Macroeconomics ECON 2301 May 2010 Marilyn Spencer, Ph.D. Professor of Economics Chapter 3

Chapter 3: Supply & Demand

Learning Objectives 1.Explain the law of demand 2.Discuss the difference between money prices and relative prices 3.Distinguish between changes in demand and changes in quantity demanded 4.Explain the law of supply 5.Distinguish between changes in supply and changes in quantity supplied 6.Understand how supply and demand interact to determine equilibrium price and quantity

Markets 4 Markets: Arrangements that individuals have for exchanging with one another ÜRepresent the interaction of buyers and sellers for goods and services ÜMarkets set the prices we pay and receive. Examples: Automobile market Health care market Labor market Stock market

The Law of Demand 4 Demand: how much of a good or service people will purchase at any price during a specified time period, other things being constant (ceteris paribus)

The Law of Demand 4 Law of Demand: Quantity demanded is inversely related to price, holding other factors constant. Price  Q d  Price  Q d 

The Demand Schedule 4 The demand schedule ÜTable relating prices to quantity demanded ÜWe must consider Time dimension Constant-quality units 4 Demand Curve: A graphical representation of the demand schedule ÜNegatively sloped line showing inverse relationship between price and quantity demanded, all else equal

Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)

The Law of Demand (cont'd) 4 What are we holding constant? ÜTastes and preferences ÜIncome ÜPrice of other goods ÜExpectations ÜDemographics ÜMany other factors

Shifts in Demand (cont'd) The Determinants of Demand Tastes and Preferences D1D1 Q/Units Price Hybrid vehicles Increase in demand D2D2 SUVs Decrease in demand D3D3

Determinants of Demand 4 Ceteris-Paribus Conditions ÜDeterminants of the relationship between price and quantity that are unchanged along a curve ÜChanges in these factors cause a curve to shift

Shifts in Demand 4 Determinants of market demand ÜIncome Normal goods Inferior goods ÜThe prices of related goods Substitutes Complements ÜTastes and preferences (including demographics!) ÜExpectations ÜNumber of buyers

Normal and Inferior Goods 4 Normal Goods: Goods for which demand rises as income rises, most goods are normal goods 4 Inferior Goods: Goods for which demand falls as income rises

Shifts in Demand (cont'd) The Determinants of Demand Income: Normal Good D1D1 Q/Units D2D2 D3D3 Price Decrease in income decreases demand Increase in income increases demand

Shifts in Demand (cont'd) The Determinants of Demand Income: Inferior Good D1D1 Q/Units Decrease in income increases demand Increase in income decreases demand Price D2D2 D3D3

Shifts in Demand (cont'd) 4 Substitutes: Two goods are substitutes when a change in the price of one causes a shift in demand for the other in the same direction as the price change. ÜMargarine & butter markets: P m down  Q d of margarine up  D for butter down

Shifts in Demand (cont'd) The Determinants of Demand Price of Related Goods: Substitutes D1D1 Q/Butter Butter & Margarine Price of both = $2/lb Price of margarine increases to $3/lb Demand for butter increases D2D2 Price

Shifts in Demand (cont'd) 4 Complements: Two goods are complements when a change in the price of one causes an opposite shift in the demand curve for the other. Example: P pc down  Q d of pc up  D for printers up

Shifts in Demand (cont'd) The Determinants of Demand Price of Related Goods: Complements D1D1 Q/Speakers Speakers and Amplifiers Decrease the relative price of amplifiers Demand for speakers increases D2D2 D3D3 Speakers and Amplifiers Increase the relative price of amplifiers Demand for speakers decreases Price

Shifts in Demand (cont'd) 4 Expectations of: Future prices Income Product availability 4 Demographics Market size (number of buyers) Age Ethnicity

Shifts in Demand (cont'd) The Determinants of Demand Expectations: Income, Future Prices D1D1 Q/Units A higher income or expectations of a higher future price will increase demand D2D2 D3D3 A lower income or expectations of a lower future price will decrease demand Price

The Determinants of Demand Market Size (Number of Buyers) D1D1 Q/Units Increase in the number of buyers increases demand D2D2 D3D3 Decrease in the number of buyers decreases demand Price Shifts in Demand (cont'd)

The Demand Schedule (cont’d) 4 Individual versus market demand curves 4 Market Demand: The demand of all consumers in the marketplace for a particular good or service ÜEquals the summation at each price of the quantity demanded by each individual

Figure 3-2 The Horizontal Summation of Two Demand Curves, Panel (a)

Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)

Figure 3-3 The Market Demand Schedule for Secure Digital Cards, Panel (a)

Figure 3-3 The Market Demand Schedule for Secure Digital Cards, Panel (b)

Demand (cont’d) 4 Relative prices and money prices ÜRelative Price: The price of a commodity in terms of another commodity ÜMoney Price: Price we observe today in today’s dollars (absolute, or nominal price)

E-Commerce Example: Quality Adjusting the Price of Broadband Service 4 In most U.S. areas, broadband Internet service is priced at about $15 per month compared to France, where price is about $36 per month. 4 U.S. providers, however, typically offer broadband speeds of less than 0.77 megabit per second compared to 20 megabits per second in France. 4 Thus, the U.S. speed-adjusted price is nearly 10 times higher than in France.

Shifts in Demand 4 Scenario ÜImagine the federal government gives every student registered in a college, university, or technical school in the United States a notebook computer. If some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right.

Figure 3-4 A Shift in the Demand Curve Suppose the federal government gives every student a notebook computer Suppose universities prohibit the use of notebook computers

Shifts in Demand (cont'd) 4 Changes in demand versus changes in quantity demanded ÜA change in a good’s own price leads to a change in quantity demanded. This is a movement along the same curve. ÜA change in any determinant OTHER THAN PRICE shifts the D curve, and we call this a change in demand. This is not the same as a change in Q d from a change in the price of the good.

The Law of Supply 4 Supply ÜSchedule showing relationship between price and quantity supplied for a specified time period, other things being equal ÜThe amount of a product or service that firms are willing to sell at alternative prices

The Law of Supply (cont'd) 4 Law of Supply: The price of a product or service and the quantity supplied are directly related. P  Q s  P  Q s 

The Supply Schedule 4 The supply schedule is a table relating prices to quantity supplied at each price. 4 Supply Curve: A graphical representation of the supply schedule ÜPositively sloped line showing direct relationship between price and quantity supplied, all else equal

Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Secure Digital Cards, Panel (a)

Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Secure Digital Cards, Panel (b)

Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)

Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)

Shifts in Supply 4 Changes in supply versus changes in quantity supplied ÜA change in one or more of the non-price determinants will lead to a change in supply. This is a shift of the whole curve. Ü A change in a good’s own price leads to a change in quantity supplied. This is a movement along the same curve.

Shifts in Supply (cont'd) 4 Determinants of supply ÜCost of inputs ÜTechnology and productivity ÜTaxes and subsidies ÜPrice expectations (AND other expectations) ÜNumber of firms in industry

Figure 3-9 A Shift in the Supply Curve: If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve If costs decrease, supply increases. If costs increase, supply decreases.

S1S1 Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) a b d c S2S2 When supply increases the quantity supplied will be greater at each price. Price per Flash Memory Pen Drive ($) Figure 3-9 A Shift in the Supply Curve (cont’d)

Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) S1S1 a c S3S3 b d When supply decreases the quantity supplied will be less at each price. Price per Flash Memory Pen Drive ($) Figure 3-9 A Shift in the Supply Curve (cont’d)

Shifts in Supply (cont'd) 4 Determinants of supply ÜCost of inputs ÜTechnology and productivity ÜTaxes and subsidies ÜPrice expectations ÜNumber of firms in industry

Shifts in Supply (cont'd) The Determinants of Supply Cost of Inputs S1S1 Q/Units Decrease in cost increases supply. S2S2 Increase in cost decreases supply. S3S3 Price

Shifts in Supply (cont'd) The Determinants of Supply Technology and Productivity S1S1 Q/Units Improvements in technology or increases in productivity increase supply. S2S2 Decreases in productivity decrease supply. S3S3 Price

Shifts in Supply (cont'd) The Determinants of Supply Taxes and Subsidies S1S1 Q/Units Decreases in taxes or increases in subsidies increase supply. S2S2 Increases in taxes or decreases in subsidies decrease supply. S3S3 Price

Shifts in Supply (cont'd) The Determinants of Supply Price Expectations S1S1 Q/Units Expectations of lower future prices increase supply. S2S2 Expectations of higher future prices decrease supply. S3S3 Price

Shifts in Supply (cont'd) The Determinants of Supply Number of Firms in Industry S1S1 Q/Units Increase in the number of firms increases supply. S2S2 Decrease in the number of firms decreases supply. S3S3 Price

Shifts in Supply (cont'd) 4 Changes in supply versus changes in quantity supplied ÜA change in one or more of the non-price determinants will lead to a change in supply. This is a shift of the whole curve. ÜA change in a good’s own price leads to a change in quantity supplied. This is a movement along the same curve. ∆S is not the same as ∆Qs!!!

Putting Demand and Supply Together 4 Equilibrium (Market Clearing) Price: The price that clears the market ÜThe price at which quantity demanded equals quantity supplied ÜThe price where the demand curve intersects the supply curve

Figure 3-10 Putting Demand and Supply Together, Panel (a)

Figure 3-10 Putting Demand and Supply Together, Panel (b)

Putting D & S Together (cont'd) 4 Shortage: The situation when quantity demanded is greater than quantity supplied Q d > Q s ÜA shortage exists at any price below the market clearing price

Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers? 4 If you’ve ever tried to get tickets to the big game you know all about “shortages.” 4 Since the quantity of tickets is fixed, the price can go pretty high. 4 Enter the scalper.

Figure 3-11 Shortages of Super Bowl Tickets

Putting D & S Together (cont'd) 4 Surplus: The situation when quantity supplied is greater than quantity demanded Q d < Q s ÜA surplus will exist at any price above the market clearing price ÜExamples: Sugar & cotton price supports Minimum wage

Summary Discussion of Learning Objectives (cont'd) 4 Determining market price and equilibrium quantity ÜThe demand and supply curves intersect at the market clearing, or equilibrium point. ÜSurpluses exist if the price of the good is greater than the market equilibrium price. ÜShortages exist when the price of a good is below the market equilibrium price.