MICROECONOMIC THEORYMICROECONOMIC THEORY
INDIVIDUAL MARKETSINDIVIDUAL MARKETSDemand & SupplyDemand & Supply
S
Dq
p
In this chapter you will learn
• What markets are• What demand is and what factors affect it• What supply is and what factors affect it• How demand and supply together determine
market equilibrium
CHAPTER 3 TOPICS
• MARKETS • DEMAND• SUPPLY• SUPPLY & DEMAND: MARKET EQUILIBRIUM
MARKETS
HOW ARE PRICES DETERMINED IN A MARKET SYSTEM?
...BY INTERACTION BETWEEN BUYERS SELLERS IN MARKETS
BY MARKETS WE MEAN…
INSTITUTIONS THAT INSTITUTIONS THAT BRING TOGETHERBRING TOGETHER
BUYERS AND SELLERSBUYERS AND SELLERS
MARKETS
• for example:– corner gas station– farmer’s market– Philippine Stock Exchange– etc.
ASSUMPTIONS
Competitive markets:• many independent buyers & sellers• standardized products
CHAPTER 2 TOPICS
MARKETS • DEMAND• SUPPLY• SUPPLY & DEMAND: MARKET EQUILIBRIUM
DEMAND
• a schedule or a curve that shows the various amounts consumers are willing and able to purchase at each of a series of possible prices, during some specified period of time
DEMAND
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
The information can be
presented in a demand schedule
DEMANDDEMAND
DEMAND
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
quantity quantity demandeddemanded
The information can be
presented in a demand schedule
or graphed
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
1212
or graphed
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
1313
or graphed
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
1414
or graphed
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
© 2002 McGraw-Hill Ryerson Ltd. 1515Chapter 3
or graphed
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
1616
or graphed
P Qd
$ 1
$ 2
$ 3
$ 4
$ 5 10
20
35
55
80
1717
LAW OF DEMAND
• ceteris paribus (all else equal), as price falls, the quantity demanded rises (& vice versa)
• supported by:– concept of diminishing marginal utility– income effect– substitution effect
INDIVIDUAL VS. MARKET DEMANDINDIVIDUAL VS. MARKET DEMAND
priceprice QQDD–1st –1st
buyerbuyerQQDD–2nd–2nd
buyerbuyer
QQDD––
marketmarket
$5$5 1010 1212
$4$4 2020 2323
$3$3 3535 3939
$2$2 5555 6060
$1$1 8080 8787
2222
4343
7474
115115
167167
++ ==
Individual Demand 1
$0
$1
$2
$3
$4
$5
0 20 40 60 80
quantity
pri
ceIndividual Demand 2
$0
$1
$2
$3
$4
$5
0 20 40 60 80
quantity
pri
ce
Market Demand
$0
$1
$2
$3
$4
$5
0 50 100 150
quantity
pri
ce
35 39
74
2020
DETERMINANTS OF DEMAND
• PRICE is the most important influence on the amount of any product purchased
• a change in price yields a movement alongalong the demand curve & a change in quantity change in quantity demandeddemanded
PA
QA
D
• change in price change in quantity demanded
Q1 Q2
P2
P1
movement alongalong the curve
CHANGE IN DEMANDCHANGE IN DEMAND
• when any OTHER determinant changes
shift in the demand curve
PA
QA
D D’
CHANGE IN DEMAND
Demand Shifters are changes in:• tastes (preferences)• number of buyers• income• prices of related goods• expectations
let’s examine these more closely…
CHANGE IN DEMAND
Changes in tastes (preferences)• positive change shifts D curve right• more will be demanded at each price
PA
QA
D D’not upnot up
or downor down
CHANGE IN DEMAND
Changes in number of buyers:• increase will shift curve right
PA
QA
D D’
CHANGE IN DEMAND
Changes in money incomes:• when income increasesdemand for NORMALNORMAL goods increasesdemand for INFERIORINFERIOR goods decreases
CHANGE IN DEMAND
Changes in prices of related goods:• when two products are SUBSTITUTESSUBSTITUTES, price of
one & demand for the other are positively related
CHANGE IN DEMAND
Changes in prices of related goods:• when two products are COMPLEMENTSCOMPLEMENTS, price
of one & demand for the other are negatively related
CHANGE IN DEMAND
Changes in prices of related goods:• when products are unrelatedno effect
CHANGE IN DEMAND
Changes in expectations:• about future prices or incomes
price
quantity
Decrease in QD
Increase in QD
D
If the price of a good changes, but all other If the price of a good changes, but all other influences on buyers’ plans are held constant, influences on buyers’ plans are held constant, there is a there is a change in quantity demandedchange in quantity demanded, but , but no change in demand.no change in demand.
NOT NOT demand!demand!
If any other determinant of demand changes If any other determinant of demand changes (tastes, no. of buyers, income, etc.) there is a (tastes, no. of buyers, income, etc.) there is a change in demandchange in demand, and a shift in the demand , and a shift in the demand curve.curve.
price
quantityD
Increase in D
Decrease in D
Figure 3-3Figure 3-3
CHAPTER 2 TOPICS
MARKETS DEMAND• SUPPLY• SUPPLY & DEMAND: MARKET EQUILIBRIUM
SUPPLY
• a schedule or a curve showing the amounts that producers are willing and able to make available for sale at each of a series of possible prices, during some specified period of time
SUPPLY
The information could be captured in a supply schedule...
SUPPLYSUPPLY
P Qs
$ 1
$ 2
$ 3
$ 4
$ 5 60
50
35
20
5
SUPPLY
quantity quantity suppliedsupplied
P Qs
$ 1
$ 2
$ 3
$ 4
$ 5 60
50
35
20
5The information
could be captured in a supply schedule...
or graphed
P Qs
$ 1
$ 2
$ 3
$ 4
$ 5 60
50
35
20
5
Supply
0
1
2
3
4
5
6
0 10 20 30 40 50 60
quantity
pric
e
3838
LAW OF SUPPLY
• all else being constant, as price rises, the quantity supplied rises (& vice versa)
• why?– price is revenue to suppliers– higher price necessary to induce higher supply, to
cover higher costs of production
INDIVIDUAL VS. MARKET SUPPLYINDIVIDUAL VS. MARKET SUPPLY
Price Qs - OneFirm
200Firms InMarket
Qs-Market
$5 60 x 200 12,000
$4 50 x 200 10,000
$3 35 x 200 7,000
$2 20 x 200 4,000
$1 5 x 200 1,000
Individual Firm Supply
0
1
2
3
4
5
6
0 10 20 30 40 50 60
quantity
pri
ce
Market Supply
0
1
2
3
4
5
6
0 5000 10000
quantity
pri
ce
DETERMINANTS OF SUPPLY
• PRICE is the most important determinant of quantity supplied
• a change in price yields a movement alongalong the supply curve & a change in quantity suppliedchange in quantity supplied
PA
QA
S
• change in price change in quantity supplied
P1
P2
Q1 Q2
movement alongalong the curve
CHANGE IN SUPPLYCHANGE IN SUPPLY
• when any OTHER determinant changes
shift in the SUPPLY curve
PA
QA
S S’
DETERMINANTS OF SUPPLY
Supply Shifters are changes in:• resource prices• technology• taxes & subsidies• prices of other goods• price expectations• number of sellerslet’s examine these more closely…
DETERMINANTS OF SUPPLYChanges in resource prices:• decrease will increase supply & shift curve
right• more will be supplied at each price
not upnot upor downor down
PA
QA
S S’
DETERMINANTS OF SUPPLYChanges in technology:• new technology will decrease costs &
increase supply
PA
QA
S S’
DETERMINANTS OF SUPPLYChanges in taxes & subsidies:• increases in taxes will reduce supply
PA
QA
SS’
DETERMINANTS OF SUPPLY
Changes in prices of other goods:• higher prices of substitutes in production will
reduce supply
PA
QA
SS’
DETERMINANTS OF SUPPLYChanges in price expectations:• of the future price of a product• difficult to generalize
DETERMINANTS OF SUPPLYChanges in number of sellers:• as the number of sellers increases, so does
supply
price
quantity
S
Increase in QS
Decrease in QS
If the price of a good changes, but all other If the price of a good changes, but all other influences on producers’ plans are held influences on producers’ plans are held constant, there is a constant, there is a change in quantity change in quantity suppliedsupplied, but , but no change in supply.no change in supply.
NOT supply!NOT supply!
price
quantity
S
Increase in S
Decrease in S
If any other determinant of supply changes If any other determinant of supply changes (resource prices, technology, etc.) there is a (resource prices, technology, etc.) there is a change in supplychange in supply, and a shift in the supply , and a shift in the supply curve.curve.
Figure 3-4Figure 3-4
CHAPTER 2 TOPICS
MARKETS DEMANDSUPPLY• SUPPLY & DEMAND: MARKET EQUILIBRIUM
EQUILIBRIUM
• equilibrium price will be established where the supply decisions of producers and the demand decisions of buyers are mutually consistent
• surpluses drive prices down• shortages drive prices up
EQUILIBRIUM
• let’s look at the process of adjustment to equilibrium graphically
Equilibrium
0
1
2
3
4
5
6
0 2 4 6 8 10 12 14 16 18
Pric
e (p
er b
ushe
l)
Bushels of corn (thousands per week)
Figure 2
6000-bushel6000-bushelsurplussurplus
SS
DD
$4 is not the $4 is not the equilibrium equilibrium
priceprice
EquilibriumFigure 3-5
0
1
2
3
4
5
6
0 2 4 6 8 10 12 14 16 18
Bushels of corn (thousands per week)
Pric
e (p
er b
ushe
l)
7000-bushel7000-bushelshortageshortage
SS
DD
$2 is not the $2 is not the equilibrium equilibrium
priceprice
EquilibriumFigure 3-5
0
1
2
3
4
5
6
0 2 4 6 8 10 12 14 16 18
Bushels of corn (thousands per week)
Pric
e (p
er b
ushe
l)
QQDD=Q=QSS DD
SS
$3 is the $3 is the equilibrium equilibrium
priceprice
Changes in Supply, Demand & Equilibrium
• changes in demand or supply will affect the equilibrium price and quantity
INCREASE IN DEMANDINCREASE IN DEMAND
An increase in demand will cause:• a shortage at the original price p1
D1D2P
Q
p1
q1 q3
S
6262
INCREASE IN DEMANDINCREASE IN DEMAND
Consumers will bid price up to p2
• QS will increase, QD will decrease
D1D2P
Q
p1
q1
p2
q2 q3
new equilibrium reached at pnew equilibrium reached at p22, q, q22
S price has increased price has increased from pfrom p11 to p to p22,,
quantity traded has quantity traded has increased from qincreased from q11
to qto q22
NOT an NOT an increase in increase in
supplysupply
6363
DECREASE IN DEMANDDECREASE IN DEMAND
An decrease in demand will cause:• a surplus at the original price p1
D2D1P
Q
p1
q1q3
S
6464
DECREASE IN DEMANDDECREASE IN DEMAND
D2D1P
Q
p1
q1q3
S
Producers will drop price to p2
• QS will decrease, QD will increase new equilibrium reached at pnew equilibrium reached at p22, q, q22
price has price has decreased from pdecreased from p11
to pto p22,,
quantity traded quantity traded has decreased has decreased
from qfrom q11 to q to q22q2
p2
NOT a NOT a decrease in decrease in
supplysupply
6565
INCREASE IN SUPPLYINCREASE IN SUPPLYS1
S2
P
Q
D
q1
p1
q3
An increase in supply will cause:• a surplus at the original price p1
6666
INCREASE IN SUPPLYINCREASE IN SUPPLYS1
S2
P
Q
D
q1
p1
q3
Producers will drop price to p2
• QS will decrease, QD will increase new equilibrium reached at pnew equilibrium reached at p22, q, q22
q2
p2
price has price has decreased from pdecreased from p11
to pto p22,,
quantity traded quantity traded has increased has increased from qfrom q11 to q to q22
6767
DECREASE IN SUPPLYDECREASE IN SUPPLYS2
S1
P
Q
D
q3
p1
q1
An decrease in supply will cause:• a shortage at the original price p1
6868
DECREASE IN SUPPLYDECREASE IN SUPPLYS2
S1
P
Q
D
q3
p1
q1
Consumers will bid price up to p2
• QS will increase, QD will decrease new equilibrium reached at pnew equilibrium reached at p22, q, q22
p2
q2
price has price has increased from pincreased from p11
to pto p22,,
quantity traded quantity traded has decreased has decreased
from qfrom q11 to q to q22
6969
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 Change in supplysupply
Change in Change in demanddemand
Effect on Effect on equilibrium equilibrium priceprice
Effect on Effect on equilibrium equilibrium quantityquantity
IncreaseIncrease DecreaseDecrease DecreaseDecrease IndeterminateIndeterminate
DecreaseDecrease IncreaseIncrease IncreaseIncrease IndeterminateIndeterminate
IncreaseIncrease IncreaseIncrease IndeterminateIndeterminate IncreaseIncrease
DecreaseDecrease DecreaseDecrease IndeterminateIndeterminate DecreaseDecrease
Table 3-9Table 3-9
Complex Cases
• A Reminder: “Other Things Equal”• Application: Pink Salmon
CHAPTER 3 TOPICS
MARKETS DEMANDSUPPLYSUPPLY & DEMAND: MARKET EQUILIBRIUM
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