1. (Demand, Supply and Market Equilibrium) Chapter 3 Supply and Demand: In Introduction

2. 2 Topics Demand Supply Market Equilibrium –Tendency to change –Intervention –Comparative study

3. 3 Demand The quantity of a good that buyers wish to buy at each price Demand curve: a schedule or graph showing demand

4. 4 Demand: key points willingness and ability to buy a relationship between quantity demanded and product price Q d = f (P) –quantity demanded is a function of price –quantity demanded is determined by price The law of demand: Q d and P are negatively related Demand Curve: downward sloping Market demand: the sum of individual demand

5. 5 Key Terms (why downward sloping?) Substitution effect (of a price change): (willingness to buy) –change in quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes –Change in Qd when switch to or from substitutes because of P changes Income effect (of a price change): (ability to buy) –change in quantity demanded of a good that results because a change in price changes the buyer ’ s purchasing power –Change in Qd when purchasing power changes because of P changes

6. 6 Key Term (why downward sloping?) buyer ’ s reservation price (willingness to pay) –The largest dollar amount the buyer would be willing to pay for a good –The benefits the buyer expects to receive (from having it) –The reservation price of the marginal buyer declines as the quantity of the good bought increases

7. 7 The Daily Demand Curve for Pizza in Chicago Figure 3.1, P.64 Exercise 3.1, P.64 -Reservation p when Qd=10k -Qd when P=$2.50

8. 8 D vs. Qd DQd A relationship between P and Qd A number at a given P A curveA point on the curve Reasons for change: change in factors other than P Reasons for change: change in P only Change: a shift of the entire curve Change: a movement along the curve

9. 9 Assumption: Other Things Equal the other things: factors affecting D --price of related goods complements vs. substitutes --income: normal vs. inferior --preference --expectations (prices, income, … ) --population --others

10. 10 An Increase in the Quantity Demanded versus an Increase in Demand Figure 3.10, P.73

11. 11 Supply: Quantity of a good that sellers wish to sell at each price Supply curve: a schedule or graph showing supply

12. 12 Supply: Key Points willingness and ability to sell a relationship between price and quantity supplied Q s = f (P) –Quantity supplied is a function of price –quantity supplied is determined by price The Law of Supply: Q s and P are positively related Supply Curve: upward sloping Market supply: the sum of individual supply

13. 13 Why upward sloping? Increasin opportunity cost (the low- hanging-fruit principle) Seller ’ s reservation price: the smallest dollar amount for which a seller would be willing to sell an additional unit (marginal cost)

14. 14 The Daily Supply Curve of Pizza in Chicago Figure 3.2,P.65 Exercise 3.2 -marginal cost when Qd=10k -Qd when P=$3.50

15. 15 S vs. Qs SQs A relationship between P and Qs A number at a given P A curveA point on the curve Reasons for change: change in factors other than P Reasons for change: change in P only Change: a shift of the entire curve Change: a movement along the curve

16. 16 A decrease in quantity supplied vs. a decrease in supply

17. 17 Assumption: Other Things Equal the other things: factors affecting S --prices of inputs goods used to produce other goods --price of related goods goods that use the same resources --technology --expectations --others

18. 18 Market Equilibrium Market: where the buyers meet the sellers Market Equilibrium: –when there is no tendency to change (unless caused by external forces) –When buyers and sellers are satisfied with their respective quantities at the market price Equilibrium price and equilibrium quantity –Price and quantity when Qd=Qs Change in D and impacts on P e and Q e Change in S and impacts on P e and Q e

19. 19 Equilibrium Price &Equilibrium Quantity of Pizza in Chicago Figure 3.3, P.66 Why no tendency to change?

20. 20 Key Terms Excess supply: (surplus) –Qs > Qd when P>Pe Excess demand: (shortage) –Qd > Qs when P<Pe

21. 21 Excess Supply Figure 3.4

22. 22 Excess Demand Figure 3.5

23. 23 What happens when there is excess demand? Excess supply? Tendency to change (not in equilibrium) until reaching equilibrium

24. 24 Graphing Supply and Demand and Finding the Equilibrium Price and Quantity Figure 3.6

25. 25 What if intentionally stay away from market equilibrium? Government intervention –Price ceiling rent control pizza price control –Price floor agricultural products minimum wage

26. 26 Interventions Interntions: welfare concerns or political interests Results: inefficiencies in markets

27. 27 Price Controls Legal restrictions on how high or low a market price may go Price Ceiling: –limiting price (on consumer goods to protect consumers welfare) –maximum price a seller can charge Price Floor: –support price (on production factors, e.g. labor) –minimum price a buyer is required to pay

28. 28 Example: Price Ceiling

29. 29 The Effects of a Price Ceiling

30. 30 Rent Controls Figure 3.8,P.70

31. 31 Price Controls in the Pizza Market Figure 3.9

32. 32 Shortages Inefficiencies  misallocation to consumers  wasted resources  low quality black markets. Problems with Price Ceilings

33. 33 Example: Price Floor

34. 34 The Effects of a Price Floor

35. 35 Surplus Inefficiencies  misallocation of sales among sellers  Wasted resources  Inefficiently high quality Illegal activity Problems with Price Floors

36. 36 Price Controls cause Inefficiency Consumer surplus Producer surplus Total surplus Deadweight loss

37. 37 Recall: Demand--the definition The quantity of a good or service consumers ’ are willing and able to buy at various prices The maximum price the consumer is willing and able to pay for the next unit of the good or service.

38. 38 Two Different Prices The maximum price the consumers are willing to pay for Vs. The market price the consumers actually paid for

39. 39 Individual consumer surplus the net gain to an individual buyer from the purchase of a good. equal to the difference between the buyer’s willingness to pay and the price paid. Total consumer surplus the sum of the individual consumer surpluses of all the buyers of a good Consumer Surplus

40. 40 Consumer Surplus The total consumer surplus generated by purchases of a good at a given price is equal to the area below the demand curve but above that price.

41. 41 A Fall in the Market Price Increases Consumer Surplus

42. 42 Recall: Supply--the definition The quantity of a good or service producers are willing and able to sell at various prices The minimum price the producer is willing and able to accept for providing the next unit of the good or service

43. 43 Two Different Prices The minimum price the producers are willing to accept Vs. The market price the producers actually get

44. 44 Producer Surplus and the Supply Curve Individual producer surplus the net gain to a seller from selling a good equal to the difference between the price received and the seller’s cost (the minimum price the producer is willing to accept) Total producer surplus the sum of the individual producer surpluses of all the sellers of a good

45. 45 The total producer surplus from sales of a good at a given price is the area above the supply curve but below that price. Producer Surplus

46. 46 A Rise in Price Increases Producer Surplus

47. 47 Putting it together: Total Surplus the total net gain to consumers and producers from trading in the market the sum of the producer surplus and the consumer surplus

48. 48 Total Surplus