Principles of Microeconomics Class 4 - B Supply and Demand in the Market for Goods and Services

What are competitive markets? Bring together the decentralized decisions of buyers and sellers Decentralized Decisions of Buyers: Drive them to try to get the lowest possible price for the goods they want Decentralized Decisions of Sellers: Drive them to try to get the highest possible price for the goods they are selling When these decisions come together – competitive markets yield: Best possible price for the product Produced at the lowest possible cost Most efficient allocation of resources

What are competitive markets? Fundamental Assumptions of Supply + Demand Model: 1. Operating under Perfect Competition Lots of buyers and sellers Goods sold are identical No cost to entering or leaving the market 2. Equal access to information 3. Externalities do not exist No single economic agent can unilaterally exert any price control

Application 1 Consider the market for oranges. Draw out the supply and demand curves based on the following supply and demand schedule: Draw out the supply and demand curves based on this information. Where is the equilibrium price and quantity? Suppose there is an exceptionally cold winter in Florida with frosts ruining many groves. What happens to this market? Illustrate. What happens if the price of apples falls? Illustrate. Price QD QS $5 10 50 $4 20 40 $3 30 $2 $1 $0 60

Market Equilibrium Price Supply P* Demand Q* Quantity

Market Equilibrium Price Supply SURPLUS P P* Demand Qd Qs Quantity

Market Equilibrium Price Supply P* P SHORTAGE Demand Qd Qs Quantity

Test your Understanding Consider the market for oranges. Draw out the supply and demand curves based on the following supply and demand schedule: Draw out the supply and demand curves based on this information. Where is the equilibrium price and quantity? Suppose there is an exceptionally cold winter in Florida with frosts ruining many groves. What happens to this market? Illustrate. What happens if the price of apples falls? Illustrate. Price QD QS $5 10 50 $4 20 40 $3 30 $2 $1 $0 60

Equilibrium P = $3 Equilibrium Q = 30

When there is a frost – increases the cost of production (weather – input in production) SUPPLY CURVE SHIFTS (IN or LEFT) At $3: S1 < D – shortage in the market for oranges Prices must adjust to P2 – movement along demand curve

If there is a decrease in the price of apples – change in the price of a related good DEMAND CURVE SHIFTS This is a substitute good – so if the price of apples falls – more people buy apples and demand less oranges SHIFTS IN or LEFT Equilibrium price falls Equilibrium quantity falls No change in willingness of sellers – movement along the supply curve!

If happens simultaneously with frost (shifts in both curves) Definite fall in equilibrium quantity Ambiguous impact on equilibrium price

Key Takeaway Market Equilibrium brings together the decentralized decisions of buyers and sellers Because each agent is looking out for their own best interest – we get the optimal results in the model Shifts in the S or D curve must come from a change in one of the factors that change either “willingness to sell” or “willingness to buy” S-D Graph is critical in helping us find equilibrium and analyze/understand changes in the market.

Application Reflection Why does this matter? Using a supply and demand schedule (a table that relates prices to quantity demanded and quantity supplied) we are able to illustrate the supply curve of various firms producing oranges and the demand curve for all of the orange consumers in the market. The graph gives a visual depiction of the equilibrium: where QS = QD. Once we have the graph in equilibrium, we are able to analyze what happens to price and quantity of oranges when there are disruptions or changes in the market such as poor weather or changes in prices of related goods. Without the graph, it is difficult to understand clearly and simply how these changes affect the market for oranges. What’s the most important takeaway? We can use a demand and supply schedule to draw each point on the supply curve and demand curve. With the S-D graph, we can identify equilibrium and analyze how changes or disruptions affect price and quantity. MUDDIEST POINT?

Application 2 Market research has revealed the following about the market for chocolate bars: Demand: Qd = 1600 – 300 P Supply: Qs = 1400 + 700 P Calculate the equilibrium price and quantity of chocolate bars. Assume that consumers incomes have risen and chocolate bars are a normal good. At each price point, consumers now enjoy an extra 50 bars of chocolate. What is the new equilibrium price and quantity? Draw a supply and demand graph showing both the old and new equilibrium points.

Application Reflection Why does this matter? Now, instead of using a simple table, we can determine demand and supply with equations, which allows us to solve for any Qd, Qs, or P. Again, even with equations, the graph helps explain how changes outside of the market (ie: incomes rising) affect the good in question. This is a more quantitative approach to what we did in Application 1. What’s the most important takeaway? Demand curves and supply curves are determined mathematically. With equations, we can graph any point related to supply and demand. Graphs are still key in helping us explain what happens in the market! MUDDIEST POINT?

Key Takeaway Demand is determined by the buyers of a good. Buyer always want to get the lowest price they can! Hence, demand is downward sloping Supply is determined by the sellers of the good. Sellers always want to get the highest price they can! Hence, supply is upward sloping Certain factors affect each of the curves and cause them to shift. The shifts come from an underlying change to the “willingness to buy” or “willingness to sell”. S-D Graph is critical in helping us find equilibrium and analyze/understand changes in the market.