lect04 - Chapter 4 Demand and Supply Ecn2802 Lecture 4 1...

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Unformatted text preview: Chapter 4 Demand and Supply Ecn2802 Lecture 4 1 Objectives After studying this chapter, you will be able to: Explain the influences on demand Explain the influences on supply Explain how demand and supply determine prices and quantities bought and sold Use demand and supply to make predictions about changes in prices and quantities Ecn2802 Lecture 4 2 This chapter explains how prices are determined and how markets guide and coordinate choices. Ecn2802 Lecture 4 3 Markets and Prices A market is any arrangement that enables buyers and sellers to get information and do business with each other. A market has two sides: buyers and sellers Market for goods, services, resources, inputs, money, securities. Physical market and non­physical market Ecn2802 Lecture 4 4 Markets vary in the intensity of competition. A competitive market is a market that has many buyers and many sellers so no single buyer or seller can influence the price. The most competitive markets are explicitly organized as auctions. Here is an interesting market at Aalsmeer in Holland, which handles a large percentage of the world’s fresh cut flowers. Roses grown in Colombia are flown to Amsterdam, auctioned at Aalsmeer, and are in vases in New York, London, and Tokyo all in less than a day. Ecn2802 Lecture 4 5 The money price of a good is the amount of money needed to buy it. The relative price of a good—the ratio of its money price to the money price of the next best alternative good—is its opportunity cost. Ecn2802 Lecture 4 6 More on Relative price Example: if the money price of coffee is $1 a cup, and the money price of gum is 50¢ a pack, then the opportunity cost of one cup of coffee is 2 packs of gum. A normal way of expressing a relative price is in terms of a “basket” of all goods and services. Ecn2802 Lecture 4 7 Relative prices Thus, generally to calculate relative price, we divide the money price of a good by the money price of a “basket” of all goods (called a price index). The theory of demand and supply determines the relative price. When we say the price will fall, we mean its price will fall relative to the average price of other goods and services. Ecn2802 Lecture 4 8 Demand If you demand something, then you: Want it, Can afford it, and Have made a definite plan to buy it. Wants are the unlimited desires or wishes people have for goods and services. Demand reflects a decision about which wants to satisfy. Ecn2802 Lecture 4 9 The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price. The quantity demanded is not necessarily the same as the quantity actually bought. Ecn2802 Lecture 4 10 Demand What Determines Buying Plans? 1. The price of the good, 2. The prices of other goods, 3. Expected future prices, 4. Income, 5. Population, and 6. Preferences. Ecn2802 Lecture 4 11 The Law of Demand Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. The law of demand results from a substitution effect an income effect Ecn2802 Lecture 4 12 Substitution effect—when the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded decreases. Income effect—when the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded decreases. Ecn2802 Lecture 4 13 Example: Think about the price of recordable compact disc (a CD­ R). Substitutes: an audiotape and prerecorded CD. What will happen when the price drops from $3 to $1.5? For substitution effect, people substitute CD­Rs for tapes and prerecoded CDs. For income effect, people can buy more CD­Rs. Therefore, the quantity of CD­Rs demanded increases. Ecn2802 Lecture 4 14 Demand Curve and Demand Schedule The term demand refers to the entire relationship between the price of the good and quantity demanded of the good. The quantity demanded refers to a point on a demand curve ― the quantity demanded at a particular price. Ecn2802 Lecture 4 15 A demand curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same. A demand schedule lists the quantities demanded at each price when all the other influences remain the same. Ecn2802 Lecture 4 16 Price Quantity (dollars per disc) (millions per week) A 0.50 9 B 1.00 6 C 1.50 4 D 2.00 3 E 2.50 2 Ecn2802 Lecture 4 17 Figure 3.1 shows a demand curve for recordable compact discs (CD­Rs). A rise in the price, other things remaining the same, brings a decrease in the quantity demanded and a movement along the demand curve. Ecn2802 Lecture 4 18 A demand curve is also a willingness­and­ability­to­ pay curve. The smaller the quantity available, the higher is the price that someone is willing to pay for another unit. Willingness to pay measures marginal benefit. Ecn2802 Lecture 4 19 A Change in Demand When any factor that influences buying plans other than the price of the good changes, there is a change in demand for that good. The quantity of the good that people plan to buy changes at each and every price, so there is a new demand curve. When demand increases, the quantity that people plan to buy increases at each and every price so the demand curve shifts rightward. When demand decreases, the quantity that people plan to buy decreases at each and every price so the demand curve shifts leftward. Ecn2802 Lecture 4 20 Several factors that change demand: Prices of related goods A substitute is a good that can be used in place of another good. A complement is a good that is used in conjunction with another good. When the price of substitute for CD­Rs rises or when the price of a complement for CD­Rs falls, the demand for CD­Rs increases. Ecn2802 Lecture 4 21 Figure 3.2 shows the shift in the demand curve for CD­Rs when the price of CD burner falls. Because a CD burner is a complement of a CD­ R, the demand for CD­ Rs increases. Ecn2802 Lecture 4 22 Expected future prices (Substitute over time) If the price of a good is expected to rise in the future, current demand increases and the demand curve shifts rightward. Ecn2802 Lecture 4 23 Example: Suppose that Florida is hit by a frost that damages the season’s orange crop. What will you expect the price of orange juice in the future? (increase) What will happen to your current consumption of orange juice today based on your expectation? What will happen to your future demand? Ecn2802 Lecture 4 24 Income When income increases, consumers buy more of most goods and the demand curve shifts rightward. A normal good is one for which demand increases as income increases. An inferior good is a good for which demand decreases as income increases. (potatoes, long­distance travel­air travel/bus trips) Ecn2802 Lecture 4 25 Population The size and the age structure also influence the changes of demand. The larger the population, the greater is the demand for all goods. 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 age group. Ecn2802 Lecture 4 26 The demand for parking spaces is much greater in New York City than it is in Charleston. For example, the number of Americans ages 20­24 decreased by 2 million during 1988­1998. As a result, the demand for college places decreased. Ecn2802 Lecture 4 27 Exercises In the market for scooters, several events occur, one at a time. Explain the influence of each event on the quantity demanded of scooters and on the demand for scooters. Illustrate the effects of each event by either a movement along the demand curve or a shift in the demand curve for scooters, and say which event (or events) illustrates the law of demand in action. These events are: Ecn2802 Lecture 4 28 Exercises The price of a scooter falls. The price of a bicycle falls. Citing rising injury rates, cities and towns ban scooters from sidewalks. Average income increases. Rumor has it that the price of a scooter will rise next month. The number of buyers increases. Ecn2802 Lecture 4 29 Note: The demand curve shows the quantity of demand buyers would hypothetically purchase at different prices during the same time period. It does not show the quantity actually bought at different prices at different times. Ecn2802 Lecture 4 30 •In the real world we usually only observe historical price-quantity combinations, so it is often difficult to distinguish between movement along a demand curve and shifts between demand curves. Ecn2802 Lecture 4 31 Prices and quantities observed at different times in the real world may result from shifting demand curves and not movement along a demand curve. Simply connecting the points may not give a good estimate of a demand curve. Ecn2802 Lecture 4 32 HISTORICAL DATA ON PRICE AND QUANTITY January February Quantity Sold 95,000 Price $7.20 91,500 $8.00 Ecn2802 Lecture 4 March April May 95,000 $7.70 90,000 $8.00 91,000 $8.20 33 PLOT OF HISTORICAL DATA ON PRICE AND QUANTITYA Average Price $8.20 8.00 T April May r 7.80 Feb. s March 7.60 7.40 Jan. 7.20 7.00 0 T 90 91 92 93 94 95 96 Quantity Demanded in Thousands Ecn2802 Lecture 4 97 98 34 PLOT OF HISTORICAL DATA AND TRUE DEMAND CURVES FOR JANUARY, FEBRUARY, AND MARCH Average Price $8.20 T F 8.00 r 7.80 Feb. w s M March M 7.60 F j 7.40 7.20 Jan. J 7.00 T 0 90 91 92 93 94 95 96 Quantity Demanded in Thousands Ecn2802 Lecture 4 97 98 35 Supply If a firm supplies a good or service, then the firm: Has the resources and the technology to produce it, Can profit from producing it, and Has made a definite plan to produce and sell it. Ecn2802 Lecture 4 36 Resources and technology determine what it is possible to produce. Supply reflects a decision about which technologically feasible items to produce. 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. Ecn2802 Lecture 4 37 What Determines Selling Plans? The amount of any particular good or service that a firm plans to supply is influenced by 1. The price of the good, 2. The prices of resources needed to produce it, 3. The prices of related goods produced, 4. Expected future prices, 5. The number of suppliers, and 6. Available technology. Ecn2802 Lecture 4 38 The Law of Supply Other things remaining the same, the higher the price of a good, the greater is the quantity supplied. The law of supply results from the general tendency for the marginal cost of producing a good or service to increase as the quantity produced increases. Producers are willing to supply only if they at least cover their marginal cost of production. Ecn2802 Lecture 4 39 Supply Curve and Supply Schedule The term supply refers to the entire relationship between the quantity supplied and the price of a good. The supply curve shows the relationship between the quantity supplied of a good and its price when all other influences on producers’ planned sales remain the same. Ecn2802 Lecture 4 40 Price Quantity (dollars per disc) (millions per week) A 0.50 0 B 1.00 3 C 1.50 4 D 2.00 5 E 2.50 6 Ecn2802 Lecture 4 41 Figure 3.4 shows a supply curve of recordable compact discs (CD­Rs). A rise in the price, other things remaining the same, brings an increase in the quantity supplied and a movement along the supply curve. Ecn2802 Lecture 4 42 A supply curve is also a minimum­supply­ price curve. The greater the quantity produced, the higher is the price that a firm must be offered to be willing to produce that quantity. Ecn2802 Lecture 4 43 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 of that good. The quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve. When supply increases, the quantity that producers plan to sell increases at each and every price so the supply curve shifts rightward. When supply decreases, the quantity that producers plan to sell decreases at each and every price so the supply curve shifts leftward. Ecn2802 Lecture 4 44 The factors that change supply: Prices of relevant resources If the price of resource used to produce a good rises, the minimum price that a supplier is willing to accept for producing each quantity of that good rises. So a rise in the price of productive resources decreases supply and shifts the supply curve leftward. Ecn2802 Lecture 4 45 Examples: The rise of jet fuel in 2001 decreased the supply of air transportation. A rise in the minimum wage decreases the supply of hamburgers. Ecn2802 Lecture 4 46 Prices of related goods produced A substitute in production for a good is another good that can be produced using the same resources. Goods are complements in production if they must be produced together. The supply of a good increases and its supply curve shifts rightward if the price of a substitute in production falls or if the price of a complement in production rises. Ecn2802 Lecture 4 47 Examples: Dairy farms sell products other thanmilk. If cheese prices rise sharply, farmers may decide to use some raw milk to make cheese, thereby reducing milk supplied (supply curve shifts inward) Suppose the price of beef goes up, which increases the meat supplied. In turn, that will raise the number of cowhides. (outward shift) Ecn2802 Lecture 4 48 Expected future prices If the price of a good is expected to fall in the future, current supply increases and the supply curve shifts rightward. Ecn2802 Lecture 4 49 The number of suppliers The larger the number of suppliers of a good, the greater is the supply of the good. An increase in the number of suppliers shifts the supply curve rightward. Ecn2802 Lecture 4 50 Example: Over the past two years, there has been a huge increase in the number of firms that design and manage Web sites. As a result, the supply of Internet and World Wide Web services has increased enormously. Ecn2802 Lecture 4 51 Technology Advances in technology create new products and lower the cost of producing existing products, so they increase supply and shift the supply curve rightward. Ecn2802 Lecture 4 52 Example: The use of new technologies in the Taiwan factories that make CD­Rs for Imation Enterprises Corp., a Minnesota based firm, have lowered the cost of producing a CD­R and increased its supply. Ecn2802 Lecture 4 53 Figure 3.5 shows how an advance in the technology for producing recordable CDs increases the supply of CD­Rs and shifts the supply curve for CD­Rs rightward. Ecn2802 Lecture 4 54 A Change in the Quantity Supplied Versus a Change in Supply Figure 3.6 illustrates the distinction between a change in supply and a change in the quantity supplied. Ecn2802 Lecture 4 55 When the price of the good changes and other influences on selling plans remain the same, there is a change in the quantity supplied and a movement along the supply curve. Ecn2802 Lecture 4 56 When one of the other factors that influence selling plans changes, there is a change in supply and a shift of the supply curve. Ecn2802 Lecture 4 57 Exercises In the market for SUVs, several events occur one at a time. Explain the influence of each event on the quantity supplied of SUVs and the supply of SUVs. Illustrate the effects of each event by either a movement along the supply curve or a shift of the supply curve of SUVs, and say which event (or events) illustrates the law of supply in action. The events are: Ecn2802 Lecture 4 58 The price of a truck rises. The price of an SUV falls. The price of an SUV is expected to fall next year. An SUV engine defect requires a huge and costly manufacturer's recall to replace the defective engines. A new robot technology lowers the cost of producing SUVs. Ecn2802 Lecture 4 59 Market Equilibrium Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers. 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 the equilibrium price. Price regulates buying and selling plans. Price adjusts when plans don’t match. Ecn2802 Lecture 4 60 Example: Demand and supply schedule Price ($) Quantity Quantity Demanded supplied Millions of discs per week Shortage/(­) /surplus (+) 0.50 9 0 ­9 1.00 6 3 ­3 1.50 4 4 0 2.00 3 5 +2 2.50 2 6 +3 Ecn2802 Lecture 4 61 Price as a Regulator Figure 3.7 illustrates the equilibrium price and equilibrium quantity in the market for CD­Rs. If the price of a disc is $2, the quantity supplied exceeds the quantity demanded and there is a surplus of discs. Ecn2802 Lecture 4 62 If the price of a disc is $1, the quantity demanded exceeds the quantity supplied and there is a shortage of discs. If the price of a disc is $1.50, the quantity demanded equals the quantity supplied and there is neither a shortage nor a surplus of discs. Ecn2802 Lecture 4 63 Price Adjustments At prices above the equilibrium, a surplus forces the price down. At prices below the equilibrium, a shortage forces the price up. At the equilibrium price, buying plans and selling plans agree and the price doesn’t change. Ecn2802 Lecture 4 64 Because the price rises if it is below equilibrium, falls if it is above equilibrium, and remains constant if it is at the equilibrium, the price is pulled toward the equilibrium and remains there until some event changes the equilibrium. Ecn2802 Lecture 4 65 Predicting Changes in Price and Quantity A Change in Demand An increase in demand shifts the demand curve rightward and creates a shortage at the original price. The price rises and the quantity supplied increases. Ecn2802 Lecture 4 66 A Change in Supply An increase in supply shifts the supply curve rightward and creates a surplus at the original price. The price falls and the quantity demanded increases. Ecn2802 Lecture 4 67 A Change in Both Demand and Supply A change in both demand and supply changes the equilibrium price and the equilibrium quantity, but we need to know the relative magnitudes of the changes to predict some of the consequences. Ecn2802 Lecture 4 68 Figure 3.10 shows the effects of a change in both demand and supply in the same direction. An increase in both demand and supply increases the equilibrium quantity but has an uncertain effect on the equilibrium price. Ecn2802 Lecture 4 69 Figure 3.11 shows the effects of a change in both demand and supply when they change in opposite directions. An increase in supply and a decrease in demand lowers the equilibrium price but has an uncertain effect on the equilibrium quantity. Ecn2802 Lecture 4 70 Mathematical Note Given demand and supply function, can you find out the equilibrium price and quantity? Ecn2802 Lecture 4 71 End of Chapter 3 Ecn2802 Lecture 4 72 ...
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This note was uploaded on 12/22/2011 for the course ACCOUNTING 0122008006 taught by Professor Muliady during the Spring '08 term at Universitas Pelita Harapan.

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lect04 - Chapter 4 Demand and Supply Ecn2802 Lecture 4 1...

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