Chapter 4 Demand, Supply, and Markets © 2009 South-Western/Cengage Learning

22 Demand Demand: a demand schedule (curve, function) shows the quantities buyers are willing and able to buy at various prices for a given time period Price: amount of money given up to purchase 1 unit of the good

3 Law of Demand Law of demand –Quantity demanded varies inversely with price, other things constant Higher price: lower quantity demanded

4 Law of Demand Substitution effect –shows the change in consumption resulting from the change in the relative price of the good –lower price lower relative price buy more of the relatively cheaper good and less of the relatively more expensive good

5 Law of Demand Income effect –shows the change in consumption resulting from the change in the purchasing power of the consumer’s income –lower price Greater real income Increase ability to purchase all goods

6 Demand Schedule and Demand Curve Demand schedule –Possible prices –Quantity demanded at each price –Law of demand Demand curve –Downward slope –Law of demand

7 Demand Shifters 1.Consumer income normal good (I increases Q d increases ) inferior good (I increases Q d decreases) 2.Prices of other goods substitutes (P y increases Q x increases) complements (P y increases Q x decreases) 3.Consumer expectations 4.Population 5.Consumer tastes / preferences

8 Supply Supply: a supply schedule (curve, function) shows the quantities producers will produce at various prices for a given time period.

9 Law of Supply Law of supply? –Quantity supplied is directly related to its price, other things constant usually upward sloping –Higher price: higher quantity supplied Higher reward, profit –More willing to increase quantity supplied Can afford to cover the marginal costs –Increasing opportunity cost –More able to increase quantity supplied

10 Supply Shifters 1.Technology 2.Input prices 3.Prices of related goods 4.Producer expectations 5.Number of producers in the market 6.Government policies 7.Natural disasters weather, earthquakes, floods, etc.

11 Market Equilibrium An equilibrium exists when all who wish to buy may do so and all who wish to sell may do so (at the existing price) Q d = Q s Surplus: Q d < Q s –Downward pressure on price Decrease quantity supplied Increase quantity demanded Shortage: Q d > Q s –Upward pressure on price Increase quantity supplied Decrease quantity demanded

If Demand shifts Increase in Demand: (shift right) increase P* increase Q* Decrease in Demand: (shift left) decrease P* decrease Q* 12

If Supply shifts Increase in Supply: (shift right) decrease P* increase Q* Decrease in Supply: (shift left) increase P* decrease Q* 13

If both Supply and Demand shift Who can tell what will happen?? –depends on the magnitude and direction of the shifts 14

Exhibit 9 Effects of both demand and supply 15 Demand increases Demand decreases Supply Increases Equilibrium price change is indeterminate. Equilibrium quantity increases. Equilibrium price falls. Equilibrium quantity change is indeterminate. Supply decreases Equilibrium price rises. Equilibrium quantity change is indeterminate. Equilibrium price change is indeterminate. Equilibrium quantity decreases. Change in demand Change in supply

Disequilibrium Surplus –downward pressure on P Shortage –upward pressure on P Disequilibrium –Temporary, or –Result of government intervention Price floors Price ceilings 16

Disequilibrium Price Floors –minimum price below which the market price cannot fall – creates a surplus –distort markets –reduce economic welfare How do we allocate scarce resources? Unintended consequences!! 17

Disequilibrium Price Ceilings –maximum price above which the market price cannot rise –creates a shortage –distort markets –reduce economic welfare How do we allocate scarce resources?? Unintended consequences!! 18