Chapter 3 Demand Supply and Market Equilibrium Copyright

Chapter 3 Demand, Supply, and Market Equilibrium Copyright © 2015 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Markets • Interaction between buyers and sellers • Markets may be • Local • National • International • Price is discovered in the interactions of buyers and sellers LO 1 3 -2

Demand • Demand schedule or demand curve • Amount consumers are willing and able to purchase at a given price • Other things equal • Individual demand • Market demand LO 2 3 -3

Law of Demand • Law of demand • Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls • Explanations • Price acts as an obstacle to buyers • Law of diminishing marginal utility • Income effect and substitution effect LO 2 3 -4

The Demand Curve P Individual demand for corn $5 Qd 10 4 20 3 35 2 55 1 80 5 Price (per bushel) P 6 4 3 2 D 1 0 10 20 30 40 50 60 70 80 Q Quantity demanded (bushels per week) LO 2 3 -5

Market Demand for Corn, Three Buyers Quantity Demanded Total Qd per week Price per bushel Joe Jen Jay $5 10 12 8 30 4 20 23 17 60 3 35 39 26 100 2 55 60 39 154 1 80 87 54 221 LO 2 3 -6

Changes in Demand P Qd $5 2000 4 4000 3 7000 2 11, 000 1 P 6 5 Price (per bushel) Market Demand for Corn, 200 Buyers, (D 1) Increase in demand Increase in Demand 4 3 2 1 16, 000 0 D 2 Decrease in demandin Demand 2 4 6 8 D 1 D 3 10 12 14 16 18 Q Quantity demanded (thousands of bushels per week) LO 2 3 -7

Changes in Demand P Change in demand 6 Price (per bushel) 5 Change in quantity demanded 4 3 2 1 0 D 2 D 1 Decrease in Demand D 3 2 4 6 8 10 12 14 16 18 Q Quantity demanded (thousands of bushels per week) LO 2 3 -8

Determinants of Demand • • LO 2 Determinants of demand Change in consumer tastes and preferences Change in the number of buyers Change in income • Normal goods • Inferior goods 3 -9

Determinants of Demand • Change in prices of related goods • Complementary good • Substitute good • Change in consumer expectations • Future prices • Future income LO 2 3 -10

Determinants of Demand: Factors That Shift the Demand Curve Determinant Examples Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones. Change in the number of buyers A decline in the birthrate reduces the demand for children’s toys. Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine. Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods). Change in consumer expectations Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans. 3 -11

Supply • Supply schedule or a supply curve • Amount producers are willing and able to sell at a given price • Individual supply • Market supply LO 3 3 -12

Law of Supply • Law of supply • Other things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls • Explanation • Price acts as an incentive to producers • At some point, costs will rise LO 3 3 -13

The Supply Curve P $5 60 4 50 3 35 2 20 1 5 5 4 Price (per bushel) Supply of Corn P Qs S 1 3 2 1 0 10 20 30 40 50 60 70 Q Quantity supplied (bushels per week) LO 3 3 -14

Changes in Supply P $6 Market Supply of Corn, 200 Producers, (S 1) P Qs 12, 000 4 10, 000 3 7000 2 4000 1 1000 4 Price (per bushel) $5 5 S 3 Decrease in supply S 2 3 2 Increase in supply 1 0 2 LO 3 S 1 4 6 8 10 12 14 16 Quantity supplied (thousands of bushels per week) Q 3 -15

Changes in Supply P Change in quantity S 3 supplied $6 S 1 5 S 2 Price (per bushel) 4 3 2 Change in supply 1 0 2 4 6 8 10 12 14 16 Q Quantity supplied (thousands of bushels per week) LO 3 3 -16

Determinants of Supply • • LO 3 Determinants of supply A change in resource prices A change in technology A change in the number of sellers A change in taxes and subsidies A change in prices of other goods A change in producer expectations 3 -17

Determinants of Supply: Factors That Shift the Supply Curve Determinant Examples Change in resource prices A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline. Change in technology The development of more effective wireless technology increases the supply of cell phones. Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education. Change in prices of other goods An increase in the price of cucumbers decreases the supply of watermelons. Change in producer expectations An expectation of a substantial rise in future log prices decreases the supply of logs today. Change in the number of suppliers An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games. 3 -18

Market Equilibrium • Equilibrium occurs where the demand curve • • LO 4 and supply curve intersect Equilibrium price and equilibrium quantity Surplus and shortage Rationing function of prices Efficient allocation 3 -19

Efficient Allocation • Productive efficiency • Producing goods in the least costly way • Using the best technology • Using the right mix of resources • Allocative efficiency • Producing the right mix of goods • The combination of goods most highly valued by society LO 4 3 -20

Market Equilibrium 6 5 Qd $5 2000 4 4000 3 7000 2 11, 000 1 16, 000 Price (per bushel) P 6, 000 bushel surplus S 4 3 2 7, 000 bushel shortage 1 0 2 4 67 8 10 D 12 14 16 P Qs $5 12, 000 4 10, 000 3 7000 2 4000 1 1000 18 Bushels of corn (thousands per week) LO 4 3 -21

Rationing Function of Prices • The ability of the competitive forces of demand supply to establish a price at which selling and buying decisions are consistent LO 4 3 -22

Changes in Demand Equilibrium D increase: P , Q D decrease: P , Q P P S S D 2 D 3 D 1 0 0 Increase in demand LO 5 D 4 Decrease in demand 3 -23

Changes in Supply and Equilibrium S increase: P , Q S decrease: P , Q P P S 1 S 4 S 2 D D 0 0 Increase in supply LO 5 S 3 Decrease in supply 3 -24

Complex Cases Effects of Changes in Both Supply and Demand Change in Supply Change in Demand Effect on Equilibrium Price Effect on Equilibrium Quantity 1. Increase Decrease Indeterminate 2. Decrease Increase Indeterminate 3. Increase Indeterminate Increase 4. Decrease Indeterminate Decrease LO 5 3 -25

Government Set Prices • Price ceiling • Set below equilibrium price • Rationing problem • Black markets • Example is rent control LO 6 3 -26

Government Set Prices S P $3. 50 P 0 Ceiling 3. 00 PC D Shortage Qs LO 6 Q 0 Qd Q 3 -27

Government Set Prices • Price floor • Prices are set above the market price • Chronic surpluses • Example is the minimum wage law LO 6 3 -28

Government Set Prices P S Surplus Floor $3. 00 Pf 2. 00 P 0 D Q LO 6 Qd Q 0 Qs 3 -29

Legal Market for Human Organs • What if we created a legal market for human organs? • Positive effects • Increase the incentive to donate • Eliminate the persistent shortage of eyes, livers, hearts, kidneys, etc. 3 -30

Legal Market for Human Organs • Negative effects • Diminishes the special nature of life by commercializing it • The market would leave out the poor and uninsured • Increases the cost of medical care • Prohibition on market solution has resulted in a $1 billion illegal market 3 -31