Demand, Supply, and Market Equilibrium

Chapter 3Demand, Supply, and Market

EquilibriumCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

3-2

Markets

• Interaction between buyers and sellers• Markets may be• Local• National• International

• Price is discovered in the interactions of buyers and sellers

LO1

3-3

Demand

• 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

LO2

3-4

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

LO2

3-5

The Demand Curve

LO2

6

5

4

3

2

1

0 10 20 30 40 50 60 70 80

Quantity demanded (bushels per week)

Pric

e (p

er b

ushe

l)P Qd

$5

4

3

2

1

10

20

35

55

80

P

Q

D

3-6

Market Demand

LO2

Market Demand for Corn, Three Buyers

Priceper bushel

Quantity Demanded Total Qd

per weekJoe 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

3-7

Changes in Demand

6

5

4

3

2

1

0

Quantity demanded (thousands of bushels per week)

Pric

e (p

er b

ushe

l)

P

Q

D1

2 4 6 8 10 12 14 16 18

D2

D3

LO2

P Qd

$5

4

3

2

1

2000

4000

7000

11,000

16,000

Decreasein demand

Increasein demand

3-8

Changes in Demand

LO2

6

5

4

3

2

1

0

Quantity demanded (thousands of bushels per week)

Pric

e (p

er b

ushe

l)P

Q

D1

2 4 6 8 10 12 14 16 18

D2

D3

Change in demand

Change in quantity demanded

3-9

Determinants of Demand

• Determinants of demand• Change in consumer tastes and preferences• Change in the number of buyers• Change in income• Normal goods• Inferior goods

LO2

3-10

Determinants of Demand

• Change in prices of related goods• Complementary good• Substitute good

• Change in consumer expectations• Future prices• Future income

LO2

3-11

Determinants of DemandDeterminants 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.

3-12

Supply

• Supply• Supply schedule or a supply curve• Amount producers are willing and able to sell

at a given price• Individual supply• Market supply

LO3

3-13

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

LO3

3-14

The Supply Curve

LO3

5

4

3

2

1

0

Pric

e (p

er b

ushe

l)

Quantity supplied (bushels per week)

S1

10 20 30 40 50 60 70

P

Q

P Qs

$5

4

3

2

1

60

50

35

20

5

3-15

Changes in Supply

LO3

$6

5

4

3

2

1

0

Pric

e (p

er b

ushe

l)

S1

Quantity supplied (thousands of bushels per week)

2 4 6 8 10 12 14 16

P

Q

S2

S3

Increasein supply

Decrease in supplyP Qs

$5

4

3

2

1

12,000

10,000

7000

4000

1000

3-16

Changes in Supply

$6

5

4

3

2

1

0

Pric

e (p

er b

ushe

l)

S1

Quantity supplied (thousands of bushels per week)2 4 6 8 10 12 14 16

P

Q

S2

S3

Change in quantity supplied

Change in supply

LO3

3-17

Determinants of Supply

• 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

LO3

3-18

Determinants of SupplyDeterminants 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.

3-19

Market Equil ibrium

• Equilibrium occurs where the demand curve and supply curve intersect

• Equilibrium price and equilibrium quantity• Surplus and shortage• Rationing function of prices• Efficient allocation

LO4

3-20

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

LO4

3-21

Market Equil ibrium

6

5

4

3

2

1

0 2 4 6 8 10 12 14 16 18

Bushels of corn (thousands per week)

Pric

e (p

er b

ushe

l)

P Qd

$5

4

3

2

1

2000

4000

7000

11,000

16,000

P Qs

$5

4

3

2

1

12,000

10,000

7000

4000

1000

7

D

S6,000 bushelsurplus

7,000 bushelshortage

LO4

3

3-22

Rationing Function of Prices

• The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent

LO4

3-23

Changes in Demand and Equil ibrium

LO5

0

P

D4

D3

0

P

D1

D2

S

Increase in demand

D increase:P↑ , Q↑

D decrease:P↓ , Q↓

Decrease in demand

S

3-24

Changes in Supply and Equil ibrium

0

P

D

S4 S3

0

P

D

S2S1

Increase in supply

S increase:P↓ , Q↑

S decrease:P↑ , Q↓

Decrease in supply

LO5

3-25

Complex Cases

LO5

Effects of Changes in Both Supply and Demand

Change in Supply Change in DemandEffect on Equilibrium

PriceEffect on Equilibrium

Quantity

1. Increase Decrease Decrease Indeterminate

2. Decrease Increase Increase Indeterminate

3. Increase Increase Indeterminate Increase

4. Decrease Decrease Indeterminate Decrease

3-26

Government Set Prices

• Price ceiling• Set below equilibrium price• Rationing problem• Black markets

• Example is rent control

LO6

3-27

Government Set Prices

SP

Q

D

P0

PC

Q0

Shortage

QdQs

Ceiling$3.50

3.00

LO6

3-28

Government Set Prices

• Price floor• Prices are set above the market price• Chronic surpluses

• Example is the minimum wage law

LO6

3-29

Government Set Prices

LO6

S

P

Q

D

P0

Pf

Q0

Surplus

QsQd

Floor

2.00

$3.00

3-30

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.

3-31

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