Economics 111.3 Winter 14

January 20th & 22nd , 2014Lecture 6 & 7

Ch. 3

A Change in the Quantity Supplied Versus a Change in Supply: a recap

Supply Shifters are changes in:

• technology• taxes and subsidies• prices of other goods• price expectations• number of sellers

A recap:

Changes in prices of other goods:• higher prices of substitutes in production

will reduce supply and vice versa

Changes in Supply

PA SS′

QA

Changes in price expectations:• of the future price of a product• difficult to generalizeChanges in number of sellers:• as the number of sellers increases, so does

supply

Changes in Supply

Equilibrium As The Marriage of Supply and Demand

• Supply and demand come together to determine equilibrium quantity and equilibrium price.

Equilibrium, cont’d• When quantity demanded equals quantity

supplied, prices have no tendency to change.• Equilibrium is a concept in which opposing

dynamic forces cancel each other out.• Equilibrium isn’t a state of the world—it's a

characteristic of the model used to look at the world.

• Equilibrium isn’t inherently good or bad—but simply a state in which dynamic pressures offset each other.

The Law of Supply and Demand

• Conventional (free market) Economics claims that the price of any good adjusts to bring the supply and demand for that good into balance.

• Excess supply – a situation in which quantity supplied is greater than quantity demanded. The same as “surplus”

• Excess demand – a situation in which quantity demanded is greater than quantity supplied. The same as “shortage”

Excess supply

Excess demand

The Law of Supply and Demand, cont’d

• The larger the difference between quantity demanded and quantity supplied, the greater the pressure for prices to rise (if there is excess demand) or fall (if there is excess supply).

Market EquilibriumDemand Schedule

Supply Schedule

3 4 4 0

Market Equilibrium

1 9 0 -92 6 3 -3

4 3 5 +25 2 6 +4

Price(dollars per tape)

Quantity demanded

Quantity

suppliedShortage (-) or surplus (+)

(millions of tapes per week)

Comparative Statics:

The derivation of predictions by analyzing the effect of a change on some exogenous variable(s) on the equilibrium

Rules:1. Decide whether the event

shifts the supply or demand curve (or both).

2. Decide whether the curve(s) shift(s) to the left or to the right.

3. Use the supply-and-demand diagram to see how the shift affects equilibrium price and quantity.

Increase in Demand

• An increase in demand will cause:• a shortage at the original price p1

D1 D2P

Q

p1

q1 q3

S

Increase in Demand

• Consumers will bid price up to p2

• QS will increase• new equilibrium reached at p2, q2

D1 D2P

Q

p1

q1

Sp2

q2 q3

Decrease in Demand

• A decrease in demand will cause:• a surplus at the original price p1

D2D1P

Q

p1

q1q3

S

Decrease in Demand

• Producers will drop price to p2

• QS will decrease• new equilibrium will be reached at p2, q2

D2D1P

Q

p1

q1q3

S

q2

p2

Increase in Supply

• An increase in supply will cause:• a surplus at the original price p1

S1S2

P

Q

D

q1

p1

q3

Increase in Supply

• Producers will drop price to p2

• QD will increase• a new equilibrium will be reached at p2, q2

S1S2

P

Q

D

q1

p1

q3q2

p2

Decrease in Supply

• A decrease in supply will cause:• a shortage at the original price p1

S2S1

P

Q

D

q3

p1

q1

Decrease in Supply

• Consumers will bid price up to p2

• a new equilibrium will be reached at p2, q2

S2S1

P

Q

D

q3

p1

q1

p2

q2

Study QuestionExplain how each of the changes below are explained by changes in either supply or demand. Use diagrams to substantiate your answers.

A. The price of guitars falls, but the quantity traded increases;

B. The price and quantity traded of saxophones decrease;

C. The price of trombones increases, while the quantity traded falls;

D. The price and quantity traded of clarinets increases.

Study question• The market for coffee is initially in equilibrium

with supply and demand curves of the usual shape. Pepsi is a substitute for coffee; cream is a complement for coffee. Consider the market for coffee. Assume that all ceteris paribus assumptions continue to hold except for the event(s) listed.

Study question

An increase in the price of Pepsi, a substitute for coffee will A) decrease the price of cream. B) decrease the price of coffee. C) increase the price of creamD) increase the price of coffee. E) cause none of the above.

Study question

• Farm land can be used to produce either cattle or corn. If the demand for cattle increases, then the A) demand for corn decreases. B) demand for corn increases. C) supply of corn increases. D) supply of corn decreases. E) both B and C.

Study questionIf A and B are complements in production and the price of A falls, the supply of B A) decreases and the price of B rises. B) increases and the price of B falls. C) increases and the price of B rises. D) decreases and the price of B falls. E) does not change.

Study question• If A and B are complements and the cost of a

factor of production used in the production of A decreases, then the price of A) both A and B will fall. B) A will fall and the price of B will rise. C) both A and B will rise. D) A will rise and the price of B will fall. E) A will fall and the price of B will remain unchanged.

Study question

• When the price of good A rises, the supply curve of good B shifts rightward. Which of the following statements are true? A) A and B are substitutes in consumption. B) A is a factor used in the production of B. C) A and B are substitutes in production. D) A and B are complements in consumption. E) A and B are complements in production.

Comparative statics: Complex Cases

• When both supply and demand change, the effect is a combination of the individual effects

• If both demand and supply shift, one of either price or quantity cannot be predicted–-the result is indeterminate

Complex Cases

Change in supply

Change in demand

Effect on equilibrium price

Effect on equilibrium

quantity

Increase Decrease Decrease Indeterminate

Decrease Increase Increase Indeterminate

Increase Increase Indeterminate Increase

Decrease Decrease Indeterminate Decrease

Study questionWhich one of the following will definitely decrease the equilibrium quantity? A) an increase in both demand and supply B) a decrease in demand combined with an increase in supply C) a decrease in both demand and supply D) an increase in demand combined with a decrease in supply E) none of the above

Study question• Which of the following will definitely result in an

increase in the equilibrium price? A) an increase in supply combined with a decrease in demand B) an increase in both demand and supply C) an increase in demand combined with a decrease in supply D) a decrease in both demand and supply E) a decrease in demand combined with an increase in supply

Study question Draw supply and demand curves to illustrate the

following market disturbances and explain your diagrams briefly:

A. The equilibrium price in the market for beef falls because the price of cattle feed grain has fallen, even though the prices of pork, poultry, and fish have increased because US imports of these products have been reduced by Government regulation;

Study questionB. Equilibrium price in the market for

wheat falls because the harvest has been unexpectedly good;

C. There is an increase in quantity of butter supplied in Winnipeg after the population has gone up.

Test 1

• Friday, January 24th, 2014• 8:30 – 9:20 Room 200 STM• Chapters to be tested: 1 – 3 • Format: Multiple-Choice Questions (MCQ):

35 questions – 100% of Test mark Time – 50 minutes