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Supply, Demand and Market Equilibrium
By:
Thomas Gruca - University of Iowa
Mark Pelzer - Kirkwood Community College
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Demand: Raw data
Name Quantity Maximum pricewilling to pay
Mary 1 4
Bob 1 1
Jane 1 5
Ed 1 3
Alice 1 21
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Demand Schedule
Price Quantity Total QuantityDemanded
5 1 1
4 1 2
3 1 3
2 1 4
1 1 51
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Demand Curve
0
1
2
3
4
5
6
1 2 3 4 5
Quantity demanded
Pri
ce
D
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Demand: Definition
• Relationship between price and quantity demanded at a given price
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Demand Curve
0
1
2
3
4
5
6
1 2 3 4 5
Quantity demanded
Pri
ce
D
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Demand Curve
0
1
2
3
4
5
6
1 2 3 4 5
Quantity demanded
Pri
ce
I
D
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Change in quantity demanded due to change in price
0
1
2
3
4
5
6
1 2 3 4 5
Quantity demanded
Pri
ce
I
II
D
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Shifts in the Demand Curve
• income
• related goods
• tastes
• number of consumers
• expectations of future prices
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Demand curve shifts to the right
0
1
2
3
4
5
6
1 2 3 4 5
Quantity demanded
Pri
ce
D
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Demand curve shifts to the left
0
1
2
3
4
5
6
1 2 3 4 5
Quantity demanded
Pri
ce
D
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Demand for an intangible good
• For example, a promise exchanged for money
• Value of the promise depends on future events
• Examples– loans– insurance
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Demand for an intangible good
• Application: a futures contract– value based on a future event– possible events
• price of a bushel of wheat in October
• Microsoft stock price on 3rd Friday of June
• value of the Euro in $ on February 1st
• price of oil on April 21st
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Assignment
• Political futures contract– pays $1 if Bradley is the Democratic nominee
for 2000– pays $0 otherwise
• Price that someone is willing to pay is based on their own prediction of a particular outcome
• Assignment: graphing a real demand curve
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Graph of Bradley demand data
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0 5 10 15 20 25 30 35 40
Quantity Demanded
Pri
ce
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The effect of NBA party on demand for Bradley contracts
00.05
0.10.15
0.20.25
0.30.35
0.4
0 5 10 15 20 25 30 35 40
Quantity Demanded
Pric
e
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Supply: Raw dataCompany Name Quantity Minimum price
willing to accept
ADC 1 3
SSW 1 2
QWE 1 5
YYJ 1 1
AQD 1 41
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Supply Schedule
Price Quantity Total QuantitySupplied
1 1 1
2 1 2
3 1 3
4 1 4
5 1 51
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Supply Curve
0
1
2
3
4
5
6
1 2 3 4 5
Quantity supplied
Pri
ce
S
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Supply: Definition
• Relationship between price and quantity supplied at a given price
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Supply Curve
0
1
2
3
4
5
6
1 2 3 4 5
Quantity supplied
Pri
ce
I
S
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Change in quantity supplied due to a change in price
0
1
2
3
4
5
6
1 2 3 4 5
Quantity supplied
Pri
ce
I
II
S
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Shifts in the Supply Curve
• prices of relevant resources
• technology
• taxes
• number of sellers
• expectations of future prices
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Supply curve shifts to the right
0
1
2
3
4
5
6
1 2 3 4 5
Quantity supplied
Pri
ce
S
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Supply curve shifts to the left
0
1
2
3
4
5
6
1 2 3 4 5
Quantity supplied
Pri
ce
S
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Supply for an intangible good
• Simplified insurance example• Why would anyone supply car insurance?• Seller expects that you will not have an
accident during the next year• If you do, they pay the bills. If not, they still
keep the premium (price of policy)• Prices depend on how likely there will be a
claim
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Political Futures Contract
• Recall our example political futures contract
• People holding this contract get $1 if Bradley is the Democratic nominee for 2000 and $0 otherwise
• They may be willing to sell if they are not 100% sure that Bradley will be the nominee
• Assignment 4: graphing a real supply curve
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Graph of Bradley supply data
0
0.1
0.2
0.3
0.4
0.5
0.6
0 5 10 15 20 25 30 35
Quantity supplied
Pri
ce
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Effect of internet taxes on supply of Bradley contracts
0
0.1
0.2
0.3
0.4
0.5
0.6
0 5 10 15 20 25 30 35
Quantity supplied
Pri
ce
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A Market
0
1
2
3
4
5
6
1 2 3 4 5
Quantity
Pri
ce
S
D
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Surplus
0
1
2
3
4
5
6
1 2 3 4 5
Quantity
Pri
ce
S
D
Surplus
Qd Qs
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Market adjustment to surplus
0
1
2
3
4
5
6
1 2 3 4 5
Quantity
Pri
ce
S
D
Surplus
Qd Qs
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Shortage
0
1
2
3
4
5
6
1 2 3 4 5
Quantity
Pri
ce
S
DShortage
QdQs
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Market adjustment to shortage
0
1
2
3
4
5
6
1 2 3 4 5
Quantity
Pri
ce
S
DShortage
Qd Qs
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Equilibrium
0
1
2
3
4
5
6
1 2 3 4 5
Quantity
Pri
ce
S
D
Eq.Q
Eq.P
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Government interventions: Price controls
• The government sets a maximum price– Example: the price of basic commodities in
many countries (milk, flour, bread, rice)– what happens to the availability of this good?
• The government sets a minimum price for wages – Example: minimum wage– what happens to the supply of labor?
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Equilibrium in the Bradley marketBradley Nomination Market (6/99-9/99)
0
0.1
0.2
0.3
0.4
0.5
0.6
0 10 20 30 40Quantity
Pri
ce
S
D
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Supply and demand information available in a real market
Price
Quantity
S
D
Exchangesthat already have occurred
Offers to sell (ask price)
Offers to buy (bid price)
Market price (observed)
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Supply and demand information available in a real market
Price
Quantity
S
D
Eq.Q Eq.Q +1
Best Ask
Best Bid
Last Trade
Note: Eq.Q. is equilibrium quantity
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Iowa Electronic Market
• The market for Bradley contracts is run by the Iowa Electronic Market– real $, real time futures market run by the
Tippie Business School at the University of Iowa
– web site: www.biz.uiowa.edu/iem
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IEM Prices: 12/10/99
Market Quotes: DCONV00
(2000 Democratic National Convention Market)
Quotes current as of 15:45:05 CST, Friday, December 10, 1999. Symbol Bid Ask Last Low High Average
BRADLEY 0.310 0.324 0.311 0.311 0.323 0.314
GORE 0.682 0.694 0.682 0.681 0.698 0.682
DCROF 0.002 0.003 0.002 0.002 0.002 0.002• DCROF is a contract for candidates other than Gore and
Bradley
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Assignment 7
• Choose one of the current markets running at the IEM
• Read the prospectus to make sure you understand how the contracts work
• Using various news sources, try to determine what events will affect prices in the IEM for two-weeks
• Using your understanding of supply and demand, predict how prices should change
• Determine if your predictions were correct and reconcile any discrepancies
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How do bid,ask prices happen?
• The bid and ask prices you see on the IEM trading screen are offers to buy and sell posted by traders in the market.
• Other information available includes:– last traded price– volume of trades– historical prices
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How do you get contracts to sell?
• There are two ways to buy contracts– Buy a bundle of contracts from the market
• each market has a set of contracts
• only one will pay $1, all others pay 0$
• keep the contracts that you think will pay off and sell the others
– Buy from another trader
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How do you make $ in the IEM markets?
• Buy and hold those contracts which eventually pay $1
• Buy contracts at a low price and sell them when the prices rise
• Sell one of each contract when sum of all bid prices is greater than $1 (Why?)