The Market Forces of Supply and Demand Chapter 4 The Market Forces of Supply and Demand 1

The Market Forces of Supply and Demand Supply and Demand are the two words that economists use most often. Supply and Demand are the forces that make market economies work! 2

Market: any institution, mechanism, or arrangement which facilitates exchange. A market is the interaction of buyers and sellers. Buyers determine demand... Sellers determine supply... 4

Market Type: A Competitive Market A Competitive Market is a market: with many buyers and sellers that is not controlled by any one person in which a narrow “range of prices” are established that buyers and sellers act upon 5

Market Type: Perfect & Otherwise Perfect Competitive: Homogeneous Products Buyers and Sellers are Price Takers Monopoly: One Seller, controls price Oligopoly: Few Sellers, not aggressive competition Monopolistic Competition: Many Sellers, differentiated products 6

Determinant of Demand: Market Price Law of Demand: There exists an inverse relationship between Price and Quantity Demanded. P Q 12

Demand Schedule and Demand Curve A table that shows the relationship between the price of the good and the quantity demanded. (Table 4-1) Demand Curve: The downward-sloping line relating price and quantity demanded. (Figure 4-1) 17

Example: Demand For Ice Cream Price of Ice Cream Quantity of Ice Cream 9

Change in Quantity Demanded verses Change in Demand Movement along the demand curve. Caused by a change in the market price of the product. (Table 4-3) Change in Demand A shift in the demand curve, either to the left or right. (Figure 4-3) 19

The Concept of Demand. . . Quantity Demanded refers to the amount (quantity) of a good that buyers are willing and able to purchase at each price for a given point in time. P Q 8

Ceteris Paribus . . . ...implies that all the relevant variables (e.g. determinants of demand) are held constant, except the one(s) being studied at the time. 18

Changes in Quantity Demanded Price $2.00 Quantity 7 20

Changes in Quantity Demanded Price $2.00 $1.00 Quantity 7 13 21

Change in Demand Price $2.00 Quantity 7 22

Change in Demand Price $2.00 Quantity 7 10 23

Determinants of Demand What factors determine how much ice cream you will buy? What factors determine how much will you really purchase? 10

Determinants of Demand 1. Consumer Income 2. Prices of Related Goods 3. Tastes 4. Expectations 5. Number of Consumers 11

Determinant of Demand: Income P As income increases the demand for a normal good will increase. Q 13

Determinant of Demand: Income P As income increases the demand for a normal good will increase. As income increases the demand for a inferior good decrease. Q 14

Determinant of Demand: Prices of Related Goods When the fall in price of one good reduces the demand for another good, the two goods are substitutes. 15

Determinant of Demand: Prices of Related Goods When the fall in price of one good increases the demand for another good, the two goods are complements. 16

Tastes and Preferences If tastes change in favor of a service or product, the demand will increase (shift to the right).

Tastes and Preferences If tastes change against a product or service, the demand for that product or service will fall (shift to the left).

Expectations about future prices If you expect the price of a product to rise in the future, the demand for the product will go up (shift to the right). If you expect the price of a product to fall in the future, the demand for the product will go down (shift to the left).

Number of Consumers If the number of consumers increase, the demand curve will shift to the right (increase). If the number decreases, the demand will fall.

Determinant of Supply: Market Price Law of Supply There exists an direct (positive) relationship between Price and Quantity Supplied. P Q 28

Supply: Schedule and Curve A table that shows the relationship between the price of the good and the quantity supplied. (Table 4-4) Supply Curve The upward-sloping line relating price and quantity supplied. (Figure 4-4) 29

Supply of Ice Cream Price Quantity 26

Change in Quantity Supplied verses Change in Supply Movement along the supply curve. Caused by a change in the market price of the product. (Table 4-6) Change in Supply A shift in the supply curve, either to the left or right. (Figure 4-7) 30

The Concept of Supply. . . Quantity Supplied refers to the amount (quantity) of a good that sellers are willing and able to make available for sale at each possible price for a given point in time. P Q 25

Changes in Quantity Supplied Price $2.00 Quantity 7 31

Changes in Quantity Supplied Price $2.00 $1.00 Quantity 1 7 32

Determinants of Supply 1. Input Prices 2. Technology 3. Expectations 4. Number of Producers 27

Change in Supply Price $2.00 Quantity 7 33

Change in Supply Price $2.00 Quantity 7 11 34

Supply and Demand Together Equilibrium Price The price at which the supply and demand curve intersect. Quantity Supplied and Quantity Demanded are equal. Equilibrium Quantity The quantity at which the supply and demand curve intersect. 36

Forces of Demand. . . Price Quantity 37

Forces of Demand and Supply. . . Price Quantity 38

Forces of Demand and Supply At Rest Market Equilibrium Price $2.00 Quantity 7 39

Actions of buyers and sellers that move toward equilibrium. Excess Supply Price is above equilibrium price, therefore producers are unable to sell all they want at the going price. Excess Demand Price is below equilibrium price, therefore consumers are unable to buy all they want at the going price. 40

Actions of buyers and sellers that move toward equilibrium. Price Quantity 41

Actions of buyers and sellers that move toward equilibrium. Price Excess Supply Quantity 42

Actions of buyers and sellers that move toward equilibrium. Price Quantity 43

Actions of buyers and sellers that move toward equilibrium. Price Excess Demand Quantity 44

Comparative Statics: Analyzing Changes in Equilibrium Determine if event shifts supply curve, the demand curve, or both. Determine if curve(s) shift to left or right. Determine how shift affects equilibrium price and quantity. Example: Demand for ice cream given hot weather. 45

Change in demand due to hot weather Price Pe Equilibrium Quantity Qe 46

Change in demand due to hot weather Price Pe Quantity Qe 47

Change in demand due to hot weather Price New Equilibrium Pe Pe Quantity Qe Qe 49