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

A Market Market: A market is an mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods and services. The goal of the chapter is to explain the way in which markets adjust to changes and the role of prices in bringing the markets toward equilibrium. 3-2

Demand (D) Demand schedule shows the various amounts of a product that consumers are willing and able to buy at each specific price during a specified time period. 3-3

Law of Demand Other things equal, Ceteris Paribus , as price (P) falls quantity demanded (Qd) rises and vice-versa. inverse relationship. A Giffen Good is a good that exeriences increased demand when the price rises and decreased demand when the price falls. Example of Giffen good: Perfume. If you lower price from $80 to $40, you may actually sell fewer units because people will perceive the perfume as lower quality. 3-4

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 3-5

Determinants of Demand (D) or Shifts in demand (D) curve Tastes (Patriotism & Kuwait flags, Boots, Fitness) Number of buyers (more people more demand) Income Normal goods (mostly all goods, TV, Mobile) Inferior goods (view goods, apartment, bean) Note on Income effect: It depends on people Price of related goods Substitute good (Air/Train, Pepsi/Coke) Complementary good (DVD/DVD Player, iPhone/App store) Unrelated goods Consumer expectations (now vs. future) 3-6

Shifts in demand (D) curve

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) 3-8

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) 3-9

Supply (S) Supply schedule shows the various amounts of a product that producer is willing and able to sell at each specific price during a specified time period. 3-10

Law of Supply Other things equal, Ceteris Paribus , as price (P) raises quantity supplied (Qs) rises and vice-versa. direct relationship. 3-11

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) 3-12

Determinants of Supply or Shifts in Supply Curve Resource prices: (price of inputs, fuel, raw materials) Technology (better tech) Taxes and subsidies (Tax is bad, Subsidy is good) Prices of other goods: in produce’s point view Substitute good (Tomatoes/Strawberries) Complement good (Chicken/Eggs, Oil/Gas) Producer expectations (now vs. future) Number of sellers (more sellers more supply) 3-13

Shifts in Supply Curve

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) 3-15

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) 3-16

Supply & Demand Market Equilibrium 200 Buyers & 200 Sellers 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) 3-17

Market Equilibrium

Market Equilibrium ∆ in D & ∆ in S Change in demand Shift of the D curve Change in supply Shift of the S curve Change in equilibrium price and quantity 3-19

? ? ? ? Market Equilibrium Supply increase; Demand decrease Price Quantity Supply increase; Demand decrease Supply decrease; Demand increase Supply increase; Demand increase Supply decrease; Demand decrease ? ? ? ? 3-21

Government-Set Prices Price Ceilings and Price Floors Price ceilings: 1. The maximum legal price a seller may charge, typically placed below equilibrium. 2. Shortages result as quantity demanded exceeds quantity supplied. 3. Examples: Rent controls and gasoline price controls (1970s) 3-22

Government-Set Prices Price Ceilings and Price Floors Price floors: 1. The minimum legal price a seller may charge typically placed above equilibrium. 2. Surpluses result as quantity supplied exceeds quantity demanded. 3. Examples: Minimum wage, farm price supports

Advanced analysis Demand is: Qd = 50 – 5P Supply is: Qs = –10 + 5P Equilibrium condition:Qs = Qd 50 – 5P = –10 + 5P 60 = 10P and 6 = P Now substitute P = 6 in either Qd or Qs to determine equilibrium quantity Qd = 50 – 5P = 50 – 5(6) = 20 or Qs = –10 + 5P = –10 + 5(6) = 20