Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 1 Chapter 2 Demand and supply

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 2 Learning objectives 1.Examine the nature of markets. 2.Carefully develop the concepts of demand and supply. 3.Discuss the separate factors that lead to shifts in the demand and supply curves. 4.Explain how prices and output are determined in both the product and resource markets through the interaction of demand and supply. 5.Discuss the rationing function of prices and their role in resource allocation.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 3 Markets defined A market is any institutional structure, or mechanism, that brings together buyers and sellers of particular goods and services. Markets exists in many forms: local, national, international, and face-to-face. Demand and supply forces within the market set the price and quantity of the good or service transacted

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 4 Perfectly competitive markets Characteristics –Large number of independently acting buyers and sellers –Standardised product Examples –Some agricultural markets e.g. livestock auction –Share market

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 5 Demand The various amounts of a product that consumers are willing and able to purchase at various prices during some specific period. Demonstrated by demand schedule and demand curve

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 6 Law of demand The inverse relationship between the price and the quantity demanded of a good or service during some period of time. –All other things being constant, when the price of a good goes up, quantity demanded falls and vice versa Rationale 1.Common sense and simple observation 2.Diminishing marginal utility 3.Income and substitution effects

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 7 Diminishing marginal utility States that successive units of a given product yield less and less extra satisfaction. Therefore, consumers will only buy more of a good if its price is reduced.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 8 Substitution effect At a lower price, consumers have the incentive to substitute the now-cheaper good for similar goods that are rendered relatively more expensive.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon 2- 9 Income effect At a lower price, on a fixed money income, consumers can buy more of a product without giving up other goods. A decline in price increases the purchasing power of money/real income and vice versa.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon The demand curve Shows the inverse relationship between price and quantity demanded for a good or service Derived from a demand schedule showing the quantity demanded at various prices

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Demand Price Quantity demanded per unit per week

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon d d Graphing demand P Q Price ($ per unit) Quantity demanded (units per week)

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Individual and market demand Market demand is derived by horizontally summing individual demand curves. Market demand is derived by adding all the quantities demanded in a demand schedule which correspond to their prices.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon The market demand curve is the sum of the individual demand curves Buyer 1 + Buyer 2 = Market + Buyer 3

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Determinants of demand Non-price determinants of market demand –Tastes or preferences of consumers –The number of consumers –Income of consumers –Prices of related goods –Expectations about future prices and income

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Changes in demand Caused by changes in the non-price determinants of demand Represented as a shift of the demand curve either to the right or left

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Increase in demand Movement along a demand curve P Q D1D1 Quantity demanded D1D1 Price ($ per unit) a b D2D2 D2D2 Increase in demand

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon D1D1 D1D1 Decrease in demand P Q Quantity demanded Price ($ per unit) D3D3 D3D3 Decrease in demand

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Changes in demand A shift in the location of the demand curve is called a change in demand. A shift in the demand curve to the right or to the left occurs when each of the determinants of demand changes as follows: – tastes or preferences – number of buyers – income: ▪ normal or superior goods—demand varies directly with income ▪ inferior goods—demand varies inversely with income.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Changes in demand (cont.) Prices of related goods –Substitute goods: there is a direct relationship between the price of one good and the demand for another. –Complementary goods: there is an indirect relationship between the price of one good and the demand for another. –Independent goods: a change in the price of one good will have negligible impact on the demand for the other. Consumer Expectations

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Changes in quantity demand Important distinction between a ‘change in demand’ versus a ‘change in the quantity demanded’. A change in the quantity demanded is caused by changes in the price of the good or service only. Represented as movement along a demand curve. Other factors determining demand are held constant.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Graphical summary of determinants of demand Quantity of X demanded (units per period) Price of X ($ per unit) Change in quantity demanded Change in demand Movement up demand curve Increase in price of X Movement down demand curve Decrease in price of X

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Supply The various amounts of a product that producers are willing and able to supply at various prices during some specific period. Demonstrated by the supply schedule and supply curve.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Law of supply Shows the direct relationship between the price and quantity supplied Increased price causes increased quantity supplied Decreased price causes decreased quantity supplied Rationale Common sense and observation Price as revenue per unit and an incentive to produce and sell a product Declining productive efficiency and rising costs

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon An individual producer's supply of product X Price Quantity supplied per unit ($) per week

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Change in supply Represented as a shift of the supply curve Caused by changes in determinants of supply other than price

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Increase in supply S1S1 P Q Price ($ per unit) Quantity supplied (000/week) S1S1 S2S2 S2S2 a b

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Decrease in supply S1S1 P Q Price ($ per unit) Quantity supplied (000/week) S1S1 S3S3 S3S3 a b

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Determinants of supply A change in any of these determinants will shift the supply curve to the left or right: –resource prices –technology –prices of other goods –expectations about future prices and economic activity –the number of sellers in the market.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Changes in quantity supplied Caused by changes in price only Represented as a movement along a supply curve

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Graphical summary of determinants of demand Quantity of X supplied (units per period) Price of X ($ per unit) Change in quantity supplied Change in supply Movement up supply curve increase in price of X Movement down supply curve decrease in price of X

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Market equilibrium Occurs when the buying decisions of households and the selling decisions of producers are equated. Determines the equilibrium price and equilibrium quantity bought and sold in the market. The intersection of the supply curve and the demand curve indicates the equilibrium point. Competitive forces where supply and demand are synchronised are called the rationing function of prices.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Market equilibrium (cont.) D P Q Price ($ per unit) Units of X (000/week) Equilibrium price S

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Market equilibrium (cont.) D P Q Price ($ per unit) Units of X (000/week) Equilibrium price surplus S

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Market equilibrium (cont.) D P Q Price ($ per unit) Units of X (000/week) Equilibrium price surplus shortage S

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Shortage (excess demand) Occurs when the quantity demanded exceeds the quantity supplied at the current price Competition amongst buyers eventually bids up the price until equilibrium is reached.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Surplus (excess supply) Occurs when the quantity supplied exceeds the quantity demanded at the current price Competition amongst producers eventually causes the price to decline until equilibrium is reached.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Changes in supply and demand Changes or shifts will disrupt the equilibrium. The market will adjust until once again an equilibrium is reached. The equilibrium price and quantity traded will change.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon S Increase in demand P Q 0 D1D1 D1D1 D2D2 D2D2 Equilibrium price & quantity rise

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Decrease in demand S P Q 0 D1D1 D1D1 D2D2 D2D2 Equilibrium price & quantity fall

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Increase in supply S1S1 P Q 0 D1D1 D1D1 Equilibrium price falls & quantity rises S2S2 S2S2 S1S1

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon S2S2 S2S2 Decrease in supply S1S1 P Q 0 D1D1 D1D1 Equilibrium price rises & quantity falls S1S1

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Both demand and supply increase S1S1 P Q 0 D1D1 D2D2 D1D1 D2D2 S2S2 S2S2 S1S1 Equilibrium quantity rises & price rises are uncertain

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Resource market Apply the concept of demand and supply in a competitive resource market. Supply curve for a resource is upward-sloping, reflecting the direct relationship between resource price and quantity supplied. Demand curve is down-sloping. Direct relationship between resource price and quantity supplied. The supply decisions of households and the demand decisions by firms in a competitive market determine the price of resources.

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon ‘Other things being equal’—again Demand and supply analysis provides an important illustration of the use of ceteris paribus assumption in economic theorising. Demand and supply curves drawn on the assumption that non-price determinants do not change Demand and supply curves shift when ceteris paribus assumptions relaxed If ceteris paribus rules not followed then market equilibrium analysis can result in confusing and seemingly contradictory results

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon Next chapter Market behaviour: elasticity, tax and price controls