Ch. 4 - Supply and Demand in Market Economies We look for...

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Unformatted text preview: Supply and Demand in Market Economies We look for the answers to these questions: Material in Mankiw Ch. 4 What factors affect buyers’ demand for goods? What factors affect sellers’ supply of goods? How do supply and demand determine the price of HW 1 due 2/5 HW 2 due 2/12 HW 3 due 2/19 Yunfei Cao Office Hours Wed. 3-4 Mon. 3-3:30 a good and the quantity sold? How do changes in the factors that affect demand or supply affect the market price and quantity of a good? How do markets allocate resources? Price of good is determined by supply and demand Buying side of market ("preferences') Markets and Competition Recall that a market is a group of buyers and sellers of a particular product. A competitive market is one with many buyers and sellers, each has a negligible effect on price. A perfectly competitive market: • all goods exactly the same • buyers & sellers so numerous that no one can affect market price – each is a “price taker” For now, we assume markets are perfectly competitive. large markets - so many buyers and sellers so it's hard to be "one" buyer or seller. Neither is big enough to set/bid price by themselves each decision of buyers and sellers is negliglble, drop in the bucket Demand Demand comes from the behavior of buyers. The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. An important determinant of the quantity demanded of a good is its price. quantity demanded is determined by its price Example: Helen’s Demand Schedule Demand Price of lattes demanded of a good falls when the price of the good rises, other things equal. (i.e. the demand curve is downward sloping) 10 4.00 8 5.00 6 6.00 “Law” of demand: the claim that the quantity 12 3.00 relationship. 14 2.00 A demand curve is a graph showing the same 16 1.00 relationship between the price of a good and the quantity demanded. Quantity of lattes demanded $0.00 A demand schedule a table that shows the 4 Notice that Helen’s preferences obey the Law of Demand. Law of Graphing Always! This is standard convention When graphing demand (or supply) curves • quantity demanded (supplied) is always placed • on the horizontal axis x- axis price is always placed on the vertical axis y- axis Example: Helen’s Demand Schedule & Curve Price Quantity of of lattes lattes demanded $0.00 16 1.00 14 2.00 12 3.00 10 4.00 8 5.00 6 6.00 4 Price of Lattes $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 Quantity 15 of Lattes Unrealistic because slope is constant, and you can't order "part" of a latte 0 5 10 The Market Demand Curve for Lattes Market Demand versus Individual Demand The quantity demanded in the market is the sum of the quantities demanded for all buyers at each price. Suppose Helen and Ken are the only two buyers in the Latte market. (Qd = quantity demanded) Ken’s Qd Market Qd P Qd (Market) $0.00 24 $5.00 1.00 21 $4.00 2.00 18 3.00 15 4.00 12 5.00 9 6.00 6 P $6.00 Price Helen’s Qd $0.00 16 + 8 = 24 1.00 14 + 7 = 21 2.00 12 + 6 = 18 3.00 10 + 5 = 15 $1.00 4.00 8 + 4 = 12 $0.00 5.00 6 + 3 = 9 6.00 4 + 2 = 6 Demand Curve Shifters The demand curve shows how price affects quantity demanded, other things being equal. These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price). Changes in them shift the demand curve. $3.00 $2.00 Q 0 5 10 15 20 25 Demand Curve Shifters An increase in demand causes a rightward shift of the curve. A decrease causes a leftward shift. Law of Graph Reading: changes in variables that are on the axes of the graph cause movements along the curve; changes in relevant variables that are not on the axes will cause shifts of the curve. ↑ Demand causes RIGHTward shift (→) ↓ Demand causes LEFTward shift (←) (refers to ENTIRE curve) Example Demand Curve Shifters: # of buyers Raising taxes (hence the price) on cigarettes decreases their by causing a movement along the demand curve.change in price (on axis) Qd Health warnings on packages and prohibitions An increase in the number of buyers causes an increase in quantity demanded at each price, which shifts the demand curve to the right. demand increased, so shifted toward right on certain kinds of advertising aim to cause a reduction in Qd by causing a leftward shift in the curve. change in demand (rel. var.) Demand Curve Shifters: # of buyers Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example). P $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 Q 0 5 10 15 20 25 30 parallel shift, but not exactly realistic Demand Curve Shifters: income Demand for a normal good is positively related to income. • An increase in income causes increase in quantity demanded at each price, shifting the D curve to the right. (Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.) ↑ income for normal good = ↑ in Qd = shift RIGHT ↑ income for inferior good = ↓ in Qd = shift LEFT Demand Curve Shifters: prices of related goods Two goods are substitutes if an increase in the price of one causes an increase in demand for the other. Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right. Other examples: Coke and Pepsi, laptops and desktop computers, compact discs and music downloads ↑ in price of one good CAUSES ↑ in demand for another then, they are SUBSTITUTES Demand Curve Shifters: prices of related goods Two goods are complements if an increase in the price of one causes a fall in demand for the other. Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left. Other examples: cell phones and calling plans, cars and tires, cameras and film ↑ in price of one good CAUSES ↓ in demand for another then, they are COMPLEMENTS Demand Curve Shifters: tastes (preferences) Demand Curve Shifters: expectations Anything that causes a shift in tastes toward a Expectations affect consumers’ buying good will increase demand for that good and shift its D curve to the right. Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right. Shift in tastes TOWARD a good CAUSES ↑ in demand for that good decisions. Examples: • If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now. • If people worry about their future job security, demand for new autos may fall now. Expectations can demand Summary: Variables That Affect Demand A change in this variable… Variable Example: Demand for Online Music Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why? Price …causes a movement along the D curve No. of buyers …shifts the D curve Income …shifts the D curve A. The price of iPods falls Price of related goods …shifts the D curve B. The price of music downloads falls Tastes …shifts the D curve Expectations …shifts the D curve Example: Demand for Online Music A. price of iPods falls Music downloads and iPods are complements. Price of music downloads A fall in price of iPods shifts the demand curve for music downloads to the right. P1 D1 Q1 Q2 C. The price of compact discs falls Example: Demand for Online Music B. price of music downloads falls Price of music downloads The D curve does not shift. Move down along curve to a point with lower P, higher Q. P1 P2 D2 Quantity of music downloads D1 Q1 Q2 Quantity of music downloads Example: Demand for Online Music C. price of CDs falls Supply comes from the behavior of sellers. CDs and music downloads are substitutes. Price of music downloads A fall in price of CDs shifts demand for music downloads to the left. P1 D2 Q2 Q1 Supply The quantity supplied of any good is the amount of the good that sellers are willing and able to sell. An important determinant of the quantity supplied of a good is its price. D1 Quantity of music downloads Supply A supply schedule a table that shows the relationship between the price of a good and the quantity supplied. A supply curve is a graph showing the same relationship. Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal. (i.e. the supply curve is upward sloping) ↑ price of good, then ↑ quantity supplied The Supply Schedule Price of lattes Quantity of lattes supplied $0.00 0 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 Notice that Starbucks’ supply schedule obeys the Law of Supply. Starbucks’ Supply Schedule & Curve Price of lattes $0.00 1.00 2.00 3.00 4.00 5.00 6.00 P $6.00 $5.00 Quantity of lattes supplied 0 3 6 9 12 15 18 $2.00 $1.00 10 15 again, not realistic because you can't get part of a latte P $0.00 0 1.00 5 2.00 10 $4.00 3.00 15 $3.00 4.00 20 $2.00 5.00 25 6.00 30 P $6.00 $5.00 $1.00 $0.00 Q 10 15 20 25 30 (Qs = quantity supplied) Price Starbucks Jitters Market Qs $0.00 0 + 0 = 0 1.00 3 + 2 = 5 2.00 6 + 4 = 10 3.00 9 + 6 = 15 12 + 8 = 20 15 + 10 = 25 18 + 12 = 30 Supply Curve Shifters QS (Market) 5 sellers in this market. Qs in market is the sum of Qs supplied by all sellers at each price The Market Supply Curve 0 Suppose Starbucks and Jitters are the only two 6.00 Q 5 the quantities supplied by all sellers at each price. 5.00 $3.00 0 The quantity supplied in the market is the sum of 4.00 $4.00 $0.00 Market Supply versus Individual Supply 35 The supply curve shows how price affects quantity supplied, other things being equal. These “other things” are non-price determinants of supply. Changes in them shift the supply curve. Supply Curve Shifters: input prices Supply Curve Shifters: input prices Examples of input prices: wages, prices of raw materials. A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right. ↓ input prices = ↑ profit margin = ↑ supply at each price Curve shifts → Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example). P $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 Q 0 Supply Curve Shifters: technology Technology determines how much inputs are required to produce a unit of output. A cost-saving technological improvement has same effect as a fall in input prices, shifts the S curve to the right. increases rate of input to output (efficiency) better technology = same effect as lower input prices shifts curve to ➞ 5 10 15 20 25 30 35 Supply Curve Shifters: # of sellers An increase in the number of sellers increases the quantity supplied at each price, shifts the S curve to the right. ↑ in sellers = ↑ of supply at each price shifts curve to ➞ Supply Curve Shifters: expectations Suppose a firm expects the price of the good it Summary: Variables That Affect Supply A change in this variable… Variable The firm may reduce supply now, to save some of its inventory to sell later at the higher price. This would shift the S curve leftward. during recessions it is common for companies to increase their inventories (stock up) causes leftward shift TODAY in hopes of selling at higher price later Example: Supply of TurboTax Deluxe Edition Draw a supply curve for the tax return preparation software TurboTax. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost. C. Professional tax return preparers raise the price of the services they provide. Price …causes a movement along the S curve Input prices …shifts the S curve Technology …shifts the S curve No. of sellers sells to rise in the future. …shifts the S curve Expectations …shifts the S curve Example: Supply of TurboTax A. fall in price of tax return software Price of tax return software S1 The S curve does not shift. Move down along the curve to a lower P and lower Q. P1 P2 Q2 Q1 Quantity of tax return software Example: Supply of TurboTax B. fall in cost of producing the software Price of tax return software S1 The S curve shifts to the right: S2 P1 Example: Supply of TurboTax C. professional preparers raise their price Price of tax return software S1 at each price, Q increases. Q1 Q2 Quantity of tax Quantity of tax return software return software Supply and Demand Together $6.00 P This shifts the demand curve for tax preparation software, not the supply curve. D S $5.00 $4.00 $3.00 Equilibrium: a situation in which demand and supply are in balance. Equilibrium price: The price that equates quantity supplied with quantity demanded P S D $6.00 P QD QS $5.00 $0 24 0 $4.00 1 21 5 $3.00 2 18 10 3 15 15 4 12 20 5 9 25 6 6 30 $2.00 $2.00 $1.00 $1.00 $0.00 $0.00 Q 0 5 10 15 20 25 30 35 Q 0 5 10 15 20 25 30 35 Equilibrium quantity: The quantity supplied and quantity demanded at the equilibrium price P S D $6.00 P QD QS $5.00 $0 24 0 $4.00 1 21 5 $3.00 2 18 10 3 15 12 20 5 9 25 6 6 At the equilibrium price buyers can buy all that they want, sellers can sell all that they want. For this reason the equilibrium price is sometimes called the “market clearing” price. 15 4 Equilibrium 30 $2.00 $1.00 $0.00 Q 0 5 10 15 20 25 30 35 Surplus: when quantity supplied is greater than quantity demanded P Example: S D Surplus $6.00 If P = $5, $5.00 then QD = 9 lattes $4.00 $3.00 and QS = 25 lattes $2.00 resulting in a surplus of 16 lattes Q $1.00 $0.00 0 5 10 15 20 25 30 35 Surplus: when quantity supplied is greater than quantity demanded P S Facing a surplus, D Surplus $6.00 sellers try to increase $5.00 sales by cutting the price. $4.00 This causes QD to rise and QS to fall… $3.00 …which reduces the surplus. $2.00 $1.00 $0.00 Q 0 5 10 15 20 25 30 35 Surplus: when quantity supplied is greater than quantity demanded P Facing a surplus, S D Surplus $6.00 sellers try to increase $5.00 sales by cutting the price. $4.00 Falling prices cause QD to rise and QS to fall. $3.00 Prices continue to fall until market reaches equilibrium. $2.00 $1.00 $0.00 Q 0 5 $5.00 $4.00 $3.00 $2.00 Q 5 10 15 20 25 30 35 5 Q 10 15 20 25 30 35 Shortage: when quantity demanded is greater than quantity supplied P Facing a shortage, S D $6.00 sellers raise the price, $5.00 causing QD to fall and QS to rise. $4.00 Prices continue to rise until market reaches equilibrium. $3.00 $2.00 $1.00 Shortage $0.00 Shortage 0 causing QD to fall and QS to rise, …which reduces the shortage. 0 $0.00 10 15 20 25 30 35 Shortage: when quantity demanded is greater than quantity supplied P Facing a shortage, S D $6.00 sellers raise the price, $1.00 Shortage: when quantity demanded is greater than quantity supplied P Example: S D $6.00 If P = $1, $5.00 then $4.00 QD = 21 lattes and $3.00 QS = 5 lattes $2.00 resulting in a $1.00 shortage of 16 lattes Shortage $0.00 Q 0 5 10 15 20 25 30 35 Three Steps to Analyzing Changes in Eqbm EXAMPLE: The Market for Hybrid Cars P price of hybrid cars To determine the effects of any event, S1 1. Decide whether event shifts S curve, D curve, or both. P1 2. Decide in which direction curve shifts. 3. Use supply-demand diagram to see how the shift changes eq’m P and Q. D1 Q Q1 quantity of hybrid cars EXAMPLE 1: A Change in Demand EVENT TO BE ANALYZED: D curve shifts because price of gas STEP 2: affects demand for D shifts right hybrids. because high gas STEP 3: Srice makes hybrids p curve does not The shift,shift causes an more because price attractive increase in price oelative to other cars. f gas does not r nd quantity affect cost of of hroducing hybrids. p ybrid cars. Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted. P Increase in price of gas. STEP 1: EXAMPLE 1: A Change in Demand S1 P2 P1 D1 Q1 Q2 D2 Q Always be careful to distinguish b/w a shift in a curve and a movement along the curve. P S1 P2 P1 D1 Q1 Q2 D2 Q Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve EXAMPLE 2: A Change in Supply EVENT: New technology P reduces cost of producing hybrid cars. Change in the quantity supplied: a movement along a fixed S curve S1 S2 STEP 1: S curve shifts because event affects P1 STEP 2: cost of production. P2 S shifts right Decausedoes not curve event b TEP 3: S seduces cost, r hift, because The shift causes production technology makes production price one of imore to fall theat s not profitable and quantity to rise. factors that affect any given price. demand. Change in demand: a shift in the D curve Change in the quantity demanded: a movement along a fixed D curve D1 Q Q1 Q2 EXAMPLE 3: A Change in Both Supply EXAMPLE 3: A Change in Both Supply EVENTS: price of gas rises AND new technology reduces production costs EVENTS: price of gas rises AND new technology reduces production costs and Demand STEP 1: Both curves shift. STEP 2: and Demand P S1 S2 P2 STEP 3, cont. P1 But if supply increases more than demand, P falls. Both shift to the right. STEP 3: Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises. D1 Q1 Q2 D2 Q P S1 S2 P1 P2 D1 Q1 Q2 D2 Q Practice: Practice: Changes in supply and demand A. fall in price of CDs Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads. P The market for music downloads S1 STEPS Event A: A fall in the price of compact discs 1. D curve shifts P1 Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. 2. D shifts left P2 3. P and Q both fall. D2 Event C: Events A and B both occur. Q2 Q1 Practice: Practice: B. fall in cost of royalties P S1 STEPS 1. S curve shifts S2 STEPS 1. Both curves shift (see parts A & B). P1 2. S shifts right C. fall in price of CDs AND fall in cost of royalties The market for music downloads P2 2. D shifts left, S shifts right. 3. P falls, Q rises. D1 Q1 Q2 Q 3. P unambiguously falls. Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q. D1 Q CONCLUSION: How Prices Allocate Resources One of the seven principles : Markets are usually a good way to organize economic activity. SUMMARY A competitive market has many buyers and sellers, each of whom has little or no influence on the market price. In market economies, prices adjust to balance Economists use the supply and demand model to supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources. The downward-sloping demand curve reflects the SUMMARY Besides price, demand depends on buyers’ incomes, tastes, expectations, the prices of substitutes and complements, and # of buyers. If one of these factors changes, the D curve shifts. The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the good’s price. Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve. analyze competitive markets. Law of Demand, which states that the quantity buyers demand of a good depends negatively on the good’s price. CHAPTER SUMMARY The intersection of S and D curves determine the market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded. If the market price is above equilibrium, a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise. CHAPTER SUMMARY We can use the supply-demand diagram to analyze the effects of any event on a market: First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one. In market economies, prices are the signals that guide economic decisions and allocate scarce resources. ...
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This note was uploaded on 02/14/2012 for the course NUBITRY 3304 taught by Professor Various during the Spring '01 term at Albertus Magnus.

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