Demand and supply In a market system, the 3 fundamental questions are resolved by a decentralized decision making process encompassing a large number of buyers and sellers. A vast number of individual decisions to buy and sell add up to “market forces”— or the forces of demand and supply.

Markets, demand, and supply A market is group of buyers and sellers with the potential to trade

Markets Defining the good or service Buyers and sellers Geography of the market

Imperfect Competition If a market is imperfectly competitive, buyers or sellers have some influence over market price. Buyers or sellers are price makers, not takers

Perfect competition In perfectly competitive markets (or just competitive markets), each buyer and seller takes the market price as a given

Supply and Demand The supply and demand model is designed to explain how prices are determined in perfectly competitive markets.

Definitions: 4Demand: The quantities of a good or service buyers are willing (and able) to buy at alternative market prices, ceteris paribus. 4Quantity demanded: The quantity of a good or service buyers are willing (and able) to buy at a specific price, ceteris paribus. What is demand?

Demand schedule $ ,500 6,500 5,000 4,000 3,500 Price (per Bottle) Quantity Demanded (Bottles per Month) The schedule showing the quantities demanded of a good or service at various prices, ceteris paribus Maple Syrup

Demand curve Demand Curve shows the relationship between the price of a good and the quantity demanded, holding constant all other variables that affect demand The Demand Curve shows the relationship between the price of a good and the quantity demanded, holding constant all other variables that affect demand

The Demand Curve Number of Bottles Price $4.00 $ A B When the price is $4.00 per bottle, 4,000 bottles are demanded (point A). At $2.00 per bottle, 6,000 bottles are demanded (point B). Maple Syrup D 4,0006,500

Individual demand An individual’s quantity demanded of any good is the total amount that individual would choose to buy at a particular price.

Here we derive the market demand curve by summing up the individual demand curves for cantaloupe.

Market demand Price ($) Quantity Anita BO 74 Deriving the market demand curve for cantaloupe

Law of demand Holding all other factors that can influence demand constant, market price and quantity- demanded are inversely related.

Quantity 0 Price D P2P2 P1P1 q1q1 q2q2 Why is the demand curve downward sloping? The Substitution effect oranges As the price of oranges decrease, ceteris paribus, oranges become cheaper relative to substitutes. Some buyers substitute oranges for tangerines, nectarines, and other fruits.

Shift of the demand curve Number of Bottles Price $ B Price (per Bottle) $ Original Quantity Demanded (Bottles per Month) 7,500 5,000 4,000 3,500 New Quantity Demanded After Increases in Income (Bottles per Month) 9,500 8,000 7,000 6,000 5,500 5,0008,000 D1D1 D2D2 C Maple Syrup

Change in demand versus movement along the demand curve A change in demand (increase or decrease in demand) refers to a shift of the demand curve—resulting from a change in some factor that can influence the demand for this good other than its price. A movement along the demand curve results from a change in the price of the good, holding all other factors constant.

Shift versus movement along the demand curve Number of Bottles Price $ B 5,0008,000 D1D1 D2D2 C Maple Syrup $4.00 A 4,000 A → B : Movement along the demand curve D 1 → D 2 : Increase in demand

Determinants of demand Besides price, what factors might influence the demand for maple syrup, or any other good or service.

A change in any of the following factors would cause a change in demand, or a shift of the entire demand curve. These influences on demand include: 8The price of substitute goods 8The price of complementary goods 8Income 8Expectations 8Number of buyers 8Tastes and preferences Determinants of demand

Substitutes Cheesecake—Tiramisu Orange juice—grapefruit juice Pizza-tacos Cab rides—subway rides VCRs-DVD players Pork-chicken A good that can be consumed in the place of another.

Price/lb. 0 A B H D1D1 D2D2 P1P1 P2P2 q1q1 q2q2 Quantity (lbs.) Let the price of chicken increase, ceteris paribus. This should cause the demand for pork to shift to the right

Complements Computers—printers Tortilla chips-salsa Tents—sleeping bags Airline service—rental cars Shot guns--shells A good that is consumed with another good

Rental fee 0 A B H D1D1 D2D2 P1P1 P2P2 q1q1 q2q2 Cars rented per day Cheaper air fares should stimulate sales in the rental car business

Normal and Inferior Goods A normal good is a good for which demand increases (shifts right) when income increases. Examples: Scotch whiskey, Swiss-made watches, lobster, air travel, vacations abroad. An inferior good is a good for which demand decreases (shifts left) when income increases. Examples: macaroni, used clothing, bus service.

Expectations Price/lb 0 Quantity (lbs.) D1D1 D2D2 Salmon If buyers anticipate that prices of fresh salmon will be falling shortly, they may purchase less today.

Price 0 A B H D1D1 D2D2 P1P1 P2P2 q1q1 q2q2 Quantity Demand could shift right due to: ÔIncrease in the price of substitutes ÔDecrease in the price of complements ÔIncrease in income (normal good) ÔIncrease in the number of buyers ÔChange of preferences

What is Supply? Quantity supplied : The amount of a good or service sellers are willing (and able) to sell during a specified period at a specific price, ceteris paribus. Supply: The relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same.

The Supply Schedule Price ($ per bottle) Quantity-supplied (millions of bottles per day) $1.002,500 $2.004,500 $3.005,000 $4.006,000 $5.006,500 A list of quantities supplied at each different price when all other influences on selling plans remain the same.

The Supply Curve Supply Curve Price 0 A B C D A graph of the relationship between the quantity supplied of a good and its price when other influences on selling plans remain constant ,500 Number of Bottles 4,500

Law of supply Holding all other factors that can influence selling plans constant, market price and quantity-supply are directly related.

Change in supply versus change in quantity- supplied Change in quantity supplied: movement along a supply curve in response to a change in priceChange in quantity supplied: movement along a supply curve in response to a change in price Change in supply: shift of a supply curve in response to some variable other than priceChange in supply: shift of a supply curve in response to some variable other than price

Changes in Quantity Supplied and Supply aa a a Number of Bottles Price per Bottle S 1 6,000 $4.00 S 2 8,000 GJ A decrease in labor costs causes the supply curve for maple syrup to shift from S 1 to S 2. At each price, more bottles are supplied after the shift. Maple Syrup

What can cause a change in supply Change in input prices Change in the profitability of producing alternative products Change in technology Change in productive capacity Change in expectations about future prices

Inputs can be economic resources (raw materials, labor) or semi- finished articles (aluminum, camshafts, soybeans)

Prices of Inputs A rise in price of an input causes a decrease in supply that shifts the supply curve to the leftA rise in price of an input causes a decrease in supply that shifts the supply curve to the left A fall in price of an input causes an increase in supply that shifts the supply curve to the rightA fall in price of an input causes an increase in supply that shifts the supply curve to the right

Profitability of Alternate Goods Alternate goods: other goods a firm could produce using some of the same kinds of inputs as the original goodAlternate goods: other goods a firm could produce using some of the same kinds of inputs as the original good When an alternate good becomes more profitable to produce becauseWhen an alternate good becomes more profitable to produce because – its price rises –the cost of producing it falls –the supply curve for the original good will shift leftward

Technology Cost-saving technological advances increase the supply of a good, shifting the supply curve to the rightCost-saving technological advances increase the supply of a good, shifting the supply curve to the right

Productive Capacity An increase in productive capacity shifts the supply curve rightward.An increase in productive capacity shifts the supply curve rightward. A decrease in productive capacity shifts the supply curve leftward.A decrease in productive capacity shifts the supply curve leftward.

Expectation of Future Prices A rise in the expected price of a good will decrease the supply, shifting the supply curve leftward.A rise in the expected price of a good will decrease the supply, shifting the supply curve leftward.

Expectation of Future Prices aa a Quantity Price Entire supply curve shifts rightward when: price of input profitability of alternate good productive capacity expected price technology improves Quantity Price (a) (b)(c) P 2 Q 3 Q 1 Q 2 P 1 P 3 Price increase moves us rightward along supply curve Price decrease moves us leftward along supply curve Quantity Price Entire supply curve shifts leftward when: price of input profitability of alternate good productive capacity expected price S S 2 S 2 S 1 S 1

Putting demand and supply together Equilibrium: state of rest - a situation that, once achieved, will not change unless there is a change in something we have been assuming constant

Putting demand and supply together Price per Bottle Bottles 0 $3.00 $1.00 S D 2,5005,0007,500 CH E Maple Syrup