Chapter 3

MarketsDemand and Supply analysis takes place

while looking at markets

For now, we will be looking only at competitive markets

These markets have many buyers and sellers influencing price and quantity

Demand CurveShows:

The various amounts of product consumers are willing and able to purchase at possible prices

Only shows demand for a specific period of time

Demand Curve

Demand Curve – 2nd PeriodDemand for Ice Cream pints

Price Quantity Demanded

$3 9

$4 7

$5 4

$6 3

$7 1

$8 0

Demand Curve – 4th PeriodDemand for Geek Chic table

Price Quantity Demanded

$1,000 7

$2,000 5

$3,000 4

$3,500 2

$4,000 1

$5,000 0

Demand Curve – 6th PeriodDemand for Jones’ Scones

Price Quantity Demanded

$2 10

$3 7

$4 3

$5 1

$6 0

Movements Along a Demand CurveCaused by a price change of that

good/service

If…Price increasesquantity demanded

decreases

Imagine a soda in the vending machine costs $5…would you still be willing to buy as many?

Movements Along a Demand Curve

Movements Along a Demand CurveIf price decreases ….. Quantity demand

increases

What if a soda from the vending machine cost 10 cents? Would you buy more?

Movements Along the Demand Curve

Movements Along the Demand Curve

When there is a movement along the demand curve we say there is a CHANGE IN THE QUANTITY DEMANDED

A movement along the curve is not a change in demand.

Law of Demando Ceteris paribus, as the price of a good/service

decreases, the quantity demanded increases

o Ceteris paribus, as the price of a good/service increases, the quantity demanded decreases

o Inverse relationship between price and quantity demanded

o Demand curve is downward sloping

How do we know this is true?1. Observation of consumer and business

behavior

2. Diminishing marginal utility: as consumption of a good/service increases, consumers gain less and less satisfaction (marginal utility) from each additional unit. Therefore, they will only buy more units at lower prices because they value each extra unit less.

How do we know this is true?In other words….

With each additional starburst I eat I am less and less satisfied. Therefore, at some point, my starbursts are less valuable to me and I will want to pay less for them.

How do we know this is true? 3. Income Effect: as price decreases, real

income increases, which allows consumers to buy more of that good/service

If I have $10 to buy $1 packets of starburst, I can buy 10 of them. If the packets cost $0.50, I can buy 20. My income is getting me more as the price decreases!

How do we know this is true?4. Substitution Effect: as price decreases,

consumers will substitute more of the now relatively cheaper good

As starbursts get cheaper…I might just start buying them to replace my $5 lunch.

Market DemandSummation of individual market demand

schedules

+ + =4

4 4

0 0 0 0

4

4 4 48 8 8 12 24

Market DemandIn other words, if I add up my demand curve

for starburst, yours, yours, you in the back – yours too, and yes you also…I get the market demand for starbursts in this class.

What makes the demand curve shift?

1. Tastes/PreferencesGood/service becomes more popular

increase in demand

Good/service becomes less popular decrease in demand

Tastes and PreferencesWould you pick this? Or This?

Tastes and PreferencesWould you pick this? Or This?

Tastes and PreferencesIt’s not just technology…

2. PopulationIncrease in number of buyersincrease in

demand

More people move into areaincrease in demand

Decrease in number of buyersdecrease in demand

People move out of areadecrease in demand

PopulationAtlanta, GA = 432,427 Humansville, MO =

1,049Assume everyone wants

at least one cell phoneDemand in ATL =

432,427

Assume everyone wants at least one cell phone

Demand in Humansville – 1,049

PopulationAtlanta, GA = 432,427 Humansville, MO =

1,049Assume everyone wants at

least one cell phoneDemand in ATL = 432,427

Population in ATL decreases by 100,000 *all moving to Humansville

Demand in ATL = 332,427

Assume everyone wants at least one cell phone

Demand in Humansville – 1,049

Population in Humansville increases by 100,000

Demand in Humansville – 101,049

3. IncomeIncome impacts our demand for products.

First must distinguish between a normal and inferior good

Taste Test Time!

3. IncomeNormal Goods:

If income increasesincrease in demand for good/service

If income decreasesdecrease in demand for good/service

3. IncomeInferior Goods

If income increasesdecrease in demand for good/service

If income decreasesincrease in demand for good/service

4. Change in Price of SubstituteIf the price of a substitute for good/service A

decreases decrease in demand for good/service A

If the price of a substitute for good/service A increases increase in demand for good/service

Let’s examine my flavored water obsession….

5. Change in the Price of a Complementary GoodWhat is a complementary good?

One that complements the other!

One often consumed with the other.

5. Change in the Price of a Complementary GoodTwo goods/service which go together

If the price of a complement for good/service A decreasesincrease in demand for good A

If the price of jelly goes down, I can get more of it and make more sandwiches. This means I’ll need more peanut butter so my demand for peanut butter goes up!

5. Change in the Price of a Complementary GoodTwo goods/service which go together

If the price of a complement for good/service A increasesdecrease in demand for good A

If the price of jelly goes up, that means I won’t want to buy as much and I will have to make a different kind of sandwich…I will be sad and I also won’t need as much peanut butter.

6. Expectations/FearsIf consumers expect that the price of a

good/service will increase in the future increase in demand for that good/service now

Think about when gas prices are due to go up…ie the gas shortage in 2008!

6. Expectations/FearsIf consumers expect that the price of a

good/service will decrease in the future decrease in demand for that good/service now

Ever waited to buy a new phone because you knew a newer version was going to come out? This could be because a. you know that you want the new technology or b. YOU KNOW THE PRICE OF THE OLDER VERSION WILL BE LESS!!!

Supply

Schedule or a curve showing the various

amounts of a product producers are willing

and able to produce and make available for

sale at each of a series of possible prices

during a specified period of time

Movements along the Supply CurveCaused by a price change of that

good/service

Price increasesquantity supplied increases

Price decreasesquantity supplied decreases

Law of SupplyCeteris paribus, as the price of a

good/service increases, the quantity supplied increases

Ceteris paribus, as the price of a good/service decreases, the quantity supplied decreases

Direct relationship between price and quantity supplied

Supply curve is upward sloping

Why is the Law of Supply True?To producers, price is = to revenue.

Therefore, at higher prices, producers have more of an incentive to produce more

Increasing costs. As production (q) increases, the costs per unit may fall at first, but eventually they rise (decreasing returns to scale). In order to cover these rising costs, the

producer would want to charge a higher price.

Why is the Law of Supply True?Labor supply: workers will supply more labor

at higher wages (the “price” of their labor)

What causes the supply curve to shift?

1. Resource PricesIf costs of production decreaseincrease in

supply

If costs of production increasedecrease in supply

Examples: wages, price of raw materials

Example: Oil risingIf the price of oil as an input rises, the supply

of all the following goods will decrease.Bicycle tiresDressesMopsUmbrellasShampooHeart valvesFood preservativesNail polishTentsTelephones

2. TechnologyIf technology improvesincrease in supply

If technology deterioratesdecrease in supply

3. Subsidies and TaxesIf subsidies increaseincrease in supply

- Subsidy: government helps to pay the cost of producing a good/service

EX: Farming

If taxes increase or imposeddecrease in supply

If taxes decrease or removedincrease in supply

4. Prices of Other Goods

If prices of other goods/services, which a

firm can easily adapt its plant and

equipment to produce, increasedecrease

in supply of good/service presently

produced

4. Prices of Other GoodsExample: I have a plant where all I manufacture are soccer balls…every day, all day. I discover that the price of footballs has increased relative to soccer ballsMy plant can easily switch and make footballs instead of soccer balls and make more moneyI will increase the amount of footballs I supply And decrease the amount of soccer balls I supply

5. ExpectationsIncreases and decreases in supply depend

on circumstancesIf agriculture prices are expected to

increase in the futuredecrease in supply (farmers might not bring as much to the market now)

If I know my crop is going to be worth more money next month…why pick it now and see it? I can wait a month and sell it when it’s worth more money!

5. ExpectationsIncreases and decreases in supply depend on

circumstancesIf manufacturing prices are expected to

increase in the futureincrease in supply now

If I know that the cost of producing my product is going to go up in the future, I want to make as much of it before that happens as I can! I will make more now so I have a stockpile going when the costs of production go up!

6. Number of SellersIf number of sellers increasesincrease in

supply

If number of sellers decreasesdecrease in supply

NOW LET’S PUT THESE TWO TOGETHERWe can now combine our supply and demand

curves.

The point where the two curves meet is where we want to be…and here’s why

SurplusesQuantity supplied is greater than the quantity

demanded

S

D

Q

P

0

Price

QDQS

ShortagesQuantity demanded is greater than the

quantity supplied

S

D

Q

P

0

Price

QDQS

EquilibriumQuantity demanded is equal to the

quantity suppliedRationing: the ability of the market

system to eliminate surpluses and shortages by changing prices and quantities supplied and demanded

Equilibrium price “clears” the market