Chapter 3 Supply and Demand ECONOMICS: Principles and Applications, 4e HALL & LIEBERMAN, © 2008 Thomson South-Western

Markets Market The economy A group of buyers and sellers with the potential to trade with each other Can be defined broadly or narrowly Macroeconomics Microeconomics The economy A collection of individual markets

Markets Macroeconomic Markets Microeconomic Markets All capital goods - one market All consumer goods - “consumption goods” Overall view of the economy Microeconomic Markets Narrowly defined Models - specific commodities

Product and Resource Markets Product market Goods and services Firms – suppliers Households – buyers Resource market Resources Firms – buyers Households – suppliers

Product and Resource Markets Figure 1 The Circular Flow Model Flow of goods and resources Resource market - Households sell resources - Firms buy resources to produce goods and services Product Market - Firms sell goods and services to households Money flows - Firms – pay the resource owners - Households – receive income for resources (to buy goods and services )

Competition in Markets Imperfectly competitive markets Buyers/sellers can influence the price A few large buyers or sellers Product differentiation Perfectly competitive markets (or just competitive markets) Buyers/sellers take the market price Many small buyers and sellers Standardized product

Using Supply and Demand Supply and demand model Designed to explain how prices are determined in perfectly competitive markets Perfect competition Rare in the real world Many markets are close to perfect competition To analyze a market, we need both, Supply and Demand

How to make a deal Single price (most cases) Quantity price(buy one get one half price) Two part tariff (membership fee) Customer price (Dentist charges different price according to customers) Bargaining price (Vehicle, House) Auction price (Antique, Land)

Demand – Quantity Demanded amount of a good all buyers in a market would choose to buy during a period of time given their constraints Implies a Choice Households choose to buy – considering the opportunity cost of their decisions

The Law of Demand When the price of a good rises and everything else remains the same, the quantity of the good demanded will fall Ceteris paribus assumption many variables change simultaneously understand each variable separately we assume “everything else remains the same” understand how demand reacts to price

Demand Schedule and Demand Curve list of different quantities demanded at different prices, ceteris paribus Demand curve relationship between the price of a good and the quantity demanded, ceteris paribus

The Demand Curve Each point on the demand curve total quantity that buyers would choose to buy at a specific price Graphical depiction of a demand schedule Slopes downward Law of Demand

The Demand Curve Figure 2 The Demand Curve – movement along the demand curve Number of Bottles per Month Price per Bottle When the price is $4.00 per bottle, 40,000 bottles are demanded A $4.00 At $2.00 per bottle, 60,000 bottles are demanded B 2.00 D 40,000 60,000

Movements Along the Demand Curve a change in the price of a good causes a movement along the demand curve, ceteris paribus. In Figure 2 a fall in price - move rightward along the demand curve (from A to B) a rise in price - move leftward along the demand curve (from B to A).

Shifts of the Demand Curve a change in any variable that affects demand—except for the good’s price— causes the demand curve to shift. An increase in quantity at any price The demand curve shifts rightward (increase in demand) A decrease in quantity at any price The demand curve shifts leftward (decrease in demand)

The Demand Curve Figure 3 A Shift of the Demand Curve Number of Bottles per Month Price per Bottle An increase in income shifts the demand curve for maple syrup from D1 to D2 D2 D1 At each price, more bottles are demanded after the shift B C $2.00 60,000 80,000

Change in Quantity Demanded A particular amount buyers would choose to buy at a specific price One point on a demand curve Change in quantity demanded A movement along a demand curve in response to a change in price

Change in Demand “Demand” Change in demand Relationship between price and quantity demanded Represented by the entire demand curve Change in demand Shift of the demand curve From changes in something other than price

Factors that Shift the Demand Curve Income Normal Good People demand more as the income rises Inferior Good People demand less as the income rises A rise in income will increase the demand for a normal good decrease the demand for an inferior good

Factors that Shift the Demand Curve Wealth Total value of everything you own minus the total dollar amount you owe Measured at a point in time An increase in wealth will increase demand (shift rightward) for a normal good decrease demand (shift leftward) for an inferior good

Factors that Shift the Demand Curve Prices of Related Goods Substitutes can be used in place of some other good fulfills more or less the same purpose A rise in the price of a substitute will: increase the demand for a good (shift the demand curve to the right)

Factors that Shift the Demand Curve Prices of Related Goods Complements used together with the good we are interested in A rise in the price of a complement will decrease the demand for a good (shifts the demand curve to the left)

Factors that Shift the Demand Curve Population An increase in population will increase the number of buyers increase the demand (rightward shift) Expected Price An expected rise in price shifts the demand curve rightward (increase) An expected fall in price shifts the demand curve leftward (decrease)

Factors that Shift the Demand Curve Tastes/Preferences tastes change toward a good demand increases (demand curve shifts right) tastes change away from a good demand decreases (demand curve shifts left)

The Demand Curve Figure 4 The Demand Curve – A summary Price ↓ Move rightward along the demand curve Price ↑ Move leftward along the demand curve P P A B P1 P2 B A P2 P1 D D Q1 Q2 Q Q2 Q1 Q

The Demand Curve Figure 4 The Demand Curve – A summary The Demand curve shifts rightward P Income or wealth ↑ Price of substitute↑ Price of complement ↓ Population ↑ Expected price ↑ Tastes shift toward good D2 D1 Q

The Demand Curve Figure 4 The Demand Curve – A summary The Demand curve shifts leftward P Income or wealth ↓ Price of substitute ↓ Price of complement ↑ Population ↓ Expected price ↓ Tastes shift away from good D1 D2 Q