Download presentation
Presentation is loading. Please wait.
1
Supply and Demand: How Markets Work
Chapter 8 Supply and Demand: How Markets Work
2
Market Exchange An enormous amount of activity is conducted through an interesting human invention: the market In fact, the definition of concepts such as the GDP of an economy is output that is produced but exchanged through markets. A lot of production takes place outside this form of organization (consider your home)
3
Different kinds of markets
There are ways in which markets differ, but a very important way is in the number of buyers and sellers in a market Competitive markets consist of many potential buyers and sellers, each acting independently, with no one participant having enough power to dictate terms to any other
4
Types of Markets One firm = 2-12 firms many firms many, many firms
Monopoly Oligopoly Monopolistic Perfect Competition Competition
5
What happens on a market
A market exchange is a transfer of title to a piece of property (a good or a service) to another party in return for some form of payment on mutually accepted terms. It is mostly a voluntary action The term market refers to the buying and selling activities of all those who want to trade (buy or sell) a particular good or service
6
What gets determined on markets
Markets work to determine two basic economic outcomes: the price at which a good or service is exchanged and the quantity of it that will be bought and sold. Alternative ways to do this?
7
A demand curve A demand curve is a graphical representation of the buyers' side of the market. It shows how much of a particular commodity the demanders of this product will want to purchase at each possible price, given their taste for the product and the amount of money they have at their disposal and other such factors which determines demand. Demand refers to ability to purchase. Not need or desire.
8
DEMAND Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises. 8
9
The Demand Curve: The Relationship between Price and Quantity Demanded
Demand Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. 17
10
Demand Schedule 17
11
The Demand Curve: The Relationship between Price and Quantity Demanded
The demand curve is a graph of the relationship between the price of a good and the quantity demanded. 17
12
Demand Schedule and Demand Curve
Price of Ice-Cream Cone $3.00 2.50 1. A decrease in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of 2. ... increases quantity of cones demanded. Ice-Cream Cones Copyright © South-Western
13
Market Demand versus Individual Demand
Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve. Sum up individual demand curves. Assume A wants 2 cones at $10 and A wants 1 cone at $20, B wants and $20. Total market demand is 5 cones at $10, 3 Demand curves are usually downward sloping (why only usually?)
14
Shifts in the Demand Curve
Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of the product. 19
15
Changes in Quantity Demanded
Price of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. B $2.00 A 1.00 D 4 8 Quantity of Ice-Cream Cones
16
Shifts in the Demand Curve
Consumer income Prices of related goods Tastes Expectations Number of buyers 11
17
Shifts in the Demand Curve
Change in Demand A shift in the demand curve, either to the left or right. Caused by any change that alters the quantity demanded at every price. 19
18
Figure 3 Shifts in the Demand Curve
Price of Ice-Cream Cone Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
19
Shifts in the Demand Curve
Consumer Income As income increases the demand for a normal good will increase. As income increases the demand for an inferior good will decrease.
20
Consumer Income Normal Good
Price of Ice-Cream Cone $3.00 An increase in income... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12
21
Consumer Income Inferior Good
Price of Mac and Cheese $3.00 2.50 An increase in income... 2.00 Decrease in demand 1.50 1.00 0.50 D2 D1 Quantity of Mac and Cheese 1 2 3 4 5 6 7 8 9 10 11 12
22
Shifts in the Demand Curve
Prices of Related Goods When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good, the two goods are called complements.
23
Variables That Influence Buyers
Copyright©2004 South-Western
24
SUPPLY Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of Supply The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises. 25
25
The Supply Curve: The Relationship between Price and Quantity Supplied
Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. 29
26
Supply Schedule Supplied 29
27
The Supply Curve: The Relationship between Price and Quantity Supplied
The supply curve is the graph of the relationship between the price of a good and the quantity supplied. 29
28
Supply Schedule and Supply Curve
Price of Ice-Cream Cone $3.00 2.50 1. An increase in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones 2. ... increases quantity of cones supplied. Copyright©2003 Southwestern/Thomson Learning
29
Market Supply versus Individual Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, individual supply curves are summed horizontally to obtain the market supply curve.
30
Shifts in the Supply Curve
Input prices Technology Expectations Number of sellers 27
31
Shifts in the Supply Curve
Change in Quantity Supplied Movement along the supply curve. Caused by a change in anything that alters the quantity supplied at each price. 30
32
Perfectly Competitive Firm’s Supply Curve
The perfectly competitive firm’s supply curve is its Marginal Cost Curve. Marginal Cost=Cost of Producing one more unit of a good. Why? At every point along a market supply curve If price>marginal cost, a supplier would produce . If price< marginal Cost, firm would not produce. Thus P=MC in a competitive market.
33
Change in Quantity Supplied
Price of Ice-Cream Cone S C $3.00 A rise in the price of Ice Cream cones results in a movement along the supply curve. A 1.00 Quantity of Ice-Cream Cones 1 5 30
34
Shifts in the Supply Curve
Change in Supply A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than price. 30
35
Shifts in the Supply Curve
Price of Supply curve, S 3 Ice-Cream curve, Supply S 1 Cone Supply curve, S 2 Decrease in supply Increase in supply Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
36
Variables That Influence Sellers
Copyright©2004 South-Western
37
SUPPLY AND DEMAND TOGETHER
Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. 36
38
SUPPLY AND DEMAND TOGETHER
Equilibrium Price The price that balances quantity supplied and quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity The quantity supplied and the quantity demanded at the equilibrium price. On a graph it is the quantity at which the supply and demand curves intersect. 36
39
SUPPLY AND DEMAND TOGETHER
Demand Schedule Supply Schedule At $2.00, the quantity demanded is equal to the quantity supplied! 36
40
Figure 8 The Equilibrium of Supply and Demand
Price of Ice-Cream Cone Supply Demand Equilibrium Equilibrium price $2.00 Equilibrium quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
41
Markets Not in Equilibrium
(a) Excess Supply Price of Ice-Cream Supply Cone Surplus Demand $2.50 10 4 2.00 7 Quantity of Quantity demanded Quantity supplied Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
42
Equilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.
43
Equilibrium Shortage When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.
44
Markets Not in Equilibrium
(b) Excess Demand Price of Ice-Cream Supply Cone Demand $2.00 7 1.50 10 4 Shortage Quantity of Quantity supplied Quantity demanded Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
45
Equilibrium Law of supply and demand
The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.
46
Three Steps to Analyzing Changes in Equilibrium
Decide whether the event shifts the supply or demand curve (or both). Decide whether the curve(s) shift(s) to the left or to the right. Use the supply-and-demand diagram to see how the shift affects equilibrium price and quantity. 45
47
How an Increase in Demand Affects the Equilibrium
Price of Ice-Cream 1. Hot weather increases the demand for Ice Cream Cone D D Supply New equilibrium $2.50 10 resulting in a higher price . . . 2.00 7 Initial equilibrium Quantity of 3. . . . and a higher quantity sold. Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
48
How a Decrease in Supply Affects the Equilibrium
Price of 1. An increase in the price of sugar reduces the supply of Ice Cream. . . Ice-Cream Cone S2 S1 Demand New equilibrium $2.50 4 resulting in a higher price of ice cream . . . Initial equilibrium 2.00 7 Quantity of 3. . . . and a lower quantity sold. Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning
49
What Happens to Price and Quantity When Supply or Demand Shifts?
Copyright©2004 South-Western
50
Price, Income and Cross Elasticity
51
Elasticity – the concept
The responsiveness of one variable to changes in another When price rises, what happens to demand? Demand falls BUT! How much does demand fall?
52
Elasticity – the concept
If price rises by 10% - what happens to demand? We know demand will fall By more than 10%? By less than 10%? Elasticity measures the extent to which demand will change
53
Elasticity 4 basic types used: Price elasticity of demand
Price elasticity of supply Income elasticity of demand Cross elasticity
54
Elasticity Price Elasticity of Demand
The responsiveness of demand to changes in price Where % change in demand is greater than % change in price – elastic Where % change in demand is less than % change in price - inelastic
55
Elasticity The Formula: % Change in Quantity Demanded
___________________________ Ped = % Change in Price If answer is between 0 and -1: the relationship is inelastic If the answer is between -1 and infinity: the relationship is elastic Note: PED has – sign in front of it; because as price rises demand falls and vice-versa (inverse relationship between price and demand)
56
Elasticity Price (£) Quantity Demanded
The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded. Quantity Demanded
57
Elasticity Total Revenue Price $5 D 100 Quantity Demanded (000s)
Total revenue is price x quantity sold. In this example, TR = $5 x 100,000 = $500,000. This value is represented by the grey shaded rectangle. The importance of elasticity is the information it provides on the effect on total revenue of changes in price. $5 Total Revenue D 100 Quantity Demanded (000s)
58
Elasticity D Total Revenue Price $5 $3 100 140
If the firm decides to decrease price to (say) $3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue. $5 $3 Total Revenue D 100 140 Quantity Demanded (000s)
59
Elasticity % Δ Price = -50% % Δ Quantity Demanded = +20%
Producer decides to lower price to attract sales 10 % Δ Price = -50% % Δ Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall 5 Not a good move! D 5 6 Quantity Demanded
60
Elasticity Producer decides to reduce price to increase sales
% Δ in Price = - 30% % Δ in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises 10 Good Move! 7 D 5 20 Quantity Demanded
61
Elasticity If demand is price elastic:
Increasing price would reduce TR (%Δ Qd > % Δ P) Reducing price would increase TR (%Δ Qd > % Δ P) If demand is price inelastic: Increasing price would increase TR (%Δ Qd < % Δ P) Reducing price would reduce TR (%Δ Qd < % Δ P)
62
Elasticity Income Elasticity of Demand:
The responsiveness of demand to changes in incomes Normal Good – demand rises as income rises and vice versa Inferior Good – demand falls as income rises and vice versa
63
Estimated Price Elasticities of Demand for Various Goods and Services
Inelastic Salt 0.1 Coffee 0.25 Fish (cod) consumed at home 0.5 Tobacco products, short-run 0.45 Physician services 0.6 Approximately Unitary Elasticity Movies 0.9 Housing, owner occupied, long-run 1.2 Elastic Restaurant meals 2.3 Foreign travel, long-run 4.0 Chevrolet automobiles Fresh tomatoes 4.6
64
Elasticity Income Elasticity of Demand:
A positive sign denotes a normal good A negative sign denotes an inferior good
65
Elasticity For example:
Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand falling by 1.8% Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand rising by 1.2% Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand rising by 4.8% Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 3% would lead to a fall in demand of 6.3%
66
Determinants of Elasticity
Time period – the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes – the greater the number of substitutes, the more elastic The proportion of income taken up by the product – the smaller the proportion the more inelastic Luxury or Necessity - for example, addictive drugs
67
Importance of Elasticity
Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Influences the behaviour of a firm
Similar presentations
© 2024 SlidePlayer.com. Inc.
All rights reserved.