Demand, Supply, and Market Equilibrium Chapter 3 Demand, Supply, and Market Equilibrium

Markets Markets (factor & product) bring together buyers (demanders or consumers) and sellers (suppliers or producers.) Farmers’ markets Chicago Board of Trade (commodities) NYSE eBay, StubHub, hotels.com, etc. NFL QBs

Demand Demand is represented by a schedule or curve that shows the quantity of a product (resource) that consumers (producers) are willing and able to purchase at each of a series of prices Price is the independent variable Quantity is the dependent variable

Law of Demand There is an inverse relationship between price and quantity demanded…why? Common sense – people buy more at low prices Law of Diminishing Marginal Utility – people need a lower price to entice them to buy more Income Effect – lower price increases purchasing power of my budget/income Substitution Effect – a lower price will entice some to switch away from the more expensive g/s to the lower priced g/s

The Demand Curve Schedule and Graph: Market demand is the sum of all the individual demand schedules in a market.

Change in Demand A change in demand results in a shift of the demand curve. (more Q at every P) An increase in demand causes the demand curve to shift to the right while a decrease in demand will result in a shift to the left of the demand curve. Important: A change in P causes a change in Q (quantity demanded) and does not cause a shift of the curve!

Determinants of Demand A change in a determinant will cause the demand curve to shift. 1. Tastes and Preferences Technology Medical research Advertising Fads

2. Number of Buyers Population growth New markets (globally) Demographics (boomers)

3. Income Normal Goods (also called superior goods) – people buy more of these goods as their incomes increase Inferior Goods – As incomes increase, consumers buy less of these goods

4. Prices of Related Goods Substitutes – goods that can be used in place of each other (“either/or”) An increase in the price of a good will increase the demand for a substitute good

Complements– goods that are used in conjunction with one another (“and”) An increase in the price of one good will result in a decrease in demand for it’s complement

5. Consumer Expectations Today’s expectations of higher prices or disposable incomes in the future lead to an increase in current demand Real Estate speculation Luxury cars

Supply Supply is a schedule or curve showing the various amounts of a product that producers are willing and able to make available for sale at a series of prices Law of Supply – There is a direct relationship between price and quantity supplied. Thus, the supply curve is up sloping.

As with demand, a change in a determinant will cause the supply curve to shift. Anything that results in a decrease in production costs will cause an increase in supply (shift to the right). Anything that results in an increase in production costs will cause a decrease in supply (shift to the left) Remember: A change in P changes Q (quantity supplied) and causes movement on the supply curve.

Determinants of Supply 1. Resource prices (costs of production!!) 2. Technology (costs) 3. Govt. taxes and subsidies (payments to produce) (costs) 4. Prices of other goods – substitution in production 5. Producer expectations 6. Number of sellers in the market 7. Natural Disasters

Market Equilibrium Also known as the market clearing price Quantity demanded = Quantity supplied Always the intersection of demand and supply Graph

The Rationing Function of Prices helps to eliminate shortages (excess demand) and surpluses (excess supply) Graph

Efficient Use of Resources Competitive Markets result in an efficient use of societies resources Productive Efficiency – least cost production (producing the most for least) Allocative Efficiency – producing the mix of goods and services most desired by society (producing where MB=MC)

Changes in Supply, Demand, and Know and understand these 8 graphs! D  PQ D  PQ S  PQ S  PQ

Shifts in Both Demand and Supply DS  P?Q DS  P?Q DS  PQ? DS  PQ? Hint: When both demand and supply shift, there will be either an indeterminate price or quantity (unless it’s clear which curve shifts further.)

Government Set Prices Price Ceilings – An effective price ceiling is set below equilibrium price. Graph Historic Example – Rent Control Results – Shortages, Black Markets

Price Floors – An effective price floor is set above equilibrium price Graph Historic Example: agriculture price supports, minimum wage Result: Surplus, Government Purchase of Surplus