Economics Winter 14 January 17 th, 2014 Lecture 5 Ch. 3

Shifts in Demand: a recap Demand Shifters are changes in: tastes (preferences) number of buyers money (nominal) income prices of related goods expectations

Normal good – a good, for which, all else equal, an increase in income leads to an increase in quantity demanded

Inferior good – a good, for which, all else equal, an increase in income leads to a decrease in quantity demanded

4. Changes in prices of related goods. Change in Demand, cont’d

Related Goods Substitutes — goods used in the place of another good Complements — goods used in conjunction with another good

Change in Demand, cont’d when two products are SUBSTITUTES, price of one & demand for the other move in the same direction

Good A and Good B are substitutes. If price of Good A Falls… Market for Good B

when two products are COMPLEMENTS, price of one and demand for the other move in opposite directions Changes in prices of related goods, cont’d

Market for blank tapes

Study question If the demand curve for product B shifts to the right as the price of product A declines, it can be concluded that: A)both A and B are inferior goods. B)A is a superior good and B is an inferior good. C)A is an inferior good and B is a superior good. D)A and B are complementary goods. E)A and B are substitute goods.

5. Changes in expectations about future prices or incomes If you expect prices to fall in the future, you may put off purchases today. If you expect your income to rise, you may consume more now. Change in Demand, cont’d

Example: Demand for Tapes The demand for tapes decreases if: – the price of a substitute falls. – the price of a complement rises. – income falls (a tape is a normal good). – the population decreases. – the price of a tape is expected to fall in the future.

Study question Which of the following statements is correct? A) A decline in the price of product X will increase the demand for substitute product Y. B)A decrease in income will decrease the demand for an inferior good. C)An increase in income will reduce the demand for a normal good. D)An increase in the price of C will decrease the demand for complementary product D.

Individual and Market Demand Goods A market demand curve is the horizontal sum of all individual demand curves. –This is determined by adding the individual demand curves of all the consumers (“demanders”).

priceQ D –1st buyer Q D –2nd buyer Q D –market $51012 $42023 $33539 $25560 $ = Market Demand

Supply: a schedule or a curve showing the amounts that producers are willing and able to make available for sale at each of a series of possible prices, during some specified period of time Price per bushel Quantity supplied per week $

Law of Supply all else being constant, as price rises, the quantity supplied rises (& vice-versa) Rationale: –Revenue motive: price is revenue to suppliers –Cost motive: higher price necessary to induce higher supply, to cover higher costs of production

A Change in the Quantity Supplied Versus a Change in Supply When price of the product changes, there is a movement along the supply curve When any other determinant of supply changes, there is a shift in the supply curve

Supply Shifters are changes in: factor prices technology taxes and subsidies prices of other goods price expectations number of sellers Determinants of Supply

Changes in factor prices: increase will decrease supply and shift curve to the left as less will be supplied at each price Rationale: 1.If costs rise, then profits go down, and there is less incentive to supply. 2.If costs go up substantially, the firm may even shut down. Changes in Supply

Changes in technology: new technology will decrease costs & increase supply (This is especially true when new technology replaces labour) Changes in Supply PAPAPAPA S S′S′S′S′ QAQAQAQA

Changes in taxes and subsidies (taxes in reverse): increases in taxes will reduce supply Changes in Supply PAPAPAPA S S′S′S′S′ QAQAQAQA

Changes in prices of other goods: higher prices of substitutes in production will reduce supply and vice versa Changes in Supply PAPAPAPA S S′S′S′S′ QAQAQAQA

Changes in price expectations: of the future price of a product difficult to generalize Changes in number of sellers: as the number of sellers increases, so does supply Changes in Supply

Equilibrium As The Marriage of Supply and Demand Supply and demand come together to determine equilibrium quantity and equilibrium price.

Equilibrium, cont’d When quantity demanded equals quantity supplied, prices have no tendency to change. Equilibrium is a concept in which opposing dynamic forces cancel each other out. Equilibrium isn’t a state of the world—it's a characteristic of the model used to look at the world. Equilibrium isn’t inherently good or bad—but simply a state in which dynamic pressures offset each other.

The Law of Supply and Demand Conventional (free market) Economics claims that the price of any good adjusts to bring the supply and demand for that good into balance. Excess supply – a situation in which quantity supplied is greater than quantity demanded. The same as “surplus” Excess demand – a situation in which quantity demanded is greater than quantity supplied. The same as “shortage” Excess supply Excess demand

The Law of Supply and Demand, cont’d The larger the difference between quantity demanded and quantity supplied, the greater the pressure for prices to rise (if there is excess demand) or fall (if there is excess supply).