SUPPLY & DEMAND Chapter 3 Spring 2012: Schaffer

Examining a Market The market for any good or service consists of all buyers and sellers of that good. As economists, typically represent a basic market in the form of supply and demand.

Demand Demand curve—a graph (or schedule) showing the total quantity of a good (or service) that buyers wish to buy at each price. Why is the demand curve downward sloping?

The only thing we allow to change along a given demand curve is the price of the good itself. If anything else changes, the curve will shift.

A change in quantity demanded is a movement along the demand curve that occurs in response to a change in price.

A change in demand is a shift of the entire demand curve. A change in demand has taken place if, at the same price, a different quantity is demanded.

Shifts in Demand Curves: 1. Change in the price of a complement. 2. Change in the price of a substitute. 3. Change in consumer income. 4. Change in preferences of demanders of the good. 5. Change in the population of potential buyers. 6. An expectation of higher future prices.

1. Change in the Price of a Complement Complements—two goods are complements in consumption if an increase in the price of one causes a leftward (inward) shift in the demand curve for the other.

Coffee and Sugar  P of Coffee

Coffee Market

Sugar Market

Substitutes—two goods are substitutes in consumption if an increase in the price of one causes a rightward (outward) shift in the demand curve for the other. 2. Change in the Price of a Substitute

Coke and Pepsi  P of Coke

Coke Market

Pepsi Market

3. Change in Consumer Income Normal good—a normal good is a good whose demand curve shifts rightward (outward) when the incomes’ of buyers increase.

 Income - Normal Good

Inferior good—an inferior good is a good whose demand curve shifts leftward (inward) when the incomes’ of buyers increase.

 Income - Inferior Good

4. Changes in the Preferences of Demanders for the Good If preferences shift away from a good, the demand curve for the good will shift downward.

Market for Peanut Butter after Salmonella Outbreak of 2009

5. Change in the Population of Potential Buyers. Increases in population generally shift outward the demand curves for most goods.

 Population

6. An Expectation of Higher Future Prices. Higher expected prices will shift outward the demand curve for a good.

 Expected Price

Practice Question #1 What might cause a demand function to shift to the right? A. An increase in the price of a substitute. B. An increase in the product's own price. C. An increase in the price of a complement. D. A decrease in the price of a substitute.

Practice Question #2 Suppose the price of a bushel of apples increases from $2.50 to $3.00. This would lead to ___________. A. A shift in the demand curve to the right B. A shift in the demand curve to the left C. A movement along the demand curve up and to the left D. A movement along the demand curve down and to the right

Practice Question #3 Suppose there is an overall increase in consumer income in the US, assuming iPads are a normal good, what would happen to the demand curve for iPads? A. Shift to the Right B. Shift to the Left C. Stay the same (i.e. a movement along the curve)

Practice Question #4 Suppose there is an overall increase in consumer income in the US, assuming Ramen Noodles are an inferior good, what would happen to the demand curve for Ramen Noodles? A. Shift to the Right B. Shift to the Left C. Stay the same (i.e. a movement along the curve)

Practice Question #5 Is there a relationship between beer and diapers? A. They could be substitutes. B. They could be complements C. Umm….What? There is no relationship.

Market Example: Beer and Diapers.  Wal-Mart Market Study (Fact or Fiction?)  Is there a relationship between beer and diapers

Supply Supply curve—a graph (or schedule) showing the total quantity of a good (or service) that sellers wish to sell at each price. Why is the supply curve upward sloping?

The only thing we allow to change along a given supply curve is the price of the good itself. If anything else changes, the entire supply curve shifts.

A change in quantity supplied is a movement along the supply curve that occurs in response to a change in price.

A change in supply is a shift of the entire supply curve. A change in supply has taken place if, at the same price, a different quantity is supplied.

Shifts in Supply Curves: 1) Changes in the cost of materials, labor, or other inputs used in the production of the good or service. 2) An improvement in technology that reduces the cost of production of the good or service. 3) A change in the weather (especially for agricultural products). 4) A change in the number of producers (suppliers). 5) An expectation of lower future prices.

1. Changes in Input Costs Changes in the cost of materials, labor, or other inputs used in the production of the good or service.

 Cost of a Production Input

2. Technology An improvement in technology that reduces the cost of production of the good or service.

 Technology

3. Weather A change in the weather (especially for agricultural products).

Better Weather

4. Change in the Number of Producers As the number of firms within a given market changes, the available supply of the goods or services produced by those firms will also fluctuate.

 Number of Producers

5. Change in Future Expectations An expectation of future prices will influence the firm’s behavior today regarding available supply of goods

 Expected Price

Practice Question #6 What might cause a supply function to shift to the left today? A. An increase in the product's own price. B. An expectation that the product's price will fall in the future. C. An expectation that the product's price will rise in the future. D. A decrease in the price of one of the inputs to making the product.

Practice Question #7 An increase in the price of trucks will cause the supply curve for trucks to: A. Shift inward. B. Shift outward. C. Not shift.

Practice Question #8 An increase in the price of trucks will cause the quantity of trucks supplied to: A. Increase. B. Decrease. C. Remain unchanged.

Supply = Demand Market equilibrium occurs when all buyers and sellers are satisfied with their respective quantities at the market price. At equilibrium, Q D =Q S.

Q D = Q S

Excess Supply A situation where Q S > Q D.

Excess Demand A situation where Q D > Q S.

Shifts in Supply and Demand Curves: 1.  D 2.  D 3.  S 4.  S 5.  D and  S 6.  D and  S 7.  D and  S 8.  D and  S

 D

 D

 S

 S

 D and  S

 D and  S

 D and  S

 D and  S

Practice Question #9 Refer to the figure. An increase in demand is represented by shifting from A. curve A to curve B. B. curve B to curve A. C. curve C to curve D. D. curve D to curve C.

Practice Question #10 Refer to the figure. An decrease in supply is represented by shifting from A. curve A to curve B. B. curve B to curve A. C. curve C to curve D. D. curve D to curve C.

Market Friction 1: Price Floor Price floor—A price floor specifies a minimum legal price below which goods cannot be sold.

Minimum Wage

Market Friction 2: Price Ceiling Price ceiling—A price ceiling specifies the highest price that firms may legally charge.

Rent Control

Market Example 1: Energy Prices  Due to relatively high unemployment over the last few years, the demand curve for energy has shifted inward.

Market Example 2: Gun Control? No, Bullet Control!  Famous Chris Rock Comedy Sketch:

Market Example 2: Gun Control? No, Bullet Control!  Can we build and economic model to describe this scenario?  Guns and Bullets: Substitutes or Complements?  Figure 1: Market for Bullets  Figure 2: The Market for Killing People (this is odd I know)

Market Example 3: Market for Bank Loans Supply of bank loans: Banks Demand for bank loans: Households and business firms Price of bank loans = interest rate on bank loans

Market for Bank Loans  Supply and Demand.

Credit Crunch  In a credit crunch banks greatly reduce their lending. As a result, the supply curve for bank loans shifts inward.

Credit Crunch  Market for bank loans.

Credit Crunch  Fewer loans are granted at a higher interest rate.

Practice Question #11 In general, when the demand curve shifts to the right and supply remains constant then A. quantity demanded will fall. B. the equilibrium price will fall. C. the equilibrium quantity will rise. D. the market cannot reestablish an equilibrium.

Practice Question #12 One observes that the equilibrium price of a DVD player increases and the equilibrium quantity increases. Which of the following best fits the observed data? A. An increase in demand with supply constant B. An increase in demand coupled with a decrease in supply C. An increase in demand coupled with an increase in supply D. A decrease in demand with supply constant

Practice Question #13 One observes that the equilibrium price of T-shirt increases and the equilibrium quantity falls. Which of the following best fits the observed data? A. An increase in demand with supply constant B. A decrease in supply with demand constant C. An increase in demand coupled with an increase in supply D. A decrease in demand with supply constant

Practice Question #14 In a market where government has set the price below the equilibrium price, one might expect A. quantity demanded to equal quantity supplied. B. excess supply. C. a black market to develop as individuals try to take advantage of unexploited opportunities. D. quantity supplied to surpass quantity demanded.

Practice Question #15 In a market where government has set the price below the equilibrium price, one might expect A. quantity demanded to equal quantity supplied. B. excess supply. C. a black market to develop as individuals try to take advantage of unexploited opportunities. D. quantity supplied to surpass quantity demanded.

Practice Question #15 Suppose the supply of a good is given by the equation P = Q S /4 and the demand for the good is given by the equation P = Q D, where quantity is measured in millions of units and P is measured in dollars per unit. What is the equilibrium price and equilibrium quantity traded within this market? Q=200, P=150