Demand, Supply, and Market Equilibrium Chapter 3 Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Chapter Objectives Demand and its determinants Supply and its determinants Supply, demand, & market equilibrium Changes in supply and demand Government-set prices 3-2

A Market Interaction between buyers and sellers Buyers demand goods Sellers supply goods Assumptions –Standardized good –Competitive market 3-3

Demand Schedule or curve Amount consumers willing and able to purchase at a given price Other things equal Individual demand Market demand 3-4

Law of Demand Other things equal, as price falls quantity demanded rises Explanations: –Diminishing marginal utility –Income effect –Substitution effect 3-5

Individual Demand Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ P Q D 3-6

Determinants of Demand Factors that shift the demand curve Cause more or less to be bought at any possible price Increase or decrease in demand Tastes Number of buyers 3-7

Determinants of Demand Income –Normal goods –Inferior goods Price of related goods –Substitute good –Complementary good –Unrelated goods Consumer expectations 3-8

Individual Demand Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ Individual Demand P Q D1D Demand Can Increase or Decrease Increase in Demand Decrease in Demand D2D2 D3D3 3-9

Individual Demand Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ Individual Demand P Q D1D Demand Can Increase or Decrease Decrease in Demand D2D2 D3D3 Change in Demand Change in Quantity Demanded 3-10

Supply Schedule or curve Amount producers willing and able to sell at a given price Individual supply Market supply 3-11

Law of Supply Other things equal, as price rises the quantity supplied rises Explanations: –Revenue implications –Marginal cost 3-12

Individual Supply Quantity Supplied (bushels per week) Price (per bushel) PQsQs $ Individual Supply P Q S1S

Determinants of Supply Resource prices Technology Taxes and subsidies Prices of other goods Producer expectations Number of sellers 3-14

Individual Supply Quantity Supplied (bushels per week) Price (per bushel) PQsQs $ Individual Supply P Q S1S1 Supply Can Increase or Decrease S2S2 S3S

Individual Supply Quantity Supplied (bushels per week) Price (per bushel) PQsQs $ Individual Supply P Q S1S1 Supply Can Increase or Decrease S2S2 S3S Change in Quantity Supplied Change in Supply 3-16

Market Equilibrium Equilibrium price and quantity Surplus and shortage Rationing function of price Efficient allocation –Productive efficiency –Allocative efficiency 3-17

Market Equilibrium Bushels of Corn (thousands per week) Price (per bushel) PQdQd $ ,000 4,000 7,000 11,000 16,000 Market Demand 200 Buyers PQsQs $ ,000 10,000 7,000 4,000 1,000 Market Supply 200 Sellers 200 Buyers & 200 Sellers 7 3 D S $4 Price Floor 6,000 Bushel Surplus $2 Price Ceiling 7,000 Bushel Shortage 3-18

Market Equilibrium Change in demand –Shift of the demand curve Change in supply –Shift of the supply curve Change in equilibrium price and quantity 3-19

Market Equilibrium Supply increase; Demand decrease Supply decrease; Demand increase Supply increase; Demand increase Supply decrease; Demand decrease Price Quantity ? ? ? ? 3-20

Government-Set Prices Price ceilings on gasoline –Rationing problem –Black markets Rent controls Price floors on wheat –Optimal allocation of resources 3-21

A Market for Human Organs Waiting list for transplants Demand for organs Supply of organs—two possibilities Market eliminates shortage Moral objections Legalize and regulate? 3-22

A Market for Human Organs P Q S2S2 S1S1 D1D1 P1P1 P0P0 Q1Q1 Q2Q2 Q3Q3 Supply of Organs Shortage at Zero Price Q 1 – Q 3 At Price P 1 the Shortage is Reduced By Q 1 – Q 2 Demand for Organs 3-23

Key Terms demand demand schedule law of demand diminishing marginal utility income effect substitution effect demand curve determinants of demand normal goods inferior goods substitute good complementary good change in demand change in quantity demanded supply supply schedule law of supply supply curve determinants of supply change in supply change in quantity supplied equilibrium price equilibrium quantity surplus shortage price ceiling price floor 3-24

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