Steven Landsburg, University of Rochester Chapter 1 Supply, Demand, and Equilibrium Copyright ©2005 by Thomson South-Western, a part of the Thomson Corporation. All rights reserved.

Landsburg, Price Theory and Applications, 6th edition2 Introduction Economic consequences of bad weather Interplay of supply and demand Supply and demand analysis –Consumers –Producers –Responsiveness of prices and quantities to variety of changes in economic environment

Landsburg, Price Theory and Applications, 6th edition3 Law of Demand Observation that when price of a good goes up, people will buy less of that good Leads to a downward sloping demand curve

Landsburg, Price Theory and Applications, 6th edition4 Demand versus Quantity Demanded Quantity Demanded –the amount of a good that a given individual or group of individuals will choose to consume at a given price –Change in price means a change in quantity demanded Movement along the demand curve Demand –A family of numbers that lists the quantity demanded corresponding to each possible price –Refers to the curve itself

Landsburg, Price Theory and Applications, 6th edition5 Demand Curves Graph illustrating demand, with prices on the vertical axis and quantities demanded on the horizontal Representation of the demand schedule

Landsburg, Price Theory and Applications, 6th edition6 Changes in Demand A change in price does not lead to a change in demand If rule for how you make purchases changes, then demand changes Entire curve shifts

Landsburg, Price Theory and Applications, 6th edition7 Changes in Demand Fall in Demand –Decision made by demanders to a buy a smaller quantity at each given price –Leftward shift of demand curve Rise in Demand –Decision made by demanders to a buy a larger quantity at each given price –Rightward shift of demand curve

Landsburg, Price Theory and Applications, 6th edition8 EXHIBIT 1.2Shifting The Demand Curve

Landsburg, Price Theory and Applications, 6th edition9 Sales Tax Example Impose a tax to be paid by consumers directly to the government Less desirable to buy the taxed good or service at every given price Demand shifts left and downward

Landsburg, Price Theory and Applications, 6th edition10 EXHIBIT 1.3The Effect of a Sales Tax on Demand

Landsburg, Price Theory and Applications, 6th edition11 Market Demand Quantity associated with a given price is the total number of that good or service that the group members would demand Slopes downward as the individual demand curve does

Landsburg, Price Theory and Applications, 6th edition12 Shape of the Demand Curve Steeply-sloped demand curve means a small change in price will lead to a small change in quantity demanded Flat demand curve means a small change in price will lead to a large change in the quantity demanded Important to producers of goods

Landsburg, Price Theory and Applications, 6th edition13 Econometrics Statistical techniques used by economist to resolve questions about slopes of various demand curves Based on direct observations in marketplace –Ex. Demand for murder –Ex. Demand for reckless driving Wide scope of economics –Allows for other investigations as well

Landsburg, Price Theory and Applications, 6th edition14 Law of Supply Observation that when the price of a good goes up, the quantity supplied goes up Leads to a upward sloping supply curve

Landsburg, Price Theory and Applications, 6th edition15 Supply versus Quantity Supplied Quantity Supplied –The amount of a good that suppliers will provide at a given price –Changes if the price changes Movement along the curve Supply –Family of numbers giving the quantities supplied at each price –Changes in anything other than price changes supply Shifts entire curve

Landsburg, Price Theory and Applications, 6th edition16 Changes in Supply Rise in Supply –Increase in quantities that supplier will provide at each price –Rightward shift of supply Fall in Supply –Decrease in quantities that supplier will provide at each price –Leftward shift of supply

Landsburg, Price Theory and Applications, 6th edition17 EXHIBIT 1.5The Supply of Coffee

Landsburg, Price Theory and Applications, 6th edition18 Excise Tax Example Impose a tax to be paid by producers directly to the government Less desirable to produce the taxed good or service at every given price Supply shifts left and upward

Landsburg, Price Theory and Applications, 6th edition19 EXHIBIT 1.6Effect of an Excise Tax

Landsburg, Price Theory and Applications, 6th edition20 Equilibrium Actual prices determined by interaction between demanders and suppliers Demanders cannot purchase more than suppliers willing to sell them Suppliers cannot sell more than demanders willing to buy

Landsburg, Price Theory and Applications, 6th edition21 Equilibrium Point Point where supply and demand curves intersect Price where quantity demanded equals quantity supplied Demanders and suppliers satisfied –Able to behave as one wants to, taking market prices as given

Landsburg, Price Theory and Applications, 6th edition22 EXHIBIT 1.7Equilibrium in the Market for Cement

Landsburg, Price Theory and Applications, 6th edition23 Changes in the Equilibrium Point Never look at price and quantity Look at effect change has on demand curve and supply curve Common mistakes arise as look at equilibrium –Supply, demand, and equilibrium misused at times –Check validity of information

Landsburg, Price Theory and Applications, 6th edition24 EXHIBIT 1.8 The Effects of Supply and Demand Shifts

Landsburg, Price Theory and Applications, 6th edition25 Effect of Sales Tax Sales tax of x¢ per item causes equilibrium price to fall by some amount less than x¢ per item Price to suppliers not same as price to demanders (price plus sales tax)

Landsburg, Price Theory and Applications, 6th edition26 Effect of Excise Tax Excise tax of x¢ per item causes the equilibrium price to rise by some amount less than x¢ per item Price to suppliers (price minus excise tax) not same as price to demanders

Landsburg, Price Theory and Applications, 6th edition27 Comparing Two Taxes Economic Incidence – the division of a tax burden according to who actually pays the tax Legal Incidence – the division of a tax burden according to who is required under the law to pay the tax The economic incidence of a tax independent of its legal incidence Ex. Social Security tax

Landsburg, Price Theory and Applications, 6th edition28 EXHIBIT 1.10A Sales Tax versus an Excise Tax