Demand, Supply, and Market Equilibrium 03 Demand, Supply, and Market Equilibrium Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Interaction between buyers and sellers Markets may be Local National International Price is discovered in the interactions of buyers and sellers LO1 3-2

Amount consumers are willing and able to purchase at a given price Demand Schedule or curve Amount consumers are willing and able to purchase at a given price Other things equal Individual demand Market demand LO1 3-3

Law of Demand Other things equal, as price falls the quantity demanded rises, and as price rises the quantity demanded falls Reasons Common sense Law of diminishing marginal utility Income effect and substitution effects LO1 3-4

The Demand Curve The Demand Curve 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 LO1 3-5

Change in Quantity Demanded Changes in Demand Demand Can Increase or Decrease P 6 5 4 3 2 1 Change in Demand Individual Demand Change in Quantity Demanded Price (per bushel) D2 Decrease in Demand D1 D3 Q 2 4 6 8 10 12 14 16 18 Quantity Demanded (bushels per week) LO1 3-6

Determinants of Demand Determinants of Demand: Factors That Shift the Demand Curve Determinant Examples Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones. Change in the number of buyers A decline in the birthrate reduces the demand for children’s toys. Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine. Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods). Change in consumer expectations Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans. LO1 3-7

Amount producers are willing and able to sell at a given price Supply Schedule or curve Amount producers are willing and able to sell at a given price Individual supply Market supply LO2 3-8

Price acts as an incentive to producers At some point, costs will rise Law of Supply Other things equal, as the price rises the quantity supplied rises, and as the price falls the quantity supplied falls Reasons Price acts as an incentive to producers At some point, costs will rise LO2 3-9

The Supply Curve Supply of Corn Price per Bushel Qs per Week $5 60 4 3 2 1 P Supply of Corn Price per Bushel Qs per Week $5 60 4 50 3 35 2 20 1 5 S Price (per bushel) Q 10 20 30 40 50 60 70 Quantity supplied (bushels per week) LO2 3-10

Change in Quantity Supplied Changes in Supply P Change in Quantity Supplied $6 5 4 3 2 1 Price (per bushel) S3 S1 S2 Change in Supply Q Quantity supplied (thousands of bushels per week) 2 4 6 8 10 12 14 16 LO2 3-11

Determinants of Supply Determinants of Supply: Factors That Shift the Supply Curve Determinant Examples Change in resource prices A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline. Change in technology The development of more effective wireless technology increases the supply of cell phones. Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education. Change in prices of other goods An increase in the price of cucumbers decreases the supply of watermelons. Change in producer expectations An expectation of a substantial rise in future log prices decreases the supply of logs today. Change in the number of suppliers An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games. LO2 3-12

Equilibrium occurs where the demand curve and supply curve intersect Market Equilibrium Equilibrium occurs where the demand curve and supply curve intersect Surplus and shortage Rationing functions of prices The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent LO3 3-13

Market Equilibrium 200 Buyers & 200 Sellers P Qd P Qs Market Market Supply 200 Sellers Market Demand 200 Buyers 6 5 4 3 2 1 6,000 Bushel Surplus S P Qd P Qs 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 7,000 Bushel Shortage D 2 4 6 8 10 12 14 16 18 7 Bushels of Corn (thousands per week) LO3 3-14

Changes in Demand and Equilibrium ` Changes in Demand and Equilibrium Changes in Demand and Equilibrium ` D increase: P, Q D decrease: P, Q P P S S D2 D3 D1 D4 Increase in demand Decrease in demand LO4 LO4 3-15

Changes in Demand and Equilibrium Changes in Supply and Equilibrium ` Changes in Demand and Equilibrium ` S increase: P, Q S decrease: P, Q P P S1 S2 S4 S3 D D Increase in supply Decrease in supply LO4 LO4 3-16

Government-Set Prices Price Ceilings Set below equilibrium price Rationing problem Black markets Example: Rent control LO5 3-17

Government-Set Prices $3.50 P0 Ceiling 3.00 PC D Shortage Q Qs Q0 Qd LO5 3-18

Government-Set Prices Price Floors Prices are set above the market price Chronic surpluses Example: Minimum wage laws LO5 3-19

Government-Set Prices Surplus Floor $3.00 Pf 2.00 P0 D Q Qd Q0 Qs LO5 3-20