Demand and Supply

Chapter 3

Competition

Provides consumers with alternativesCompetition by producers to satisfy consumer wants underlies markets which are characterized by demand and supply

Demand

Relates the quantity of a good that consumers would purchase at each of various possible prices over some period of time

Quantity demanded The quantity that

consumers would purchase at a given price

Ceteris paribus Holding all else

constant

DemandPrice Quantity

$4 600

$5 400

$6 350

$7 250

Demand

$6

350

5

400

Law of Demand

The quantity demanded of a good will move inversely to the price of the goodAs price increases, quantity demanded decreasesAs price decreases, quantity demanded increases.Inverse relationship leads to downward sloping demand curve

Movement along demand curve

Occur when price and only price changesGo from $6 to $4Called movement along the demand curveQuantity demanded changesHappens when ceteris paribus occurs When we hold other things constant

Other things constant“Assumptions”

IncomePrice of related goodsTastesExpected future prices

When any of these change then DEMAND CHANGESWe shift the curveCreate a new relationship to quantity demand at each and every price

Increase in Demand

$4

600 750

D1

D2

At each and every price more of the good is demanded.

Price Q1 Q2

$4 600 750

$5 400 500

$6 350 450

$7 300 400A shift occurs in the Demand curve

Increase in Demand

Increase in consumer incomeMore money consumers have the more they are willing to pay for a goodMore units sold at each and every price

Increase in Demand

Normal goods Demand for these

goods varies directly with income

Inferior Goods Demand for these

goods varies inversely with income

Increase in Demand

Change in tasteIf good becomes in style then consumers are willing to buy more of the good at any price

Increase in Demand

Price of related goodsComplements Two goods that

must be consumed together

Decrease in the price of one will increase demand for the other

Increase in Demand

Substitutes Two goods that

must be consumed separately

Coke and Pepsi Gasoline and diesel Increase in price of

one will cause an increase in the demand of the other

                                    

Increases in Demand

Demand will increase to the extent that population increasesA change in consumer expectations about future prices will shift demand in the present

Decrease in Demand

At each and every priceLess of the good will be demanded

Price Q1 Q2

$4 600 500

$5 400 300

$6 350 250

$7 300 200

D1

D2

4

500 600

Demand curve shifts

Decrease in demand

Change in income Income decreases Consumers have

less money to spend and buy less at each and every price

Depends on inferior or normal good

Decrease in demand

Change in taste Something

becomes out of style

Consumers will buy less at each and every price

Decrease in demand

Complement As price of one

good increases, demand for the other good decreases

Decrease in demand

Substitutes As the price of

one substitute decreases, the demand for the other will decrease

Supply

Relates the quantity of a good that will be offered for sale at each of various possible prices, over some period of time, ceteris paribusQuantity supplied: the quantity of that will be offered for sale at a given price.

Law of Supply

There is a direct relationshipbetween the price of a good and the quantity supplied

Upward sloping curve due toDirect relationship

As price increases, quantitySupplied increases

As price decreases, quantity Supplied decreases

Supply

Price Q1

$5 100

$6 200

$7 300

$8 400

Movement along Supply Curve

Caused by changes in price and only in the price of the goodMove from one position on line to another

4

3

100 150

Changes in Supply

Caused by a change in the other things constantAt each and every price a new quantity is suppliedCurve will shift

Increase in Supply

At each and every price, more of the good is suppliedSupply shifts to the right

S1

S2

P Q1 Q2

$5 100 150

$6 200 300

$7 300 400

$8 400 500

7

300 400

Other things constant

Resource pricesTechnologyNumber of sellersPrice of jointly produced goodsProducer expectationsProduction Restrictions

Increase in Supply

Resource pricesIf the price of resources such as land, labor and capital decreases, supply increases

Increase in supply

Changes in technologyMakes production cheaper or easierIncreases supply

Increase in supply

Increase in the number of sellers will increase supply

Increase in Supply

Producers expectations of future pricesIf we expect prices to decline in the future, increase production today

Increase in Supply

Price of jointly produced goodsIf it rises then supply increasesPrice of beef rises, causing the supply of leather to increase

Decrease in Supply

At each and every price less of the good is suppliedLeft shift S1

S2

6

150200

Decrease in supply

Decrease in number of sellersIncrease in resource pricesStrike or disaster

Price of substitute risesPrice of jointly produced product fallsProducers expect future prices to rise

Decrease in Supply

Production restrictions Natural disasters Strikes

Equilibrium

When supply and demand meet in the marketplace, a market price is createdThere is only one price that clears the market, meaning that the quantity supplied equals the quantity demanded.A situation in which there is no tendency for either price or quantity to change

Equilibrium

Where Quantity Demanded = Quantity SuppliedOne or only one equilibrium price

S

D

Pe

Qe

Equilibrium Surplus Situation

If market price is above equilibriumThen surplus occursQd < QsWhat happens? Suppliers drop price to sell inventory

Surplus: Qs > QdPrice drops until we reach equilibrium

S

D

Pa

Pe

Qd Qs

Equilibrium Shortage

D

S

Pe

Qe

Pb

Qs Qd

At Pb, a price belowEquilibrium, Qd > QsWe experience a shortage

Shortage : Qd > Qs

Consumers push the priceuntil we reach equilibrium

Market always moves Toward equilibrium

Changes in Market Equilibrium

Caused by shifts in demand or supplyEquilibrium price not longer holds trueMarket moves toward new equilibrium point

Change in SupplyS1

P1

Q1

S2

P2

Q2

Economy in EquilibriumAt P1 and Q1 (pt. A)

Resource prices dropsThen supply shifts out

At old price, surplus occurs so market priceis dropped by suppliers

New Eq. is lower price And larger quantity

A

B

Government Intervention

When the market failure occurs, government enters the economyPrice controlsSubsidies

Price controls

Government artificially creates the market priceMarket will fail to reach equilibriumShortage or surplus occurs

Price Floor

Pe

Qe

Pf Price floor

S

D

Qd Qs

Government sets Price above equilibriumPrice.Causes a surplus

Price cannot drop

No market equilibriumSurplus is permanent

Price floor – minimumLegal price

Price Ceiling

Pe

Qe

Pc Price ceiling

Qs Qd

Price ceiling – maximum Legal price

If Pc is below Pe theneconomy has a shortage

Price cannot rise andEliminate shortage

Shortage is permanent

Subsidies

Government pays corporations Not to produce To reduce

production costs

Change in Demand

D1

S

D2

P2

P1

Q1 Q2

Economy in equilibriumWhen demand shifts dueTo change in income

At P1, we face a shortageSo market price increasesTo P2

New Eq. is higher price andhigher quantity