Download Demand, Supply and Market Equilibrium

Demand, Supply and Market
Equilibrium
MB Chp: 3
Lecture: 3
Chapter Objectives

Demand and its determinants

Supply and its determinants

Supply, demand, & market equilibrium

Changes in supply and demand

Government-set prices
Markets

A market is an institution or mechanism that brings
together buyers (demanders) and sellers (suppliers) of
particular goods and services

This chapter concerns purely competitive markets with a
large number of independent buyers and sellers
Demand

Demand is a schedule or a curve that shows the various
amounts of a product consumers are willing and able to
buy at each specific price in a series of possible prices
during a specified time period

Demand is simply a statement of a buyers' plans, or
intentions

Price will be determined by interaction of demand and
supply
Individual Demand
P
6
P
$5
Qd
10
4
20
3
35
2
55
1
80
Price (per bushel)
5
4
3
2
1
0
D
10
20
30
40
50
60
70
80
Q
Quantity Demanded (bushels per week)
3-5
Law of Demand

Law of Demand is a fundamental characteristic of demand
behavior

All else equal, as price falls, the quantity demanded rises,
and as price rises, the quantity demanded falls – there is
an inverse (or negative) relationship between price and
quantity demanded

“All else equal” implies that tastes, income, price of
substitutes etc are constant

This inverse r/s is the law of demand
Explanation behind the Law of
Demand
1. Diminishing marginal utility – the decrease in added
satisfaction that results as one consumers additional units of a
good or services i.e the second Big Mac yields less satisfaction
(or utility) than the first. Thus you will only buy additional units
if price is reduced
2. Income effect : A lower price increases the purchasing power
of money income enabling the consumer to buy more of the
product than before (or less at a higher price)
3.Substitution effect: A lower price (of good X), gives the incentive
to substitute (or buy more of good X) the lower- priced good
for now relatively higher-priced goods
Market Demand Curve

By adding the quantities demanded by all consumers at
each of the various possible prices, we can get a market
demand schedule from individual demands

It is the horizontal sum of individual curves
Change in Demand

There are several determinants of demand or the “other
things” besides price , which affect demand

Changes in these determinants cause the demand
schedule to shift graphically

This is called a change in demand

A change in quantity demanded comes from price
changes and it is a movement ALONG demand schedule
(with no shifts involved)
Determinants of Demand
1. Tastes
Favorable change leads to increase in demand , unfavorable change
to decrease
2. Number of buyers
An increase in the number of buyers in a market will result in
increase in product demand
3. Income
As income increases, demand for normal (or superior) goods varies
directly. However, demand for inferior goods decreases as income
increases (used cars, clothing etc)
Determinants of Demand
4. Price of related goods:

Substitute good is one that can be used in place of another good. An
increase in price of a substitute will increase the demand for actual good
(direct R/s)

Complementary good is one that is used together with another good.
The goods have a joint demand An increase in price of comp. good will
decrease the demand for the other good (inverse R/s)
5.Consumer Expectations
Consumers views about future prices, product availability and income can
shift demand

A change in demand must not be confused with a change
in quantity demanded

A change is demand is a shift of the demand curve


Occurs due to one or more of the determinants of demand
altering
A change in quantity demanded is a movement from one
point to another point

Cause of such a change is the increase or decrease in price
Supply

Supply is a schedule or curve showing the various
amounts of a product that producers are willing and
able to make available for a sale at each of a series of
possible prices during a specific period
Individual Supply
 Supply is a schedule or curve showing the various amounts of a product that
producers are willing and able to make available for a sale at each of a series
of possible prices during a specific period
P
6
S1
P
$5
Qs
60
4
50
3
35
2
20
1
5
Price (per bushel)
5
4
3
2
1
0
10
20
30
40
50
60
70
Quantity Supplied (bushels per week)
Q
Law of Supply

Law of Supply:
As price increases, quantity supplied will also increase. There is a direct relationship
between price and supplied qty.
Explanations:
1. Revenue implications
Given product costs, a higher price means greater profits and thus an incentive to
increase the qty supplied
2. Marginal cost
Beyond some production level, producers usually encounter increasing costs per
added unit of output

Market supply is derived by horizontally adding the supply curves of individual
producers
Determinants of Supply
Changes in any of the determinants cause shifts in the supply curve
1. Resource prices
A rise in resource prices will cause a decrease in supply or
leftward shift
2. Technology
Technological improvements leading to efficient production and
lower costs can increase supply
3. Taxes and Subsidies
Tax is treated as cost, subsidy lowers cost and increases supply
Determinants of Supply
4. Price of related goods
If price of substitute good increases, prod. might shift
production to that good
5.Expectations about future price of product
Can lead to increases or decreases in supply
6. Number of sellers
Larger number of sellers lead to greater supply
Market Equilibrium
 Equilibrium
 Where
price and quantity
qty demanded and supplied
equals
 Can
any other price exist?
 Surplus
and shortage
Rationing function of price
 Ability
of competitive forces of supply
and demand to establish a price at
which selling and buying decisions are
consistent
 At
equilibrium price, no surplus or
shortage remains – market clearing
price
Efficient allocation
Competitive markets ensure:

Productive efficiency


Allocative efficiency


Production of any particular good in the least costly way
The particular mix of goods and services most highly
valued by society
At the intersection of D and S therefore, MB =MC and
there is neither an underallocation of an overallocation
of resources to a particular product
Market Equilibrium
 Change
 Shift
of the demand curve
 Change
 Shift
in demand
in supply
of the supply curve
 Change
quantity
in equilibrium price and
Complex cases
Price Quantity
 Supply
increase; Demand
decrease
 Supply decrease; Demand
increase
 Supply increase; Demand
increase
 Supply decrease; Demand
decrease
?
?
?
?
Price Floors

A price floor is a minimum price fixed by the government.
A price at or above the price floor is legal, a price below
is not.

Support prices for wheat, minimum wages for labor are
good examples

Price floors result in excess supply
Price Floors contd.

Govt. has to either restrict supply by giving permits to certain
farmers to produce OR

Increase demand by finding new uses for the product

Govt. has to buy the excess output (store or destroy it)

PF lead to distorted allocation of scarce resources – allocative
inefficiency

Consumers pay higher prices;

Tax money wasted on purchasing excess output
Price Ceilings

A price ceiling sets the maximum legal price a seller can charge for a
product or service. A price at or below the ceiling is legal, a price
above it not.

Price Ceiling results in excess demand which will cause problems:
1. Rationing Problem:

How will the available amount be apportioned among consumers who
demand a higher amount?

coupons
2. Black Market


Many buyers are willing to pay a higher price and it therefore profitable
for producers to sell to these customers
A black market will flourish where the product is bought and sold at a
higher price
Market Equilibrium
6
6,000 Bushel
Surplus
P
Qd
$5
2,000
4
4,000
3
7,000
2
11,000
1 16,000
Price (per bushel)
5
S
$4 Price Floor
4
3
$2 Price Ceiling
2
7,000 Bushel
Shortage
1
0
2
4
6 7 8
10
D
12
14
16
18
Bushels of Corn (thousands per week)
P
Qs
$5
12,000
4
10,000
3
7,000
2
4,000
1
1,000