SUPPLY AND DEMAND I: HOW MARKETS WORK 2 SUPPLY AND DEMAND I: HOW MARKETS WORK

The Market Forces of Supply and Demand 4 The Market Forces of Supply and Demand

Supply and demand are the two words that economists use most often. Supply and demand are the forces that make market economies work. Modern microeconomics is about supply, demand, and market equilibrium. 2

MARKETS AND COMPETITION A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behaviour of people . . . as they interact with one another in markets. 4

MARKETS AND COMPETITION Buyers determine demand. Sellers determine supply 4

Competitive Markets A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price. In a perfectly competitive market: All goods exactly the same Buyers & sellers so numerous that no one can affect market price – each is a “price taker” In this chapter, we assume markets are perfectly competitive. 5

Competition: Perfect and Otherwise Perfect Competition Products are identical Many buyers and sellers so that each has no influence over price Buyers and Sellers are price takers Monopoly One seller, and seller controls price Broadband Internet Provider: TTNET (99%) 6

Competition: Perfect and Otherwise Oligopoly Few sellers Not always aggressive competition Network providers: Turkcell, Avea, Vodafone Monopolistic Competition Many sellers Slightly differentiated products Each seller may set price for its own product Personal Computers: Dell, Acer, Toshiba, etc. 6

DEMAND Quantity demanded is the amount of a good that buyers are willing and able to purchase. What is the most influential factor that affects the quantity demanded? PRICE OF THE GOOD!!!! Law of Demand The law of demand is the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises. 8

The Demand Curve: The Relationship between Price and Quantity Demanded Demand Schedule The demand schedule shows the quantitative relationship between the price of the good and the quantity demanded, other things being equal (i.e. ceteris paribus). 17

Sabine’s Demand Schedule 17

The Demand Curve: The Relationship between Price and Quantity Demanded The demand curve (also known as demand) is a graph of the relationship between the price of a good and the quantity demanded. 17

Figure 1 Sabine’s Demand Schedule and Demand Curve Copyright©2011 South-Western

Demand & Willingness to Pay Willingness and Ability to Pay A demand curve is also a willingness-and-ability-to-pay curve. The smaller the quantity available, the higher is the price that someone is willing to pay for another unit. Willingness to pay measures marginal benefit.

Market Demand versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

Shifts in the Demand Curve Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of the product. 19

Changes in Quantity Demanded Price of Ice-Cream Cones An increase in the price of ice-cream cones results in a movement along the demand curve. B €2.00 A €1.00 D 4 8 Quantity of Ice-Cream Cones

Shifts in the Demand Curve Other factors that influence the demand of a good Is the price of ice-cream cones ONLY factor that affect the quantity demanded of ice-cream cones? NO! There are other factors such as: Consumer income Prices of related goods Tastes Expectations Number of buyers 11

Shifts in the Demand Curve Change in Demand A shift in the demand curve (either to the left or right) is caused by any change that alters the quantity demanded at every price. 19

Figure 3 Shifts in the Demand Curve Price of Ice-Cream Cones Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Quantity of Ice-Cream Cones Copyright©2011 South-Western

Shifts in the Demand Curve Consumer Income As income increases the demand for a normal good will increase. As income increases the demand for an inferior good will decrease.

Consumer Income Normal Good Price of Ice-Cream Cones € 3.00 An increase in income... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Consumer Income Inferior Good Price of Ice-Cream Cones € 3.00 2.50 An increase in income... 2.00 Decrease in demand 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Shifts in the Demand Curve Prices of Related Goods When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good, the two goods are called complements.

Table 1 Variables That Influence Buyers Variable A change in this variable… Price …causes a movement along the D curve # of buyers …shifts the D curve Income …shifts the D curve Price of related goods …shifts the D curve Tastes …shifts the D curve Expectations …shifts the D curve Copyright©2010 South-Western

A C T I V E L E A R N I N G 1 Demand Curve Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why? A. The price of iPods falls B. The price of music downloads falls C. The price of CDs falls In each case, there are only three possible answers: - The curve shifts to the right - The curve shifts to the left - The curve does not shift (though there may be a movement along the curve) 26 Copyright © 2011 Nelson Education Limited

SUPPLY Quantity supplied is the amount of a good that sellers are willing and able to sell. 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. 25

The Supply Curve: The Relationship between Price and Quantity Supplied Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. 29

Häagen’s Supply Schedule 29

The Supply Curve: The Relationship between Price and Quantity Supplied The supply curve is the graph of the relationship between the price of a good and the quantity supplied. 29

Figure 5 Häagen’s Supply Schedule and Supply Curve Copyright©2010 South-Western

Copyright © 2013 Pearson Canada Inc., Toronto, Ontario Supply Minimum Supply Price A supply curve is also a minimum-supply-price curve. As the quantity produced increases, marginal cost increases. The lowest price at which someone is willing to sell an additional unit rises. This lowest price is marginal cost. Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Market Supply versus Individual Supply Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

Shifts in the Supply Curve Other factors that influence the supply of a good Is the price of ice-cream cones ONLY factor that affect the quantity supplied of ice-cream cones? NO! There are other factors such as: Input prices Technology Expectations Number of sellers Nature 27

Shifts in the Supply Curve Change in Quantity Supplied Movement along the supply curve. Caused by a change in anything that alters the quantity supplied at each price. 30

Change in 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 1 5 30

Shifts in the Supply Curve Change in Supply A shift in the supply curve (either to the left or right) is caused by a change in a determinant other than price. 30

Figure 7 Shifts in the Supply Curve Price of Supply curve, S 3 Ice-Cream curve, Supply S 1 Cones Supply curve, S 2 Decrease in supply Increase in supply Quantity of Ice-Cream Cones Copyright©2011 South-Western

Table 2 Variables That Influence Sellers Variable A change in this variable… Price …causes a movement along the S curve Input Prices …shifts the S curve Technology …shifts the S curve # of Sellers …shifts the S curve Expectations …shifts the S curve Copyright©2011 South-Western

SUPPLY AND DEMAND TOGETHER Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. 36

SUPPLY AND DEMAND TOGETHER Equilibrium Price The price that balances quantity supplied and 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. On a graph it is the quantity at which the supply and demand curves intersect. 36

SUPPLY AND DEMAND TOGETHER Demand Schedule Supply Schedule At €2.00, the quantity demanded is equal to the quantity supplied! 36

Figure 8 The Equilibrium of Supply and Demand Price of Ice-Cream Cones 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 Copyright©2011 South-Western

Equilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

Figure 9 Markets Not in Equilibrium (a) Excess Supply Price of Ice-Cream Supply Cones Surplus Demand € 2.50 10 4 2.00 7 Quantity of Quantity demanded Quantity supplied Ice-Cream Cones Copyright©2011 South-Western

Equilibrium Shortage When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Figure 9 Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cones Demand € 2.00 7 1.50 10 4 Shortage Quantity of Quantity supplied Quantity demanded Ice-Cream Cones Copyright©2011 South-Western

Law of supply and demand Equilibrium Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

Figure 10 How an Increase in Demand Affects the Equilibrium Price of Ice-Cream 1. Hot weather increases the demand for ice cream . . . Cones D D Supply New equilibrium € 2.50 10 2. . . . resulting in a higher price . . . 2.00 7 Initial equilibrium Quantity of 3. . . . and a higher quantity sold. Ice-Cream Cones Copyright©2011 South-Western

Figure 11 How a Decrease in Supply Affects the Equilibrium Price of 1. An increase in the price of sugar reduces the supply of ice cream. . . Ice-Cream Cones S2 S1 Demand New equilibrium € 2.50 4 2. . . . resulting in a higher price of ice cream . . . Initial equilibrium 2.00 7 Quantity of 3. . . . and a lower quantity sold. Ice-Cream Cones Copyright©2011 South-Western

Table 4 What Happens to Price and Quantity When Supply or Demand Shifts? Copyright©2011 South-Western

Three Steps to Analyzing Changes in Equilibrium Decide whether the event shifts the supply or demand curve (or both). Decide whether the curve(s) shift(s) to the left or to the right. Use the supply and demand diagram to see how the shift affects equilibrium price and quantity. 45

A C T I V E L E A R N I N G 3 Shifts in supply and demand Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads. Event A: A fall in the price of CDs Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. Event C: Events A and B both occur. Important note about Event B: The royalties that sellers must pay the artists are part of sellers’ “costs of production.” Typically, this royalty is a fixed amount each time one of the artist’s songs is downloaded. Event B, therefore, describes a reduction in sellers’ “costs of production.” Copyright © 2011 Nelson Education Limited

A C T I V E L E A R N I N G 3 A. Fall in price of CDs The market for music downloads STEPS P Q 1. D curve shifts S1 2. D shifts left D2 D1 This is an extension of Active Learning exercise 1C, where we saw that a fall in the price of compact discs would cause a fall in demand for music downloads, because the two goods are substitutes. P1 Q1 3. P and Q both fall. P2 Q2 Copyright © 2011 Nelson Education Limited

A C T I V E L E A R N I N G 3 B. Fall in cost of royalties The market for music downloads STEPS P Q 1. S curve shifts S1 S2 D1 2. S shifts right NOTE: Don’t worry that the text on this slide looks garbled in “Normal view” (i.e., edit mode). It works fine in “Slide Show” (i.e., presentation mode). Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. This event causes a fall in “costs of production” for sellers of music downloads. Hence, the S curve shifts to the right. P1 Q1 (Royalties are part of sellers’ costs) Q2 P2 3. P falls, Q rises. Copyright © 2011 Nelson Education Limited

1. Both curves shift (see parts A & B). A C T I V E L E A R N I N G 3 C. Fall in price of CDs and fall in cost of royalties STEPS 1. Both curves shift (see parts A & B). 2. D shifts left, S shifts right. 3. P unambiguously falls. Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q. It’s not necessary to draw a graph here. The answers to steps 1 and 2 should be clear from parts A and B. The answer to step 3 is a combination of the results from A and B. Copyright © 2011 Nelson Education Limited

It’s not necessary to draw a graph here It’s not necessary to draw a graph here. The answers to steps 1 and 2 should be clear from parts A and B. The answer to step 3 is a combination of the results from A and B. Copyright © 2011 Nelson Education Limited