Chapter 3 Supply, Demand & Price 1 Part I –Supply & Demand Part II –Market Price

Chapter 3 Supply, Demand & Price 2 Part I Supply & Demand

Chapter 3 Supply, Demand & Price 3 Learning Objectives Market as the Invisible Hand Money Price vs. Relative Price Determination of Market Price

Chapter 3 Supply, Demand & Price 4 Learning Objectives Market as the Invisible Hand Money Price vs. Relative Price Determination of Market Price

Father of Economics Adam Smith ( )

Father of Economics An Inquiry into the Nature and Causes of The Wealth of Nations (1776)

Chapter 3 Supply, Demand & Price 7 Market as the Invisible Hand The market is the ‘invisible hand’ that guides the human behaviours, which are motivated by self-interest, to obtain the social good.

Father of Economics 2 online sources of the “Wealth of Nations”: 1. /Smith/Wealth/index.html /Smith/Wealth/index.html 2. org/reference/archive/smith/works/wea lth-of-nations/index.htm org/reference/archive/smith/works/wea lth-of-nations/index.htm

Chapter 3 Supply, Demand & Price 9 Learning Objectives Market as the Invisible Hand Money Price vs. Relative Price Determination of Market Price

Question What is ‘price’?

Chapter 3 Supply, Demand & Price 11 Money Price vs. Relative Price Price is physical exchange rate of one good for another. Price is also known as the relative price.

Chapter 3 Supply, Demand & Price 12 Money Price vs. Relative Price There are 2 common names of price: 1.Money price 2.Relative price Money Price is the price of a good measured in terms of a dollar.

Price (Relative Price) Money Price

Question Suppose that the price of an apple is $10 and the price of an orange is $5. a) What is the money price and relative price of an apple and an orange? b) If inflation causes the prices of both apples and oranges to double, what are the changes in money and relative prices of apples and oranges?

Chapter 3 Supply, Demand & Price 15 Learning Objectives Market as the Invisible Hand Money Price vs. Relative Price Determination of Market Price

Chapter 3 Supply, Demand & Price 16 Determination of Market Price The market price is determined by the market demand and market supply.

0 Apples (kg per week) P Q Demand Price ($ per unit) Supply Q D = Q S P* Market price

Chapter 3 Supply, Demand & Price 18 Learning Objectives Market Demand Factors Affecting Demand Change in Demand Vs. Change in Quantity Demanded

Chapter 3 Supply, Demand & Price 19 Learning Objectives Market Demand Factors Affecting Demand Change in Demand Vs. Change in Quantity Demanded

0 Apples (kg per week) P Q Market demand Price ($ per unit)

Chapter 3 Supply, Demand & Price 21 Market Demand A demand curve is a curve showing the relationship between the ‘price’ and the ‘quantity demanded’ of a good over a specific time period, given a constant level of other determinants.

0 Apples (kg per week) P Q Market demand Price ($ per unit) Price Quantity demanded

Chapter 3 Supply, Demand & Price 23 Market Demand 2 types of demand curves: –Market demand curve –Individual demand curve

Chapter 3 Supply, Demand & Price 24 Market Demand Market demand curve is the demand curve for the whole market. Individual demand curve is the demand curve for a single person.

Digression 2 general variables: 1. Stock variable 2. Flow variable

Digression A stock is a quantity of something held at a specific point of time. Examples… A flow is an increase or a decrease in quantity over a specific period of time. Examples…

Question  Interest  Distance Flow Stock   DepositsVelocity

Price of apples ($ per unit) Quantity of apples (kg per week) A demand schedule

Chapter 3 Supply, Demand & Price 29 Market Demand 2 confusing terms: 1.Demand 2.Quantity demanded

Chapter 3 Supply, Demand & Price 30 Market Demand The term ‘demand’ refers to the whole demand curve or demand schedule. Quantity demanded is the amount of a good that a consumer is willing and able to buy at a given price over a given period of time.

0 Apples (kg per week) P Q Market Demand Price ($ per unit) the quantity demanded of apple when the price is $8.

0 Apples (kg per week) P Q Market Demand Price ($ per unit) the quantity demanded of apple when the price is $2.

Question Why is the market demand curve downward sloping?

Chapter 3 Supply, Demand & Price 34 Market Demand Law of demand states that there is an inverse relationship between the price and quantity demanded, keeping all other things constant.

Question Is a demand curve necessarily downward sloping?

Chapter 3 Supply, Demand & Price 36 Learning Objectives Market Demand Factors Affecting Demand Change in Demand Vs. Change in Quantity Demanded

Chapter 3 Supply, Demand & Price 37 Factors Affecting Demand Factors affecting demand: 1.Tastes 2.Number of consumers 3.Price of substitute goods 4.Price of complementary goods 5.Income 6.Expectations of future price changes

fallsrises2.No. of consumers less preferablemore preferable1.Taste Decrease in DemandIncrease in Demand

Decrease in Demand 1.Tastemore preferableless preferable 2.No. of consumersrisesfalls 3.Price of substitute goods 4.Price of complementary goods

Chapter 3 Supply, Demand & Price 40 Factors Affecting Demand Substitutes are goods that are considered to be alternatives to each other. Complementary goods are goods that are consumed together.

risesfalls 4.Price of complementary goods fallsrises 3.Price of substitute goods fallsrises2.No. of consumers less preferablemore preferable1.Taste Decrease in DemandIncrease in Demand

Decrease in Demand 1.Tastemore preferableless preferable 2.No. of consumersrisesfalls 3.Price of substitute goods risesfalls 4.Price of complementary goods fallsrises 5.Income Normal good Inferior good

Chapter 3 Supply, Demand & Price 43 Factors Affecting Demand Normal goods are goods whose demand rises as people’s income rises. Inferior goods are goods whose demand falls as people's income rises.

fallsrisesNormal good Inferior goodrisesfalls 5.Income risesfalls 4.Price of complementary goods fallsrises 3.Price of substitute goods fallsrises2.No. of consumers less preferablemore preferable1.Taste Decrease in DemandIncrease in Demand

fallsrisesNormal good Inferior goodrisesfalls 5.Income risesfalls 4.Price of complementary goods fallsrises 6.Expectations of future price changes fallsrises 3.Price of substitute goods fallsrises2.No. of consumers less preferablemore preferable1.Taste Decrease in DemandIncrease in Demand

A General Demand Function Quantity demanded Expectations of future price changes Price Income Price of complementary goods Price of substitute goods No. of consumers Tastes

Chapter 3 Supply, Demand & Price 47 Learning Objectives Market Demand Factors Affecting Demand Change in Demand Vs. Change in Quantity Demanded

Chapter 3 Supply, Demand & Price 48 Change in Demand Vs. Change in Quantity Demanded Change in ‘P’ causes a movement along the demand curve. Change in ‘all other factors’ except ‘P’ causes the demand curve to shift.

0 Change in quantity demanded P Q Movement along the demand curve 0 Change in demand P Q Shifting of demand curve Demand

Question Draw a diagram that shows the relationship between income (I) and quantity demanded (Q d ) of apple that assumed to be a normal good.

0 Apples (kg per week) I Q Income ($ per period)

0 Apples (kg per week) I Q Income ($ per period) a

Question What would happen to the curve if the price of apple falls?

0 Apples (kg per week) I Q Income ($ per period) a b I1I1 Q1Q1 Q1’Q1’ Q2’Q2’ I2I2 Q2Q2

Chapter 3 Supply, Demand & Price 55 Learning Objectives Market Supply Factors Affecting Supply Change in Supply Vs. Change in Quantity Supplied

Chapter 3 Supply, Demand & Price 56 Learning Objectives Market Supply Factors Affecting Supply Change in Supply Vs. Change in Quantity Supplied

0 Apples (kg per week) P Q Price ($ per unit) Market supply

Chapter 3 Supply, Demand & Price 58 Market Supply A supply curve is a curve showing the relationship between the ‘price’ and the ‘quantity supplied’ of a good over a specific time period, given a constant level of other determinants.

0 Apples (kg per week) P Q Price ($ per unit) Price Quantity suplied Market supply

Chapter 3 Supply, Demand & Price 60 Market Supply 2 types of supply curves: –Market supply curve –Individual supply curve

Chapter 3 Supply, Demand & Price 61 Market Supply Market supply curve is the supply curve for the whole market. Individual supply curve is the supply curve for a single person.

Price of apples ($ per unit) Quantity of apples (kg per week) A supply schedule

Chapter 3 Supply, Demand & Price 63 Market Supply 2 confusing terms: 1.Supply 2.Quantity supplied

Chapter 3 Supply, Demand & Price 64 Market Supply The term ‘supply’ refers to the whole supply curve or supply schedule. Quantity supplied is the amount of a good that a seller is willing to sell at a given price over a given period of time.

0 Apples (kg per week) P Q Price ($ per unit) the quantity supplied of apple when the price is $2. Market supply

0 Apples (kg per week) P Q Price ($ per unit) the quantity demanded of apple when the price is $8. Market supply

Question Why is the market supply curve upward sloping?

Chapter 3 Supply, Demand & Price 68 Market Supply Law of increasing costs states that when an economy applies more and more resources to the production of any specific good, the marginal cost of production of that good increases.

Chapter 3 Supply, Demand & Price 69 Learning Objectives Market Supply Factors Affecting Supply Change in Supply Vs. Change in Quantity Supplied

Chapter 3 Supply, Demand & Price 70 Market Supply Factors affecting supply: 1.Costs of production 2.Number of suppliers 3.Expectations of future profitability

fallsrises 3.Expectations of future profitability fallsrises2.No. of suppliers increase in costdecrease in cost1.Costs of production Decrease in SupplyIncrease in Supply

A General Supply Function Quantity supplied Expectations of future profitability Price No. of suppliers Costs of Production

Chapter 3 Supply, Demand & Price 73 Learning Objectives Market Supply Factors Affecting Supply Change in Supply Vs. Change in Quantity Supplied

Chapter 3 Supply, Demand & Price 74 Change in Demand Vs. Change in Quantity Supplied Change in ‘P’ causes a movement along the supply curve. Change in ‘all other factors’ except ‘P’ causes the supply curve to shift.

0 Change in quantity supplied P Q 0 Change in supply P Q Supply Movement along the supply curve Shifting of supply curve

Chapter 3 Supply, Demand & Price 76 Learning Objectives Market Equilibrium Change in Equilibrium Price and Quantity

Chapter 3 Supply, Demand & Price 77 Learning Objectives Market Equilibrium Change in Equilibrium Price and Quantity

Chapter 3 Supply, Demand & Price 78 Market Equilibrium Market equilibrium refers to a situation where all participants in the market have no tendency to change their behaviour. It is also graphically defined as the intersection point of the supply and demand curves at the point which the quantity demanded is equal to the quantity supplied.

0 Apples (kg per week) P Q Demand Price ($ per unit) Supply Q D = Q S Equilibrium

Question What happens when a market is not at equilibrium?

Chapter 3 Supply, Demand & Price 81 Market Equilibrium When a market is not at equilibrium, the market price will change and so as the quantity of goods transacted.

0 P Q D S Q* P* QdQd QsQs P Excess quantity demanded Market equilibrium price or market clearing price

0 P Q D S Q* P* QsQs QdQd P Excess quantity supplied Market equilibrium price or market clearing price

Question What is the market equilibrium condition?

Chapter 3 Supply, Demand & Price 85 Learning Objectives Market Equilibrium Change in Equilibrium Price and Quantity

Question What will make the equilibrium price and quantity change?

Chapter 3 Supply, Demand & Price 87 Change in Equilibrium Price and Quantity Any changes in the determinants of the demand and supply, except price, will shift the demand and supply curves respectively, and will cause the equilibrium price and quantity to change.

0 P Q D2D2 S Q** P** Q* P* Excess quantity demanded D1D1 Example of an increase in demand

0 P Q D S2S2 Q** P** Q* P* Excess quantity supplied S1S1 Example of an increase in supply

Question How can we confirmed that market equilibrium is attained in a market in real life?

Chapter 3 Supply, Demand & Price 91 Change in Equilibrium Price and Quantity In reality, the equilibrium state cannot be observed, it is only assumed to exist by economists. When there is sufficient evidence to show that the factors determining the market demand and supply will not change, then economists assume that the market equilibrium has been reached.

Chapter 3 Supply, Demand & Price 92 Part II Market Price

Chapter 3 Supply, Demand & Price 93 Learning Objectives Functions of Price Price Adjustments & Flexibility Price Controls

Chapter 3 Supply, Demand & Price 94 Learning Objectives Functions of Price Price Adjustments & Flexibility Price Controls

Chapter 3 Supply, Demand & Price 95 Functions of Price There are 2 major functions of price: 1.Criterion of competition 2.Transmitting market information

Chapter 3 Supply, Demand & Price 96 Functions of Price Because of the existence of scarcity, those people who are able and willing to pay the price will get the good or services.

Chapter 3 Supply, Demand & Price 97 Functions of Price There are 2 major functions of price: 1.Criterion of competition 2.Transmitting market information

Increase in demand Increase in market price Increase in production Consumer Producer Market Decrease in consumption Increase in market price Increase in cost of production

Chapter 3 Supply, Demand & Price 99 Functions of Price The adjustments of an ‘ideal’ market mechanism do not require that consumers and sellers consider the welfare of each other. They act only according to their self-interests.

Question What is the key element of the market mechanism?

Chapter 3 Supply, Demand & Price 101 Learning Objectives Functions of Price Price Adjustments & Flexibility Price Controls

Question What will cause a change in market price?

Chapter 3 Supply, Demand & Price 103 Price Adjustments & Flexibility The market price is not always flexible, the flexibility (or rigidity) of it depends on: –the cost of price adjustments –market intervention.

Chapter 3 Supply, Demand & Price 104 Price Adjustments & Flexibility The lower the cost of price adjustment, the more frequent of adjusting price according to the changes in demand and supply.

Example Will a restaurant change it’s menu prices at different hours of a day?

Question How can the excess quantity demanded or supplied be solved when the price is not flexible.

Chapter 3 Supply, Demand & Price 107 Price Adjustments & Flexibility One of the common way to solve an excess quantity demanded when the price is not flexible is ‘waiting’. ‘Waiting’ is a form of non-price competition which serves the rationing purpose.

Chapter 3 Supply, Demand & Price 108 Price Adjustments & Flexibility The market price is not always flexible, the flexibility (or rigidity) of it depends on: –the cost of price adjustments –market intervention.

Chapter 3 Supply, Demand & Price 109 Learning Objectives Functions of Price Price Adjustments & Flexibility Price Controls

Chapter 3 Supply, Demand & Price 110 Price Controls Price controls refer to the situation whereby the government intervenes in the market. There are 2 types of price control: 1.price ceiling 2.price floor.

Chapter 3 Supply, Demand & Price 111 Price Controls Price ceiling is a legal maximum price that can be charged for a good or service. The price ceiling is effective only when the controlled price is set below the market equilibrium price.

0 P Q D S P* QdQd QsQs P’ Excess quantity demanded/Shortage Price Ceiling

0 P Q D S P* P’ Price Ceiling

Example Examples of price ceiling:  Rent control  Interest rate control

Example Are the followings examples of price control?  Education  Housing  Medical service  Minimum wage  Fixed exchange rate

0 P Q D S P* QsQs PsPs PfPf Medical service PWPW Regulated money price Shortage Full price Non-monetary price of waiting

Chapter 3 Supply, Demand & Price 117 Price Controls There are 2 types of price control: 1.price ceiling 2.price floor.

Chapter 3 Supply, Demand & Price 118 Price Controls Price floor is a legal minimum price below which a good or service cannot be sold. The price ceiling is effective only when the controlled price is set above the market equilibrium price.

0 P Q D S P* QsQs QdQd P’’ Excess quantity supplied/Surplus Price Floor

0 P Q D S P* P’’ Price Floor

Question What are the usual consequences of price controls?

Chapter 3 Supply, Demand & Price 122 Price Controls The usual consequences of price controls are –non-price competition –‘black market’.