MBA201a: Introduction to Supply and Demand

Professor WolframMBA201a - Fall 2009 Page 1 Economic units come in two classes. Buyers –Consumers: finished goods and services. –Firms: raw materials, labor, intermediate goods. Sellers –Firms: finished goods. –Workers: skilled and unskilled labor. –Resource owners: land, raw materials. MARKET: A collection of economic units resulting in the possibility of exchange. - Can be a physical location: NYSE floor, Fulton Street Fish market. - Can be a related set of transaction that are not in the same geographical location: Berkeley housing market, labor market for IT professionals.

Professor WolframMBA201a - Fall 2009 Page 2 Demand, the buyer side of the market Demand: the quantities of a good or service that people are willing to buy at various prices within some given time period, other factors besides price held constant. Willing to buy: a consumer would both like to (i.e., has the taste for it) and is able to (i.e., have sufficient income to pay for it) buy the good. Time period: especially for non-durables, the amount I’m willing to buy depends on the time period. Other factors: the focus of demand is on the relationship between price and quantity. A demand curve describes the relationship between the price and the quantity customers are ready to purchase at that price.

Professor WolframMBA201a - Fall 2009 Page 3 A demand curve example How do buyers respond to a change in price? –Lower price  buyers willing to purchase more. –Higher price  buyers willing to purchase less. Price (per slice) Quantity demanded $ $ $ $ $ The daily demand for pizza in Berkeley:

Professor WolframMBA201a - Fall 2009 Page 4 The demand for pizza in Berkeley graphically Quantity Price $6 $3 0 $4.5 $

Professor WolframMBA201a - Fall 2009 Page 5 Demand versus quantity demanded Quantity Price 0 Quantity Price 0 $ Demand Quantity demanded “Demand” describes the entire curve. “Quantity demanded” describes a particular point, corresponding to a particular price.

Professor WolframMBA201a - Fall 2009 Page 6 What, other than price, drives demand? P Q Demand Curve B Demand Curve A - TASTES (e.g. advertising) - PRICES OF RELATED PRODUCTS (substitutes and complements) -INCOME -DEMOGRAPHICS

Professor WolframMBA201a - Fall 2009 Page 7 A supply curve summarizes the supply side of the market. Supply: the quantities of a good or service that firms are willing to sell at various prices within some given time period, other factors besides price held constant. This definition is identical to the definition of demand, except that we’ve substituted the word “sell” for the word “buy.” A supply curve describes the relationship between the price and the quantity firms are willing to supply at that price.

Professor WolframMBA201a - Fall 2009 Page 8 A supply curve example How do firms respond to a change in price? –Lower price  firms willing to supply less. –Higher price  firms willing to supply more. Price (per slice) Quantity supplied $ $ $ $ $0 0 The daily supply of pizza in Berkeley:

Professor WolframMBA201a - Fall 2009 Page 9 The supply of pizza in Berkeley graphically Quantity Price $6 $3 0 $4.5 $

Professor WolframMBA201a - Fall 2009 Page 10 Demand and supply on the same graph Quantity Price $6 $3 0 $4.5 $ S D

Professor WolframMBA201a - Fall 2009 Page 11 What happens if the price is $4.50? Quantity Price $6 $3 0 $4.5 $ D S

Professor WolframMBA201a - Fall 2009 Page 12 What happens if the price is $1.50? Quantity Price $6 $3 0 $4.5 $ D S

Professor WolframMBA201a - Fall 2009 Page 13 What happens if the price is $3.00? Quantity Price $6 $3 0 $4.5 $ D S

Professor WolframMBA201a - Fall 2009 Page 14 The market mechanism If the market price is above the equilibrium price (P>P * ), there will be a surplus until: producers tend to lower their prices, and quantity demanded tends to expand. If the market price is below the equilibrium price (P<P * ), there will be a shortage until: producers tend to raise their prices, and quantity demanded tends to contract. At the market clearing price (P = P * ),, there is no tendency for the price to change and the market is in equilibrium. Consumers can buy all they want, given the price. Firms can sell all they want, given the price.

Professor WolframMBA201a - Fall 2009 Page 15 Market equilibrium A perfectly competitive market equilibrium is economically efficient: –Every consumer who values the product at least as much as it costs to produce it is able to purchase it. –Every producer can find buyers willing to pay a price that at least covers the costs of production.

Professor WolframMBA201a - Fall 2009 Page 16 Supply versus quantity supplied Quantity Price 0 Quantity Price 0 $ Supply Quantity supplied “Supply” describes the entire curve. “Quantity supplied” describes a particular point, corresponding to a particular price.

Professor WolframMBA201a - Fall 2009 Page 17 What, other than price, drives supply? P Q Supply Curve B Supply Curve A - PRICE OF INPUTS (both substitutes and complements) - TECHNOLOGY