chapter two demand and supply
TRANSCRIPT
NHM 373: Consumer EconomicsMicroeconomics and Behavior
Chapter Two: Demand and Supply
Learning Objectives
1. Explain how the demand and supply curves summarize the behavior of buyers and sellers
2. Explain why the equilibrium in a market identifies a price-quantity pair for which buyers and sellers are satisfied.
3. Explain how shifts in supply and demand curves cause equilibrium prices and quantities to change
4. Explain why transactions can always be found that make some parties better off without harming others whenever a market is not in equilibrium.
5. Explain why attempts to peg prices below or above equilibrium levels produces negative side-effects and describe both the rationing and allocative functions of price.
6. List some determinants of supply and demand. 7. Solve for equilibrium prices and quantities when supply and demand curves are
expressed in algebraic form.
Questions
Seasonal goodso Why do crabs become cheaper during the crab season, while vacations
rentals become more expensive during the vacation season? The demand of the vacation rental is high so the price will be high. The number of carbs/supply has increased which means that price
will be lower.o What are other seasonal goods and how do their prices vary by season?
Crab, Strawberries Because of the supply
Why do some bars charge customers for water but give them peanuts for free?o They are going to need the water after all of the alcohol.
Why does a mobile phone sell for only $39.99, while a spare battery for that same phone sells for $59.99
o You are going to eventually need a replacement battery for your phone.
Market
A place where a good or service is bought and soldo Can be a virtual place or physical place.
Demand Curve
1
o Horizontal Interpretation: Mathematical relationship that tells how many
units of the good buyers wish to purchase at various possible prices, holding all else constant.
o Vertical Interpretation: Mathematical relationship that tells how much ($)
the consumers are willing to pay for another unit at a given quantity of the good.
Example: Demand Curve for Lobsters
The demand curve tells the quantities buyers will wish to purchase at various prices. Its key property us its downward slope; when price falls, the quantity demanded increases. This property is called the law of demand.
How much you are willing to pay versus how many units you will purchase. Supply curve
o Horizontal Interpretation: Mathematical relationship that tells how many
units of the good sellers wish to offer at various possible prices, holding all else constant.
o Vertical Interpretation: mathematical relationship that tells marginal cost of
delivering an additional unit at a given quantity of the good.
Example: Supply Curve for Lobsters
The upward slope of the supply schedule reflects the fact that costs tend to rise when producers expand production in the short run.
The price sellers are willing to sell the item for versus quantity for the price.
Law of Demand and Law of Supply
Law of Demando Inverse relationship between price and the quantity demanded
o Downward sloping demand curve
Price increases quantity demanded decreases Price decreases quantity demanded increases
o Other things being equal, consumers will buy less of a good at a high price
than at a low price. Price High Demand Low Price Low Demand Low Law of Supply
o Upward-sloping supply curve
Price Increases Quantity Supplied Increases Price Decreases Quantity supplied decreases
o Other things being equal, the quantity supplied rises as the price of a
product rises. Price high Quantity High Price Low Quantity decreases
Market Equilibrium
Market equilibrium is obtained where the supply and demand curves intersect. o Equilibrium price is where
QDemanded = QSupplied
This price is also called “market clearing price.”
Example: Equilibrium in the Lobster Market
The intersection of the supply and demand curves represents the price-quantity pair at which all participants in the market are “satisfied” : Buyers are buying the amount they want to buy at that price, and the sellers are selling the amount they want to sell.
The Algebra of Supply and Demand
Suppose:o Supply: P = 2 + 3Qs
o Demand: P = 10 - QD
Since the equilibrium is where Qs = QD, we don’t need the subscripts.o P = 2 + 3Q*
o P = 10 – Q8
o Therefore, 2 + 3Q* = 10 – Q*
Q* = 2o Plug this back into one of the two equations and get
P* = 8
What if somebody (like government or monopolist) sets the price elsewhere?
When price exceeds the equilibrium level, there is excess supply or surplus. When price is below the equilibrium level, there is excess demand, or shortage.
Excess Supply and Excess Demand
If the price is set above the market equilibrium:o Short Run
Excess Supply (or surplus) The quantity supplied will exceed the quantity demanded
o Long Run
Sellers will compete for buyers by offering better rates Price will fall until it meets the equilibrium price
If the price is set below the market equilibrium:o Short Run
Excess Demand (or shortage) The quantity demanded will exceed the quantity supplied.
o Long Run
Buyers will compete for products by increasing their bids Price will fall rise until it meets the equilibrium price.
At a price of $4 in this hypothetical lobster market, how much excess demandfor lobsters will there be?
How much excess supply will there be at a price of $20?
Attractive Properties of Equilibrium
If price and quantity take anything other than the equilibrium, it will always be possible to reallocate so as to make at least some people better off without harming others.
Example o Suppose that the price of a lobster is $4. Only 2000 lobsters will be
supplied.
o A Dissatisfied consumer were to offer $5 for a lobster
o Sellers will gradually supply more lobsters.
o Sellers are made better off because they can sell MORE at HIGHER price.
o Since at Q=2000 the value of a lobster to consumers is $8, consumers are
still better off by paying $5 and buy more. (Consumers get $8-$5 =$3 benefit per lobster consumed).
When the quantity traded in the marker is below (or above) the equilibrium quantity, it is always possible to reallocate resources in such a way that some people are made better off without harming others. Here, a dissatisfied buyer can pay a seller $10 for an additional lobster, thus making both parties better off.
Government Price Controls
Price Ceiling: a legal maximum on the price at which a good can be sold. Price Floor: a legal minimum on the price at which a good can be sold.
Price Ceilings
Why?o Hold inflation in check
o Keep the purchase of a certain item within the reach of low-income
consumers. If the price ceiling is set below the equilibrium price, the quantity demanded
exceeds the quantity supplied.o Shortage
Example: Rent Control It is illegal to charge more than an X price the government has set for a certain
city.
Price Ceilings (Rent Control)
With the rent control level set at $400 a month, there is an excess demand of 40,000 apartments a month.
Price Floors
Why?o Increase (or guarantee) the incomes of those who sell the item
If the price floor is set above the equilibrium price, the quantity supplied exceeds the quantity demanded
o Surplus
Example:o agriculture price support
Protect the farms income by preventing the price to drop lower than X.
o Minimum Wage
You cannot pay your employees lower than X
Price Floors (Agricultural Price Support)
For a price support to have any impact, it must be set above the market-clearing price. Its effect is to create excess supply, which the government then purchases.
Minimum Wage and Unemployment
Economic theory predicts that raising minimum wage will cause unemployment among low-skilled workers.
There is ongoing debate on minimum wage and teen unemployment. What do you think?
Exercise
The demand for apartment is P= 1200-QD while the supply is P=QS Unitso What would the equilibrium price be?
(Find P that satisfies QD = QS) $600
o The government imposes rent control at P=$300/month. How many
apartment units would be in shortage under the rent control? (Find QD – QS at P=300)
900 Quantity Demanded and 300 Quantity supplied Shortage if units is 600
Determinant of Supply and Demand
Determinants of demando Income
o Taste
o Prices of substitutes and complements
o Expectations
o Population
Determinants of Supplyo Technology
o Factor Prices
o Number of suppliers
o Expectations
o Weather
Factors that shift Demand Curves
Factors that Shift Supply Curves
Market Analysis
To analyze how any event influences a market, we use the supply-and-demand diagram to examine how the event affects the equilibrium price and quantity.
o First, we decide whether the event shifts supply or demand (or both)
o Second, we decide which direction the curve shifts.
o Third, we compare the new equilibrium with the old equilibrium
Four Simple Rules
Using Diagrams, show what changes in price and quantity would be expected in the following markets under the scenarios given
As petroleum reserves decrease, it becomes more difficult to find and recover crude oil. What will happen in the crude Oil market?
Worries about air safety cause travelers to shy away from air travel. What will happen in:
o Air Travel Market?
o Rail Travel Market?
o Hotel Rooms in Hawaii?
A genetically engineered hormone enables large milk producers to cut production costs. What will happen to milk price and Quantity at the equilibrium?
Questions
How will a decline in airfare affect intercity bus fares?o Hint: Flying and riding intercity buses are substitutes.
How will the increase in pay for federal employees affect the rent for conveniently located apartments in Washington DC area?
o Hint: Convienently located homes are normal goods.
What will happen to the equilibrium price and quantity of new houses if the wage rate of carpenters falls?
o Hint: Carpenters are inputs to building new houses.