1. Individual Markets Demand and Supply Lecture 5 & 6 Dominika Milczarek-Andrzejewska

2. 2 Outline of Lecture 5 & 6 Definition of Market Demand Supply Market Equilibrium Changes in Supply and Demand, and Equilibrium Applications

3. 3 Market Market is an institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods and services –Local, national, or international markets –Highly personal, face-to-face exchanges or impersonal and remote markets A product market involves goods and services A resource market involves factors of production

4. 4 Demand Demand schedule shows the various amounts of a product that consumers are willing and able to buy –at each specific price in a series of possible prices –during a specified time period

5. $5 4 3 2 1 10 20 35 55 80 Various Amounts A Series of Possible Prices …a specified time period …other things being equal PQDQD Demand Schedule

6. 6 Law of Demand Law of demand is a fundamental characteristic of demand behavior Other things being equal, as price increases, the corresponding quantity demanded falls Restated, there is an inverse relationship between price and quantity demanded “Other-things-equal” assumption refers to: –consumer income and tastes, –prices of related goods, –and other things besides the price of the product being discussed

7. 7 Explanation of the Law of Demand: Diminishing marginal utility –The decrease in added satisfaction with consumption of additional units of a good or service, –i.e., the second “Big Mac” yields less extra satisfaction (or utility) than the first Income effect –A lower price increases the purchasing power of money income, enabling the consumer to buy more at a lower price Substitution effect – A lower price gives an incentive to substitute the lower-priced good for now relatively higher-priced goods

8. 8 Demand Curve: Illustrates the inverse relationship between price and quantity The downward slope indicates –lower quantity (horizontal axis) at higher price (vertical axis) and –higher quantity at lower price, reflecting the Law of Demand

9. P Q o $5 4 3 2 1 PQDQD $5 4 3 2 1 10 20 35 55 80 D Price of Corn Quantity of Corn CORN 10 20 30 40 50 60 70 80 Graphing Demand

10. 10 Individual Versus Market Demand Transition from an individual to a market demand - summing individual quantities at various price levels Market curve is horizontal sum of individual curves

11. 11 Individual Versus Market Demand

12. 12 Individual Versus Market Demand

13. 13 Change in Demand An increase in demand involves a rightward shift, and A decrease in demand involves a leftward shift

14. P Q o $5 4 3 2 1 PQDQD $5 4 3 2 1 D Price of Corn Quantity of Corn CORN 10 20 30 40 50 60 70 80 D’ Increase in Demand Increase in Quantity Demanded 10 20 35 55 80 30 40 60 80 + Increase in Demand

15. P Q o $5 4 3 2 1 PQDQD $5 4 3 2 1 10 20 35 55 80 D Price of Corn Quantity of Corn CORN 10 20 30 40 50 60 70 80 -- 10 20 40 60 D’ Decrease in Demand Decrease in Quantity Demanded Decrease in Demand

16. 16 Determinants of the Change in Demand 1. Tastes favorable change leads to an increase in demand unfavorable change - a decrease in demand 2. Number of buyers more buyers lead to an increase in demand fewer buyers lead to a decrease

17. 17 3.Income more leads to an increase in demand less leads to a decrease in demand for normal goods The rare case of goods whose demand varies inversely with income is called inferior goods 4. Expectations consumer views about future prices, product availability, and income can shift demand Determinants of the Change in Demand

18. 18 Determinants of the Change in Demand 5.Prices of related goods a. Substitute goods - can be used in place of each other The price of the substitute good and demand for the other good are directly related If the price of Coke rises, demand for Pepsi should increase

19. 19 Determinants of the Change in Demand 5.Prices of related goods b. Complementary goods - are used together like tennis balls and rackets there is an inverse relationship between the price of one and the demand for the other

20. 20 Increase in Demand 1.Favorable change in consumer tastes 2.Increase in the number of buyers 3.Rising income if product is a normal good 4.Falling incomes if product is an inferior good 5.Increase in the price of a substitute good 6.Decrease in the price of a complementary good 7.Consumer expectation of higher prices or incomes in the future

21. 21 Decrease in Demand 1.Unfavorable change in consumer tastes 2.Decrease in number of buyers 3.Falling income if product is a normal good 4.Rising income if product is an inferior good 5.Decrease in price of a substitute good 6.Increase in price of a complementary good 7.Consumers expectation of lower prices or incomes in the future

22. 22 Important Distinction Between: a change in quantity demanded caused by price change and a change in demand caused by change in determinants.

23. 23 Supply Supply - a schedule that shows amounts of a product a producer is willing and able to produce and sell at each specific price –in a series of possible prices –during a specified time period What quantities will be offered at various prices or What price will be required to induce various quantities to be offered?

24. $1 2 3 4 5 PQSQS CORN Various Amounts A Series of Possible Prices …a specified time period …other things being equal 5 20 35 50 60 Supply Schedule

25. 25 Law of Supply Producers will produce and sell more of their product at a high price than at a low price There is a direct relationship between price and quantity supplied Explanation: –Given product costs, a higher price means greater profits and thus an incentive to increase the quantity supplied –Beyond some production quantity producers usually encounter increasing costs per added unit of output

26. 26 Supply Curve shows a direct relationship in an upward sloping curve.

27. S P Q o $5 4 3 2 1 10 20 30 40 50 60 70 80 $5 4 3 2 1 60 50 35 20 5 PQSQS Price of Corn Quantity of Corn CORN Graphing Supply

28. 28 Change in Supply An increase in supply involves a rightward shift and a decrease in supply involves a leftward shift

29. S P Q o $5 4 3 2 1 10 20 30 40 50 60 70 80 Price of Corn Quantity of Corn $5 4 3 2 1 60 50 35 20 5 PQSQS CORN 80 70 60 45 30 S’ Increase in Supply Increase in Quantity Supplied Increase in Supply

30. S P Q o $5 4 3 2 1 10 20 30 40 50 60 70 80 $5 4 3 2 1 60 50 35 20 5 PQSQS Price of Corn Quantity of Corn CORN S’ 45 30 20 0 -- Decrease in Supply Decrease in Quantity Supplied Decrease in Supply

31. 31 Determinants of the Change in Supply Six basic determinants of supply: 1. Resource prices a rise in resource prices causes a decrease in supply a decrease in resource prices causes an increase in supply 2. Technology a technological improvement means more efficient production and lower costs, so an increase in supply results

32. 32 Determinants of the Change in Supply 3. Taxes and subsidies a business tax is treated as a cost, so decreases supply a subsidy lowers cost of production, so increases supply 4. Prices of related goods if the price of substitute production good rises, producers might shift production toward the higher-priced good, causing a decrease in supply of the original good

33. 33 Determinants of the Change in Supply 5. Expectations about the future price of a product 6. Number of sellers generally, the larger the number of sellers the greater the supply

34. 34 Important Distinction Between: a change in quantity supplied due to price changes and a change or shift in supply due to change in determinants of supply

35. 35 Market Equilibrium Where quantity supplied equals the quantity demanded The equilibrium price and quantity. –Market clearing or market price is another name for equilibrium price –The rationing function of prices is the ability of competitive forces of supply and demand to establish a price where buying and selling decisions are coordinated

36. 36 Market Equilibrium An excess quantity or surplus –at prices above the equilibrium An excess quantity demanded or shortage –at prices below the equilibrium

37. 2,000 4,000 7,000 11,000 16,000 10 20 35 55 80 $5 4 3 2 1 $5 4 3 2 1 60 50 35 20 5 200 B U Y E R S PQDQD BUSHELS OF CORN MARKET DEMAND 200 S E L E R S 12,000 10,000 7,000 4,000 1,000 PQSQS BUSHELS OF CORN MARKET SUPPLY EQUILIBRIUM xx Market Demand and Supply

38. 38 Market Equilibrium Graphically, the equilibrium price and quantity are where the supply and demand curves intersect It is NOT correct to say supply equals demand!

39. $5 4 3 2 1 7 S P Q o $5 4 3 2 1 2 4 6 8 10 12 14 16 PQDQD $5 4 3 2 1 2,000 4,000 7,000 11,000 16,000 12,000 10,000 7,000 4,000 1,000 D P QSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Market Clearing Equilibrium Market Equilibrium

40. 7 S P Q o $5 4 3 2 1 2 4 6 8 10 12 14 16 PQDQD $5 4 3 2 1 2,000 4,000 7,000 11,000 16,000 $5 4 3 2 1 12,000 10,000 7,000 4,000 1,000 D P QSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Surplus At a $4 price more is being supplied than demanded Surplus

41. 11 7 S P Q o $5 4 3 2 1 2 4 6 8 10 12 14 16 PQDQD $5 4 3 2 1 2,000 4,000 7,000 11,000 16,000 $5 4 3 2 1 12,000 10,000 7,000 4,000 1,000 D P QSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET At a $2 price more is being demanded than supplied Shortage

42. 42 The Analogy of Scissors Economist Alfred Marshall (1842-1924) used the analogy of scissors to illustrate the relative importance of supply and demand: Equilibrium price and quantity is determined by both supply and demand, just as both blades of a pair of scissors cut the paper

43. 43 Key Terms MARKET DEMAND LAW OF DEMAND DEMINISHING MARGINAL UTILITY INCOME EFFECT SUBSTITUTION EFFECT DEMAND CURVE DETERMINANTS OF DEMAND NORMAL GOODS INFERIOR GOODS SUBSTITUTE GOODS COMPLEMENTARY GOODS CHANGE IN DEMAND CHANGE IN QUANTITY DEMANDED SUPPLY LAW OF SUPPLY SUPPLY CURVE DETERMINANTS OF SUPPLY CHANGE IN SUPPLY CHANGE IN QUANTITY SUPPLIED SURPLUS SHORTAGE EQUILIBRIUM PRICE EQUILIBRIUM QUANTITY RATIONING FUNCTION OF PRICES