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Lecture 4: Demand, Supply and Equilibrium
Required Text: Chapter 2
Law of Demand
When price of a good goes up, people buy less of that good Leads to downward sloping demand curve
Price ($/cup)
Quantity Demanded (cups)
0.50 5
0.75 4
1.00 3
1.25 2
1.50 1
Demand versus Quantity Demanded
Quantity Demanded Amount of a good consumed at a given price Change in price means a change in quantity
demanded Movement along the demand curve
Demand A family of numbers that lists the quantity
demanded corresponding to each possible price Demand Schedule Demand Curve
Demand Schedule and Demand Curve
Demand Schedule - Refers to the demand table that shows quantity demanded at each price
Demand Curve - Graph illustrating demand - Graphical representation of the demand schedule Price on the vertical axis Quantity demanded on the horizontal axis
Demand Equation Qd = (price, income, tastes and preferences,
expectations, and prices of other goods)
Changes in Demand
Price change does not lead to change in demand Change in anything other than price lead to demand changes
- Entire curve shifts Income Price of related goods
Substitutes Complements
Taste (preference) Sales Tax Number of consumers
Shifting Demand
Fall in Demand Decision made by demanders to buy a smaller
quantity at each given price Leftward shift of demand curve
Rise in Demand Decision made by demanders to a buy a larger
quantity at each given price Rightward shift of demand curve
Sales Tax Example
Sales Tax – A tax imposed on consumers Paid directly to the government Does not affect the price Consumers pay “Price plus sales tax”
Less desirable to buy the taxed good or service at every given price
Demand shifts downward and to the left
Effect of a Sales Tax on Demand
A new law requires $0.25 sales tax per cup of coffee
Price ($/cup)
Quantity (cups) before Tax
Quantity (cups) after tax
0.50 5 4
0.75 4 3
1.00 3 2
1.25 2 1
1.50 1 0
Shape of the Demand Curve
Steeply-sloped demand curve Large change in price leads to small change in
quantity demanded
Flat demand curve Small change in price leads to large change in
the quantity demanded
Important to producers of goods and services
Econometrics
Statistical techniques used by economist to resolve questions about slopes of various demand curves
Based on direct observations in marketplace Ex. Demand for murder Ex. Demand for reckless driving
Wide scope of economics Allows for other investigations as well
Market (Aggregate) Demand
Aggregate quantity of a good demanded by all consumers in a community (market) at each given price
The aggregate or market demand is obtained by the horizontal summation of all individual consumer’s demand curves.
Similar to the individual demand curve - Slopes downward
Market (Aggregate) Demand
Suppose, there are 10,000 SB coffee consumers in Lubbock Each individual consumer’s demand for SB coffee is the same
Price ($/cup)
Ind. Quantity (cups)
Ag. Quantity (cups)
0.50 5 50,000
0.75 4 40,000
1.00 3 30,000
1.25 2 20,000
1.50 1 10,000
Law of Supply
When the price of a good goes up, the quantity supplied goes up Leads to a upward sloping supply curve
Price ($) Quantity (cups)
0.25 0
0.50 100
0.75 200
1.00 300
1.25 400
1.50 500
Supply versus Quantity Supplied
Quantity Supplied Amount of a good that suppliers will provide at a given
price Changes if the price changes
Movement along the curve
Supply Family of numbers giving the quantities supplied at each
price Change in anything other than price changes supply
Shifts the entire curve
Changes in Supply
Supply Equation Qs = (price, expectations, input prices, prices of other
goods, technological change, number of producers)
Rise in Supply Increase in quantities that supplier will provide at each price Rightward shift of supply
Fall in Supply Decrease in quantities that supplier will provide at each price Leftward shift of supply
Changes in Supply
Price change does not lead to change in supply Factors that lead to supply changes - Entire curve shifts
Production costs Improvement in production technology Change in the wage rate
Changes in the Prices of other goods (subs. or comps.)
Excise Tax Number of Producers
Excise Tax Example
The government imposes a tax on producers Producers pay the tax directly to the
government Price does not change, but the cost
Less desirable to produce the taxed good or service at every given price
Supply shifts to the left and upward
Effect of an Excise Tax on Supply
An excise tax of $0.25 per cup of coffee
Price ($/cup)
Quantity Supplied before tax
Quantity Supplied after tax
0.25 0 0
0.50 100 0
0.75 200 100
1.00 300 200
1.25 400 300
1.50 500 400
Market (Aggregate) Supply
Aggregate quantity of a good supplied by all producers in a community (market) at each given price
The aggregate or market supply is obtained by the horizontal summation of all individual producer’s supply curves.
Similar to the individual producer’s supply curve – Market supply curve slopes upward
Market (Aggregate) Supply
Suppose, there are 10 SB coffee sellers in Lubbock Each individual seller’s supply for SB coffee is the same
Price ($/cup)
Ind. Quantity (cups)
Ag. Quantity (cups)
0.50 1,000 10,000
0.75 2,000 20,000
1.00 3,000 30,000
1.25 4,000 40,000
1.50 5,000 50,000
Market Equilibrium
Actual price and Quantity determined by interactions between demanders (consumers) and suppliers (sellers) Demanders cannot purchase more than
suppliers willing to sell Suppliers cannot sell more than demanders
willing to buy
Equilibrium Point
Point where the market demand and supply curves intersect Price at which quantity demanded equals
quantity supplied
Demanders and suppliers are satisfied Able to behave as one wants to, taking market
prices as given
Market Equilibrium for SB Coffee
Equilibrium price – $1.00 per cup Equilibrium quantity – 30,000 cups per day
Price ($/cup)
Ag. Quantity Demanded
Ag. Quantity Supplied
0.50 50,000 10,000
0.75 40,000 20,000
1.00 30,000 30,000
1.25 20,000 40,000
1.50 10,000 50,000
Changes in the Equilibrium Point
The only way that anything can affect the equilibrium price and quantity is by causing a shift in either the supply curve or the demand curve Never look at price and quantity Look at the effect of the change has on demand curve
and/or supply curve
The factors that shifts the demand and supply curves affect the equilibrium price and quantity
The Effects of Supply and Demand Shifts
Landsburg, Price Theory and Applications, 7th edition
Effect of Sales Tax
Sales tax of x¢ per item causes equilibrium price to fall by some amount less than x¢ per item
Price to suppliers not same as price to demanders (price plus sales tax)
Effect of Excise Tax
Excise tax of x¢ per item causes the equilibrium price to rise by some amount less than x¢ per item
Price to suppliers (price minus excise tax) not same as price to demanders
Comparing Two Taxes Economic Incidence – the division of a tax burden
according to who actually pays the tax
Legal Incidence – the division of a tax burden according to who is required under the law to pay the tax
The economic incidence of a tax independent of its legal incidence
Ex. Social Security tax
A Sales Tax versus an Excise Tax
Landsburg, Price Theory and Applications, 7th edition
Aggregated Effects of a Demand Curve Shift (for example change in income)
Price
Q
SD D’
P0
P1
Q0 Q1
Firm’s response to increased demand
What steps could a firm manager take to react to a shift in the demand curve to the right for an agricultural/food product?
For a competitive (atomistic) firm manager Knowledge of the increase in demand is first seen by a noticed increase
in price received. Usual reaction is to increase output.
Other firm managers see that above normal profits are being earned and enter the market thus putting some upward pressure on input costs.
The increased production lower prices to an equilibrium price (where price = average cost) that is somewhat higher than the initial price.
Firm’s response to increased demand …
For the firm in monopolistic competition the firm manager (remember the firm is a price maker)
would first be aware of the increase in demand by an increase in sales or product orders.
The firm’s reaction would be to increase output and/or increase price.
Seeing the above normal profits, other firms would enter and increase the supply.
The firm would experience a weakened demand for its product with the resulting equilibrium price a little higher that the initial price.
This higher price is due to the increased average costs.
Firm’s response to increased demand
For the oligopolistic firm manager The increase in demand would be recognized by an
increase in sales/orders. Reaction would be to increase output and price. Entry is possible, but more difficult. With entry, demand would weaken. The resulting price
is not predictable.
Impacts of Large Decline in Demand in Alternative Market Models
Situations Atomistic Monopolist Competition
Oligopoly
First indication
Price falls Orders/Sales decline
Orders/Sales decline
First Reaction
Cut output Cut output, change promotion
Cut output, change promotion
Long run Many firms exit
A few firms exit Possibly an exit
Impact of Exits
Price raises Increase sales Increase sales
Domestic Demand vs. Export Demand
Consideration of demand for the farm commodity must consider total demand where total demand equals domestic demand plus export demand.
Domestic food demand is fairly stable with little change from year to year. However, droughts and other disasters that occur in foreign countries can create large swings in foreign demand from year to year.
Question What can be the major result of these often-unexpected shifts in
foreign demand?
Agricultural/Food Sector Trends
Moving from atomistic markets towards monopolistic competition:
How: creating differentiation: regional (California fruit), branding (Dole, green giant, Del Monte)
Why: more alternative marketing strategies For example rice, bananas, tomatoes, lettuce, beef?