Microeconomics-chapter3.pptx - Microeconomics ELEVENTH EDITION Michael Parkin Chapter 3 Demand and Supply Markets and Prices Market is any arrangement

Microeconomics-chapter3.pptx - Microeconomics ELEVENTH...

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Unformatted text preview: Microeconomics ELEVENTH EDITION Michael Parkin Chapter 3 Demand and Supply Markets and Prices Market is any arrangement that enables buyers and sellers to get information and do business with each other. There are markets for goods, services, factors of production, manufactured inputs, financial securities and money market. Some markets are physical and some are connected through internet such as ecommerce and currency markets. Markets vary in the intensity of competition. A competitive market is a market that has many buyers and sellers, so no single buyer and seller can influence the price. Markets and Prices The price of an object is the number of dollars that must be given up in exchange for it - Money Price. The Opportunity cost is the highest valued alternative forgone. The ratio of one price to another is called a relative price, and a relative price is an opportunity cost. The normal way of expressing a relative price is in terms of a “basket” of all goods and services. So, the relative price is the ratio of the money price of a good by the money price of a “basket” of all goods (called a price index). Markets and Prices William Gregg owned a mill in South Carolina. In December 1862, he placed a notice in the Edgebill Advertiser announcing his willingness to exchange cloth for food and other items. Here is an extract: 1 yard of cloth for 1 pound of bacon. 2 yards of cloth for 1 pound of butter. 4 yards of cloth for 1 pound of wool. 8 yards of cloth for 1 bushel of salt. a) b) c) What is the relative price of butter in terms of wool? If the money price bacon was 20¢ a pound, what do you predict was the money price of butter? If the money price of bacon was 20¢ a pound and the money price of salt was $2.00 a bushel, do you think anyone would accept Mr. Gregg’s offer of cloth for salt? Demand If you demand something, then you Want it. Can afford it. Plan to buy it. The Quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price. It is not a must that the quantity demanded is the same as the quantity bought. Sometimes the quantity demanded exceeds the amount of goods available. How does the quantity demanded of a good change as its price changes, if all other things remain the same? The Law of Demand Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded. Why does a higher price reduce the quantity demanded? Substitution effect Income effect The Law of Demand Substitution effect When the relative price (opportunity cost) of a good rises, other things remaining the same, people seek substitutes for it, so the quantity demanded of the good or service decreases. Income effect When a price rises, other things remaining the same, the price rises relative to income. Faced with a higher price and unchanged income, people cannot afford to buy all the things they previously bought. So, the quantity demanded will decrease. Demand Curve and Demand Schedule Demand refers to the entire relationship between the price of a good and the quantity demanded of that good. Demand Curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumer’s planned purchases remain the same. Demand Curve and Demand Schedule The Demand Curve 25 20 15 Price (dollars per bar) 10 5 0 0 0.5 1 1.5 2 2.5 3 Quantity demanded (millions of bars per week) Price (dollars per bar) Quantity demanded (millions of bars per week) 0.5 22 1 15 1.5 10 2 7 2.5 5 Demand Curve and Demand Schedule Willingness and ability to pay Demand curve can be considered as a willingness-and-ability-to-pay curve, which is a measure of the marginal benefit. If a small quantity is available, the highest price that someone is able to pay for one more unit is high. But as the quantity available increases, the marginal benefit of each additional unit falls along the demand curve. A Change in Demand A change in demand occurs when any factor that influences buying plans changes, other than the price of the good. Six main factors bring changes in demand. They are changes in: The prices of related goods Expected future prices Income Expected future income and credit Population Preferences An Increase in Demand 3 2.5 2 Price (dollars per bar) 1.5 1 0.5 0 0 5 10 15 20 25 30 35 Quantity demanded (millions of bars per week) Original demand schedule Original income New demand schedule New higher income Price (dollars per bar) Quantity demanded (millions of bars per week) Price (dollars per bar) Quantity demanded (millions of bars per week) 0.5 22 0.5 32 1.00 15 1.00 25 1.50 10 1.50 20 2.00 7 2.00 17 2.50 5 2.50 15 Prices of related goods The quantity of a good that consumers plan to buy depends in part on the prices of substitutes. A substitute is a good that can be used in place of another good. For example, a bus ride is a substitute for a train ride and chicken is a substitute of meat. If the price of a substitute for an energy bar rises, people buy less of the substitute and more of energy bars. Prices of related goods The quantity of a good that people plan to buy also depends on the prices of complements. A complement is a good that is used in conjunction with another good. For example, hamburgers and fries are complements, and so are energy bars and exercise. If the price of an hour at the gym falls, people buy more gym time and more energy bars. Expected Future Prices If the price of a good is expected to rise in the future, current demand for the good increases and the demand curve shifts rightward. For example, if a Florida frost damages the season’s orange crops, then the price of orange juice is expected to rise. So the current demand of it will increase. If the price of a good is expected to fall in the future, current demand for the good decreases and the demand curve shifts leftward. For example, computer prices are constantly falling, the current demand for computers is less. Income When consumer’s income increases, consumer’s demand increases and vise versa. Although an increase in income leads to an increase in the demand for most goods, it does not lead to an increase in the demand for all goods. Normal good: is one for which demand increases with income. Inferior good: is one for which demand decreases with increasing income. For example: As income increases, the demand for air travel (normal good) increases, and the demand for long-distance bus trips (inferior good) decreases. Expected Future Income and Credit When expected future income increases or credit becomes easier to get, demand for a good might increase now. For example, a salesperson expects to receive a big bonus at the end of the year, so he goes into debt and buys a new car right now. Population The larger the population, the greater is the demand for all goods and services. For example, the demand for parking spaces and movies is greater in New York City than it is in Bahrain. The larger the proportion of the population in a given age group, the greater is the demand for the goods and services used by that group. For example, As the number of Americans aged 85 years and over increases, the demand for nursing home services increases. Preferences Preferences determine the value that people place on each good and service. Preferences depend on such things as the weather, information and fashion. For example, greater health and fitness awareness has shifted preferences in favor of energy A Change in the Quantity Demanded Versus a Change in Demand Changes in the influences on buying plans bring either a change in the quantity demanded or a change in demand. A change in the quantity demanded can be expressed by a movement along the demand curve. A change in demand can be expressed by a shift of the • A change in the price causes a change in the quantity demanded which leads to a movement along the demand curve. • A change in any other influence on buying plans causes a change in the demand which is shown as a shift in the demand curve. A Change in the Quantity Demanded Versus a Change in Demand Movement along the demand curve: A fall in the price of a good increases the quantity demanded. A rise in the price of a good decreases the quantity demanded of it. A shift of the demand curve: If the price of a good remains constant but some other influence on buying plans changes, there is a change in demand for that good. Demand increases if the price of a substitute rises, the price of a complement falls, the expected future price rises, income increases (normal good), expected future income or credit increases, or the population increases and vice versa. Some Exercises The price of food increased during the past year. a. Explain how the substitution effect influences food purchases and provide some examples of substitutions that people might make when the price of food rises and other things remain the same. b. Explain how the income effect influences food purchases and provide some examples of the income effect that might occur when the price of food rises and other things remain the same. Some Exercises Place the following goods and services into pairs of likely substitutes and pairs of likely complements (You may use an item in more than one pair). The goods and services are Coal, oil, natural gas, wheat, corn, rye, pasta, pizza, sausage, skateboard, roller blades, video game, laptop, iPod, cell phone, text message, email, phone call, voice Some Exercises In January 2010, the price of gasoline was $2.70 a gallon. By spring 2010, the price had increased to $3.00 a gallon. Assume that there were no changes in average income, population, or any other influence on buying plans. Explain how the rise in the price of gasoline would affect a. The demand of gasoline Supply If a firm supplies a good or service, the firm a. Has the resources and technology to produce it. b. Can profit from producing it. c. Plans to produce it and sell it. •. The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. •. The quantity supplied is not necessarily the same amount as the quantity sold. Law of Supply Other things remaining the same , the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. Why does higher price increase the quantity supplied? When the price of a good rises, other things remaining the same, producers are willing to incur a higher marginal cost, so they increase production. The higher price brings forth an increase in the quantity supplied. Supply Curve and Supply Schedule Supply: refers to the entire relationship between the price of a good and the quantity supplied of it. It is illustrated by the supply curve and supply schedule Supply Curve: shows the relationship between the quantity supplied of a good and its price when all other when all other influences on producer’s planned sales remain the same. Supply Curve and Supply Schedule The supply curve 3 2.5 2 Price (dollars per bar) 1.5 1 0.5 0 0 2 4 6 8 10 12 14 16 Quantity supplied (millions of bars per week) Price (dollars per bar) Quantity supplied (millions of bars per week) 0.5 0 1 6 1.5 10 2 13 2.5 15 Minimum Supply Price The supply curve can be interpreted as a minimum-supply-price-curve that shows the lowest price at which someone is willing to sell (marginal cost). If a small quantity is produced, the lowest price at which someone is willing to sell one more unit is low. But as the quantity produced increases, the marginal cost of each additional unit rises, so the lowest price at which someone is willing to sell an additional unit rises along the supply curve. A Change in Supply When any factor that influences selling plans other than the price of the good changes, there is a change in supply. Six main factors bring changes in supply. They are changes in The prices of factors of production The prices of related goods produced Expected future prices The number of suppliers Technology The state of nature Prices of Factors of Production If the price of a factor rises, the lowest price that a producer is willing to accept for that good rises, so supply decreases. For example, during 2008, as the price of jet fuel increased, the supply of air travel decreased. Prices of Related Goods Produced If the price of energy gel rises, firms switch production from bars to gel. The supply of energy bars decreases. Energy bars and energy gel are substitutes in production. Prices of Related Goods Produced If the price of beef rises, the supply of cowhide increases. Beef and cowhide are complements in production-goods that must be produced together. Expected Future Prices If the future price of a good rises, the return from selling the good in the future increases and is higher it is today. So supply decreases today and increases in the future. The Number of Suppliers The larger the number of firms that produce a good, the greater is the supply of the good. As new firms enter an industry, the supply in that industry increases. Technology A technology change occurs when a new method is discovered that lowers the cost of producing a good and increase the supply of it. The State of Nature It includes all the natural forces that influence production such as weather, and more broadly the natural environment. Good weather can increase the supply of many agricultural products and bad weather can decrease their supply. A Change in the Quantity Supplied Versus a Change in Supply Changes in the influences on selling plans bring either a change in the quantity supplied or a change in supply. A movement along the supply curve shows a change in the quantity supplied. A shift of the supply curve shows a change in supply. A Change in the Quantity Supplied Versus a Change in Supply Exercises In 2008, the price of corn increased by 35 percent and some cotton farmers in Texas stopped growing cotton and started to grow corn. a. Does this fact illustrate the law of demand or the law of supply? Explain your answer. b. Why would a cotton farmer grow corn? Exercises Dairies make low-fat milk from full-cream milk. In the process of making low-fat milk, the dairies produce cream, which is made into ice cream. In the market for low-fat milk, the following events occur one at a time: a. The wage rate of dairy workers rises. b. The price of cream rises. c. The price of low-fat milk rises. d. With the period of low rainfall extending, dairies raise their expected price of low-fat milk next year. e. With advice from health-care experts, dairy farmers decide to switch from producing full-cream milk to growing vegetables. f. A new technology lowers the cost of producing ice cream. .Explain the effect of each event on the supply of low-fat milk. .Use a graph to illustrate the effect of each event. .Does any event (or events) illustrate the law of supply? Market Equilibrium As the price of a good rises, the quantity demanded decreases and the quantity supplied increases. An equilibrium is a situation in which opposing forces balance each other. It occurs in the market when the price balances buying plans and selling plans. The equilibrium price is the price at which the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at equilibrium price. Market Equilibrium A market moves toward its equilibrium because: Price regulates buying and selling plans Price adjust when plans don’t match. Price as a regulator The price of a good regulates the quantities demanded and supplied. If the price is too high, the quantity supplied exceeds the quantity demanded (Surplus). If the price is too low, the quantity demanded exceeds the quantity supplied (Shortage). There is one price at which the quantity supplied equals the quantity demanded (Equilibrium). Equilibrium Equilibrium Price (dollars per bar) Quantity demanded Quantity supplied Shortage (-) Or surplus (+) (millions of bars per week) 0.50 22 0 -22 1.00 15 6 -9 1.50 10 10 0 2.00 7 13 +6 2.50 5 15 +10 Price Adjustments A shortage forces the price up When the quantity demanded exceeds the quantity supplied, powerful forces operate to increase the price and move it toward the equilibrium price. The rising price reduces the shortage because it decreases the quantity demanded and increases the quantity Price Adjustments A surplus forces the price down When the quantity supplied exceeds the quantity demanded, powerful forces operate to lower the price and move it toward the equilibrium price. The falling price decreases the surplus because it increases the quantity demanded and decreases the quantity Exercises “As more people buy computers, the demand for Internet service increases and the price of Internet service decreases. The fall in the price of Internet service decreases the supply of Internet service.” Explain what is wrong with this statement. Exercises The demand and supply schedule for gum are: Price (cents per pack) Quantity demanded Quantity supplied 20 180 60 40 140 100 60 100 140 80 60 180 100 20 220 (millions of packs a week) Exercises Draw a graph of the market for gum and mark in the equilibrium price and quantity. Suppose that the price of gum is 70¢ a pack. Describe the situation in the gum market and explain how the price adjusts. Suppose that the price of gum is 30¢ a pack. Describe the situation in the gum market and How To Get The Equilibrium There are three approaches to get the equilibrium price: 1. From the graph 2. From schedule 3. From the equation The graph price equilibriu m equilibriu m price Supply 10 Deman d quantity 550 equilibriu m quantity The Schedule Price (per lb) Quantity supplied Quantity demanded 0.3 1000 9800 0.6 2000 8600 0.90 3000 7400 1.20 4000 6200 1.50 5000 5000 1.80 6000 3800 2.10 7000 2600 2.40 8000 1400 2.50 9000 200 Market Equilibrium QD = 20 - 2P QS = -4 + 2P Algebraic analysis of supply and demand At Equilibrium Supply = Demand To find an equilibrium in a market Set supply equal to demand and solve for P. Substitute P in the supply and demand equations to get the quantities. Market Equilibrium As QS = QD 20 - 2P = -4 + 2P 4P= 24 P= 6 As P = 6 Then Q = -4 + 2(6) Q= 8 s Market Equilibrium QD = 10 - 2P QS = -2 + P Market Equilibrium As QS = QD 10 - 2P = -2 +P 3P= 12 P= 4 As P = 4 Then Q = -2 + 4 Q= 2 s Market Equilibrium QD = 28 - 8P QS = -2 + 2P Market Equilibrium As QS = QD 28 - 8P = -2 +2P 10P= 30 P= 3 As P = 3 Then Q = 28 – 8(3) Q= 4 d Predicting Changes in Price and Quantity A change in price stems from: A change in demand. A change in supply. A change in both, demand and supply. An Increase in Demand The effects of a Change in Demand Price (dollars per bar) 3 Supply for energy bars 2.5 2 1.5 Demand fro energy bars (new) 1 Demand for energy bars (original) 0.5 0 0 5 10 15 20 25 30 35 Quantity (millions of bars per week) An Increase in Demand Price (dollars per bar) Quantity demanded (millions of bars per week) Original New Quantity supplied (millions of bars per week) 0.50 22 32 0 1.00 15 25 6 1.50 10 20 10 2.00 7 17 13 2.50 5 15 15 An Increase in Demand As more people join health club, demand for energy bars increases. The increase in demand causes a shortage at the original price. Therefore, the price must rise. At the new equilibrium point, both the price and quantity increases. There is an increase in the quantity supplied but no change in the supply (movement along the supply curve). A decrease in Demand The effects of a Change in Demand Price (dollars per bar) 3 Supply for energy bars 2.5 2 1.5 Demand fro energy bars (original) 1 Demand for energy bars (new) 0.5 0 0 5 10 15 20 25 30 35 Quantity (millions of bars per week) A Decrease in Demand Look at the same figure by reversing this change. The equilibrium price decreases to solve the surplus problem and the q...
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