Demand, Supply, and Equilibrium Chapter 17 Demand, Supply, and Equilibrium 17-1 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Objectives Individual and market demand Changes in demand Individual and market supply Changes in supply Graphing supply and demand curves Finding equilibrium price and quantity 17-2 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand Defined Demand is the schedule of quantities of a good or service that people will purchase at various prices The law of demand: when the price of a good is lowered, more of it is demanded; When it is raised, less is demanded There is an implicit assumption that there is no change in any other factors 17-3 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Individual and Market Demand The law of demand holds for both individuals and markets Individual demand is the schedule of quantities that a person would purchase at various prices Market demand is the schedule of quantities that everyone in the market would buy at various prices 17-4 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Table 1, Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Venus 30 Price QD $30 0 25 2 20 3 15 3 10 4 5 5 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-5 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Table 1, Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Martina 30 Price QD $30 1 25 1 20 2 15 3 10 5 5 6 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-6 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Table 1, Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Serena 30 Price QD $30 2 25 3 20 5 15 6 10 7 5 7 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-7 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Table 1, Hypothetical Individual Demand and Market Demand Schedules Quantity demanded by Lindsay 30 Price QD $30 1 25 3 20 4 15 6 10 7 5 8 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-8 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-9 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-10 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-11 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-12 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 $10 4 5 7 7 23 30 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-13 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 $10 4 5 7 7 23 $ 5 5 6 7 8 26 30 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-14 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 $10 4 5 7 7 23 $ 5 5 6 7 8 26 Market Demand 30 P r i c e 24 18 12 6 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Quantity 17-15 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

What Is the Market? The market is where people buy and sell Local markets Gasoline, groceries Regional Automobiles National or international Computers EBay has created a global market for goods that previously had purely local markets 17-16 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

A change in demand would be a change in the schedule Changes in Demand A change in demand would be a change in the schedule Price QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 17-17 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

An Increase in Demand An increase in demand is an increase in the quantity people are willing to purchase at all prices Price QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 The demand curve shifts to the right 17-18 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

An Increase in Demand A decrease in demand means people are willing to purchase less at all prices Price QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 The demand curve shifts to the left 17-19 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand A and B are on the same line, therefore, they are on the same schedule. If they are on the same schedule, there can be no change in demand C A B D1 D2 Move from point A to point B A change in quantity demanded 17-20 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand Movement from A to B is simply a change in quantity demanded in response to a change in price C A B D1 D2 Move from point A to point B A change in quantity demanded 17-21 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand There is an increase in demand because people are willing to buy more at all prices on G’s curve which is to the right of F’s curve E G I F H Move from point F to point G An increase in demand 17-22 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand There is a decrease in demand because people are willing to buy less at all prices on H’s curve which is to the left of G’s curve E G I F H Move from point G to point H A decrease in demand 17-23 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand As long as we remain on the same curve, there is no change in demand E G I F H Move from point H to point I A change in quantity in demanded 17-24 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand As long as we remain on the same curve, there is no change in demand L J G K M N Move from point J to point K A change in quantity in demanded 17-25 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand From K to L is an increase in demand because L’s demand curve is entirely to the right of K’s curve L J G K M N Move from point K to point L An increase in demand 17-26 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand From L to M is a decrease in demand because M’s demand curve is entirely to the left of L’s curve L J G K M N Move from point L to point M A decrease in demand 17-27 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Demand We don’t know on which of an infinite number of possible demand curves N is situated, therefore, the most we can say is that there is a change in demand L J G K M N Move from point M to point N A change in demand 17-28 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

What Causes Changes in Demand? Changes in income Changes in the price of related goods and services Changes in taste and preferences Changes in price expectations Changes in population 17-29 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Income The demand for NORMAL goods varies directly with income When income goes up people buy more, therefore demand goes up The demand for INFERIOR goods varies inversely with income When income goes up people buy less, therefore demand goes down 17-30 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in the Price of Related Goods and Services Goods and services are related in two ways One can be used as a substitute for the other Hot dogs and hamburgers; tuna and salmon One can complement the other Videos and VCRs; gasoline and cars, tires 17-31 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Prices of Substitute Goods Directly related The price of hamburgers goes up The price of hotdogs would also go up As the price of hamburgers goes up people will buy less hamburgers and more hotdogs. This increases the demand for hotdogs . . . thus increasing the price of hotdogs 17-32 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-33 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Prices of Complementary Goods Inversely related Prices of weenies go up . . . the price of hotdog buns goes down The price of weenies goes up . . . people buy less weenies. If people buy less weenies, they will also buy less hotdog buns This decreases the demand for hotdog buns and lowers the price of hotdog buns 17-34 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-35 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Taste and Preferences Taste and preferences tend to change over time Smaller cars and less-fattening foods Preferring designer clothing and brand- name sneakers Less people are smoking (has been helped by a campaign to reduce smoking) 17-36 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Price Expectations If people expect the price of something to rise, they rush out to stock up before it does This increases the demand If people expect the price of something to fall, they will hold off buying it This decreases the demand 17-37 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Population As the nation’s population increases, the demand for particular goods and services increase General growth increases the demand for food, housing, autos, etc. The changing age distribution affects demand In the next three decades there will be a higher demand for retirement homes, nursing homes, wheel chairs, bifocal glasses, etc. 17-38 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Supply Defined Supply is . . . a schedule of quantities of a good or service that people are willing to sell at various prices As prices rise . . . people are willing to sell more Thus, there is a positive or direct relationship between price and quantity Price rises . . . quantity supplied rises Prices declines . . . quantity supplied declines We’re assuming there is no change in any of the factors that influence supply 17-39 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Individual and Market Supply Hypothetical Supply of American Cars, 2004 (in thousands) Daimler Japanese- Price GM Ford Chrysler Owned Firms Total $20,000 5311 2356 1245 535 9,447 18,000 4617 1984 991 384 7,976 16,000 4002 1584 762 270 6,618 14,000 3623 1216 601 208 5,648 12,000 3190 996 491 181 4,858 17-40 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Supply of American Cars, 2004 17-41 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-42 A change in quantity supplied Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-43 An increase in supply Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-44 A change in supply Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-45 A change in quantity supplied Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-46 17-56 An increase in supply Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-47 A change in quantity supplied Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-48 A decrease in supply Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Supply 17-49 A change in supply Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-50 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-51 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-52 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-53 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-54 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-55 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17-56 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Hypothetical Demand Schedule Price Quantity Demanded(QD) $10 1 $ 9 2 $ 8 4 $ 7 7 $ 6 12 17-57 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Hypothetical Supply Schedule Price Quantity Supplied (QS) $10 14 $ 9 12 $ 8 9 $ 7 5 $ 6 1 17-58 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Hypothetical Demand and Supply Schedules Price QD QS $10 1 14 $ 9 2 12 $ 8 4 9 $ 7 7 5 $ 6 12 1 The equilibrium point is where the demand and supply curves cross 17-59 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Hypothetical Demand and Supply Schedules Price QD QS $10 1 14 $ 9 2 12 $ 8 4 9 $ 7 7 5 $ 6 12 1 Equilibrium price is about $7.20 Equilibrium quantity is 6 17-60 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Above equilibrium price there are surpluses Price Price Price always tends toward equilibrium. If price is above equilibrium, sellers will lower prices until the price declines to the equilibrium price Price 17-61 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Below equilibrium price there are shortages Price always tends toward equilibrium. If price is below equilibrium, buyers will bid prices up until the price rises to the equilibrium price Price Price Price 17-62 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Finding Equilibrium Price and Quantity If we draw our graphs accurately, we can usually find equilibrium price and quantity in a couple of seconds, especially if we’ve used graph paper. But sometime we need to do further analysis to find really accurate equilibrium prices and quantities Hypothetical Demand and Supply Schedule Price Quantity Demanded Quantity Supplied $15 2 19 $14 4 17 $13 7 12 $12 12 6 $11 20 3 How much is the equilibrium price? 17-63 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Finding Equilibrium Price and Quantity Hypothetical Demand and Supply Schedule Price Quantity Demanded Quantity Supplied $15 2 19 $14 4 17 $13 7 12 $12 12 6 $11 20 3 How much is the equilibrium price? First we add a “Units apart” column 17-64 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Finding Equilibrium Price and Quantity Hypothetical Demand and Supply Schedule Price Quantity Demanded Units Apart Quantity Supplied $15 2 17 19 $14 4 13 17 $13 7 5 12 $12 12 6 6 $11 20 17 3 How much is the equilibrium price? First we add a “Units apart” column Equilibrium price is a little closer to $13 than to $12 17-65 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Finding Equilibrium Price and Quantity Hypothetical Demand and Supply Schedule Price Quantity Demanded Units Apart Quantity Supplied $15 2 17 19 $14 4 13 17 $13 7 5 12 $12 12 6 6 $11 20 17 3 How much is the equilibrium price? First we add a “Units apart” column Equilibrium price is a little closer to $13 than to $12 Therefore, equilibrium price has to be something greater than $12.50 and less than $13 17-66 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Demand and Supply Schedule Price Quantity Demanded Units Apart Quantity Supplied $15 2 17 19 $14 4 13 17 $13 7 5 12 $12 12 6 6 $11 20 17 3 How much is the equilibrium quantity? Equilibrium quantity demanded is closer to 7 than 12. The midpoint between 12 and 7 is 9.5. Therefore, we know the equilibrium quantity demanded must be something less than 9.5 Equilibrium quantity supplied is closer to 12 than 6. The midpoint between 12 and 6 is 9. Therefore, we know the equilibrium quantity supplied is something more than 9.0 The equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3 17-67 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

This is the graph of the previous Demand and Supply schedule $12.60 plus or minus .05 is about the best you can do Remember, equilibrium price has to be something greater than $12.50 and less than $13 17-68 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

This is the graph of the previous Demand and Supply schedule $12.60 plus or minus .05 is about the best you can do Remember, the equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3 In this instance, this technique proved useful. 17-69 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Is This Type of Analysis Necessary? It isn’t when you’ve got an equilibrium price or quantity that is clearly closer to one figure than to another You will be able to spot this when you draw your graph But when the demand and supply curves cross about halfway between two figures, then you will need to go back to the original schedule to figure out more precisely where the equilibrium point lies 17-70 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.