Chapter 3 Demand, Supply, and Market Equilibrium McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Demand and its determinants Supply and its determinants Supply, demand, & market equilibrium Changes in supply and demand Government-set prices 3-2

A Market Interaction between buyers and sellers Buyers demand goods Sellers supply goods Assumptions Standardized good Competitive market 3-3

Demand Schedule or curve Amount consumers willing and able to purchase at a given price Other things equal Individual demand Market demand 3-4

Law of Demand Other things equal, as price falls quantity demanded rises Explanations: Diminishing marginal utility Income effect Substitution effect 3-5

Individual Demand Individual Demand P Qd $5 4 3 2 1 10 20 35 55 80 P 6 5 4 3 2 1 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week) Price (per bushel) Individual Demand P Qd $5 4 3 2 1 10 20 35 55 80 D Q 3-6

Individual Demand P Price D Q Quantity Demanded of Chicken Raised to 45% from 14% Price D Q 3-7

Individual Demand P Price D Q Quantity Demanded of Meat fall to 18% from 51% Price D Q 3-8

Determinants of Demand Factors that shift the demand curve Cause more or less to be bought at any possible price Increase or decrease in demand Tastes Number of buyers 3-9

Determinants of Demand Income Normal goods Inferior goods Price of related goods Substitute good Complementary good Unrelated goods Consumer expectations 3-10

Individual Demand Demand Can Increase or Decrease Individual Demand P 6 5 4 3 2 1 Individual Demand P Qd Increase in Demand $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 Decrease in Demand D1 D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week) 3-11

Change in Quantity Demanded Individual Demand Demand Can Increase or Decrease P 6 5 4 3 2 1 Change in Demand Individual Demand P Qd Change in Quantity Demanded $5 4 3 2 1 10 20 35 55 80 Price (per bushel) D2 Decrease in Demand D1 D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week) 3-12

Supply Individual supply Market supply Schedule or curve Amount producers willing and able to sell at a given price Individual supply Market supply 3-13

Law of Supply Other things equal, as price rises the quantity supplied rises Explanations: Revenue implications Marginal cost 3-14

Individual Demand P S Quantity Supplied Price Q

Individual Supply Individual Supply P Qs $5 4 3 2 1 60 50 35 20 5 P S1 Individual Supply S1 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3-16

Determinants of Supply Resource prices Technology Taxes and subsidies Prices of other goods Producer expectations Number of sellers 3-17

Individual Supply Supply Can Increase or Decrease Individual Supply P 6 5 4 3 2 1 S3 Individual Supply S1 S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3-18

Change in Quantity Supplied Individual Supply Supply Can Increase or Decrease P 6 5 4 3 2 1 S3 Individual Supply S1 Change in Quantity Supplied S2 P Qs $5 4 3 2 1 60 50 35 20 5 Price (per bushel) Change in Supply 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3-19

Market Equilibrium Equilibrium price and quantity Surplus and shortage Rationing function of price Efficient allocation Productive efficiency Allocative efficiency 3-20

Market Equilibrium 200 Buyers & 200 Sellers S D Equilibrium Price Equilibrium Quantity 3-21

Market Equilibrium 200 Buyers & 200 Sellers P Qd P Qs Market Market Supply 200 Sellers Market Demand 200 Buyers 6 5 4 3 2 1 6,000 Bushel Surplus S P Qd P Qs $4 Price Floor 2,000 4,000 7,000 11,000 16,000 $5 4 3 2 1 $5 4 3 2 1 12,000 10,000 7,000 4,000 1,000 Price (per bushel) 3 $2 Price Ceiling 7,000 Bushel Shortage D 2 4 6 8 10 12 14 16 18 7 Bushels of Corn (thousands per week) 3-22

Market Equilibrium Change in demand Change in supply Shift of the demand curve Change in supply Shift of the supply curve Change in equilibrium price and quantity 3-23

? ? ? ? Market Equilibrium Supply increase; Demand decrease Price Quantity Supply increase; Demand decrease Supply decrease; Demand increase Supply increase; Demand increase Supply decrease; Demand decrease ? ? ? ? 3-24

Government-Set Prices Price ceilings on gasoline Rationing problem Black markets Rent controls Price floors on wheat Optimal allocation of resources 3-25

A Market for Human Organs Waiting list for transplants Demand for organs Supply of organs—two possibilities Market eliminates shortage Moral objections Legalize and regulate? 3-26

A Market for Human Organs P Supply of Organs Shortage at Zero Price Q1 – Q3 P1 At Price P1 the Shortage is Reduced By Q1 – Q2 Demand for Organs D1 P0 Q1 Q2 Q3 Q 3-27

Key Terms supply demand supply schedule demand schedule law of supply law of demand diminishing marginal utility income effect substitution effect demand curve determinants of demand normal goods inferior goods substitute good complementary good change in demand change in quantity demanded supply supply schedule law of supply supply curve determinants of supply change in supply change in quantity supplied equilibrium price equilibrium quantity surplus shortage price ceiling price floor 3-28

Public and Private Sectors Next Chapter Preview… The U.S. Economy: Public and Private Sectors 3-29