1 CHAPTER 3 Demand, Supply and Market Equilibrium

Markets An institution or mechanism that brings together buyers and sellers of particular goods and services. This chapter focuses on competitive markets. What is a competitive market? 2

3 A schedule or a curve that shows the various amounts consumers are willing and able to purchase at each of a series of possible prices, during. some specified period of time Demand

Demand Schedule for DVDs Price (dollars/dvd) Quantity (millions of dvds/week) ABCDEABCDE

5 Ceteris paribus, as price falls, the quantity demanded rises (& vice-versa) Explanation of law of demand: 1. diminishing marginal utility 2. income effect 3. substitution effect Law of Demand

Individual versus Market demand The market demand us the horizontal sum of individual demand curve. 6

Market Demand Schedule for DVDs Quantity demanded (millions/week) Total quantity demanded /week Price (dollars/dvd) Buyer 1Buyer 2Buyer 3 ABCDEABCDE

8 A change in one or more of the determinants of demand results in a shift in the demand curve Changes in Demand

9 Changes in any of these determinants will cause a change in demand: tastes (preferences) number of buyers income prices of related goods expectations let’s examine these more closely… Changes in Demand

10 Changes in Tastes (preferences) positive change shifts D curve right more will be demanded at each price PAPAPAPA QAQAQAQA D D′D′D′D′ Changes in Demand

11 Changes in Number of Buyers: decrease will shift curve left PAPAPAPA QAQAQAQA D’ D Changes in Demand

12 Changes in Money Incomes: when income increases  demand for NORMAL goods increases  demand for INFERIOR goods decreases Changes in Demand

13 Changes in Prices of Related Goods: when two products are SUBSTITUTES, price of one & demand for the other move in the same direction when two products are COMPLEMENTS, price of one & demand for the other move in opposite directions when products are unrelated  no effect Changes in Demand

14 Changes in Consumer Expectations: about future prices or incomes Changes in Demand

15 when price of the product changes, there is a movement along the demand curve…this is called a change in quantity demanded. when any other determinant of demand changes, there is a shift in the demand curve… this is called a change in demand. Change in Quantity Demanded

16 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. Supply

Supply Schedule for DVDs Price (dollars/dvd) Quantity (millions of dvds/week) ABCDEABCDE

18 Ceteris paribus, as price rises, the quantity supplied rises (& vice-versa) why? price is revenue to suppliers higher price necessary to induce higher supply, to cover higher costs of production Law of Supply

19 Changes in any of these determinants will cause the supply curve to shift: factor prices technology taxes & subsidies prices of other goods producer expectations number of sellers let’s examine these more closely… Determinants of Supply

20 A change in quantity supplied is a movement from one point to another on a fixed supply curve A change in supply is a shift of the entire curve price quantityS Increase in Q S Decrease in Q S NOT supply! Changes in Quantity Supplied

21 Equilibrium price will be established where the supply decisions of producers and the demand decisions of buyers are mutually consistent Market Equilibrium

Market Supply & Demand for DVDs Price (dollars/dvd) Quantity demanded (millions of dvds/week) Quantity supplied (millions of dvds/week) Shortage (-) or surplus (+) (millions of dvds/week)

Equilibrium price & quantity 23 Equilibrium price (market clearing price) is the price in a competitive market at which the quantity demanded is equal to the quantity supplied. There is neither a shortage nor a surplus at this price. Equilibrium quantity is the quantity demanded & supplied at the equilibrium price in a competitive market.

24 What is the rationing function of prices?

Efficient allocation 25 Efficient allocation of society’s resources occur in a competitive market at equilibrium. Efficient allocation means: 1. Productive efficiency 2. Allocative efficiency

26 when both supply and demand change, the effect is a combination of the individual effects if both demand and supply shift, one of either price or quantity cannot be predicted–the result is indeterminate Complex Cases

27 Change in supply Change in demand Effect on equilibrium price Effect on equilibrium quantity IncreaseDecrease Indeterminate DecreaseIncrease Indeterminate Increase Indeterminate Increase Decrease Indeterminate Decrease Table 3-3 Complex Cases

28 Price Ceilings: A legally established maximum price for a good or service. 3.4 Applications: Government Set Prices

29 Rationing Problem Black Markets Price Ceilings and Shortages

30 Price Floor: A legally established price above an equilibrium price Government Set Prices: Price Floors

31 Additional consequences Distort resource allocation Cause shortages or surpluses Produce negative side effects Price Floors and Surplus

Mathematics of Market Equilibrium P = Q d P = Q s Calculate the equilibrium quantity & price Step 1: Set the right hand side of both equations to equal on another & solve for Q* (Q*= Q d = Q s in equilibrium) Step 2: Substitute Q* into either equation & solve for P* (P*=P in equilibrium) 32

Homework questions Study questions are end of chapter: 3,6,7, 8, 9,13, 14, 17 The key will be posted on my website. 33