chapter the market forces of supply and demand 4

Chapter

The Market Forces of Supplyand Demand

4

Markets and Competition

• Market– A group of buyers and sellers of a particular

good or service• Can be highly organized

– E.g.: agricultural commodities

• Can be less organized– E.g.: ice cream, espresso carts, Freemont Sunday

market

2

Markets and Competition• Market Types

– 1. Perfect Competition• No individual buyer/seller has a significant influence on

market price– 2. Monopoly

• Single producer of good; chooses output (quantity supplied) that max’es profit

– 3. Oligopoly• Small number of suppliers; may “collude” to set price like

a monopolist– 4. Monopolistic Competition

• Compete on both price and quality against several producers

3

Markets and Competition• Perfectly competitive market

– Each buyer/seller has a negligible impact on market price

– Why? (Key assumptions)• Goods offered for sale - exactly the same• Buyers and sellers – numerous

– No single buyer or seller has any influence over the market price– Must accept the price determined in the market– Price takers

• At the market price– Buyers - buy all they want– Sellers - sell all they want

4

Demand

• Basic Vocabulary– Quantity demanded

• Amount of a good purchased at a given price– A point on the demand curve

– Demand • The entire schedule (curve)

– Quantity demanded at various prices

– Difference between a change in quantity demanded and demand• Movement along the Demand Curve (change in

price) versus movement of the D Curve5

Demand

• Demand schedule - a table– Relationship between

• Price of a good• Quantity demanded

• Demand curve - a graph– Relationship between

• Price of a good• Quantity demanded

• Individual demand vs Market Demand– One individual vs all people in buying the good

6

Demand curve

Catherine’s demand schedule and demand curve

1

7

The demand schedule is a table that shows the quantity demanded at each price.The demand curve, which graphs the demand schedule, illustrates how the quantity demanded of the good changes as its price varies. Because a lower price increases the quantity demanded, the demand curve slopes downward.

Price ofIce-cream cone

Quantity ofCones demanded

$0.000.501.001.502.002.503.00

12 cones1086420

0 1210 1191 2 3 4 5 6 7 8Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice-Cream

Cones 1. A decreasein price . . .

2. . . . increases quantityof cones demanded.

Demand

• Variables that can shift the demand curve– Income– Prices of related goods– Tastes– Expectations– Number of buyers

8

Appendix

FIGURE 1A-5

Showing Three Variables on a Graph

Graphs of Two Variables

Taking into Account More Than Two Variables on a Graph

Shifts in the demand curve

3

10

Price of Ice-Cream

Cones

Quantity of Ice-Cream Cones 0

Demand curve, D1Demand

curve, D3

Demand curve, D2

Increase inDemand

Decrease inDemand

Any change that raises the quantity that buyers wish to purchase at any given price shifts the demand curve to the right. Any change that lowers the quantity that buyers wish to purchase at any given price shifts the demand curve to the left.

Change/Shift in Demand

• Shifts in demand (not quantity demanded)– Increase in Demand

• Any change that increases the quantity demanded at every price

• Entire Demand curve shifts right

– Decrease in Demand• Any change that decreases the quantity

demanded at every price• Entire Demand curve shifts left

11

Shifts versus Movement Along a Demand Curve – Change in Price of Related Goods

1. Along the demand curve: • price of hamburger rises, the quantity of hamburger demanded declines

2.Movement of the demand curve: (change in price of substitute or complement)• same price rise for hamburger shifts the demand for chicken (a substitute

for hamburger) to the right and the demand for ketchup (a complement to hamburger) to the left.

TABLE 3.2 Shift of Alex’s Demand Schedule Due to Increase in Income

Schedule D0 Schedule D1

Price(per

Gallon)

Quantity Demanded(Gallons per Week at an

Income of $500 per Week)

Quantity Demanded(Gallons per Week at

an Income of $700 per Week)

$ 8.00 0 3

7.00 2 5

6.00 3 7

5.00 5 10

4.00 7 12

3.00 10 15

2.00 14 19

1.00 20 24

0.00 26 30

Shift of a Demand Curve following a Rise in Income

Increase in income changes the relationship between price and quantity; there is a shift of the demand curve, in this case from D0 to D1. Gasoline is a normal good.

Shift of Demand versus Movement Along a Demand Curve

Demand

• Variables that can shift the demand curve– Income– Prices of related goods– Tastes– Expectations– Number of buyers

14

Demand

• Market demand– Sum of all individual demands for a good or

service• Market demand curve

– Sum - individual demand curves horizontally– Total quantity demanded of a good varies

• As the price of the good varies• All other factors that affect how much consumers

want to buy are hold constant

15

Figure

Market demand as the sum of individual demands(demand schedule)

2

16

Price of ice-cream cone Catherine Nicholas Market

$0.000.501.001.502.002.503.00

121086420

+ 7654321

= 19161310741

The quantity demanded in a market is the sum of the quantities demanded by all thebuyers at each price. Thus, the market demand curve is found by adding horizontallythe individual demand curves. At a price of $2.00, Catherine demands 4 ice-creamcones, and Nicholas demands 3 ice-cream cones. The quantity demanded in themarket at this price is 7 cones.

Figure

Market demand as the sum of individual demands

2

17

DCatherine

0 1210 1191 2 3 4 5 6 7 8

Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice

CreamCones

Catherine’sdemand

DNicholas

0 1 2 3 4 5 6 7

Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice

CreamCones

Nicholas’s demand+ =

DMarket

0 182 4 6 8 10 12 14 16

Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice

CreamCones

Market demand

Figure Market Demand Curve

18

Figure Sum of Individuals = Market Demand Curve

19

Demand

• Income– Normal good

• Other things constant• An increase in income

– Increase in demand

– Inferior good• Other things constant• An increase in income

– Decrease in demand

20

Demand • Prices of related goods

– Substitutes - two goods• An increase in the price of one• Leads to an increase in the demand for the other

– Complements – two goods• An increase in the price of one• Leads to a decrease in the demand for the other

21

Price of Substitute Increases

Price of a Complement Decreases

Demand for Hot Dogs

Price of Buns

Demand

• Tastes– Change in tastes – changes the demand

• Expectations - about the future (income, prices)– Affect current demand

• Number of buyers – increase– Market demand - increases

23

Table 4.1 Factors That Shift the Demand Curve

1. Shift the demand curve for cigarettes and other tobacco products – Public service announcements– Mandatory health warnings on cigarette packages– Prohibition of cigarette advertising on television

• If successful– Shift demand curve to the left

Two ways to reduce the quantity of smoking demanded

25

2. Try to raise the price of cigarettes– Tax the manufacturer

• Much of tax – passed to consumers (high prices)

– Movement along demand curve• 10% increase in price → 4% decrease in smoking• Teenagers: 10% increase in price → 12% decrease

smoking

• Demand for cigarettes vs. demand for marijuana – Appear to be complements

Two ways to reduce the quantity of smoking demanded

26

Supply

• Quantity supplied– Amount of a good– Sellers are willing and able to sell

• Law of supply– Other things equal– When the price of the good rises

• Quantity supplied of a good rises

28

Supply

• Supply schedule - a table – Relationship between

• Price of a good• Quantity supplied

• Supply curve - a graph– Relationship between

• Price of a good • Quantity supplied

• Individual supply– Supply of one seller

29

Figure

Ben’s supply schedule and supply curve

5

30

Supply curve

The supply schedule is a table that shows the quantity supplied at each price. Thissupply curve, which graphs the supply schedule, illustrates how the quantity suppliedOf the good changes as its price varies. Because a higher price increases the quantity supplied, the supply curve slopes upward.

Price ofIce-cream cone

Quantity ofCones supplied

$0.000.501.001.502.002.503.00

0 cones012345

0 1210 1191 2 3 4 5 6 7 8Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice-Cream

Cones

1. An increasein price . . .

2. . . . increases quantityof cones supplied.

Supply

• Market supply– Sum of the supplies of all sellers for a good or

service• Market supply curve

– Sum - individual supply curves horizontally– Total quantity supplied of a good varies

• As the price of the good varies• All other factors that affect how much suppliers

want to sell are hold constant

31

Figure

Market supply as the sum of individual supplies(supply schedule)

6

32

Price of ice-cream cone Ben Jerry Market

$0.000.501.001.502.002.503.00

0012345

+ 0002468

= 00147

1013

The quantity supplied in a market is the sum of the quantities supplied by all the sellers at each price. Thus, the market supply curve is found by adding horizontally the individual supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones, and Jerry supplies 4 ice-cream cones. The quantity supplied in the market at this price is 7 cones

Figure

Market supply as the sum of individual supplies

6

33

SBen

0 1210 1191 2 3 4 5 6 7 8

Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice

CreamCones

Ben’ssupply

SJerry

0 1 2 3 4 5 6 7

Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice

CreamCones

Jerry’ssupply+ =

SMarket

0 182 4 6 8 10 12 14 16

Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice

CreamCones

Marketsupply

Supply

• Shifts in supply– Increase in supply

• Any change that increases the quantity supplied at every price

• Supply curve shifts right

– Decrease in supply• Any change that decreases the quantity supplied

at every price• Supply curve shifts left

34

Figure

Shifts in the supply curve

7

35

`

Price of Ice-Cream

Cones

Quantity of Ice-Cream Cones 0

Supply curve, S1

Supply curve, S3

Supply curve, S2

Increase inSupply

Decrease insupply

Any change that raises the quantity that sellers wish to produce at any given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at any given price shifts the supply curve to the left.

Supply

• Variables that can shift the supply curve– Input Prices

• Supply – negatively related to prices of inputs

– Technology• Advance in technology – increase in supply

– Expectations about future • Affect current supply

– Number of sellers – increase• Market supply - increase

36

Table

Variables that influence sellers

2

37

Variable A Change in This Variable . . .

Price of the good itself Input prices Technology Expectations Number of sellers

Represents a movement along the supply curve

Shifts the supply curveShifts the supply curveShifts the supply curveShifts the supply curve

This table lists the variables that affect how much producers choose to sell of any good. Notice the special role that the price of the good plays: A change in the good’s price represents a movement along the supply curve, whereas a change in one of the other variables shifts the supply curve

Supply and Demand Together

• Equilibrium - a situation– Market price has reached the level :

• Quantity supplied = quantity demanded

• Equilibrium price - the price:– Balances quantity supplied and quantity

demanded• Equilibrium quantity

– Quantity supplied and the quantity demanded at the equilibrium price

38

Figure

The equilibrium of supply and demand

8

39

Supply

0 1210 1191 2 3 4 5 6 7 8Quantity of Ice-Cream Cones

$3.00

2.50

2.00

1.50

1.00

0.50

Price of Ice-Cream

Cones

Equilibrium

Demand

Equilibriumprice

Equilibriumquantity

The equilibrium is found where the supply and demand curves intersect. At the equilibrium price, the quantity supplied equals the quantity demanded. Here the equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied, and 7 ice-cream cones are demanded.

Supply and Demand Together

• Surplus– Quantity supplied > quantity demanded– Excess supply– Downward pressure on price

• Shortage– Quantity demanded > quantity supplied– Excess demand– Upward pressure on price

40

Figure

Markets not in equilibrium

9

41

Price ofIce

CreamCones

Quantity of Ice-Cream Cones 0

Demand

7

$2.50

(a) Excess Supply

In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level. In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in both cases, the price adjustment moves the market toward the equilibrium of supply and demand

(b) Excess demand

2.00

Supply Surplus

4

Quantitydemanded

10

Quantitysupplied

Price ofIce

CreamCones

Quantity of Ice-Cream Cones 0

Demand

7

1.50

$2.00

Supply

Shortage

4

Quantitysupplied

10

Quantitydemanded

Supply and Demand Together

• Law of supply and demand– The price of any good adjusts

• Bring the quantity supplied and the quantity demanded into balance

– In most markets• Surpluses and shortages are temporary

42

Supply and Demand Together

• Three steps to analyzing changes in equilibrium1. Decide: the event shifts the supply curve,

the demand curve, or both curves2. Decide: curve shifts to right or to left3. Use supply-and-demand diagram

• Compare initial and new equilibrium• How the shift affects equilibrium price and

quantity

43

Table

Three steps for analyzing changes in equilibrium

3

44

1. Decide whether the event shifts the supply or demand curve (or perhaps both).

2. Decide in which direction the curve shifts.

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

Supply and Demand Together

• Example: A change in market equilibrium due to a shift in demand– One summer - very hot weather– Effect on the market for ice cream? 1.Hot weather - demand curve (tastes ) 2.Demand curve shifts to the right 3.Higher equilibrium price; higher equilibrium

quantity

45

Figure

How an increase in demand affects the equilibrium

10

46

Supply

New equilibrium

D2

An event that raises quantity demanded at any given price shifts the demand curve to the right. The equilibrium price and the equilibrium quantity both rise. Here an abnormally hot summer causes buyers to demand more ice cream. The demand curve shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to rise from 7 to 10 cones

Price ofIce-Cream

Cones

Quantity of Ice-Cream Cones 0 7

$2.50

2.00

10

D1

Initial equilibrium

1. Hot weatherincreases the demandfor ice cream . . .

2. …resulting in a higher price . . .

3. …and a higher quantity sold.

Supply and Demand Together

• Shifts in curves versus movements along curves – Shift in the supply curve

• Change in supply

– Movement along a fixed supply curve• Change in the quantity supplied

– Shift in the demand curve• Change in demand

– Movement along a fixed demand curve• Change in the quantity demanded

47

Supply and Demand Together

• Example: A change in market equilibrium due to a shift in supply– One summer - a hurricane destroys part of

the sugarcane crop• Price of sugar - increases

– Effect on the market for ice cream?1.Change in price of sugar - supply curve2.Supply curve - shifts to the left3.Higher equilibrium price; lower equilibrium

quantity48

Figure

How a decrease in supply affects the equilibrium

11

49

S1

New equilibrium

S2

An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises, and the equilibrium quantity falls. Here an increase in the price of sugar (an input) causes sellers to supply less ice cream. The supply curve shifts from S1 to S2, which causes the equilibrium price of ice cream to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 cones

Price ofIce-Cream

Cones

Quantity of Ice-Cream Cones 0 7

$2.50

2.00

4

Demand

Initial equilibrium

1. An increase in theprice of sugar reducesthe supply of ice cream . . .

2. …resulting in a higher price . . .

3. …and a smaller quantity sold.

Supply and Demand Together

• Example: shifts in both supply and demand– One summer: hurricane and heat wave

1. Heat wave – shift demand curve; hurricane – shift supply curve

2. Demand curve shifts to the right; Supply curve shifts to the left

3. Equilibrium price raises– If demand increases substantially while supply falls

just a little: equilibrium quantity –rises– If supply falls substantially while demand rises just a

little: equilibrium quantity falls

50

Figure

A shift in both supply and demand

12

51

Price ofIce

CreamCones

Quantity of Ice-Cream Cones

0

D1

P2

(a) Price Rises, Quantity Rises

Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2.

(b) Price Rises, Quantity Falls

P1

S1

Q1 Q2

D2

S2

Initialequilibrium

New equilibrium

Smalldecreasein supply

Largeincreasein demand

Price ofIce

CreamCones

Quantity of Ice-Cream Cones

0

D1

P2

P1

S1

Q1Q2

D2

S2

Initialequilibrium

New equilibrium

Large decreasein supply

Small increasein demand

Table

What happens to price and quantity when supply or demand shifts?

4

52

No change In Supply

An increaseIn Supply

A decreaseIn supply

No changeIn demand

An increaseIn demand

A decreaseIn demand

P sameQ same

P upQ up

P downQ down

P downQ up

P ambiguousQ up

P DownQ ambiguous

P upQ down

P upQ ambiguous

P ambiguousQ down