Chapter 3: Supply and Demand Part 1 Econ 101: Microeconomics

Hall & Leiberman; Economics: Principles And Applications, Supply and Demand Model Single most useful tool of economic analysis Explains how prices of goods and quantity bought and sold are determined in certain types of markets What you will learn in this chapter How the model of supply and demand works and how to use it Strengths and limitations of model

Hall & Leiberman; Economics: Principles And Applications, Markets Market: Buyer and seller of a particular good and service Competitive market: A market in which there are many buyers and many sellers so that each has a negligible impact on the market price Perfectly competitive markets: In addition to “many buyers and sellers” the goods offered for sale are all the same. Imperfectly competitive markets: Markets in which there are just a few buyers and sellers and goods offered for sale are unique in some way.

Hall & Leiberman; Economics: Principles And Applications, Competition in Markets In perfectly competitive markets each buyer and seller takes the market price of a good as a given. “Price takers”. In imperfectly competitive markets, individual buyer or seller can influence the price of the product. “Price setters”.

Hall & Leiberman; Economics: Principles And Applications, Buyers and Sellers Buyers and sellers in a market can be Households Business firms Government agencies All three can be both buyers and sellers in the same market, but are not always For purposes of simplification we will follow the following guidelines In markets for consumer goods, we’ll view business firms as the only sellers, and households as only buyers

Hall & Leiberman; Economics: Principles And Applications, Demand A household’s quantity demanded of a good Quantity Demanded Quantity demanded is the amount of a good that all buyers in the market would choose to buy over some time period, given A particular price they must pay for the good All other constraints on households

Hall & Leiberman; Economics: Principles And Applications, Demand Desired purchases are not necessarily the same as actual purchases Let’s first consider individual demand for a particular good What factors influence the quantity of a good that a given household would be willing to purchase?

Hall & Leiberman; Economics: Principles And Applications, Determinants of Demand Own Price Law of Demand: Other things equal, when the price of a good rises the quantity demanded of the good falls Income Normal Good: Other things equal, an increase in income leads to an increase in quantity demanded Inferior Good: Other things equal, an increase in income leads to a decrease in quantity demanded.

Hall & Leiberman; Economics: Principles And Applications, Determinants of Demand Prices of related goods Substitutes: Two goods for which an increase in the price of one, other things equal, lead to an increase in the quantity demanded of the other. Complements: Two goods for which an increase in the price of one, other things equal, leads to a decrease in the quantity demanded of the other. Others Tastes Expectations Population

Hall & Leiberman; Economics: Principles And Applications, Demand Curve Demand curve A graph of the relationship between the price of a good and the quantity demanded, other things equal. Each point on the curve shows the total buyers would choose to buy at a specific price Law of demand tells us that demand curves virtually always slope downward

Hall & Leiberman; Economics: Principles And Applications, The Demand Curve Quantity Price A B D Price on the vertical axis; quantity on the horizontal axis Law of demand says that the demand curve slopes down.

Hall & Leiberman; Economics: Principles And Applications, Individual Demand vs. Market Demand Quantity Price 15 Consumer 1 demand Individual demands are added horizontally to get market demand. Quantity Price Market demand Consumer 2 demand

Hall & Leiberman; Economics: Principles And Applications, Shifts vs. Movements Along The Demand Curve A change in the own price of a good causes a movement along the demand curve A fall (rise) in price would cause a movement to the right (left) along the demand curve A change in income, prices of relative goods and other factors cause a shift in the demand curve itself Demand curve has shifted to the right of the old curve as income has risen A change in any variable that affects demand—except for the good’s own price—causes the demand curve to shift

Hall & Leiberman; Economics: Principles And Applications, A Shift of The Demand Curve BC $ ,00080,000 D1D1 D2D2 An increase in income shifts the demand curve for a good from D 1 to D 2. Number of Bottles per Month Price per Bottle At each price, more goods are demanded after the shift

Hall & Leiberman; Economics: Principles And Applications, Movements Along The Demand Curve Price P2P2 Q2Q2 Q1Q1 Q3Q3 P1P1 P3P3 Price increase moves us leftward along demand curve Price increase moves us rightward along demand curve Movement along a demand curve Quantity A1A1 A A1A1

Hall & Leiberman; Economics: Principles And Applications, Shifts of The Demand Curve Quantity Price D2D2 D1D1 Entire demand curve shifts rightward when: income or wealth ↑ price of substitute ↑ price of complement ↓ population ↑ expected price ↑ tastes shift toward good Rightward shift in demand is called “an increase in demand”. P1P1 Q1Q1 Q2Q2 A B

Hall & Leiberman; Economics: Principles And Applications, Shifts of The Demand Curve Price D1D1 D2D2 Entire demand curve shifts leftward when: income or wealth ↓ price of substitute ↓ price of complement ↑ population ↓ expected price ↓ tastes shift away from good Quantity A leftward shift in demand is called “a decrease in demand”. P1P1 Q2Q2 Q1Q1 B A

Hall & Leiberman; Economics: Principles And Applications, Dangerous Curves: “Change in Quantity Demanded” vs. “Change in Demand” Language is important when discussing demand “Quantity demanded” means A particular amount that buyers would choose to buy at a specific price It is a number represented by a single point on a demand curve When a change in the price of a good moves us along a demand curve, it is a change in quantity demand The term demand means The entire relationship between price and quantity demanded—and represented by the entire demand curve When something other than price changes, causing the entire demand curve to shift, it is a change in demand

Hall & Leiberman; Economics: Principles And Applications, Supply A firm’s quantity supplied of a good Quantity Supplied Quantity supplied is the specific amount of a good that all sellers in the market would choose to sell over some time period, given A particular price for the good All other constraints on firms

Hall & Leiberman; Economics: Principles And Applications, Determinants of Supply Own Price Law of Supply: Other things equal, when the price of a good rises the quantity supplied of the good rises Input prices Technology Changes in Weather Expectations Number of Firms

Hall & Leiberman; Economics: Principles And Applications, Supply Curve Supply curve A graph of the relationship between the price of a good and the quantity supplied, other things equal. Each point on the curve shows quantity supplied at a specific price, other things equal. Law of supply tells us that supply curves virtually always slope upward

Hall & Leiberman; Economics: Principles And Applications, The Supply Curve A B S Law of supply says that the supply curve slopes up Quantity Price

Hall & Leiberman; Economics: Principles And Applications, A Shift of The Supply Curve S2S2 G J S1S1 A decrease in transportation costs shifts the supply curve for a good from S 1 to S 2. Quantity Price At each price, more goods are supplied after the shift

Hall & Leiberman; Economics: Principles And Applications, Movements Along The Supply Curve Price P2P2 Q2Q2 Q1Q1 Q3Q3 P1P1 P3P3 Price increase moves us rightward along supply curve Price decrease moves us leftward along supply curve Movement along a supply curve Quantity A A1A1 A2A2

Hall & Leiberman; Economics: Principles And Applications, Shifts of The Supply Curve Quantity Price CAUTION: A rightward shift in supply can also be thought as a downward shift in supply, but it is an increase in supply!!! P1P1 Q1Q1 Q2Q2 Entire supply curve shifts rightward when: price of input ↓ price of alternate good ↓ number of firms ↑ expected price ↓ technological advance favorable weather S1S1 S2S2 A B

Hall & Leiberman; Economics: Principles And Applications, Shifts of The Supply Curve Price S1S1 S2S2 Quantity A leftward shift in supply is called “a decrease in supply”. P1P1 Q2Q2 Q1Q1 Entire supply curve shifts leftward when: price of input ↑ price of alternate good ↑ number of firms ↓ expected price ↑ unfavorable weather B A

Hall & Leiberman; Economics: Principles And Applications, Shifts vs. Movements Along The Supply Curve A change in the own price of a good causes a movement along the supply curve A fall (rise) in price would cause a movement to the left (right) along the demand curve A change in input prices, prices of related goods, technology, number of firms, expected prices, favorable and unfavorable natural events cause a shift in the supply curve itself Supply curve has shifted to the right of the old curve as transportation costs (input prices) have dropped A change in any variable that affects supply—except for the good’s own price—causes the supply curve to shift