Download Demand

Lecture 5 & 6
Dominika Milczarek-Andrzejewska
Individual Markets
Demand and Supply
Outline of Lecture 5 & 6
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Definition of Market
Demand
Supply
Market Equilibrium
Changes in Supply and Demand, and
Equilibrium
• Applications
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Market
Market is an institution or mechanism that brings
together buyers (demanders) and sellers
(suppliers) of particular goods and services
–
–
•
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Local, national, or international markets
Highly personal, face-to-face exchanges or
impersonal and remote markets
A product market involves goods and services
A resource market involves factors of
production
3
Demand
Demand schedule shows the various
amounts of a product that consumers are
willing and able to buy
– at each specific price in a series of possible
prices
– during a specified time period
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Demand Schedule
P
$5
4
3
2
1
QD
10
20
35
55
80
Various Amounts
A Series of Possible Prices
…a specified time period
…other things being equal
Law of Demand
Law of demand is a fundamental characteristic of
demand behavior
• Other things being equal, as price increases, the
corresponding quantity demanded falls
• Restated, there is an inverse relationship
between price and quantity demanded
“Other-things-equal” assumption refers to:
– consumer income and tastes,
– prices of related goods,
– and other things besides the price of the product being discussed
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Explanation of the Law of Demand:
• Diminishing marginal utility
– The decrease in added satisfaction with consumption
of additional units of a good or service,
– i.e., the second “Big Mac” yields less extra
satisfaction (or utility) than the first
• Income effect
– A lower price increases the purchasing power of
money income, enabling the consumer to buy more at
a lower price
• Substitution effect
– A lower price gives an incentive to substitute the
lower-priced good for now relatively higher-priced
goods
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Demand Curve:
• Illustrates the inverse relationship
between price and quantity
• The downward slope indicates
– lower quantity (horizontal axis) at higher price
(vertical axis) and
– higher quantity at lower price,
• reflecting the Law of Demand
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Graphing Demand
Price of Corn
CORN
P
$5
4
3
2
1
QD
10
20
35
55
80
P
$5
4
3
2
1
o
D
10 20 30 40 50 60 70 80
Quantity of Corn
Q
Individual Versus Market Demand
• Transition from an individual to a market
demand - summing individual quantities
at various price levels
• Market curve is horizontal sum of
individual curves
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Individual Versus Market Demand
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Individual Versus Market Demand
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Change in Demand
• An increase in demand involves a
rightward shift, and
• A decrease in demand involves a leftward
shift
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Increase in Demand
Price of Corn
$5
CORN
P
QD
$5
4
3
2
1
10
20
35
55
80
Increase
in Quantity
Demanded
P
30
40
60
80
+
4
3
2
1
o
Increase
in
Demand
10 20 30 40 50 60 70 80
Quantity of Corn
D’
D
Q
Decrease in Demand
Price of Corn
Decrease
in Quantity
Demanded
$5
CORN
P QD
$5 10
4 20
3 35
2 55
1 80
P
-10
20
40
60
4
3
2
1
o
Decrease
in
Demand
10 20 30 40 50 60 70 80
Quantity of Corn
D
D’
Q
Determinants of the Change in Demand
1. Tastes
• favorable change leads to an increase in demand
• unfavorable change - a decrease in demand
2. Number of buyers
• more buyers lead to an increase in demand
• fewer buyers lead to a decrease
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Determinants of the Change in Demand
3. Income
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more leads to an increase in demand
less leads to a decrease in demand for normal
goods
The rare case of goods whose demand varies
inversely with income is called inferior goods
4. Expectations
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consumer views about future prices, product
availability, and income can shift demand
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Determinants of the Change in Demand
5. Prices of related goods
a. Substitute goods - can be used in place of each
other
• The price of the substitute good and demand
for the other good are directly related
• If the price of Coke rises, demand for Pepsi
should increase
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Determinants of the Change in Demand
5. Prices of related goods
b. Complementary goods - are used together like
tennis balls and rackets
• there is an inverse relationship between the
price of one and the demand for the other
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Increase in Demand
1.
2.
3.
4.
5.
6.
Favorable change in consumer tastes
Increase in the number of buyers
Rising income if product is a normal good
Falling incomes if product is an inferior good
Increase in the price of a substitute good
Decrease in the price of a complementary
good
7. Consumer expectation of higher prices or
incomes in the future
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Decrease in Demand
1.
2.
3.
4.
5.
6.
7.
Unfavorable change in consumer tastes
Decrease in number of buyers
Falling income if product is a normal good
Rising income if product is an inferior good
Decrease in price of a substitute good
Increase in price of a complementary good
Consumers expectation of lower prices or
incomes in the future
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Important Distinction Between:
• a change in quantity demanded caused
by price change and
• a change in demand caused by change in
determinants.
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Supply
• Supply - a schedule that shows amounts
of a product a producer is willing and
able to produce and sell at each specific
price
– in a series of possible prices
– during a specified time period
• What quantities will be offered at various prices
or
• What price will be required to induce various
quantities to be offered?
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Supply Schedule
CORN
Various Amounts
A Series of Possible Prices
P QS
$1
2
3
4
5
5
20
35
50
60
…a specified time period
…other things being equal
Law of Supply
• Producers will produce and sell more of their
product at a high price than at a low price
• There is a direct relationship between price and
quantity supplied
• Explanation:
– Given product costs, a higher price means greater
profits and thus an incentive to increase the quantity
supplied
– Beyond some production quantity producers usually
encounter increasing costs per added unit of output
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Supply Curve
• shows a direct relationship in an upward
sloping curve.
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Graphing Supply
Price of Corn
P
$5
S
P QS
4
$5
4
3
2
1
3
2
1
o
CORN
10 20 30 40 50 60 70 80
Quantity of Corn
Q
60
50
35
20
5
Change in Supply
• An increase in supply involves a rightward
shift
• and a decrease in supply involves a
leftward shift
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Increase in Supply
Price of Corn
P
$5
4
3
2
1
Increase
in
Supply
S
S’
CORN
P QS
$5
4
3
Increase 2
in Quantity 1
Supplied
o
10 20 30 40 50 60 70 80
Quantity of Corn
Q
60 80
50 70
35 60
20 45
5 30
Decrease in Supply
Price of Corn
P
$5
4
3
2
1
o
Decrease
in
Supply
S’
S
CORN
P QS
$5
4
3
Decrease
2
in Quantity 1
Supplied
10 20 30 40 50 60 70 80
Quantity of Corn
Q
60 45
50 30
35 20
20 0
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Determinants of the Change in Supply
Six basic determinants of supply:
1. Resource prices
• a rise in resource prices causes a decrease in
supply
• a decrease in resource prices causes an increase
in supply
2. Technology
• a technological improvement means more
efficient production and lower costs, so an
increase in supply results
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Determinants of the Change in Supply
3. Taxes and subsidies
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a business tax is treated as a cost, so decreases
supply
a subsidy lowers cost of production, so
increases supply
4. Prices of related goods
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if the price of substitute production good rises,
producers might shift production toward the
higher-priced good, causing a decrease in
supply of the original good
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Determinants of the Change in Supply
5. Expectations
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about the future price of a product
6. Number of sellers
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generally, the larger the number of sellers the
greater the supply
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Important Distinction Between:
• a change in quantity supplied due to
price changes and
• a change or shift in supply due to change
in determinants of supply
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Market Equilibrium
• Where quantity supplied equals the
quantity demanded
• The equilibrium price and quantity.
– Market clearing or market price is another
name for equilibrium price
– The rationing function of prices is the ability
of competitive forces of supply and demand to
establish a price where buying and selling
decisions are coordinated
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Market Equilibrium
• An excess quantity or surplus
– at prices above the equilibrium
• An excess quantity demanded or
shortage
– at prices below the equilibrium
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Market Demand and Supply
BUSHELS
OF CORN
P
$5
4
3
2
1
QD
10
20
35
55
80
MARKET
200
x
B
U
Y
E
R
S
DEMAND
2,000
4,000
7,000
11,000
16,000
BUSHELS
OF CORN
P QS
$5
4
3
2
1
60
50
35
20
5
MARKET
200
x
S
E
L
L
E
R
S
EQUILIBRIUM
SUPPLY
12,000
10,000
7,000
4,000
1,000
Market Equilibrium
• Graphically, the equilibrium price and
quantity are where the supply and
demand curves intersect
• It is NOT correct to say supply equals
demand!
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Market Equilibrium
Price of Corn
CORN
MARKET
P QD
$5 2,000
4 4,000
3 7,000
2 11,000
1 16,000
P
CORN
MARKET
S
$5
P
4
Market
$5
Clearing
Equilibrium 4
3
3
2
1
2
D
1
o
2
4
6
78
10 12 14 16
Quantity of Corn
Q
QS
12,000
10,000
7,000
4,000
1,000
Surplus
Price of Corn
CORN
MARKET
P
QD
$5
4
3
2
1
2,000
4,000
7,000
11,000
16,000
P
Surplus
$5
4
S
P
QS
At a $4 price
more is being $5 12,000
supplied than 4 10,000
7,000
3
demanded
4,000
2
1,000
1
3
2
1
o
CORN
MARKET
D
2
4
6
78
10 12 14 16
Q
Quantity of Corn
Shortage
Price of Corn
CORN
MARKET
P QD
$5 2,000
4 4,000
3 7,000
2 11,000
1 16,000
P
S
$5
P
4
QS
At a $2 price
more is being $5 12,000
demanded than 4 10,000
3
7,000
supplied
2
4,000
1
1,000
3
2
Shortage
1
o
CORN
MARKET
2
4
6
78
10 1112 14 16
Quantity of Corn
D
Q
The Analogy of Scissors
Economist Alfred Marshall (1842-1924) used the
analogy of scissors to illustrate the relative
importance of supply and demand:
• Equilibrium price and quantity is
determined by both supply and demand,
just as both blades of a pair of scissors
cut the paper
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Key Terms
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MARKET
DEMAND
LAW OF DEMAND
DEMINISHING MARGINAL
UTILITY
INCOME EFFECT
SUBSTITUTION EFFECT
DEMAND CURVE
DETERMINANTS OF DEMAND
NORMAL GOODS
INFERIOR GOODS
SUBSTITUTE GOODS
COMPLEMENTARY GOODS
CHANGE IN DEMAND
• CHANGE IN QUANTITY
DEMANDED
• SUPPLY
• LAW OF SUPPLY
• SUPPLY CURVE
• DETERMINANTS OF SUPPLY
• CHANGE IN SUPPLY
• CHANGE IN QUANTITY
SUPPLIED
• SURPLUS
• SHORTAGE
• EQUILIBRIUM PRICE
• EQUILIBRIUM QUANTITY
• RATIONING FUNCTION OF
PRICES
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