Demand, Supply, and Market Equilibrium 03 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Markets Interaction between buyers and sellers Markets may be Local National International Price is discovered in the interactions of buyers and sellers LO1 3-2

Demand Schedule or curve Amount consumers are willing and able to purchase at a given price Other things equal Individual demand Market demand LO1 3-3

Law of Demand Other things equal, as price falls the quantity demanded rises, and as price rises the quantity demanded falls Reasons Common sense Law of diminishing marginal utility Income effect and substitution effects LO1 3-4

Quantity Demanded (bushels per week) Price (per bushel) PQdQd $ P Q D The Demand Curve LO1 The Demand Curve 3-5

Changes in Demand LO Quantity Demanded (bushels per week) Price (per bushel) Individual Demand P Q D1D Demand Can Increase or Decrease Decrease in Demand D2D2 D3D3 Change in Demand Change in Quantity Demanded 3-6

Determinants of Demand LO1 Determinants of Demand: Factors That Shift the Demand Curve DeterminantExamples Change in buyers’ tastesPhysical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones. Change in the number of buyersA decline in the birthrate reduces the demand for children’s toys. Change in incomeA rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine. Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods). Change in consumer expectationsInclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans. 3-7

Supply Schedule or curve Amount producers are willing and able to sell at a given price Individual supply Market supply LO2 3-8

Law of Supply Other things equal, as the price rises the quantity supplied rises, and as the price falls the quantity supplied falls Reasons Price acts as an incentive to producers At some point, costs will rise LO2 3-9

The Supply Curve LO Price (per bushel) Quantity supplied (bushels per week) S Supply of Corn Price per Bushel Q s per Week $ P Q 3-10

Changes in Supply LO2 $ Price (per bushel) S1S1 Quantity supplied (thousands of bushels per week) P Q S2S2 S3S3 Change in Quantity Supplied Change in Supply 3-11

Determinants of Supply LO2 Determinants of Supply: Factors That Shift the Supply Curve DeterminantExamples Change in resource pricesA decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline. Change in technologyThe development of more effective wireless technology increases the supply of cell phones. Change in taxes and subsidiesAn increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education. Change in prices of other goodsAn increase in the price of cucumbers decreases the supply of watermelons. Change in producer expectationsAn expectation of a substantial rise in future log prices decreases the supply of logs today. Change in the number of suppliersAn increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games. 3-12

Market Equilibrium Equilibrium occurs where the demand curve and supply curve intersect Surplus and shortage Rationing functions of prices The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent LO3 3-13

Market Equilibrium LO 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 6,000 Bushel Surplus 7,000 Bushel Shortage 3-14

` Changes in Demand and Equilibrium LO4 0 P D4D4 D3D3 ` Changes in Demand and Equilibrium LO4 0 P D1D1 D2D2 S Increase in demand D increase: P , Q  D decrease: P , Q  Decrease in demand S 3-15

` Changes in Demand and Equilibrium LO4 0 P D S4S4 ` Changes in Supply and Equilibrium LO4 S3S3 0 P D S2S2 S1S1 Increase in supply S increase: P , Q  S decrease: P , Q  Decrease in supply 3-16

Government-Set Prices Price Ceilings Set below equilibrium price Rationing problem Black markets Example: Rent control LO5 3-17

Government-Set Prices LO5 S P Q D P0P0 PCPC Q0Q0 Shortage QdQd QsQs Ceiling $

Government-Set Prices Price Floors Prices are set above the market price Chronic surpluses Example: Minimum wage laws LO5 3-19

Government-Set Prices LO5 S P Q D P0P0 PfPf Q0Q0 Surplus QsQs QdQd Floor 2.00 $