demand supply and market equilibrium

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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