Download Chapter 4

Demand, Supply and Market
Equilibrium
Chapter 4
1
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The Basic Decision-Making Units in
the Economy:
Firms and Households
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Firms and Households
A firm is an organization that transforms
resources (inputs) into products (outputs).
Firms are the primary producing units in a
market economy.
Households are the consuming unit in the
economy.
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The Entrepreneur
The entrepreneur is the person who organizes,
manages, and assumes the risks of a firm,
taking a new idea or a new product and turning
it into a successful business.
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Markets
Product or output markets are the markets in
which goods and services are exchanged.
Input or factor markets are the markets in
which resources used to produce products are
exchanged
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Labour Markets
Labour markets are the input/factor markets in
which households supply work for wages to
firms that demand labour.
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Capital Markets
Capital markets are the input/factor markets in
which households supply their savings, for
interest or for claims to future profits, to firms
that demand funds in order to buy capital
goods.
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Land Markets
Land markets are the input/factor markets in
which households supply land or other real
property in exchange for rent.
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Factors of Production
The inputs into the production process. Land,
labour, and capital are the three key factors of
production.
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The Circular Flow
A circular flow diagram describes the interaction
of firms and households in markets for outputs
and inputs.
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The Circular Flow of Economic
Activity (Figure 4.1)
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Determinants of Household Demand:
The price of the product in question
The income available to the household
The households amount of accumulated wealth
The prices of other products available
Tastes and preferences
Expectations about future income, wealth, and
prices
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Quantity Demanded
The quantity demanded represents the amount
(number of units) of a product that a household
would buy in a given period if it could buy all it
wanted at the current market price.
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Changes in Quantity Demanded vs.
Changes in Demand
Changes in the price of a product affect the
quantity demanded per period. Changes in any
other factor, such as income or preferences,
affect demand. An increase in income, for
instance, tends to increase demand. While a
drop in prices will increase the quantity
demanded.
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The Demand Schedule
A demand schedule is a table or chart showing
how much of a given product a household
would be willing to buy at different prices.
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The Demand Curve
The demand curve is a graph illustrating how
much of a given product a household would be
willing to buy at different prices.
Demand curves are usually derived from
demand schedules.
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The Demand Curve
P
D
0
17
Q
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The Law of Demand
The negative relationship between price and
quantity demanded. As price rises, quantity
demanded decreases. As price falls, quantity
demanded increases
This is why we observe a negative slope in
demand curves.
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Anna’s Demand Schedule for
Telephone Calls (Table 4.1)
Price per call
0
0.50
3.50
7.00
10.00
15.00
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Quantity Demanded in
calls per month
30
25
7
3
1
0
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Anna’s Demand Curve
Price
$15.00
$10.00
$7.50
$3.50
$ .50
01
20
3
7
25 30
Quantity demanded
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Other Determinants of Household
Demand
 Income and Wealth
Income: The total of all earnings received by a
household in a given period of time
Wealth: The total value of what a household owns
less what it owes
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Income as a Determinant of Demand
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.
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Prices of Other Goods and Services
as Determinants of Demand
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, and vice versa.
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Other Determinants of Household
Demand:
Tastes and Preferences - These are quite
subjective and tend to change over time.
Expectations - With respect to future income,
wealth, prices, and availability.
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Shift of Demand vs. Movement Along
Demand Curve
Shift of a demand curve is the change that takes
place in a demand curve when a new
relationship between the quantity demanded of
a good and the price of that good is brought
about by a change in the original conditions.
Movement along the demand curve is what
happens when a change in price causes quantity
demanded to change.
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Anna’s Demand for Telephone Calls Change in Quantity Demanded
Price
$15.00
 The graph shows a
shift in quantity
demanded from 3 to
7 caused by a change
in price from $7.50 to
$3.50.
$10.00
$7.50
$3.50
$ .50
01
26
3
7
25 30
Quantity demanded
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A
Anna’s Demand for Telephone Calls A Change in Demand
$15.00
$10.00
$7.50
$3.50
D1
$ .50
01
27
3
7
25 30
 When any factor
except price
changes the
relationship
between price and
quantity is
different; there is a
of the
D2 shift
demand curve, in
this case from D1
to D2.
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Changes in Demand
Income Changes
Income Rises
P
P
D2
Demand for inferior good
shifts left
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D1
Q
D1
Demand for normal good
shifts right
D2
Q
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Changes in Demand
Prices of Related Goods
P
Price of
hamburger rises
P
P
Q
D2
Demand for complement
good (ketchup) shifts left
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D1
Q
Quantity of
hamburger
demanded
falls
D1 D2
Demand for substitute
good (chicken) shifts right
Q
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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.
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Market Demand Defined
Market demand may be defined as 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.
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Deriving market demand from the
individual demand curves:
P
P
$3.50
DA
$1.50
0
P
$3.50
DB
$1.50
4
8 Qd
DC
$3.50
$1.50
0
3
Price
Qd
0
4
9
Qd
Market Demand
$3.50
$1.50
0
32
8
20
Qd
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Supply
A firm’s decision about what quantity of product
to supply depends on:
The price of the good or service
The cost of producing the product which depends on:
The price of required inputs (land, labour, capital)
The technologies to be used to produce the product
The prices of related products
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Quantity Supplied
The amount of a particular product that a firm
would be willing and able to offer for sale at a
particular price during a given time period.
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The Law of Supply
The positive relationship between price and
quantity of a good supplied. An increase in
market price will lead to an increase in quantity
supplied, and a decrease in market price will
lead to a decrease in quantity supplied.
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The Supply Schedule and Supply
Curve
A supply schedule is a table, or chart, showing
how much of a product firms will supply at
different prices.
A supply curve is a graph illustrating how much
of a product a firm will supply at different
prices.
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Clarence Brown’s Supply Schedule for
Soybeans (Table 4.3)
Price (per tonne)
75
85
115
150
200
250
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Quantity Supplied
(tonnes per year)
0
400
600
800
1200
1200
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Clarence Brown’s Soybean
Supply Curve (Figure 4.6)
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Changes in Quantity Supplied vs.
Changes in Supply:
Changes in quantity supplied imply movement
along a supply curve.
Changes in supply imply a shift in the entire
supply curve.
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A Change in the Quantity Supplied of
Clarence Brown’s Soybeans (Figure 4.6)
 Change in quantity
supplied from 600
to 800 tonnes per
year due to an
increase in price
from $115 to $150
per tonne.
 Causes movement
along supply
curve.
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Shift Of Supply Curve for Soybeans
Following Development of New Strain
(Figure 4.7)
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Changes in Quantity Supplied vs.
Changes in Supply:
P
S
P
S1
Q
An increase in the
quantity supplied
42
An increase in supply
S2
Q
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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.
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Market Supply
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 firms’
supply curves.
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From Individual Firm to Market
Supply (Figure 4.8)
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Market Equilibrium
The operation of the market depends on the
interaction between suppliers and demanders.
An equilibrium is the condition that exists when
quantity supplied and quantity demanded are
equal.
At equilibrium, there is no tendency for the
price to change.
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Market Equilibrium
P
PE
S
E
D
QE
47
Q
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The market for soybeans in
equilibrium:
P
S
$ per
tonne
125
D
0
48
3500
Tonnes of Soybeans
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Excess Demand
Excess Demand is the condition that exists
when quantity demanded exceeds quantity
supplied at the current price.
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Excess Demand
(Figure 4.9c)
 At $85 per tonne
quantity
demanded
exceeds quantity
supplied by 2500
tonnes.
 Excess demand
tends to lead to
an increase in
prices.
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Excess Supply
Excess supply is the condition that exists when
quantity supplied exceeds quantity demanded at
the current price.
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Excess Supply
(Figure 4.10)
 At $150, quantity
supplied exceeds
the quantity
demanded by
2000 tonnes.
 This causes prices
to fall
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Changes in Equilibrium
Demand Shifts/Supply is Constant
P
P
S
P2
P1
P1
D2
D1
Q1
Q2
Increase in Demand
53
S
Q
P2
D1
D2
Q2
Q1
Q
Decrease in Demand
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Changes in Equilibrium
Supply Shifts/Demand is Constant
P
S1
S2
P
S2
P1
S1
P2
P2
D
Q1
Q2
Increase in Supply
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Q
P1
D
Q2
Q1
Q
Decrease in Supply
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Changes in Equilibrium Supply & Demand
both Increase (or Decrease)
P
S1
P
S2
S2
S1
P
P=?
?
D1
Q1
55
D1
D2
Q2
Q
Increase in Demand
& Supply
D2
Q2
Q1
Q
Decrease in Demand &
Supply
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Changes in Equilibrium
Demand & Supply Move Opposite
P
S2
S1
S1
P
P1
S2
P2
D2
P1
D1
P2
D2
D1
Q= ?
Demand Increases &
Supply Decreases
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Q
Q=?
Q
Demand Decreases &
Supply Increases
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Review Terms & Concepts
 capital Market
 complements,
complementary Goods
 demand curve
 demand schedule
 entrepreneur
 equilibrium
 excess demand
 excess supply
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 factors of production
 firm
 households
 income
 inferior goods
 input or factor markets
 labour market
 land market
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Review Terms & Concepts
(continued)
 law of demand
 law of supply
 market demand
 market supply
 movement along a
demand curve
 normal goods
 perfect substitutes
 product or output
markets
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 profit
 quantity demanded
 quantity supplied
 shift of a demand curve
 substitutes
 supply curve
 supply schedule
 wealth or net worth
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