15
20
25
30
35
40
Demand Curve
Quantity
Demanded
40
35
30
25
20
15
10
5
0
10
Increase in Demand

When demand
increases, the
quantity
demanded is
greater at every
price.
Price
0
5
10
15
20
25
30
35
40
Demand Curve
Original
Increased
Demand
Demand
40
50
35
45
30
40
25
35
20
30
15
25
10
20
5
15
0
10
11
Decrease in Demand

When demand
decreases, the
quantity
demanded is
lower at every
price.
Price
0
5
10
15
20
25
30
35
40
Demand Curve
Decreased
Original
Demand
Demand
35
40
30
35
25
30
20
25
15
20
10
15
5
10
0
5
0
12
The Demand Curve (Graph)


The same
demand curve
can be
represented by a
simple graph
with a negative
slope.
Price
Demand
25
At price = 25, the
quantity
demanded = 15.
15
Quantity
13
Change in the Quantity
Demanded


A change in the
quantity
demanded is a
movement along
the demand
curve.
When price falls
to 10, the
quantity
demanded
increases to 30.
Price
Demand
25
10
15
30
Quantity
14
Increase in Demand



An increase in
demand is a
rightward shift in
the entire curve.
More is
demanded at
every price
At price = 25, the
quantity
demanded = 25
after the
increase.
Price
Demand
New Demand
25
15
25
Quantity
15
Decrease in Demand
A decrease in
demand is a
leftward shift in
the entire curve.
 Less is
demanded at
every price
 At price = 25, the
quantity
demanded = 10
after the
decrease.

Price
Demand
25
New Demand
10
15
Quantity
16
The Demand Curve (Equation)


XD = 40 - P
Mathematically, the
demand curve is an
equation that shows a
negative relation
between price (P) and
quantity (X) for all
positive prices and
quantities.
Beware of the equation
and the graph of
demand.
P
15 = 40 - 25
D
25
15
Q
17
Supply Concepts
 The
supply function for X:
XS = g(PX, Pfop, Poc, S&T, N)
Where:
XS = quantity supplied
PX = X’s price
Pfop = prices of factors of production
Poc = opportunity costs (alternatives in productions)
S&T = science and technology
N = number of firms in the market
18
The Supply Curve (Verbal)
 The
supply curve, a.k.a. supply, describes the
relation between a good’s price and the
maximum quantity that producers are willing
and able to sell at that price, ceteris paribus.
– Ceteris paribus means holding all the other supply
function variables constant at some given level.
19
The Supply Curve (Verbal)




The Law of Supply states that the relationship
between a good’s price and the quantity supplied of
the good is positive.
Example: when the price of a good falls from 25 to
10, the quantity supplied falls from 31 to 16.
This is referred to as a “change in quantity supplied”
and in this case an “decrease in quantity supplied.”
Own-price changes cause movements along a given
supply curve.
20
Movements vs. Shifts
 A movement
along the supply curve for
X would be caused by a change in Px.
 A shift of the entire supply curve would
be caused by a change in one of the
“ceteris paribus” supply variables.
– This would be referred to as an increase or
decrease in supply.
21
Increase in Supply
 When
supply increases, the quantity
supplied by producers increases at
every price.
 Example: when supply increases, the
quantity supplied at a price of 25 rises
from 31 to 36.
22
Decrease in Supply
 When
supply decreases, the quantity
supplied by producers falls at every
price.
 Example: when supply decreases, the
quantity supplied at a price of 25 falls
from 31 to 21.
23
The Supply Curve (Table)

The quantity
supplied is an
increasing
function of the
price, as the
table to the right
illustrates.
Price
0
5
10
15
20
25
30
35
40
Supply Curve
Quantity
Supplied
6
11
16
21
26
31
36
41
46
24
Increase in Supply

When supply
increases, the
quantity
supplied is
greater at every
price.
Price
0
5
10
15
20
25
30
35
40
Supply Curve
Original
Increased
Supply
Supply
6
11
11
16
16
21
21
26
26
31
31
36
36
41
41
46
46
51
25
Decrease in Supply

When supply
decreases, the
quantity
supplied is lower
at every price.
Price
0
5
10
15
20
25
30
35
40
Supply Curve
Decreased
Original
Supply
Supply
6
1
11
6
16
11
21
16
26
21
31
26
36
31
41
36
46
26
The Supply Curve (Graph)


The same
supply curve can
be represented
by a simple
graph with a
positive slope.
Price
Supply
25
At price = 25, the
quantity supplied
= 31.
31
Quantity
27
Change in the Quantity
Supplied


A change in the
quantity supplied
is a movement
along the supply
curve.
At price = 10, the
quantity supplied
= 16.
Price
Supply
25
10
16
31
Quantity
28
Increase in Supply



An increase in
supply is a
rightward shift in
the entire curve.
More is supplied
at every price
At price = 25, the
quantity supplied
= 36 after the
increase.
Price
Supply
25
New Supply
31
36 Quantity
29
Decrease in Supply



A decrease in
supply is a
leftward shift in
the entire curve.
Less is supplied
at every price
At price = 25, the
quantity supplied
= 21 after the
decrease.
Price
New Supply
Supply
25
21
31
Quantity
30
The Supply Curve (Equation)


Mathematically, the XS
supply curve is an
equation that shows a
positive relation
between price (P) and
quantity (X) for all
positive prices and
quantities.
Beware of the equation
and the graph of supply.
=6+P
31 = 6 + 25
S
P
25
31 Q
31
Market Equilibrium (Verbal)
 The
equilibrium price and quantity in a
market occur at the price where the
quantity demanded equals the quantity
supplied.
 Example: for the demand and supply
curves used above, the equilibrium
price is 17, where the quantity
demanded, 23, equals the quantity
supplied, 23.
32
Market Equilibrium (Table)

At a price of 17,
the quantity
demanded is
equal to the
quantity
supplied, as the
table to the right
illustrates.
Price
0
5
10
15
17
20
25
30
35
40
Market Equilibrium
Quantity
Quantity
Demanded
Supplied
40
6
35
11
30
16
25
21
23
23
20
26
15
31
10
36
5
41
0
46
33
Market Equilibrium (Equations)
 The
equilibrium price and quantity satisfy
both the demand and supply equations
simultaneously.
 To find P*, set XD = XS .
–
–
–
–
Recall: XD = 40 - P and XS = 6 + P
So… (40 - P*) = (6 + P*)
34 = 2P* or P* = 34/2 so... P*=17
To find X*, plug P* into either the demand or
supply equation.
– X*=23 = 40 - 17 or X*=23 = 6 + 17
34
Market Equilibrium (Graph)


The market
equilibrium
occurs at the
intersection of
the supply and
demand curves.
At price = 17, the
quantity supplied
= quantity
demanded = 23.
Price
Demand
Supply
17
23
Quantity
35
Comparative Statics
 Using
the model to make predictions.
 Something changes in the market.
 Compare one market equilibrium with
another market equilibrium and see
what happens to P* and X*
 Compare two equilibria - compare two
static situations - comparative statics!
36
First…demand side changes
 Demand
shifts and the demand
variables:
– PX - not a shift! (a movement along)
– Ps - positively related to demand
– PC - negatively related to demand
– I - depends: is X normal or inferior?
– T&P - positively related to demand
– Pop - positively related to demand
37
Increase in Demand

An increase in
demand is a
rightward shift of
the entire curve.

More is
demanded at
every price.

At price = 25, the
quantity
demanded = 25
Price
Demand
New Demand
25
15
25
Quantity
38
Market Equilibrium
Increased Demand


The increased
demand
intersects the
original supply
curve to the right
of the original
equilibrium.
Price
Demand
New Demand
Supply
22
17
Price = 22 and
quantity supplied
= quantity
demanded = 28
23
28
Quantity
39
Summary: Market Equilibrium
Increased Demand
 Increased
demand is indicated by a greater
quantity demanded at every price.
 The demand curve shifts right and a
movement along the supply curve results.
 When demand increases:
– Equilibrium price increases
– Equilibrium quantity increases
– Note the movement in the same direction
40
Market Equilibrium
Decreased Demand


The decreased
demand
intersects the
original supply
curve to the left
of the original
equilibrium.
Price = 14.5 and
quantity supplied
= quantity
demanded = 20.5
Price
Demand
Supply
17
14.5
New Demand
20.5 23
Quantity
41
Summary: Market Equilibrium
Decreased Demand
 Decreased
demand is indicated by a smaller
quantity demanded at every price.
 The demand curve shifts left and a
movement along the supply curve results.
 When demand decreases:
– Equilibrium price decreases
– Equilibrium quantity decreases
– Note the movement in the same direction
42
Now…supply side changes
 Supply
shifts and the supply variables:
– PX - not a shift!
– Pfop - negatively related to supply
– Poc - negatively related to supply
– S&T - positively related to supply
– N - positively related to supply
43
Increase in Supply

An increase in
supply is a
rightward shift of
the entire curve.
Price
Supply
25

More is supplied
at every price.

At price = 25, the
quantity supplied
= 36
New Supply
31
36 Quantity
44
Market Equilibrium
Increased Supply

The increased
supply intersects
the original
demand curve to
the right of the
original
equilibrium.
Price
Demand
Supply
17
14.5

Price = 14.5 and
quantity supplied
= quantity
demanded = 25.5
New Supply
23 25.5
Quantity
45
Summary: Market Equilibrium
Increased Supply
 Increased
supply is indicated by a greater
quantity supplied at every price.
 The supply curve shifts right and a movement
along the demand curve results.
 When supply increases:
– Equilibrium price decreases
– Equilibrium quantity increases
– Note the movement in opposite directions
46
Summary: Market Equilibrium
Decreased Supply
 Decreased
supply is indicated by a smaller
quantity supplied at every price.
 The supply curve shifts left and a movement
along the demand curve results.
 When supply decreases:
– Equilibrium price increases
– Equilibrium quantity decreases
– Note the movement in opposite directions
47
Examples: Changes in
Demand
 An
increase in family income increases
the demand for automobiles.
 An increase in the price of software
decreases the demand for computers.
 An increase in the price of hockey
tickets increases the demand for
basketball tickets.
48
Automobile Market



Increased family
income increases
the demand for
automobiles.
New price = P* and
new quantity
supplied = new
quantity demanded
= X*.
Price
Supply
of Autos
P*
P
Equilibrium price
and quantity both
rise.
X
X*
Quantity
49
Computer Market



An increase in the
price of software
decreases the
demand for
computers.
New price = P* and
new quantity supplied
= new quantity
demanded = X*.
Price
Supply of
Computers
P
P*
Equilibrium price and
quantity both fall.
X*
X
Quantity
50
Explanation of Computer
Example
 Software
is an example of good that is
demand “complementary” with
computers. When the price of a
complementary good (software) rises,
the demand for the good itself
(computers) decreases.
 The market moves down the supply
curve.
51
Basketball Market

An increase in the
price of hockey
tickets increases the
demand for
basketball tickets.
Price
Supply of
Basketball
P*


New price = P* and
new quantity
supplied = new
quantity demanded
= X*.
Equilibrium price
and quantity both
rise.
P
X
X*
Quantity
52
Explanation of Basketball
Example
 Hockey
games are demand
“substitutes” for basketball games.
When the price of a substitute good
(hockey) rises, the demand for the good
itself (basketball) increases.
 The market moves up the supply curve.
53
Examples: Changes in Supply
 A flood
in Bordeaux in September
decreases the supply of fine red wine.
 A decrease in the price of energy
increases the supply of steel.
 An increase in the wage rate for
engineers decreases the supply of new
microprocessors.
54
Red Wine Market



The decreased
supply intersects the
original demand
curve to the left of the
original equilibrium.
New price = P* and
new quantity supplied
= quantity demanded
= X*.
Price
P*
P
Equilibrium price
rises and equilibrium
quantity falls.
X*
X
Quantity
55
Explanation of Red Wine
Example
 Flood
conditions in Bordeaux dilute the
grapes and make them unsuitable for
fine red wine. Thus, the supply of red
wine is reduced because of reduced
production at all prices.
 The market retreats along the demand
curve.
56
Steel Market



The decreased price
of energy increases
the supply of steel.
Price
New price = P* and
new quantity
supplied = quantity
demanded = X*.
Equilibrium price
falls and equilibrium
quantity rises.
P
P*
X X*
Quantity
57
Explanation of Steel Example
 Energy
is a factor in the production of
steel. When the price of energy falls, it
becomes less costly to produce steel.
Thus the supply of steel increases at all
prices.
 The market moves down the demand
curve.
58
Microprocessor Market

The decreased
supply intersects the
original demand
curve to the left of the
original equilibrium.
Price
P*


New price = P* and
new quantity supplied
= quantity demanded
= X*.
P
Equilibrium price
rises and equilibrium
quantity falls.
X*
X
Quantity
59
Explanation of Microprocessor
Example
 Engineers
are a one of the types of
labor used to design new
microprocessors. When engineers
become more expensive, the cost of
designing microprocessors rises and
supply falls at all prices.
 The market moves up the demand
curve.
60
4 Government interventions
 Price
floors
 Price ceilings
 Quantity Quotas
 Taxes
61
Price floor
 government
established minimum
selling price.
– floor must be above P* to be binding
– examples: supporting milk prices,
minimum wage law
– government usually thinks the market price
is too low for some reason
 Usually
end up with….surpluses
62
Market Surplus





Equilibrium is at P =
17 and X = 23.
The price floor is 25.
At the artificially high
price of 25, sellers
want to sell 31.
But buyers only
want to buy 15.
Price
Demand
Supply
Surplus = 16
25
17
There is a surplus of
16.
15
23
31
Quantity
63
Price ceiling
 government
established maximum
selling price.
– must be below P* to be binding
– examples: gas price ceilings; apartment
rent control
– government usually thinks the market price
is too high for some reason
 Usually
end up with….shortages
64
Market Shortage

Equilibrium is at P =
17 and X = 23.

Suppose there is a
price ceiling of 10.

At the artificially low
price of 10, buyers
want to buy 30.
But sellers only want
to sell 16.
There is a shortage of
14.


Price
Demand
Supply
17
10
Shortage = 14
16
23
30
Quantity
65
Quantity quota
 government
established maximum
number of units sold.
– Qq must be below Q* to be binding
– example: import restrictions
– government thinks too many units are
being traded
 end up with…higher prices and more.
66