ECON 100 Lecture 10 Wednesday, March 5

MARCH 22 Saturday starts at 10:00 MIDTERM EXAM #1

Demand, supply, and market equilibrium web link to chapter 4 (publisher’s website, perfectly legal) http://www.cengage.com/economics/mankiw/samplechapter/Mankiw6e_Econ_Ch04.pdf

This is the most important chapter in the textbook This is the most important chapter in the textbook. It is also one of the longest chapters.

Today’s lecture is mostly about Supply!

A few words on competitive markets and market equilibrium. But I want to say A few words on competitive markets and market equilibrium.

Competitive markets and market equilibrium

Competitive markets are markets where there are many buyers and many sellers and no individual buyer or seller is big enough to change the market price alone!

Price taking behavior: Everyone takes the market price as given Price taking behavior: Everyone takes the market price as given. Consumers decide how much to buy (choose their quantity demanded) Producers decide how much to produce (choose their quantity supplied)

Market equilibrium Equilibrium means demand equals supply! This is wrong!

Market equilibrium The market for good XYZ is in equilibrium means that … Given the current price of good XYZ, the quantity demanded (of XYZ) equals the quantity supplied (of XYZ).

In class exercise at the end of the lecture on Monday

Demand for running shoes Draw the market demand curve for running shoes. Choose a price (say PO) and label the quantity demanded (Q1) at that price. Draw a new demand curve that shows a smaller quantity demanded (Q2) at the same price PO. Give three (3) reasons for the decrease in demand.

Demand for running shoes 3 REASONS A decrease in consumers’ income (running shoes are a normal good.) A major scientific study finds that running is actually bad for your health. The city government opens many swimming pools free to the general public. Demand for running shoes Price of running shoes decrease in demand PO D1 D2 Quantity demanded Q2 Q1

Summary The demand curve shows the relationship between the price and quantity demanded.

Summary The law of demand: As the price of a good falls (rises), the quantity demanded rises (falls). Therefore, the demand curve slopes downward. price quantity demanded

Summary Other determinants of quantity demanded are: income, the prices of complement and substitute goods, consumer’s tastes, etc., If one of these “other” determinants changes, the demand curve shifts.

Normal goods: When income increases demand increases; (when income decreases demand decreases). Inferior goods: When income increases, demand decreases. (When income decreases demand increases).

Complement goods: Demand for a good will increase if the price of the complement good falls. (Demand for cars will increase if the price of gasoline falls.)

Substitute goods: Demand for a good will decrease if the price of the substitute good falls. (Demand for rice will fall If the price of bulgur or pasta falls.)

Learning activity #1

What are the largest and smallest values for X and Y such that … good X is a normal good for Zeynep, and Zeynep’s demand satisfies the “law of demand,” Please explain your reasoning. Zeynep’s income Price of X 120 80 3 16 Y 4 X

This concludes our discussion of demand! Now, we turn to the supply.

Introduction: basic definitions Supply is the relationship between two variables: price and quantity supplied. Quantity supplied is the amount of a good that sellers are willing and able to provide/bring to the market for sale. 25

What determines the quantity supplied? Sellers probably prefer to make a profit from their sales. Profit is defined as revenue minus cost. Therefore anything that influences revenues or costs can influence the quantity supplied. It is common sense that the sellers will increase the quantity supplied if they see a rise in the price they receive, and/or if their costs decrease.

The relationship between quantity supplied and price The supply schedule is … a table that shows the relationship between the price of the good and the quantity supplied. The supply curve is … the graph of the relationship between the price of a good and the quantity supplied. 25

Supply Schedule – Ice-cream Dondurmacı Ali Usta (Moda) 29

Supply Schedule – Ali Usta (Moda) Price of ice-cream Quantity of ice-cream cones supplied 0.00 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 29

Ali Usta’s Supply Schedule & Curve Price Quantity supplied 0.00 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 P Q 30

The Law of Supply The law of supply is the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises, (and falls when the price falls).

A change in the quantity supplied Price of Ice-Cream Cones S C 3.00 A rise in the price of ice cream cones results in a movement along the supply curve. A 1.00 Quantity of Ice-Cream Cones 3 9 30

Market Supply versus Individual Supply The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. Suppose Ali Usta (Moda) and Veli Usta (Tarabya) are the two sellers in this market. (Qs = quantity supplied) 0.00 6.00 5.00 4.00 3.00 2.00 1.00 Price 18 15 12 9 6 3 Ali U. 12 10 8 6 4 2 Veli U. Market Qs + = + = 5 + = 10 Again, the assumption of only two sellers is a clear violation of perfect competition. However, it’s much easier for students to learn how the market supply curve relates to individual supplies in the two-seller case. + = 30 25 20 15 33

The Market Supply Curve P QS (Market) 0.00 1.00 5 2.00 10 3.00 15 4.00 20 5.00 25 6.00 30 P Q 34

Supply Curve Shifters The supply curve shows how price affects quantity supplied, other things being equal. These “other things” are Input prices (for ice-cream these are prices of sugar and milk, workers’ wages, rent …) and technology. Changes in them shift the S curve… “Non-price determinants of supply” simply means the things – other than the price of a good – that determine sellers’ supply of the good. 35

Learning activity #2

Finding the supply schedule and drawing the graph of the supply curve

A really nice example A small t-shirt factory uses one machine (leased at 2000TL a week) to produce t-shirts. The machine is operated by one worker and produces 10 t-shirts per hour. The worker is paid 10TL per hour on weekdays, 20TL per hour on Saturdays , and 30TL per hour on Sundays. Working day is max 8 hours by law. (strictly enforced.) All other costs, such as raw materials, electricity, etc., are 5TL per t-shirt.

Who is the buyer? Benetton is the only buyer of t-shirts from our small factory. They will buy as many as the factory can supply.

The offer Suppose Benetton made an offer to buy at 20TL per t-shirt. Given this offer, how many t-shirts will the company supply? Should the factory operate on Saturday?

How many t-shirts will be supplied if Benetton pays… P = 10TL? _________ P = 20TL? _________ P = 30TL? _________ P = 40TL? _________ Use your answers to prepare the supply schedule. Put these price and quantity supplied figures in a table form with 2 columns. Draw a price - quantity supplied graph, put these price and quantity supplied figures on the graph and connect the dots with a line. What is the shape of the line?

Now back to Supply Curve Shifters

Supply Curve Shifters The supply curve shows how price affects quantity supplied, other things being equal. These “other things” are Input prices (sugar, milk, workers’ wages, rent, for ice- cream) and technology. Changes in them shift the S curve… “Non-price determinants of supply” simply means the things – other than the price of a good – that determine sellers’ supply of the good. 43

Supply Curve Shifters: Input Prices Examples of input prices: wages, and 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. In the second bullet point, “output price” just means the price of the good that firms are producing and selling. I have used “output price” here to distinguish it from “input prices.” 44

Supply Curve Shifters: Input Prices Again, the animation here is carefully designed to help make clear that a shift in the supply curve means that there is a change in the quantity supplied at each possible price. If it seems tedious, you can turn it off. In any case, be assured that, by the end of this chapter, the animation of curve shifts will be streamlined and simplified. 45

Supply Curve Shifters: Input Prices P Q Suppose the price of milk falls. At each price, the quantity of ice- cream supplied will increase. Again, the animation here is carefully designed to help make clear that a shift in the supply curve means that there is a change in the quantity supplied at each possible price. If it seems tedious, you can turn it off. In any case, be assured that, by the end of this chapter, the animation of curve shifts will be streamlined and simplified. 46

Supply Curve Shifters: Technology Technology determines how much inputs are required to produce a unit of output. A technological improvement (more production with a given amount of inputs) has the same effect as a fall in input prices, A technological improvement shifts the supply curve to the right. 47

Supply Curve Shifters: The ice-cream making technology improves! P Q Again, the animation here is carefully designed to help make clear that a shift in the supply curve means that there is a change in the quantity supplied at each possible price. If it seems tedious, you can turn it off. In any case, be assured that, by the end of this chapter, the animation of curve shifts will be streamlined and simplified. 48

Shifts versus movements along the curve: Supply When the price of the good changes we show the change in production levels as a movement along the supply curve. We call it a change in quantity supplied. When input prices, or technology change, we show this as a shift in the supply curve. We call it a change in supply.

A change in supply versus a change in quantity supplied A decrease in supply (give reasons) A decrease in quantity supplied (give reasons) S2 S1

The equilibrium in the competitive market

What is a market? A market is a group of buyers and sellers of a particular good or service. A market need not be a physical location. What is a competitive market?

Definition: A competitive market is a market in which individual buyers and sellers have no impact (or a negligible impact) on the market price.

Supply and demand together Equilibrium : The price has reached the level where quantity supplied equals quantity demanded. 36

SUPPLY AND DEMAND TOGETHER Equilibrium Price The price at which quantity supplied equals quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity The quantity supplied and the quantity demanded at the equilibrium price. 36

Supply and demand together Demand Schedule Supply Schedule At $2.00, the quantity demanded is equal to the quantity supplied! 36

Price of Ice-Cream Cone Supply Demand Equilibrium Equilibrium price $2.00 Equilibrium quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of Ice-Cream Cones

(a) Excess Supply Price of Ice-Cream Supply Cone Surplus Demand $2.50 10 4 2.00 7 Quantity of Quantity demanded Quantity supplied Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Equilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. The price will gradually fall, thereby reducing QS and increasing QD The market will move toward equilibrium.

Figure 9 Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cone Demand $2.00 7 1.50 10 4 Shortage Quantity of Quantity supplied Quantity demanded Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Equilibrium Shortage When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. The price will gradually increase (because too many buyers are chasing too few goods), This will reduce QD and increase QS so that the market will move toward equilibrium.

Learning activity #3

The demand and supply of bicycles The demand and supply of bicycles. For each event, determine which curve is affected (supply or demand for bicycles), and what direction is it shifted? a. The price of cars increases. (assume cars and bicycles are substitute goods.) b. Consumers' incomes decrease, (assume bicycles are a normal good). c. The price of steel used to make bicycle frames increases. d. An environmental movement shifts tastes toward bicycling. e. A technological advance in the manufacture of bicycles occurs. f. The price of bicycle helmets and shoes is reduced. g. Consumers' incomes decrease, (assume bicycles are an inferior good).

End of the lecture