Chapter 3 Supply Demand Price Supply P Demand

Chapter 3: Supply & Demand Price ($) Supply P* Demand Q* Quantity (Units) 1

Value, Prices, & Markets • Prices communicate information about the value of a good or service. • Prices arise from the interaction of supply and demand in a market economy. • Supply and Demand, and thus prices, coordinate the production and distribution of goods and services in the economy. 2

Competitive Markets • Definition: A competitive market is a market in which there are many buyers and sellers of the same good or service. • A completely competitive market is one where no one individual or firm can make a noticeable impact on the price. • Think about monopoly or oligopoly. 3

Supply & Demand • Supply & Demand: A simple model that describes how competitive markets work, and how prices are determined. • The Elements of the Model: – Supply and Demand Curves – What Factors Cause the Curves to Shift – Equilibrium Price and Changes in Equilibrium 4

Other Things Equal • When analyzing the relationship between the price and quantity demanded other variables must be kept constant. • Ceteris paribus (“all else equal”) 5

The Demand Schedule • The Demand Schedule is a Table which shows how much consumers will want to buy at each price. Price ($ per ticket) Quantity demanded (tickets) 350 5, 000 300 6, 000 250 8, 000 200 11, 000 15, 000 100 20, 000 6

The Demand Curve • The Demand Curve is a Graph of the Demand Schedule which shows how much consumers will want to buy at each price. 7

The LAW of DEMAND • The Law of Demand says that a higher price for a good, other things constant, means people will demand a smaller quantity of the good. 8

Individual vs. Market Demand For each price level sum the “individual quantity demanded” to get the “market quantity demanded” at that price level. 9

Individual vs. Market Demand For each price level sum the “individual quantity demanded” to get the “market quantity demanded” at that price level. 10

“Demand” vs. “Quantity Demanded” • When we talk about “Demand” we are talking about the ENTIRE DEMAND schedule or curve. • When we talk about “Quantity Demanded” we are talking about a SPECIFIC POINT on the demand curve – the quantity on the demand curve at SPECIFIC PRICE. 11

“Movement Along” vs. “Shift” A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price. theresult ØØfrom Ø it Itisisthe point A toofofa an in increase in of the fall point B: C: theincrease price in quantity demanded the good. demanded quantity at any given price. reflects a shift of movement the demandalong curve the demand curve 12

“Movement Along” vs. “Shift” Causes of a “Movement Along” Causes of a “Shift” Change in Price Changes in the Prices of Other Goods Changes in Incomes Changes in Tastes & Preferences Changes in Expectations 13

Shifts in Demand • A change in quantity demanded at any given price represents a shift in the demand curve. A decrease Ø an “increasein demand means in demand”, a leftward means a shift of the demand rightward shift of curve. the demand Price Decrease Increase D 3 D 1 D 2 Quantity 14

Change in Prices of Other Goods • Substitutes: Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good. Ex. : muffins and donuts. • Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good. Ex: PB&J, Computers/Monitors 15

Changes in Income • Normal Goods: When a rise in income increases the demand for a good—the normal case—we say that the good is a normal good. • Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good. Ex: instant noodles. 16

Changes in Tastes or Expectations • Tastes & Preferences are constantly changing with Fads, Fashions, Needs and Wants. Can you think of any examples? • Expectations: Consumers choose not only which products to buy but also when to buy them. 17

Shifts in Demand • Suppose Tom Brady announces retirement and that the next game is his last game! What happens at the next game? 18

Check Understanding Question A What would be the effect of a sharp increase in the price of squash balls on the demand for squash racquets? Why? If the price of a compliment good rises, then demand decreases for the good in question and the demand curve shifts left. Price Decrease D 2 D 1 Quantity 19

Check Understanding Question B What would be the effect of a sharp increase in the price of Pepsi on the demand for Coke? Why? If the price of a substitute good rises, then demand increases for the good in question and the demand curve shifts right. Price Increase D 1 D 2 Quantity 20

Check Understanding Question C As Larissa’s income goes up, she buys less instant noodles. What kind of a good is instant noodles for Larissa? Goods for which demand decreases if your income rises are called inferior goods. In this case, instant noodles are an inferior good. Price Decrease D 2 D 1 Quantity 21

Check Understanding Question D Following David Beckham and Sting, more men start to follow the fashion of wearing skirts. What would the effect of this change in tastes be on the demand for skirts? Price If tastes change in favor of a certain good, then demand increases for the good. Increase D 1 D 2 Quantity 22

Supply • Producers or Firms must make a decision about how much of a good or service to sell in the market place. • Quantity Supplied: The actual amount of a good or service that people are willing to sell at some specific price. 23

The Supply Schedule • The Supply Schedule is a Table which shows how much of good or service will be supplied at different prices. Supply Schedule for Tickets Price ($ per ticket) Quantity Supplied (tickets) 350 8, 800 300 8, 500 250 8, 000 200 7, 000 150 5, 000 100 2, 000 24

The Supply Curve • The Supply Curve is a Graph of the Supply Schedule which shows how much sellers will want to sell at each price. 25

• Law of supply holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied. 26

Individual vs. Market Supply Price (DVD’s) Firm 1 Firm 2 Market Supply A $0. 50 2 B $1. 00 3 1 4 C $1. 50 4 2 6 D $2. 00 5 3 8 27

“Supply” vs. “Quantity Supplied” • When we talk about “Supply” we are talking about the ENTIRE SUPPLY schedule or curve. • When we talk about “Quantity Supplied” we are talking about a SPECIFIC POINT on the supply curve – the quantity on the supply curve at a SPECIFIC PRICE. 28

“Movement Along” vs. “Shift” Causes of a “Movement Along” Causes of a Supply “Shift” Change in Price Changes in Input Prices Changes in Technology Changes in Expectations 29

“Movement Along” vs. “Shift” A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good’s price. theresult ofa ØØfrom Ø it Itisisthe point A toofpoint andecrease B: fall C: in the price ininofthe quantity supplied at good. supplied quantity any given price. reflects a shift movement of the along the supply curve 30

Shifts in Supply • A change in quantity supplied at any given price represents a shift in the supply curve. A decrease Ø an “increasein supply means a in supply”, leftwardashift of means the supplyshift curve. rightward of the supply curve. Price S 3 S 1 S 2 Decrease Increase Quantity 31

Change in Input Prices • Why might input prices matter? • If the price of inputs rises, your costs go up, therefore you want to supply fewer goods at each price – supply decreases (shifts left) • If the price of inputs falls, your costs go down, therefore you are willing to supply more goods at each price – supply increases (shifts right) 32

Changes in Technology • A change in technology doesn’t necessarily mean just changes in electronics. Changes in technology can simply be changes in how things are done. • If a change in technology improves the production of a good (higher productivity or efficiency) then costs fall. • Producers are willing to supply more at every price – supply increases (shifts right) 33

Changes in Expectations • Expectations: Producer expectations about future events such as changes in costs or prices can cause supply to shift. • If you believe the price of your good will be higher in the future, you supply less today, thus supply decreases. • If you believe the price of your good will be lower in the future, you supply more today, thus supply increases. 34

Shifts in Supply (for scalpers) • Suppose Brady announces retirement and that the next game is his last game! Supply shifts left since scalpers have a harder time getting tickets. 35

Check Understanding Question A More homeowners put their houses up for sale during a real estate boom that has caused house prices to rise. Is this a shift or movement along…? Price S 1 A change in prices results in a movement along the curve Quantity 36

Check Understanding Question B Strawberry farmers open temporary roadside stands during harvest season even though prices are usually lower at that time. Price S 1 S 2 Increase Quantity Farmer’s have much more supply during harvest season. They need to sell them before they go bad. Increased supply reduces the prices. 37

Supply, Demand Equilibrium Competitive Market Equilibrium: when the quantity demanded of a good equals the quantity supplied of that good. The price at which this takes place is the equilibrium price (a. k. a market-clearing price) Every buyer finds a seller and vice versa The quantity of the good bought and sold at that price is the equilibrium quantity. 38

Equilibrium for Football Tickets Equilibrium Price = $250 Equilibrium Quantity = 8, 000 Tickets 39

Why does the market price fall if it is above the equilibrium price? ØLet’s say the market price of $350 is above the equilibrium price of $250 ØThis creates a surplus ØThis surplus will push the price down until it reaches the equilibrium price of $250. 40

Surplus There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level. 41

Why does the market price rise if it is below the equilibrium price? ØLet’s say the market price of $150 is below the equilibrium price of $250. ØThis creates a shortage. ØThis shortage will push the price up until it reaches the equilibrium price of $250. 42

Shortage There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level. 43

Markets are never in equilibrium but they always tend to the equilibrium • Demand Supply both matter because neither consumers or firms dictate equilibrium price. • Firm cannot sell anything at any price unless it can find a willing buyer. • A consumer cannot buy anything at any price without finding a willing seller. 44

What happens when the demand curve shifts? Coffee and tea are substitutes: if the price of tea rises (falls), the demand for coffee will increase (decrease). But how does the price of tea affect the market for coffee? When E A shortage : A The rise demand equilibrium original inexists the for 1 new 2 equilibrium price at is a good reached theof original increases, tea, at ina. Ethe price 2, market substitute, P with the equilibrium a higher price for coffee shifts rises is 1, so at Edemand the and equilibrium price , and at quantity thethe price curve. P 2 1 the intersection rightward supplied and equilibrium a higher increases, to of itsthe new supply position a equilibrium quantity movement curve atof. Dquantity the S. and 2 along the Q good original bothcurve. rise. 2. supply demand curve D 1. Shortage 45

What happens when the supply curve shifts? Technological innovation: Engineers learned how to put microscopic electronic components onto a silicon chip; allowing ever more components to be put on each chip. Surplus When The A E : A The shift: new supply original After exists of aata 1 surplus 2 technological the equilibrium good original increases, in is price the market change P reached the equilibrium price for increases at silicon Efalls 1, so 2, with chips the and a price lower supply the is ofequilibrium at quantity the E of 1 good , at the intersection silicon demanded price falls and Pchips, theatheof 2 and the demand supply increases, higher equilibrium curve a curve shifts D andtothe right movement quantity its Qrises. original. along 2 new supply position the demand curve at S 2 curve. . S 1. 46

Simultaneous Shifts in Supply and Demand What happens when the both supply and demand curves shift simultaneously? The increase There is a in simultaneous demand is rightwardlarger relatively shift of the demand than the decrease curve and in supply, leftward so the shift of the supplyprice equilibrium curve. rises and the equilibrium quantity increases. 47

Simultaneous Shifts in Supply and Demand Another Scenario The decrease There is a in simultaneous supply is relatively rightward larger than shift the of the demand increase in curve and leftward demand, so the shift of the supply equilibrium price curve. and the rises equilibrium quantity decreases. 48

The Effect of Demand Supply Shifts on Equilibrium How Shifts in Demand Supply Affect Equilibrium Price (P) and Quantity (Q) SUPPLY CURVE UNCHANGED SHIFTS TO THE RIGHT SUPPLY CURVE SHIFTS TO THE LEFT Q unchanged P unchanged Q increases P decreases Q decreases P increases DEMAND CURVE SHIFTS TO THE RIGHT Q increases P increases or decreases Q increases or decreases P increases DEMAND CURVE SHIFTS TO THE LEFT Q increases or decreases P decreases Q decreases P decreases or increases DEMAND CURVE UNCHANGED Q decreases P decreases 49