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Chapter 17 Demand, Supply, and Equilibrium Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-1 Chapter Objectives • • • • • • Individual and market demand Changes in demand Individual and market supply Changes in supply Graphing supply and demand curves Finding equilibrium price and quantity Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-2 Demand Defined • Demand is the schedule of quantities of a good or service that people will purchase at different prices – The law of demand: when the price of a good is lowered, more of it is demanded; When it is raised, less is demanded Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-3 Individual and Market Demand • The law of demand holds for both individuals and markets • Individual demand is the schedule of quantities that a person would purchase at different prices • Market demand is the schedule of quantities that everyone in the market would buy at different prices Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-4 Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Venus 30 Price QD $30 0 P 24 25 2 r 20 3 15 3 10 4 c 5 5 e 6 18 i 12 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-5 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Martina 30 Price QD $30 1 P 24 25 1 r 20 2 15 3 10 5 c 5 6 e 6 18 i 12 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-6 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Serena 30 Price QD $30 2 P 24 25 3 r 20 5 15 6 10 7 c 5 7 e 6 18 i 12 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-7 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Lindsay 30 Price QD $30 1 P 24 25 3 r 20 4 15 6 10 7 c 5 8 e 6 18 i 12 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-8 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-9 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-10 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-11 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-12 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus $30 0 $25 2 $20 3 $15 3 $10 4 Martina 1 1 2 3 5 Serena 2 3 5 6 7 Lindsay Total 1 4 3 9 4 14 6 18 7 23 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-13 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus $30 0 $25 2 $20 3 $15 3 $10 4 $ 5 5 Martina 1 1 2 3 5 6 Serena 2 3 5 6 7 7 Lindsay Total 1 4 3 9 4 14 6 18 7 23 8 26 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-14 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Venus $30 0 $25 2 $20 3 $15 3 $10 4 $ 5 5 Martina 1 1 2 3 5 6 Serena 2 3 5 6 7 7 Lindsay Total 1 4 3 9 4 14 6 18 7 23 8 26 Market Demand 30 P 24 r 18 i c 12 e 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-15 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. What Is the Market? • The market is where people buy and sell – Local markets • Gasoline, groceries – Regional • Automobiles – National or international • Computers Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-16 Changes in Demand A change in demand would be a change in the schedule Price QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 30 25 20 15 10 D1 D2 5 0 10 20 30 40 50 Quantity Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-17 An Increase in Demand An increase in demand is an increase in the quantity people are willing to purchase at all prices Price QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 30 25 20 15 10 The demand curve shifts to the right D1 D2 5 0 10 20 30 40 50 Quantity Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-18 An Increase in Demand A decrease in demand means people are willing to purchase less at all prices Price QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 30 25 20 15 10 The demand curve shifts to the left D1 D2 5 0 10 20 30 40 50 Quantity Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-19 Changes in Demand A and B are on the same line, therefore, they are on the same schedule. If they are on the same schedule, there can be no change in demand C A B D1 D2 Move from point A to point B A change in quantity demanded 17-20 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Demand Movement from A to B is simply a change in quantity demanded in response to a change in price C A B D1 D2 Move from point A to point B A change in quantity demanded 17-21 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Demand There is an increase in demand because people are willing to buy more at all prices on G’s curve which is to the right of F’s curve E G I F H Move from point F to point G An increase in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-22 Changes in Demand There is a decrease in demand because people are willing to buy less at all prices on H’s curve which is to the left of G’s curve E G I F H Move from point G to point H A decrease in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-23 Changes in Demand As long as we remain on the same curve, there is no change in demand E G I F H Move from point H to point I A change in quantity in demanded 17-24 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Demand As long as we remain on the same curve, there is no change in demand L J G K M N Move from point J to point K A change in quantity in demanded 17-25 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Demand From K to L is an increase in demand because L’s demand curve is entirely to the right of K’s curve L J G K M N Move from point K to point L An increase in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-26 Changes in Demand From L to M is a decrease in demand because M’s demand curve is entirely to the left of L’s curve L J G K M N Move from point L to point M A decrease in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-27 Changes in Demand We don’t know on which of an infinite number of possible demand curves N is situated, therefore, the most we can say is that there is a change in demand L J G K M N Move from point M to point N A change in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-28 What Causes Changes in Demand? • Changes in income • Changes in the price of related goods and services • Changes in taste and preferences • Changes in price expectations • Changes in population Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-29 Changes in Income • The demand for NORMAL goods varies directly with income – When income goes up people buy more therefore demand goes up • The demand for INFERIOR goods varies inversely with income – When income goes up people buy less, therefore demand goes down Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-30 Changes in the Price of Related Goods and Services • Goods and services are related in two ways – They can be used as a substitute for the other • Hot dogs and hamburgers; Tuna and salmon – They can complement the other • Videos & VCRs; Gasoline & cars, tires Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-31 Prices of Substitute Goods • Directly related – If the price of hamburgers goes up – The price of hot dogs would also go up • As the price of hamburgers goes up people will buy less hamburgers and more hot dogs. This increases the demand for hot dogs . . . thus increasing the price of hot dogs Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-32 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-33 Prices of Complementary Goods • Inversely related – Prices of weenies go up . . . the price of hot dog buns goes down • The price of weenies goes up . . . people buy less weenies. If people buy less weenies, they will also buy less hot dog buns • This decreases the demand for hot dog buns and lowers the price of hotdog buns Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-34 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-35 Changes in Taste and Preferences • Taste and preferences tend to change over time – Smaller cars and less fattening foods – Preferring designer clothing and brand name sneakers – Fewer people are smoking (has been helped by a campaign to reduce smoking) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-36 Changes in Price Expectations • If people expect the price of something to rise, they rush out to stock up before it does – This increases the demand • If people expect the price of something to fall, they will hold off buying it – This decreases the demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-37 Changes in Population • As the nation’s population increases, the demand for particular goods and services increase – General growth increases the demand for food, housing, autos, etc. • The changing age distribution affects demand – Next three decades there will be a higher demand for retirement homes, nursing homes, wheel chairs, bifocal glasses, etc. Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-38 Supply Defined • Supply is a schedule of quantities of a good or service that people are willing to sell at various prices – As prices rise, people are willing to sell more – Thus, there is a positive or direct relationship between price and quantity • Price rises . . . quantity supplied rises • Prices declines . . . quantity supplied declines Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-39 Individual and Market Supply Hypothetical supply of American Cars, 2001 (in thousands) Price GM Ford Daimler Chrysler Japanese Owned Firms $20,000 5311 2356 1245 535 9,447 18,000 4617 1984 991 384 7,976 16,000 4002 1584 762 270 6,618 14,000 3623 1216 601 208 5,648 12,000 3190 996 491 181 4,858 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. Total 17-40 Hypothetical Supply of American Cars, 2001 20,000 18,000 Market supply 16,000 14,000 12,000 456789 Output (in millions) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-41 Changes in Supply Move from E to F A change in quantity supplied G F E H I Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-42 Changes in Supply Move from F to G An increase in supply G F E H I Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-43 Changes in Supply Move from G to H A change in supply G F E H I Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-44 Changes in Supply Move from H to I A change in quantity supplied G F E H I Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-45 Changes in Supply An increase in supply Move from J to K M L N J K Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-56 17-45 Changes in Supply A change in quantity supplied Move from K to L M L N J K Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-47 Changes in Supply A decrease in supply Move from L to M M L N J K Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-48 Changes in Supply A change in supply Move from M to N M L N J K Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-49 What Causes Changes in Supply? • The main reason for a change in supply is changes in the cost of production – cost of raw materials, labor, capital, insurance, interest, rent, wages, etc. – when these cost go up . . . supply decreases – this causes the price to increase S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-50 What Causes Changes in Supply • Technological advance – A technological improvement will increase supply – Companies are able to produce more at reduced cost cost with an improvement in quality – A supply increase will cause the price to decline S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-51 What Causes Changes in Supply • Prices of other goods – Changes in the prices of other goods can shift the supply curve for a product • If the price of corn rises, a farmer may cut back on the production of wheat • If the price of hair transplants declines, some dermatologist may do more facelifts S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-52 What Causes Changes in Supply • Change in the Number of Suppliers – When new firms enter an industry, supply rises – When firms leave an industry, Supply falls S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-53 What Causes Changes in Supply – Changes in taxes • The basic effect of taxes is to reduce supply • The effect of taxes on supply will be covered later in the next chapter S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-54 What Causes Changes in Supply – Expectation of price increases • Suppliers will hold current production off the market in anticipation of the higher prices • The effect is that of reducing supply S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-55 What Causes Changes in Supply – Expectation of price decreases • Suppliers will try to sell all they have before the price drops • The effect is that of increasing supply S2 S1 P2 P1 D Q2 Q1 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-56 Graphing the Demand and Supply Curves Hypothetical Demand Schedule Price Quantity Demanded(QD) $10 1 $ 9 2 $ 8 4 $ 7 7 $ 6 12 10 9 8 7 D 6 2 4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 6 8 Quantity 10 12 14 17-57 Graphing the Demand and Supply Curves 10 Hypothetical Supply Schedule Price Quantity Supplied (QS) $10 14 $ 9 12 $ 8 9 $ 7 5 $ 6 1 S 9 8 7 6 2 4 6 8 10 12 14 Quantity Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-58 Graphing the Demand and Supply Curves Hypothetical Demand and Supply Schedules Price QD QS $10 1 14 $ 9 2 12 $ 8 4 9 $ 7 7 5 $ 6 12 1 10 S 9 8 7 D 6 2 4 6 8 Quantity 10 12 14 The equilibrium point is where the demand and supply curves cross Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-59 Graphing the Demand and Supply Curves Hypothetical Demand and Supply Schedules Price QD QS $10 1 14 $ 9 2 12 $ 8 4 9 $ 7 7 5 $ 6 12 1 10 S 9 8 7 D 6 Equilibrium price is about $7.20 2 4 6 8 Quantity 10 12 14 Equilibrium quantity is 6 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-60 Graphing the Demand and Supply Curves Above equilibrium price there are surpluses Price always tends toward equilibrium. If price is above equilibrium, sellers will lower prices until the price declines to the equilibrium price 10 Price 9 Price 8 Price S 7 D 6 2 4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 6 8 Quantity 10 12 14 17-61 Graphing the Demand and Supply Curves Below equilibrium price there are shortages 10 S 9 Price always tends toward equilibrium. If price is below equilibrium, buyers will bid prices up until the price rises to the equilibrium price 8 Price Price Price 7 D 6 2 4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 6 8 Quantity 10 12 14 17-62 Finding Equilibrium Price and Quantity If we draw our graphs accurately, we can usually find equilibrium price and quantity in a couple of seconds, especially if we’ve used graph paper. But sometime we need to do further analysis to find really accurate equilibrium prices and quantities Hypothetical Demand and Supply Schedule Price $15 $14 $13 $12 $11 Quantity Demanded 2 4 7 12 20 Quantity Supplied 19 17 12 6 3 How much is the equilibrium price? Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-63 Finding Equilibrium Price and Quantity Hypothetical Demand and Supply Schedule Price $15 $14 $13 $12 $11 Quantity Demanded 2 4 7 12 20 Quantity Supplied 19 17 12 6 3 How much is the equilibrium price? First we add a “Units apart” column Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-64 Finding Equilibrium Price and Quantity Hypothetical Demand and Supply Schedule Price $15 $14 $13 $12 $11 Quantity Demanded 2 4 7 12 20 Units Apart 17 13 5 6 17 Quantity Supplied 19 17 12 6 3 How much is the equilibrium price? First we add a “Units apart” column Equilibrium price is closer to $13 than to $12 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-65 Finding Equilibrium Price and Quantity Hypothetical Demand and Supply Schedule Price Quantity Demanded Units Apart $15 2 17 $14 4 13 $13 7 5 $12 12 6 $11 20 17 How much is the equilibrium price? First we add a “Units apart” column Quantity Supplied 19 17 12 6 3 Equilibrium price is a little closer to $13 than to $12 Therefore, equilibrium price has to be something greater than $12.50 and less than $13 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-66 Hypothetical Demand and Supply Schedule Price Quantity Demanded Units Apart $15 2 17 $14 4 13 $13 7 5 $12 12 6 $11 20 17 How much is the equilibrium quantity? Quantity Supplied 19 17 12 6 3 Equilibrium quantity demanded is closer to 7 than 12. The midpoint between 12 and 7 is 9.5. Therefore, we know the equilibrium quantity demanded must be something less than 9.5 Equilibrium quantity supplied is closer to 12 than 6. The midpoint between 12 and 6 is 9. Therefore, we know the equilibrium quantity supplied is something more than 9.0 The equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-67 Graph of the Previous Demand and Supply Schedule S 15 14 13 $12.60 plus or minus .05 is about the best you can do 12 D 11 4 8 12 16 20 Quantity Remember, equilibrium price has to be something greater than $12.50 and less than $13 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-68 Graph of the Previous Demand and Supply Schedule S 15 14 13 $12.60 plus or minus .05 is about the best you can do 12 D 11 4 8 12 16 20 Quantity Remember, the equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3 In this instance, this technique proved useful. Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-69 Is This Type of Analysis Necessary? • It isn’t when you’ve got an equilibrium price or quantity that is clearly closer to one figure than to another – You will be able to spot this when you draw your graph • But when the demand and supply curves cross about halfway between two figures, then you will need to go back to the original schedule to figure out more precisely where the equilibrium point lies Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-70