Demand, Supply and Market Equilibrium Lecture 02 Demand, Supply and Market Equilibrium

The Basic Decision-Making Units in the Economy: Firms and Households

Firms and Households A firm is an organization that transforms resources into products Firms are the primary producing units in a market economy. Households are the consuming units in an economy.

The Entrepreneur The entrepreneur is the person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

Markets Product Factor Product or output markets are the markets in which goods and services are exchanged. Input or Factor markets are the markets in which resources used to produce products are exchanged.

Labor Markets Labor markets are the input markets in which households supply work for wages to firms that demand labor.

Capital Markets Capital markets are the input markets in which households supply their savings, for interest or for claims to future profits, to firms that demand funds in order to buy capital goods.

Land Markets Land markets are the input markets in which households supply land or other real property in exchange for rent.

The Circular Flow A circular flow diagram describes the interaction of firms and households in markets for outputs and inputs.

The Circular Flow Firms House holds Supply Demand Supply Demand Output Markets (Goods & Services) Supply Demand House holds Firms Input Markets: Labor (wages) Capital (interest) Land (rent) Supply Demand

Demand in the Product Markets The quantity demanded represents the amount of a product that a household buy in a given time period at the current market price. A household’s decision about what quantity of a product to demand depends on a number of factors...

Determinants of Household Demand: PRICE of the product INCOME available Amount of accumulated WEALTH PRICES OF RELATED PRODUCTS TASTES and PREFERENCES EXPECTATIONS with respect to future income, wealth, and prices

The Demand Schedule A demand schedule is a table or chart showing how much of a given product a household would be willing to buy at different prices.

The Demand Curve The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. Demand curves are usually derived from demand schedules.

The Demand Curve P D Q

Anna’s Demand Schedule for Telephone Calls - (Table 4.1) Price (per call) $ 0 .50 3.50 7.00 10.00 15.00 Quantity Demanded (calls per month) 30 25 7 3 1

Anna’s Demand Curve - (Figure 4.2) $15.00 30 $10.00 $7.50 $3.50 $ .50 25 7 3 1 Quantity demanded Price

The Law of Demand There is a negative, or inverse, relationship between the quantity of a good demanded and its price. This means that demand curves typically have a negative slope.

Other Determinants of Household Demand: 1) Income and Wealth Income: The total of all earnings received by a household in a given period of time Wealth: The total value of what a household owns less what it owes

Income as a Determinant of Demand Normal Goods: Goods for which demand goes up when income is higher and for which demand goes down when income is lower Inferior Goods: Goods for which demand falls when income rises.

Prices of Other Goods and Services as Determinants of Demand Substitutes: Goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up - Perfect substitutes are identical products. Complements: Goods that ‘go together’; when the price of one increases, demand for the other goes down.

Other Determinants of Household Demand: Tastes and Preferences - These are quite subjective and tend to change over time. Expectations - With respect to future income, wealth, prices, and availability.

Changes in Quantity Demanded vs. Changes in Demand: Important Distinction!! Changes in quantity demanded imply movement along a demand curve. Changes in demand imply a shift in the entire demand curve.

Anna’s Demand for Telephone Calls - A Change in Quantity Demanded $15.00 30 $10.00 $7.50 $3.50 $ .50 25 7 3 1 Quantity demanded Price D Change in quantity demanded from 3 to 7 caused by a change in price from $7.50 to $3.50

Anna’s Demand for Telephone Calls - A Change in Demand Change in demand caused by a change in a demand factor other than price $15.00 $10.00 $7.50 $3.50 D2 D1 $ .50 1 3 7 25 30 Quantity demanded

Changes in Demand - Income Changes - Income Rises P P D2 D1 D2 D1 Q Q Demand for inferior good shifts left Demand for normal good shifts right

Changes in Demand - Prices of Related Goods - Price of hamburger rises P P Q Quantity of hamburger demanded falls D2 D1 D1 D2 Q Q Demand for substitute good (chicken) shifts right Demand for complement good (catsup) shifts left

From Household to Market Demand Demand for a good or service can be defined for an individual household, or for a group of households that make up a market.

Market Demand - Defined - Market demand may be defined as the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

Deriving market demand from the individual demand curves: P 4 8 Qd 3 $1.50 $3.50 DB P DC 9 Price 20 Market Demand DA

Supply in Output Markets A firm’s decision about what quantity of a product to supply depends on a number of factors...

Quantity Supplied The quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period

Factors Determining Firm Supply: PRICE of the product COST of producing the product - Prices of required inputs - Technologies used to produce the product PRICES of RELATED products

The Law of Supply There is a positive, or direct, relationship between the quantity of a good supplied and its price. This means that supply curves typically have a positive slope.

The Supply Schedule and Supply Curve A supply schedule is a table, or chart, showing how much of a product firms will supply at different prices. A supply curve is the graphical representation of a supply schedule.

Clarence Brown’s Soybean Supply Schedule Price per bushel $ 1.50 1.75 2.25 3.00 4.00 Bushels per year 10,000 20,000 30,000 45,000

Clarence Brown’s Soybean Supply Curve $4.00 30 $3.00 $2.25 $1.75 $1.50 40 20 10 Quantity demanded (1,000s) Price S 50

Changes in Quantity Supplied vs. Changes in Supply: IMPORTANT DISTINCTION ! Changes in quantity supplied imply movement along a supply curve. Changes in supply imply a shift in the entire supply curve.

A Change in the Quantity Supplied of Clarence Brown’s Soybeans $4.00 30 $3.00 $2.25 $1.75 $1.50 40 20 10 Quantity demanded (1,000s) 50 S Change in quantity supplied from 10 to 20 caused by a change in price from $1.75 to $2.25

A Shift in Clarence Brown’s Soybean Supply Price S1 $4.00 S2 $3.00 Change in supply caused by a change in a supply factor other than price $2.25 $1.75 $1.50 10 20 30 40 50 Quantity demanded (1,000s)

Changes in Quantity Supplied vs. Changes in Supply: An increase in supply An increase in the quantity supplied

From Individual Firm to Market Supply The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry.

Market Supply The sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service. As with market demand, market supply is the horizontal summation of the individual firms’ supply curves.

From Individual Firm to Market Supply Firm A’s supply Firm B’s supply P P SB SA 3.00 3.00 1.75 1.75 Q Q 10,000 30,000 5,000 10,000 P SA+B 3.00 1.75 Market Supply Curve Q 25,000 65,000

Market Equilibrium The operation of the market depends on the interaction between suppliers and demanders.

Market Equilibrium An equilibrium is the condition that exists when quantity supplied is equal to quantity demanded. At equilibrium, there is no tendency for the market price to change.

Market Equilibrium P S E PE D Q QE

The market for soybeans in equilibrium: P Bushels of soybeans (1,000s) D S $2.50 35

Excess Demand Excess Demand is the condition that exists when quantity demanded exceeds quantity supplied at the current price.

At a price of $1.75 there is Excess Demand in the Soybean Market: $2.50 $1.75 D Q 25 35 50

Excess Supply Excess supply is the condition that exists when quantity supplied exceeds quantity demanded at the current price.

At a price of $3.00 there is Excess Supply in the Soybean Market: $2.50 D Q 22 35 40

Changes in Equilibrium - Demand Shifts/Supply is Constant - Q1 Q2 Q 2 Q1 Decrease in Demand Increase in Demand

Changes in Equilibrium - Supply Shifts/Demand is Constant - Q1 Q2 Q 2 Q1 Decrease in Supply Increase in Supply

Changes in Equilibrium - Supply & Demand both Increase (or Decrease) - ? P ? D2 D1 D1 D2 Q Q1 Q2 Q Q2 Q1 Increase in Demand & Supply Decrease in Demand & Supply

Changes in Equilibrium - Demand & Supply Move Opposite - Demand Increases & Supply Decreases Demand Decreases & Supply Increases

Review Terms & Concepts Capital Market Complements Demand curve Demand schedule Entrepreneur Equilibrium Excess demand Excess supply Factors of production Firm Households Income Inferior goods Input markets labor market land market

Review Terms & Concepts (continued) Law of demand Law of supply Market demand Market supply Movement along a curve Normal goods Perfect substitutes Product markets Profit Quantity demanded Quantity supplied Shift of a curve Substitutes Supply curve Supply schedule Wealth or net worth