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Demand, Supply, Demand, Supply, andand

Market Market EquilibriumEquilibriumChapter 3Chapter 3

In this chapter, you will In this chapter, you will learn:learn:

1.1. What demand is and what affects it.What demand is and what affects it.

2.2. What supply is and what affects it.What supply is and what affects it.

3.3. How supply & demand together determine market How supply & demand together determine market equilibrium.equilibrium.

4.4. How changes in supply & demand affect equilibrium How changes in supply & demand affect equilibrium prices & quantities.prices & quantities.

5.5. What government-set prices are and how they can What government-set prices are and how they can cause product surpluses & shortages.cause product surpluses & shortages.

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MarketsMarkets

Consist of large numbers of Consist of large numbers of independently acting buyers & sellers independently acting buyers & sellers of of standardizedstandardized products products

These are highly competitive marketsThese are highly competitive markets

All such markets involve demand, All such markets involve demand, supply, price, and quantitysupply, price, and quantity

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DemandDemand A schedule or curve that shows the various amounts A schedule or curve that shows the various amounts

of a product that consumers are willing & able to of a product that consumers are willing & able to buy at all prices during a specific period of timebuy at all prices during a specific period of time

Can be easily shown in table form (Demand Can be easily shown in table form (Demand schedule)schedule)

Table shows relationship between price and quantity Table shows relationship between price and quantity demanded at each pricedemanded at each price

Table does not tell us which price will exist in the Table does not tell us which price will exist in the market…depends on interaction of demand market…depends on interaction of demand andand supplysupply

Law of demandLaw of demand

Fundamental characteristic: Other Fundamental characteristic: Other things equal, as price falls, the things equal, as price falls, the quantity demanded risesquantity demanded rises

As price rises, quantity demanded As price rises, quantity demanded fallsfalls

In short, negative or In short, negative or inverseinverse relationship between price and relationship between price and quantity demanded (Law of Demand)quantity demanded (Law of Demand)

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Why Inverse Why Inverse Relationship?Relationship?

People ordinarily People ordinarily dodo buy more of a product at a lower price buy more of a product at a lower price (common sense)(common sense)

In any specific time period, each buyer of a product will derive In any specific time period, each buyer of a product will derive less satisfaction (or benefit, or utility) for each successive unit of less satisfaction (or benefit, or utility) for each successive unit of the product consumed (the product consumed (diminishing marginal utilitydiminishing marginal utility))

Income & substitution effectsIncome & substitution effects

Lower price – increases purchasing power of a buyer’s money Lower price – increases purchasing power of a buyer’s money income, enabling the buyer to purchase moreincome, enabling the buyer to purchase more

At a lower price, buyers have the incentive to At a lower price, buyers have the incentive to substitutesubstitute what is what is now less expensive product for similar products that are now now less expensive product for similar products that are now more expensivemore expensive

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Demand curve (Fig. 3.1)Demand curve (Fig. 3.1)

Quantity demanded on Quantity demanded on horizontalhorizontal axis axis

PricePrice on vertical axis on vertical axis

Downslope reflects the law of demandDownslope reflects the law of demand People buy more of a product, service, or People buy more of a product, service, or

resource as its price falls. (inverse or resource as its price falls. (inverse or negative relationship)negative relationship)

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Market demandMarket demand By adding the quantities demanded by By adding the quantities demanded by allall consumers at consumers at

each price, we can calculate the market demand (Fig. 3.2)each price, we can calculate the market demand (Fig. 3.2) Price is Price is most important influencemost important influence on demand on demand

Determinants of demandDeterminants of demand

When determinants change, the demand curve will shift When determinants change, the demand curve will shift to the right or leftto the right or left

Consumers’ tastes (preferences), # of buyers, consumers’ Consumers’ tastes (preferences), # of buyers, consumers’ income, prices of related goods, consumer expectationsincome, prices of related goods, consumer expectations

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Change in DemandChange in Demand

Change in demand schedule or curve Change in demand schedule or curve is called a “change in demand”is called a “change in demand”

Increase in demand = rightward Increase in demand = rightward shift of curveshift of curve

Decrease in demand = leftward shift Decrease in demand = leftward shift of curveof curve

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Increase in Demand may be Increase in Demand may be caused by:caused by:

Favorable change in Favorable change in consumer tasteconsumer taste

Increase in # of buyersIncrease in # of buyers

Rising income if product Rising income if product is is normalnormal good good

Falling income if Falling income if product is product is inferiorinferior good good

An increase in price of a An increase in price of a substitute goodsubstitute good

A decrease in price of a A decrease in price of a complementary goodcomplementary good

New expectation that New expectation that either prices or income either prices or income will be higher in futurewill be higher in future

Reverse these for Reverse these for decrease in demanddecrease in demand

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Changes in Qty. Changes in Qty. DemandedDemanded

Movement from one point to another Movement from one point to another point on a point on a fixedfixed demand curve demand curve

Cause of such a change is an Cause of such a change is an increase or decrease in the price of increase or decrease in the price of the product under considerationthe product under consideration

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Supply (3.2) Supply (3.2) Schedule or curve showing various amounts of a Schedule or curve showing various amounts of a

product that product that producersproducers are willing & able to make are willing & able to make available for sale at all prices during a period of timeavailable for sale at all prices during a period of time

Supply schedule – shows quantities of a product that Supply schedule – shows quantities of a product that will be supplied at various priceswill be supplied at various prices

Law of supply – positive or direct relationship that Law of supply – positive or direct relationship that prevails between price & quantity supplied…as price prevails between price & quantity supplied…as price rises, quantity supplied rises toorises, quantity supplied rises too

Higher prices represent more revenue to the producer Higher prices represent more revenue to the producer which increases their incentives to producewhich increases their incentives to produce

Supply curveSupply curve

Upward slope of the curve reflects Upward slope of the curve reflects the law of supplythe law of supply

Producers offer more of a good, Producers offer more of a good, service, or resource for sale as its service, or resource for sale as its price risesprice rises

Relationship is positive or directRelationship is positive or direct

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Market supplyMarket supply

We sum the quantities supplied by We sum the quantities supplied by each producer at each price.each producer at each price.

Price – vertical axisPrice – vertical axis

Quantity supplied – horizontal axisQuantity supplied – horizontal axis

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Determinants of supplyDeterminants of supply Price is most significant influence on quantity Price is most significant influence on quantity

supplied of any productsupplied of any product

Other factors can and do affect supplyOther factors can and do affect supply

A A change in supplychange in supply will shift the entire supply will shift the entire supply curvecurve

A shift to the right increases supplyA shift to the right increases supply

A shift to the left decreases supplyA shift to the left decreases supply

Basic Determinants of Basic Determinants of SupplySupply

Resource pricesResource prices

TechnologyTechnology

Taxes & subsidiesTaxes & subsidies

Prices of other goodsPrices of other goods

Producer expectationsProducer expectations

# of sellers# of sellers

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Changes in Quantity Changes in Quantity SuppliedSupplied

Movement from one point to another Movement from one point to another on a on a fixedfixed supply curve supply curve

Cause of such a movement is a Cause of such a movement is a change in the price of the specific change in the price of the specific product being consideredproduct being considered

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Market equilibrium (3.3)Market equilibrium (3.3)

Only price where the intentions of Only price where the intentions of buyers & sellers matchbuyers & sellers match

No shortage or surplus & equilibriumNo shortage or surplus & equilibrium

Competition among buyers & among Competition among buyers & among sellers drives the price to equilibriumsellers drives the price to equilibrium

SurplusSurplus

Above equilibrium (supply>demand)Above equilibrium (supply>demand)

Encourages sellers to offer more but Encourages sellers to offer more but discourages many consumers from discourages many consumers from buying itbuying it

Surpluses drive prices down to Surpluses drive prices down to equilibriumequilibrium

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ShortageShortage

Below equilibrium (demand>supply)Below equilibrium (demand>supply)

Discourages sellers from devoting Discourages sellers from devoting resources to the productresources to the product

Consumers desire more of the Consumers desire more of the product at the lower priceproduct at the lower price

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Efficient allocationEfficient allocation Competition among producers forces them to use the Competition among producers forces them to use the

best technology & right mix of productive resourcesbest technology & right mix of productive resources

Otherwise, their costs will be too high relative to the Otherwise, their costs will be too high relative to the market price …market price …unprofitableunprofitable

Productive efficiencyProductive efficiency Production of a good in the least costly wayProduction of a good in the least costly way

Allocative efficiencyAllocative efficiency Producing the mix of goods & services most wanted Producing the mix of goods & services most wanted

by societyby society

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Changes in demandChanges in demand (show (show

graphically)graphically)

Supply stays constant but demand increasesSupply stays constant but demand increases Increase in Increase in bothboth price & quantity price & quantity

Decrease in demand Decrease in demand Decreases Decreases bothboth price & quantity price & quantity

Changes in SupplyChanges in Supply Demand is constantDemand is constant Increase in supply lowers price & increases Increase in supply lowers price & increases

quantityquantity Decrease in supply increases price & lowers Decrease in supply increases price & lowers

quantityquantity

Complex Cases Complex Cases (show graphically)(show graphically)

Supply increase; demand decreaseSupply increase; demand decrease

Supply decrease; demand increaseSupply decrease; demand increase

Supply increase; demand increaseSupply increase; demand increase

Supply decrease; demand decreaseSupply decrease; demand decrease

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Government-set pricesGovernment-set prices

Sometimes government concludes Sometimes government concludes that supply & demand will produce that supply & demand will produce prices that are unfairly high for prices that are unfairly high for buyers or unfairly low to sellersbuyers or unfairly low to sellers

Government may place legal limits on Government may place legal limits on how high or low a price may gohow high or low a price may go

Is that a good idea?Is that a good idea?

Price ceilingPrice ceiling Maximum legal price a seller may charge for a product or serviceMaximum legal price a seller may charge for a product or service

A price at or below the ceiling is legal; a price above is notA price at or below the ceiling is legal; a price above is not

Rationale: enable consumers to obtain an “essential” good or Rationale: enable consumers to obtain an “essential” good or service that they couldn’t afford at equilibriumservice that they couldn’t afford at equilibrium

Example: Rent ControlExample: Rent Control Maximum price for rent that can be charged for housingMaximum price for rent that can be charged for housing

Ceilings result in a shortage which leads to illegal Ceilings result in a shortage which leads to illegal black marketsblack markets Product or service sold above the ceiling to meet the excess Product or service sold above the ceiling to meet the excess

demand created by the ceilingdemand created by the ceiling

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Price floorPrice floor Minimum price fixed by the governmentMinimum price fixed by the government

A price at or above the price floor is legalA price at or above the price floor is legal

Price floors are invoked when the market economy does Price floors are invoked when the market economy does not provide sufficient income for certain groups of not provide sufficient income for certain groups of resource suppliers or producersresource suppliers or producers

Creates a surplus of the product or service.Creates a surplus of the product or service.

Examples:Examples: Minimum wageMinimum wage Target price for agricultural productsTarget price for agricultural products

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