The Market Forces of Supply and Demand Ratna K. Shrestha Chapter 4

Overview  Market and Competition  Demand  Supply  Equilibrium  Price and Resource Allocation

Supply and Demand  Supply and Demand are the forces that make market economies work!  Supply is determined by the producers.  Demand is determined by the consumers.  Modern microeconomics is about supply, demand, and market equilibrium.

Markets and Competition The terms supply and demand refer to the behavior of people......as they interact with one another in markets.

Market: any institution, mechanism, or arrangement which facilitates exchange of goods and services.  A market is a group of buyers and sellers of a particular good or service. –A market for cars. –A market for computers. –A market for legal services. What is Market?

Market Type: A Competitive Market  A Competitive Market is a market:  with many buyers and sellers selling/buying homogeneous Products.  Where no single consumer or a firm can influence the price. Total demand and supply determine the price.  Where firms can enter or exit freely.  in which a narrow “range of prices” are established that buyers and sellers. e.g. steel and agricultural product markets.

Other Types of Market  Monopoly: –One Seller, controls price. e.g. BC Hydro, Shaw Cable, ICBC, Microsoft.  Oligopoly: –Few Sellers, not aggressive competition  Monopolistic Competition: –Many Sellers, differentiated products –e.g. auto, computer, restaurants. –Honda Civic is different from Toyota Corolla.

Spectrum of Market Structure Pure Competition Pure Monopoly Imperfect Competition

Four Types of Market Structure MonopolyOligopoly Monopolistic Competition Perfect Competition Tap water Cable TV Tennis balls Crude oil Hockey Skates Novels, CD Movies Wheat Milk Number of Firms? Type of Products? Many firms One firm Few firms Differentiated products Identical products

The Concept of Demand...  Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at various prices for a given period. P Q

Individual Demand Schedule Cathy’s Demand: Ice Cream Cones

Individual Demand Curve Cathy’s Demand: Ice Cream Cones P $/Cone Q # Cones Per Day $2.50 $2.00 $ Demand Equation:

Market Demand Schedule  Market demand is the sum of all individual demands at each possible price.  Assume the ice cream market has two buyers as follows: Price Per Cone Cathy Nick Mkt Demand $ = 19 $ = 16 $ = 13 $ = 10 $ = 7

Market Demand Curve All Buyers P $/Cone Q # Cones Per Day $2.00 $1.50 $

Determinants of Demand  What factors determine how much ice cream you will buy?  Product’s Own Price  Consumer Income  Prices of Related Goods  Tastes  Expectations  Number of Consumers

Determinant of Demand: Product’s Own Price Law of Demand: There exists an inverse relationship between Price and Quantity Demanded. P Q As P Q

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.

Change in Quantity Demanded vs. Change in Demand  Change in Quantity Demanded Movement along the demand curve is caused by a change in the Price of the product.  Change in Demand (Shift) A shift in the demand curve, either to the left or right is caused by changes in Non-Price Factors.

Changes in Quantity Demanded Price Quantity $ D

Changes in Quantity Demanded Price Quantity $ $ D

Changes in Quantity Demanded Price Quantity $ $ Caused by a change in Price D

Change (Shift) in Demand Price Quantity $ D

(Shift) Change in Demand Price $ Quantity 10 D D’

(Shift) Change in Demand Price $ Quantity 10 Caused by Non-Price Factors: Income, Tastes... D D’

Determinant of Demand: Income  As income increases the demand for a normal good will increase.  Examples?  Why the demand curve shifts? P Q

Determinant of Demand: Income  As income increases the demand for an inferior good will decrease.  Examples?  In Japan, Ashahi Brewery did well during recession. What is the possible implication of this? P Q

Examples?? Melbourne newspaper reports that local book retailers are faring better this Christmas than last. So the income elasticity seems to be helping out here. Possibly books are inferior goods. reportsinferior goods

Determinant of Demand: Prices of Related Goods  When the fall in price of one good reduces the demand for another good (shift of demand curve to the left), the two goods are substitutes.  Examples?

Determinant of Demand: Prices of Related Goods  When the fall in price of one good increases the demand for another good (shift of demand curve to the right), the two goods are complements.  Examples?

Quick Quiz!  List the determinants of the demand for pizza.  Give an example of a demand schedule for pizza.  Give an example of something that would shift the demand curve.

The Concept of Supply...  Quantity Supplied refers to the amount of a good that sellers are willing to make available for sale at alternative prices for a given period.  The minimum price a seller is willing to accept for a product is its cost of production.

Individual Supply Schedule Ben’s Store: Ice Cream Cones

P Q # Cones Per Day $2.50 $2.00 $ Individual Supply Curve Ben’s Store: Ice Cream Cones Supply Equation:

Market Supply Schedule  Market supply is the sum of all individual supplies at each possible price.  Assume the ice cream market has two firms as follows: Price Cone Ben’s Jerry’s IceMart Market Supply $ = 0 $ = 0 $ = 1 $ = 4 $ = 7

P Q # Cones Per Day $2.00 $1.50 $ Market Supply Curve All Sellers S

Determinants of Supply  Product’s Own Price Other Factors:  Input Prices (cost of production)  Technology  Expectations  Number of Producers

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

Change in Quantity Supplied vs. Change in Supply  Change in Quantity Supplied  Movement along the supply curve.  Caused by a change in the Price of the product.  Change in Supply (Shift)  A shift in the supply curve, either to the left or right.  Caused by changes in Non-Price Factors

Changes in Quantity Supplied Price Quantity $ S

Changes in Quantity Supplied Price Quantity $ $ S

Changes in Quantity Supplied Price Quantity $ $ Caused by a change in Price S

Change in Supply Price Quantity $ S

Change in Supply (Shift) Price Quantity $ Caused by Non-Price Factors: Technology, Input Prices S S’

Quick Quiz!  List the determinants of the supply for pizza.  Give an example of a supply schedule for pizza.  Give an example of something that would shift the supply curve.

Supply and Demand Together  Equilibrium Price The price at which the supply and demand curve intersect.  Equilibrium Quantity The quantity at which the supply and demand curve intersect; that is, Quantity Supplied and Quantity Demanded are equal.

Forces of Demand and Supply At Rest Market Equilibrium Price Quantity $ S D

Equilibrium is a state in which there is no tendency to change. This occurs when everyone is doing the best he or she can. Is there Equilibrium in this Picture?

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.

Actions of buyers and sellers that move toward equilibrium. Price Quantity $2.50 $ S D 7

Actions of buyers and sellers that move toward equilibrium. Price Quantity $2.50 $ Excess Supply = 6 cones 7 S D

Actions of buyers and sellers that move toward equilibrium. Price Quantity $2.00 $ S D

Actions of buyers and sellers that move toward equilibrium. Price Quantity $2.00 $ Excess Demand =6 cones S D

Comparative Statics: Analyzing Changes in Equilibrium  Determine if an event shifts supply curve, the demand curve, or both.  Determine if curve(s) shift to left or right.  Determine how the shift affects equilibrium price and quantity.  Example Event: Heat Wave Product: Ice Cream Cones

Heat Wave Affects Buyers (Demand) Price Quantity P1P1 Q1Q1  S D

Heat Wave Will Cause: Rightward Shift in Demand Price Quantity P1P1 Q1Q1 P2P2 Q2Q2   S D D’

An Increase in Demand: Demand Shifts Right Price Quantity P1P1 Q1Q1 P2P2 Q2Q2   Both P and Q increase. D D’ S

S’ Changes In Market Equilibrium u When Income Increases & at the same time raw material prices fall –Quantity increases –If the shift in D is greater than the shift in S, price increases P Q S P2P2 Q2Q2 D P1P1 Q1Q1

Shifts in Supply and Demand u When supply and demand shift simultaneously, the impact on the equilibrium price and quantity is determined by: 1.The relative size and direction of the change 2.The shape or slope of the supply and demand models

Market for a College Education Q ( millions enrolled)) P ( annual cost in 1970 dollars) D 1970 S 1970 S 2002 D 2002 $3, $2,

S 2002 D 2002 D 1900 S 1900 S 1950 D 1950 Long-Run Path of Price and Consumption Copper Market Equilibrium Quantity Price

Concluding Thoughts...  Market economies harness the forces of supply and demand...  Supply and Demand together determine the prices of the economy’s different goods and services...  Prices in turn are the signals that guide the allocation of resources.

BC Cranberry Case Study  After the discovery of beneficial health effect of Cranberry in 1996 (Harvard Study), BC cranberry farmers expected its demand and hence price to go up. But to their dismay, the price fell instead.  Analyze what might have caused this unexpected result??

Practice Numerical Problems 1. Given (i) Q D = 50 – 3P; Q S = P  Draw S and D curves.  Find equilibrium P and Q. (ii) Q D = 50 – 3P + I  Draw D curve for I = 10.  Show the effect of increase in I from $10 to $25.