microecon intro

8/9/2019 Microecon Intro

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Microeconomics:Theory of Supply and

Demand


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Overview

Market (who, what, how)

Supply and demand is an economic model Designed to explain how prices are determined in

certain types of markets

How the model of supply and demand works andhow to use it

1. The law of demand

2. The law of supply

3. The determination of market equilibrium4. Factors shifting demand or supply curves


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Markets

In economics, a market is not a place but rather agroup of buyers and sellers with the potential to

trade with each other Market is defined not by its location but by itsparticipants

First step in an economic analysis is to define andcharacterize the market or collection of markets to

analyzeEconomists think of the economy as a collection

of individual markets


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How Broadly Should We Define The

Market

Defining the market often requires economists to

group things together

Aggregation is the combining of a group of distinctthings into a single whole

Markets can be defined broadly or narrowly,

depending on our purpose

How broadly or narrowly markets are defined is one ofthe most important differences between

Macroeconomics and Microeconomics


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Defining Macroeconomic

MarketsGoods and services are aggregated to the

highestlevels

Macro models lump all consumer goods into

the single category consumption goods

Macro models will also analyze all capital

goods as one market Macroeconomists take an overall view of the

economy without getting bogged down in

details


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Defining Microeconomic

MarketsMarkets are defined narrowly

Focus on models that define much more

specific commodities

Always involves some aggregation

But stops it reaches the highest level of

generality that macroeconomics investigates


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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 this text willusually follow these guidelines In markets for consumer goods, well view business

firms as the only sellers, and households as only buyers

In most of our discussions, well be leaving out themiddleman


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Competition in Markets

In imperfectly competitive markets, individual buyers orsellers can influence the price of the product

In perfectly competitive markets (or just competitive

markets), each buyer and seller takes the market price as agiven

What makes some markets imperfectly competitive andothers perfectly competitive? Perfectly competitive markets have many small buyers and sellers

Each is a small part of the market, and the product is standardized

Imperfectly competitive markets have just a few large buyers andsellers

Or else the product of each seller is unique in some way


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Using Supply and Demand

Supply and demand model is designed to explainhowprices are determinedin perfectly competitivemarkets

Perfect competition is rare but many markets comereasonably close

Perfect competition is a matter of degree rather than anall or nothing characteristic

Supply and demand is one of the most versatileand widely used models in the economists tool kit


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Demand

A households quantity demanded of a good

Specific amount household would choose to buy over

some time period, given

A particular price that must be paid for the good All other constraints on the household

Marketquantity demanded (or quantity

demanded) is the specific amount of a good that

all buyers in the market would choose to buy oversome time period, given

A particular price they must pay for the good

All other constraints on households


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Quantity Demanded

Implies a choice

How much households would like to buy when they take into

account the opportunity cost of their decisions?

Is hypothetical

Makes no assumptions about availability of the good

Stresses price

Price of the good is one variable among many that influences

quantity demanded Well assume that all other influences on demand are held constant,

so we can explore the relationship between price and quantity

demanded


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The Law of Demand

The price of a good rises and everythingelse remains the same, the quantity of the

good demanded will fall The words, everything else remains the sameare important

In the real world many variables changesimultaneously

However, in order to understand the economy wemust first understand each variable separately

Thus we assume that, everything else remains thesame, in order to understand how demand reacts to

price


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The Demand Schedule

Demand schedule

A list showing the quantity of a good that

consumers would choose to purchase atdifferent prices, with all other variables heldconstant

Demand and Quantities demanded

- demand is the entire relationship between priceand quantity

- quantities demanded are specific amount ofgoods buyers want to buy


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The Demand Curve

The market demand curve (or just demand

curve) shows the relationship between the

price of a good and the quantity demanded ,holding constant all other variables that

influence demand

Each point on the curve shows the total buyerswould choose to buy at a specific price

Law of demand tells us that demand curves

virtually always slope downward


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Figure 1: The Demand Curve

Number of Bottlesper Month

Price perBottle

A

B

$4.00

2.00

D

40,000 60,000

At $2.00 per bottle,60,000 bottles aredemanded (point B).

When the price is $4.00

per bottle, 40,000 bottlesare demanded (point A).


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Shifts vs. Movements Along

The Demand CurveMove along the demand curve

From a change in the price of the good we analyze

In maple syrup example, Figure 1 A fall in price would cause a movement to the right along the

demand curve (point A to B)

See figure 3(a)


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Figure 3(a): Movements Along

and Shifts of The Demand Curve

Quantity

Price

P2

Q2 Q1 Q3

P1

P3

Price increase moves usleftward alongdemandcurve

Price increase moves usrightward alongdemandcurve


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Shifts vs. Movements Along

The Demand CurveShift of demand curve

a change in other things than price of the good causes ashift in the demand curve itself, for example, income

In Figure 2

Demand curve has shifted to the right of the old curve(from Figure 1) as income has risen

A change in any variable that affects demandexcept

for the goods pricecauses the demand curve to shift


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Figure 2: A Shift of The

Demand Curve

B C

$2.00

60,000 80,000

D1D2

An increase in incomeshifts the demand curve formaple syrup from D1 to D2.


Price perBottle

At each price, more bottlesare demanded after theshift


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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 asinglepointon a demand curve

When a change in the price of a good moves us along ademand curve, it is a change in quantity demand

The term demand means

The entire relationship between price and quantitydemandedand represented by the entire demand curve

When something other than price changes, causing the entiredemand curve to shift, it is a change in demand


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Income: Factors That Shift The

Demand CurveAn increase in income has effect of shifting

demand for normal goods to the right

However, a rise in income shifts demand forinferior goods to the left

A rise in income will increase the demandfor a normal good, and decrease the demand

for an inferior goodNormal good and inferior good are defined

by the relation between demand and income


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Wealth: Factors That Shift The

DemandC

urveYour wealthat any point in timeis the

total value of everything you own minus the

total dollar amount you owe

- Example

An increase in wealth will

Increase demand (shift the curve rightward) fora normal good

Decrease demand (shift the curve leftward) for

an inferior good


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Prices of Related Goods: Factors

that Shift the DemandC

urveSubstitutegood that can be used in place of

some other good and that fulfills more or less thesame purpose

A rise in the price of a substitute increases the demandfor a good, shifting the demand curve to the right

Complementused together with the good we areinterested in

A rise in the price of a complement decreases thedemand for a good, shifting the demand curve to theleft


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Other Factors That Shift the

DemandC

urve Population

As the population increases in an area Number of buyers will ordinarily increase

Demand for a good will increase

Expected Price An expectation that price will rise (fall) in the future shifts the

current demand curve rightward (leftward)

Tastes Combination of all the personal factors that go into determining

how a buyer feels about a good When tastes change toward a good, demand increases, and the

demand curve shifts to the right

When tastes change away from a good, demand decreases, and thedemand curve shifts to the left


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Small Summary

-- Factors Affecting DemandIncome (depends on goods nature: normal

or inferior)

Wealth (depends on goods nature)

Prices ofsubstitutes (positively related)

Prices ofcomplements (negatively related)

Population (positively related)

Expectedprice (positively related)

Tastes (positively related)


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Figure 3(b): Movements Along

and Shifts of The DemandC

urve

Quantity

Price

D2

D1

Entire demand curve shiftsrightward when: income or wealth price of substitute

price of complement population expected price tastes shift toward good


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Figure 3(c): Movements Along

and Shifts of The DemandC

urve

Quantity

Price

D1

D2

Entire demand curve shiftsleftward when: income or wealth price of substitute

price of complement population expected price tastes shift toward good


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Supply

A firms quantity suppliedof a good is the specificamount its managers would choose to sell oversome time period, given

A particular price for the good

All other constraints on the firm

Market quantity supplied (or quantity supplied) isthe specific amount of a good that all sellers in themarket would choose to sell over some timeperiod, given

A particular price for the good

All other constraints on firms


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Quantity Supplied

Implies a choice Quantity that gives firms the highest possible profits when they

take account of the constraints presented to them by the real world

Is hypothetical Does not make assumptions about firms ability to sell the good

How much would firms managers want to sell, given the price ofthe good and all other constraints they must consider?

Stresses price

The price of the good is just one variable among many thatinfluences quantity supplied

Well assume that all other influences on supply are held constant,so we can explore the relationship between price and quantitysupplied


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The Law of Supply

States that when the price of a good risesand everything else remains the same, the

quantity of the good supplied will rise The words, everything else remains the same

are important

In the real world many variables change

simultaneously However, in order to understand the economy we

must first understand each variable separately

We assume everything else remains the same inorder to understand how supply reacts to price


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The Supply Schedule and The Supply

CurveSupply scheduleshows quantities of a

good or service firms would choose to

produce and sell at different prices, with allother variables held constant

Supply curvegraphical depiction of a

supply schedule Shows quantity of a good or service supplied at

various prices, with all other variables held

constant


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Figure 4: The Supply Curve

F

G

2.00

S

40,000 60,000

$4.00

At $4.00 per bottle,quantity supplied is

60,000 bottles (pointG

).

When the price is $2.00per bottle, 40,000 bottlesare supplied (point F).


Price perBottle


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Shifts vs. Movements Along the Supply

CurveA change in the price of a good causes a

movement along the supply curve

In Figure 4 A rise (fall) in price would cause a rightward (leftward)

movement along the supply curve

A drop in transportation costs will cause a shift inthe supply curve itself

In Figure 5 Supply curve has shifted to the right of the old curve (from

Figure 4) as transportation costs have dropped

A change in any variable that affects supplyexcept for thegoods pricecauses the supply curve to shift


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Figure 5: A Shift of The Supply Curve

S2

GJ

S1

60,000

$4.00

80,000

A decrease in transportationcosts shifts the supply curve formaple syrup from S1 to S2.


Price perBottle

At each price, more bottlesare supplied after the shift


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Factors That Shift the Supply Curve

Input prices

A fall (rise) in the price of an input causes an increase

(decrease) in supply, shifting the supply curve to the

right (left)Price of Related Goods

When the price of an alternate good rises (falls), the

supply curve for the good in question shifts leftward

(rightward)Technology

Cost-saving technological advances increase the supply

of a good, shifting the supply curve to the right


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Number of Firms

An increase (decrease) in the number of

sellerswith no other changesshifts thesupply curve to the right (left)

Expected Price

An expectation of a future price increase(decrease) shifts the current supply curve to the

left (right)


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Changes in weather

Favorable weather

Increases crop yields Causes a rightward shift of the supply curve for that crop

Unfavorable weather

Destroys crops

Shrinks yields

Shifts the supply curve leftward

Other unfavorable natural events may effect all

firms in an area

Causing a leftward shift in the supply curve


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Figure 6(a): Changes in Supply

and in Quantity Supplied

P2

Q3 Q1 Q2

P1

P3

Quantity

Price Price increase movesus rightward alongsupply curve

S

Price increase moves

us leftward alongsupply curve


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Figure 6(b): Changes in Supply


Quantity

Price

S2

S1Entire supply curve shiftsrightward when: price of input price of alternate good number of firms expected price technological advance favorable weather


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Figure 6(c): Changes in Supply


Quantity

Price

S1

S2Entire supply curve shiftsrightward when: price of input

price of alternate good number of firms expected price unfavorable weather


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Summary: Factors That Shift

The SupplyC

urveThe short list of shift-variables for supply that we

have discussed is far from exhaustive

In some cases, even the threat of such events cancause serious effects on production

Basic principle is always the same

Anything that makes sellers want to sell more or less of

a good at any given price will shift supply curve


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Equilibrium: Putting Supply and

Demand TogetherWhen a market is in equilibrium

Both price of good and quantity bought and sold havesettled into a state ofrest

The equilibrium price and equilibrium quantity arevalues for price and quantity in the market but, onceachieved, will remain constant

Unless and until supply curve or demand curve shifts

The equilibrium price and equilibrium quantity

can be found on the vertical and horizontal axes,respectively At point where supply and demand curves cross


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Figure 7: Market Equilibrium

E

H

J1.00

$3.00

D

S

50,000 75,00025,000

Excess Demand

4. until price reaches itsequilibrium value of $3.00

.

2. causes the priceto rise . . .

3. shrinking theexcess demand . . .

1. At a price of $1.00 perbottle an excess demandof 50,000 bottles . . .


Price perBottle


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Excess Demand

Excess demand

At a given price, the excess of quantity

demanded over quantity supplied

Price of the good will rise as buyers

compete with each other to get more of the

good than is available


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Figure 8: Excess Supply and

Price Adjustment

3. shrinking theexcess supply . . .

K L

E

3.00

D

S

$5.00

50,00035,000 65,000

Excess Supply at $5.00

2.causes theprice to drop,

4. until price reaches itsequilibrium value of

$3.00.


Price perBottle

1. At a price of $5.00 perbottle an excess supplyof 30,000 bottles . . .


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Excess Supply

Excess Supply

At a given price, the excess of quantity supplied

over quantity demanded

Price of the good will fall as sellers compete

with each other to sell more of the good

than buyers want


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Solve for Equilibrium

AlgebraicallySuppose that demand is given by the

equation , where is

quantity demanded, P is the price of thegood. Supply is given by

where is quantity supplied.

What is the equilibrium price and quantity?

PQD 10140!

PQS

580!

DQ

sQ


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Income Rises: What Happens

When ThingsC

hangeIncome rises, causing an increase in demand

Rightward shift in the demand curve causes

rightward movement along the supply curve Equilibrium price and equilibrium quantity both

rise

Shift of one curve causes a movement alongthe other curve to new equilibrium point


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Figure 9

1. An increase indemand . . .

E

F'

3.00

D1

D2

S

$4.00

50,000 60,000

3. to a newequilibrium.

5. and equilibrium quantityincreases too.

2. moves us alongthe supplycurve . . .

Number of Bottles ofMaple Syrup per Period

Price perBottle

4.Equilibriumpriceincreases


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An Banjir Hits: What Happens When

Things Change

Banjir causes a decrease in supply

Weather is a shift variable for supply curve

Any change that shifts the supply curve leftward in amarket will increase the equilibrium price

And decrease the equilibrium quantity in that market


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Figure 10: A Shift of Supply and

A New Equilibrium

E'

E3.00

D

$5.00

50,00035,000

S2 S1

Number of Bottles

Price perBottle


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Using Supply and Demand: The

Invasion of KuwaitWhy did Iraqs invasion of Kuwait cause the

price of oil to rise?

Immediately after the invasion,United Statesled a worldwide embargo on oil from both Iraq

and Kuwait

A significant decrease in the oil industrysproductive capacity caused a shift in the supply

curve to the left

Price of oil increased


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Figure 12: The Market For

Oil

P2

D

E'

P1E

Q2 Q1

S2

S1

Barrels of Oil

Price per

Barrel of Oil


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Using Supply and Demand: The

Invasion of KuwaitWhy did the price of natural gas rise as well?

Oil is a substitute for natural gas

Rise in the price of a substitute increasesdemand for a good

Rise in price of oil caused demand curve for

natural gas to shift to the right

Thus, the price of natural gas rose


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Figure 13: The Market For

NaturalG

as

Cubic Feet ofNatural Gas

Price perCubicFoot of Natural

Gas

P4

P3

F

Q3 Q4

S

D2

F'

D1


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Figure 11: Changes in the

Market for Handheld PC

s

1. An increase insupply . . .

2. and a decreasein demand . . .

5. and quantitydecreased as well.

A

B

$400

D2003

S2002

S2003

D2002

$500

2.45 3.33 Millions of Handheld PCsperQuarter

Price perHandheld

PC

4.Price

decreased . . .

3. moved the market toa new equilibrium.


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Both Curves Shift

When just one curve shifts (and we know the

direction of the shift) we can determine the

direction that both equilibrium price and quantitywill move

When both curves shift (and we know the

direction of the shifts) we can determine the

direction for either price or quantitybut not both Direction of the other will depend on which curve shifts

by more


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The Three Step Process

Key Step 1Characterize the Market

Decide which market or markets best suit problem

being analyzed and identify decision makers (buyers

and sellers) who interact there

Key Step 2Find the Equilibrium

Describe conditions necessary for equilibrium in the

market, and a method for determining that equilibrium

Key Step 3What Happens When Things Change

Explore how events or government polices change

market equilibrium


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Summaries Through the study of the chapter, you will be able to Characterize a market.

Use a demand schedule and a demand curve to demonstrate the law ofdemand.

Explain the difference between a change in demand(shift of the curve)

and a change in quantity demanded(movement along the curve). List the factors that will lead to a change in demand, and give

examples of each.

Similar analysis for supply side.

Explain how equilibrium price and quantity are determined in acompetitive market.

Explain what will happen in a competitive market after a shift in thesupply curve, the demand curve, or both.

Describe the three steps economists take to answer almost anyquestion about the economy.

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