ECN202: Macroeconomics

ECN202: Macroeconomics

S&D

Supply & DemandSupply & Demand

Think of how important markets are in your life? Stories about them fill the news, as you can see in some headlines. Markets determine the price you pay for food, phones, and air travel, which affects what you eat, what phone you buy, and if you travel by plane. They also affect the wages you earn or the interest you pay on a loan or the value of the US $. In this unit we will look at the model economists use to explain movements in price so you will be able to explain past moves and forecast future moves. We start with some examples of how prices can be really wrong. Like the housing bubble we just experienced, and the one China may be in right now. Then we get some practice with those curves.

What are the major stories of prices?

One group of stories about prices are about disequilibrium prices and shortages and surpluses that are associated with those prices. There is a shortage of tickets to the finals of the NFL playoff game at the current price?

The second, and more frequent, group of stories is about price changes driven by shocks to the market. This is the type we spend the most time on in this course.

What are the primary drivers of price changes?

1. Demand shocks

2. Supply shocks

3. Changes in market power (competition)

4. Government intervention

Cookbook approach1.Identify the market2.Identify the participants3.Identify the determinants of behavior4. Identify the type of problem

1.disequilibrium - wrong price 2.comparative static - price change

5. Identify the appropriate curves

How should you approach these questions about prices and markets?

Follow these steps one-by-one.

Some Practice: What is the market?

1. “The ageing of baby-boomers casts doubt over asset prices”

2. “Race to satisfy caviar craving”

3. “A love affair with SUVs begins to cool”

Identify the market in these headlines

Write it down and then read on

What is the market?

1. “The ageing of baby-boomers casts doubt over asset prices” (Market for assets such as stocks or homes)

2. “Race to satisfy caviar craving” (Market for caviar)

3. “A love affair with SUVs begins to cool” (Market for SUVs)

Identify the market in the headlines

Determinants of demanders’ behavior

1. Ability to pay (income )2. Number (demographics )3. Preferences (fads, fashions, habits)4. Expectations (bubbles )5. Price of other things (complements &

substitutes)6. Price of product

Make a list of factors that affect demand for some product and then see if you missed anything.

• Ability to pay – an increase in income or wealth would increase demand

• Number – an increase in the number of driving age population would increase demand

• Preferences – increased advertising expenses will increase demand

• Price of other things – increase in price of gas will reduce demand

• Price of product – increase in price of SUVs will reduce quantity demanded

Headline: “A love affair with SUVs begins to cool”Market: SUVsWhat affects demand for SUVs?

Determinants of suppliers’ behavior

1. Number of suppliers

2. Costs of production

1. Price of inputs / resources

2. Productivity / efficiency of resources

3. Price of product

• Number of suppliers - an increase in the number of fish farms increases supply

• Costs of production

– Price of inputs – an increase in feed costs raises cost, which decreases supply

– Productivity – new harvesting technique reduces harvesting costs = increases supply

• Price of product – increases in price = increase quantity supplied

Headline: “Race to satisfy caviar craving”Market: domestic grown caviarWhat affects supply domestic grown caviar?

Now let’s look closely at those S&D curves

We will use a simple numerical example, so get out that pad of paper

Demand Curve

Relationship between Price and Quantity (amount) demanded.

Nature of relationship: As price rises demand falls.

Picture of relationship: Plot these points on the following graph before moving on.

Price Quantity$2 20$4 15

Demand Curve“Picture” of

Buyers / demanders Now plot those points from the table

Demand Curve

$2

20 Q1s

$4

15

Price

Quantity

@ price of $4 demand is 15

@ price of $2 demand is 20

Here is what it should look like

What can change demand?

Short answer: Change in any of the factors that affect demand

Longer answer: There are two “Types” of factors

1.price change –if the price changes then this causes a change in quantity demanded

2.Change in ANYTHING else –if any factor other than price changes then this causes a change in demand

Decrease in quantity demanded______

D

$2

20

Increase in quantity demandedWhen P falls to $2 demand rises to 20

Movement ALONG demand curve

Q1s

$4

15

INCREASE in demand______

D

$2

20 Q1s

$4

15

Increase in demandWhen income of buyers increase

@ each price demandis now higher

INCREASE in demand______

D

$2

20 Q1s

$4

15

Increase in demandWhen income of buyers increase

@ each price demandis now higher

Supply Curve

Relationship between Price and Quantity (amount) supplied.

Nature of relationship: As price rises supply rises.

Picture of relationship: Plot these points on the following graph before moving on.

Price Quantity$2 18$4 22


Sellerss Now plot those points from the table

Supply Curve

$2

22

$4

18

Price

Quantity

@ price of $4 supply is 22

@ price of $2 supply is 18

Here is what it should look like

What can change supply?

Short answer: Change in any of the factors that affect demand

Longer answer: There are two “Types” of factors

1.price change –if the price changes then this causes a change in quantity supplied

2.Change in ANYTHING else –if any factor other than price changes then this causes a change in supply

Supply Curve

$2

22

$4

18

Price

Quantity

Increase in quantity suppliedWhen P rises to $4 supply rises to 22

Movement ALONG supply curve

Supply Curve

$2

22

$4

18

Price

Quantity

Increase in supplyWhen productivity increases

@ each price supplyis now higher

Supply Curve

$2

22

$4

18

Price

Quantity

Increase in supplyWhen productivity increases

@ each price supplyis now higher

Summary

A curve shifts – something other than the price shocks the market•Increase in demand – demand curve shifts OUT•Increase in supply– supply curve shifts OUT

No curve shifts when the price changes – this is just a movement along a curve.

Hint

The most common mistake is to shift two curves. •Most shocks only directly affect either buyers or sellers so we have only one shift.

Example1: How do we show higher incomes on demand for Toyota cars? – it is the buyers’ income that changes so it will be demand that changes – so supply does not shift. Demanders of cars feel wealthier and will buy more cars and this increases demand – the D curve shifts out. NO shift in S.

Hint

The most common mistake is to shift two curves. •Most shocks only directly affect either buyers or sellers so we have only one shift.

Example2: How do we show higher jet fuel prices on market for airplane travel? – you never wake up and think about jet fuel prices and neither do other travelers – so demand does not shift. Suppliers of seats, however, do care about jet fuel prices and this raises costs so it reduces supply – the S curve shifts in. NO shift in D.

•Example1: How do we show higher incomes on demand for Toyota cars?

Supply & Demand Curves

Disequilibrium prices

Equilibrium price

Picture of market

Price Supply Demand$2 18 20$3 19 19$4 22 15


Buyers & Sellers Now plot those points from the table

Supply & Demand Curves

$2

22

$4

18

Price

@ price of $4 supply is 22 & demand is 15 = surplusHere is what it should look like

@ price of $2 supply is 18 & demand is 20 = shortage

What will happen?What will happen?

• If price is $2 then the shortage will prompt sellers to raise the price and as the price rises the shortage falls as quantity supplied increases and quantity demanded decreases.

• If price is $4 then the surplus will prompt sellers to lower the price and as the price falls the surplus falls as quantity supplied decreases and quantity demanded increases.

• So prices keep moving until at some price S = D. We call it the equilibrium price and that happens where the S&D curves intersect.

Equilibrium

$2.5

19

Price

@ price of $2.5 supply = demand = 19 = equilibrium

Now let’s look at some examples to see how Now let’s look at some examples to see how well you have mastered this.well you have mastered this.

On the next two slides think about how we show the impact of the shock on the market – and use the cookbook approach. Do it before you move on.

How will China’s economic rise affect the price of oil in the US?

How will China’s economic rise affect the price of labor in the US?


1. Identify the market – oil market2. Identify the participants – demanders (us), suppliers

(oil companies)3. Identify the determinants of behavior- China is a

demander of oil4. Identify the type of problem

comparative static - price change from shock5. Identify the appropriate curves - China’s growth

increases demand for oil = demand curve shifts outward



1. Identify the market – US labor market2. Identify the participants – demanders (US firms),

suppliers (US workers)3. Identify the determinants of behavior- China is a

substitute for US workers as firms move to China4. Identify the type of problem

comparative static - price change from shock5. Identify the appropriate curves - China’s growth

decreases demand for US workers by US firms = demand curve shifts inward


Use a S&D graph to demonstrate the Impact on oil market of _____.

a.US increases in mileage standards on automobiles

b.Nigeria revolt upsets oil supply

c.New technology finds new oil in old wells

d.Rise in smart phones behind drop in computer sales

QuestionsQuestions

a. US increases in mileage standards on automobiles

b. Nigeria revolt upsets oil supply

c. New technology finds new oil in old wells

d. Rise in smart phones behind drop in computer sales

Use a S&D graph to demonstrate the Impact on oil market of _____.

a. US increases in mileage standards on automobiles – if costs rise this will decrease Supply

b. Nigeria revolt upsets oil supply– Nigeria is supplier = decrease in supply

c. New technology finds new oil in old wells– New tech increases supply

d. Rise in smart phones behind drop in computer sales– People buying a smartphone instead of computer =

decrease in demand

QuestionsQuestions

Generalization: Single Shift

Price Quantity

Demand -

Demand -

Supply -

Supply -

Fill in the table again – see if it is easier now

What will happen to the price of marijuana if it is legalized? Do this before you move on

QuestionsQuestions

Marijuana legalized

•Reduces social cost of getting caught - increases demand = DP, Q

•Reduces cost of transportation – increase supply= SP, Q

•Combined effect - Q, not forecast change in Q

What will happen to the price of marijuana if it is legalized? Big increase in D

QuestionsQuestions

What will happen to the price of marijuana if it is legalized? Big increase in S

QuestionsQuestions

Double shiftWhen we have two curves shifting it s only possible to predict either price or quantity change, but not both. I suggest always trying to figure out what happens to price and you are done.

Example: Increase S&D •increase in D pushes prices higher•Increase in supply pushes prices lower•Can’t predict price•Both increase in D & S push quantity higher

Generalizations: Double Shift

Price Quantity

Demand increase Supply increase

Demand increase Supply decrease

Demand decrease Supply increase

Demand decrease Supply decrease

Fill in the table again – see if it is easier now

Documents

ECN202: Macroeconomics