2 Supply and Demand Outline Demand consumer side

2 Supply and Demand

Outline ● Demand –consumer side of the market ● Supply –seller side of the market ● Equilibrium –how prices and quantities are determined by the market ● Changes in equilibrium –shifts in D and S ● Price ceilings and price floors –government’s attempt to restraint or bolster prices Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Demand Quantity Demanded ● Quantity of demand = the amount that buyers wish to purchase at each price ● Qd depends on P, population size, consumer incomes, tastes, and P of other products ● D focus only on relationship between P and Qd ● Consider D schedule for milk –table showing the Qd at each P Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

1. Demand Schedule for Milk TABLE Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Demand Quantity Demanded ● The Demand Curve ♦ Graph of a demand schedule ♦ Negative slope ■ As ↑P milk ↓Qd milk because: 1. People consume less milk. 2. Some people drop out of the market for milk and drink tea or orange juice instead. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

1. Demand Curve for Milk FIGURE Price per Quart D $1. 50 A B 1. 40 C 1. 30 E 1. 20 F 1. 10 G 1. 00 H . 90 0 D 45 50 55 60 65 70 75 Quantity Demanded in Billions of Quarts per Year Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Demand Quantity Demanded ● Along D curve all other determinants of Qd for milk (e. g. , consumer incomes, P orange juice, or P cereal) are held constant. P of milk is the only determinant of D for milk that is allowed to . ● Law of Demand the lower P of the good, the larger Q consumers wish to purchase. In general, D curves have a (-) slope. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Demand Quantity Demanded ● Shifts of the Demand Curve ♦ Movement along a fixed demand curve: ■ Price ♦ Shift in the entire demand curve: ■ Incomes ■ Population ■ Preferences ■ Prices and availability of related goods Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

2. Movement along vs. a shift in the Demand Curve FIGURE Movement along: A to B (or C to D) D 1 Outward shift: A to C (and B to D) Price per Quart D 0 A $1. 30 C D B 1. 10 D 1 D 0 55 65 70 80 Quantity Demanded in Billions of Quarts per year Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Factors that shift demand 1. ∆ income: ● ● Normal goods: ↑ income shifts D out Inferior goods: ↑ income shifts D in Ø What are some examples of inferior goods? Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Factors that shift demand 2. ∆ P of related products: a) Two goods are compliments if they are consumed together. ● ↓P of a compliment shifts D out ● E. g. , ↓P cereal shifts D milk out What will happen to D for milk if ↑ P oreos? Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Factors that shift demand 2. ∆ P of related products: b) Two goods are substitutes if one can replace the other in consumption. ● ↓P of a substitute shifts D in ● E. g. , ↓P orange juice shifts D milk in What will happen to D for milk if ↑ P tea? Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Factors that shift demand 3) ∆ tastes: ♦ If consumers worry about their daily calcium intake D milk shifts out ♦ As population ages D milk shifts in Why have we seen a rise in the number of milk ads? 4) ∆ population: ♦ If the size of the population increases D milk shifts out. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Supply and Quantity Supplied ● Quantity of supply = amount that producers wish to sell at each price ● Qs depends on P, size of the industry, P of inputs, and technology. ● S focus only on relationship between P and Qs ● Consider S schedule for milk –table showing the Qs at each P Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

2. Supply Schedule for Milk TABLE Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Supply and Quantity Supplied ● The Supply Curve ♦ Graph of a supply schedule ♦ Positive slope ■ Farmers require ↑P milk to ↑Qs because ↑costs as they produce more ● Higher milk prod. requires more cows, feed, milking equipment, dairy workers, etc. Suppliers want to make profits, so they raise P to cover their costs. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

3. Supply Curve for Milk FIGURE a $1. 50 S b Price per Quart 1. 40 c 1. 30 e 1. 20 f 1. 10 g 1. 00. 90 0 h S 30 40 50 60 70 80 90 Quantity Supplied in Billions of Quarts per Year Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Supply and Quantity Supplied ● Along S curve all other determinants of Qs of milk (e. g. , P feed, weather, wages of dairy workers) are held constant. P of milk is the only determinant of S of milk that is allowed to . ● Law of Supply the higher P of the good, the larger Q firms want to produce. In general, S curves have a (+) slope. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Supply and Quantity Supplied ● Shifts of the Supply Curve ♦ Movement along a fixed supply curve: ■ Price ♦ Shift in the entire supply curve: ■ Size of the industry ■ Technological progress ■ Prices of inputs ■ Prices of related outputs Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

4. Movement along vs. a shift in the Supply Curve FIGURE Movement along: A to B (or C to D) S 0 Price per Quart Outward shift: A to C (and B to D) S 1 B $1. 30 D A 1. 10 C S 0 S 1 50 70 75 95 Quantity Supplied in Billions of Quarts per Year Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Factors that shift supply 1. Size of the industry: ● ↑number of firms shifts S out What happens to the S milk if the number of dairy farms decreases? 2. Price of inputs: ● ↓price of an input shifts S out What happens to the S milk if dairy workers unionize and negotiate higher wages? Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Factors that shift supply 3. Technological progress: ● Improvements in technology shifts S out ● Example: many dairy farmers use BGH to ↑output of milk per cow. 4. ∆ Prices of related products: ● ∆ P of 1 good produce a multi-product industry can shift S curve of other goods produced by that industry. ♦ E. g. , if ↑P cheese shifts S milk in Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Supply and Demand Equilibrium ● In a free market, Q of goods and services is determined by the intersection of S and D. ● E consumers are willing to buy exactly what producers are willing to sell Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

3. Equilibrium Price & Quantity of Milk TABLE Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Supply and Demand Equilibrium ● E occurs where Qs = Qd = 60 at P = $1. 20 ● If P > PE surplus (with Qs > Qd). Surplus ends with frustrated sellers ↓P to reduce inventories. ● If P < PE shortage (with Qd > Qs). Shortage ends with frustrated consumers offering ↑P to obtain the good. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

5. Supply-Demand Equilibrium FIGURE D a A $1. 50 S Price per Quart 1. 40 1. 30 E 1. 20 1. 10 g G 1. 00. 90 0 D S 30 40 50 60 70 80 90 Quantity in Billions of Quarts per Year Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Adjustment to Shifts in Demand ● Any shift in S or D E ● Shifts in Demand ♦ Shifts in D equilibrium P and Q in the same direction ■Example: any inward shift in D lowers equilibrium P and Q. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

6. Inward shift in the Demand Curve FIGURE 1 to 2: D shifts in. Price per Quart D 0 S D 2 Surplus ends as ↓P. 1 $1. 20 2 3 1. 10 D 0 S Point 2: surplus of 15 as Qd < Qs. D 2 45 50 60 Quantity ↓P encourages ↑Qd (2 to 3) and ↓ Qs (1 to 3) which ends the surplus. Point 3: new E. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Adjustment to Shifts in Supply ● Shifts in Supply ♦ Shifts in S equilibrium P and Q in opposite directions ■Example: any inward shift in S lowers equilibrium Q and raises equilibrium P. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

7. Inward shift in the Supply Curve FIGURE 1 to 2: S shifts in. S 2 Point 2: shortage of 22. 5 as Qs < Qd. Price per Quart D 3 $1. 40 S 0 Shortage ends as ↑P. 1 2 1. 20 ↑P encourages ↓Qd (1 to 3) and ↑Qs S 2 S 0 D 37. 5 50 60 Quantity (2 to 3) which ends the shortage. Point 3: new E. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Government Intervention in Markets: Price Ceilings ● A price ceiling is a legal maximum on the price that may be charged for a good. ■ Example: Rent control in NY City 1. Persistent shortage develops as Qd > Qs ♦ Low vacancy rate (1/2 national average) 2. “Black” markets arise with higher prices ♦ “Key money” to move up on wait lists or forced to buy wretched furniture at high P Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Price Ceilings 3. Illicit suppliers get substantial portion of P ♦ E. g. , theater ticket P controls in NY City 4. Investment in the industry dries up ♦ ♦ ♦ Convert apartments to office space or condos Inadequately maintained apartments Abandoned buildings With all of these problems, why have rent controls in NY City continued since WWII? Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

8. Rent Control FIGURE S Rent per Month D $2, 000 1, 200 Market rent Rent ceiling E C B S 0 D 2. 5 3 3. 5 Millions of Dwellings Rented per Month Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Government Intervention in Markets: Price Floors ● A price floor is a legal minimum on the price that may be charged for a good. ■ Examples: min. wage and agricultural P supports 1. Persistent surplus develops ♦ E. g. , EU with CAP. Europeans export surplus; lowers world food Ps and fuels trade disputes with U. S. 2. Disposal problems ♦ E. g. , Gov. has to purchase, store, and dispose of the agricultural surplus. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Price Floors 3. Sellers offer inefficient discounts ♦ E. g. , In 1980 s, regulated airlines competed in food quality and attractiveness of flight attendants. 4. Overinvestment in the industry ♦ Inefficient businesses can survive with a high P floor. Trucking and airline industries faced massive layoffs after deregulation in 1980 s. 5. Vested interests that resist change ♦ P supports began in 1933. Still exist today, even though farmers are only 2% of the U. S. workforce. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

FIGURE 9. Milk Price Supports Surplus = 30 (A to B) D S A Gov Cost = $1. 40 x 30 = $ 42 billion B Price $1. 40 E $1. 20 D S 50 60 80 Quantity Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

More problems with price ceilings or floors ● Favoritism and corruption ♦ E. g. , Discriminate against renters with children or Soviet officials who purchased goods that others could not get. ● Auxiliary restrictions ♦ E. g. , NY City has laws banning the conversion of rentcontrolled apartments to condos. ● Misallocation of resources ♦ E. g. , Russian farmers fed their animals bread because the P ceiling was below the P of grain. U. S. imported cereal from Canada to remove the sugar when P was extremely high. Copyright© 2006 South-Western/Thomson Learning. All rights reserved.