supply and demand - university of wisconsin–madisonctaber/100/supp-dem.pdf · 2011-10-17 ·...
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C H A P T E R 2
SUPPLY AND DEMAND
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YOU ARE HERE
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DEFINITIONS
• Supply and Demand: the name of the most important model in all economics • Price: the amount of money that must be paid for
a unit of output • Market: any mechanism by which buyers and
sellers exchange goods or services • Output: the good or service and/or the amount of
it sold
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DEFINITIONS (CONTINUED)
• Consumers: those people in a market who are wanting to exchange money for goods or services • Producers: those people in a market who are wanting
to exchange goods or services for money • Equilibrium Price: the price at which no consumers
wish they could have purchased more goods at that price; no producers wish that they could have sold more • Equilibrium Quantity: the amount of output exchanged
at the equilibrium price
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QUANTITY DEMANDED AND QUANTITY SUPPLIED
• Quantity demanded: how much consumers are willing and able to buy at a particular price during a particular period of time
• Quantity supplied: how much firms are willing and able to sell at a particular price during a particular period of time
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CETERIS PARIBUS
• As I talked about before economists use models to focus on what is most important
• Models typically hold other variables constant to examine the effect of other variables.
• For example in looking at the supply and demand for peanut butter we typically hold the price of jelly constant
• We sometimes use the Latin phrase ceteris paribus which means “holding other things equal” to identify this case.
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DEMAND AND SUPPLY
• Demand is the relationship between price and quantity demanded, ceteris paribus.
• Supply is the relationship between price and quantity supplied, ceteris paribus.
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FIGURING OUT THE DEMAND CURVE
• There are really two different parts to it which are similar
• One is the “extensive margin” that is who buys the good
• The second is the “intensive margin” or how much of the good each person buys
• Guell focuses on the intensive margin, but I want to start with the extensive as I think it is easier to think about
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EXTENSIVE MARGIN
• Think about something like an ipad where there is really no reason to buy more than one • Suppose there are 5 people in the economy and
this is what they are willing to pay:
Name WTP
Jim $200
Jackie $400
Bill $600
Sally $800
Lisa $1000
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DEMAND CURVE
So what does demand look like: • At $1200 I sell no ipads • At $1000 I sell to Lisa only • At $800 I sell 2 • At $600 I sell 3 • At $400 I sell 4 • And at $200 I sell5
0
200
400
600
800
1000
1200
1400
0 2 4 6
Price
ipads
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INTENSIVE DEMAND
• Now suppose it is just one worker say me • I like to go to basketball games (either pro or
college) • Suppose the seats are all the same, how many
games would I go to? • At $200 per seat I would probably go to a game • At $50 per seat I would probably go to like 4 games a year • At $25 I would go to like 15 • At $5 I would go to like 20 • At $0 I would go to like 20 • Thus demand slopes down for me-the larger the price the
fewer games I would go to
• Demand in the economy picks up both the intensive and extensive margin
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THE LAW OF DEMAND
The relationship between price and quantity demanded is a negative or inverse one. This occurs both on the extensive and intensive margin There are 3 reasons to expect it on the intensive margin
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The Substitution Effect • moves people toward the good that is now cheaper or
away from the good that is now more expensive • If the price of Mobil gas goes up I buy more Amoco
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The Real Balances Effect • When a price increases it decreases your buying
power causing you to buy less.
• If I live in New York and am spending almost all of my money on rent, if rent doubles I have to move into cheaper place because I can’t afford my current place any more
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The Law of Diminishing Marginal Utility • The amount of additional happiness that you get from
an additional unit of consumption falls with each additional unit.
• This is what was really going on with my basketball tickets-I like going but I get tired of it if I go to two many games
• Pretty much any good we can think of has this characteristic
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Put it all together and we are pretty confident that demand curves slope down
P
Q
p
q
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DETERMINANTS OF DEMAND
• Taste • Income • Normal Goods • Inferior Goods
• Price of Other Goods • Complement • Substitute
• Population of Potential Buyers • Expected Price • Excise Taxes • Subsidies
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MOVEMENTS IN THE DEMAND CURVE
Determinant Result of an increase in the determinant
Result of a decrease in the determinant
Taste D shifts right D shifts left
Income-Normal Good D shifts right D shifts left
Income-Inferior Good D shifts left D shifts right
Price of Other Goods-Complement D shifts left D shifts right
Price of Other Goods-Substitute D shifts right D shifts left
Population of Potential Buyers D shifts right D shifts left
Expected Future Price D shifts right D shifts left
Excise Taxes D shifts left D shifts right
Subsidies D shifts right D shifts left
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P
Times Eating Out
Example: Demand for Eating Out When Income Falls
p
q1 q2
At a given price people eat out less
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P
Ketchup
Example: Demand for ketchup when the price of beef falls
p
q2 q1
At a given price the People want more Ketchup
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A PITFALL: CONFUSING MOVEMENT ALONG VS. SHIFTS IN DEMAND
• Price changes cause movements along a demand curve.
• Other factors will cause shifts in demand.
• These are not the same
• The “Quantity Demanded” can change either because the price changes or because the demand curve changed
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P
Q
Two ways that Quantity Demanded can Increase:
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SUPPLY
• Supply is more complicated and harder to think about than demand (at least for me) • In demand for an ipad a person buys an ipad and
brings it home • In supply for an ipad you have to design it, buy all
the components, build it, ship it, sell it in the store • The Law of Supply is the statement that there is a
positive relationship between price and quantity supplied. • If I am trying to sell something, the higher is the price
the more I will want to sell
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WHY DOES THE LAW OF SUPPLY MAKE SENSE?
• Because of Increasing Marginal Costs firms require higher prices to produce more output.
• Because many firms produce more than one good, an increase in the price of good A makes it (at the margin) more profitable so resources are diverted from good B to produce more of good A (think about the PPF)
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THE SUPPLY SCHEDULE
Price Individual Qs QS for 10 firms $0.00 0 0 $0.50 0 0 $1.00 1,000 10,000 $1.50 2,000 20,000 $2.00 3,000 30,000 $2.50 4,000 40,000
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THE SUPPLY CURVE
0 10 20 30 40 50
P
Q (in thousands)
$2.50 $2.00 $1.50 $1.00 $0.50 0
Supply
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MOVEMENTS IN THE SUPPLY CURVE
Determinant Result of an increase in the determinant
Result of a decrease in the determinant
Price of Inputs S shifts left S shifts right
Technology S shifts right S shifts left
Price of Other Potential Outputs S shifts left S shifts right
Number of Sellers S shifts right S shifts left
Expected Future Price S shifts left S shifts right
Excise Taxes S shifts left S shifts right
Subsidies S shifts right S shifts left
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NUMBER OF SELLERS GOES UP
0 10 20 30 40 50
P
Q (in thousands)
$2.50 $2.00 $1.50 $1.00 $0.50 0
At a given price quantity supplied will increase
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PRICE OF AN INPUT GOES UP
0 10 20 30 40 50
P
Q (in thousands)
$2.50 $2.00 $1.50 $1.00 $0.50 0
At a given price quantity supplied will decrease
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MARKET EQUILIBRIUM
• A competitive market is in equilibrium when price has moved to a level at which quantity demand equals quantity supplied of that good. • Competitive markets have many buyers and sellers and none
is large enough to individually affect the price.
• Why do markets reach an equilibrium? • If prices are too high, there is excess supply (a surplus) and
firms will lower prices. • If prices are too low, there is excess demand (a shortage) and
firms will raise prices.
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A COMBINED SUPPLY AND DEMAND SCHEDULE
Price QD QS Shortage Surplus
$0.00 50,000 0 50,000 $0.50 40,000 0 40,000 $1.00 30,000 10,000 20,000 $1.50 20,000 20,000 $2.00 10,000 30,000 20,000 $2.50 0 40,000 40,000
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THE SUPPLY AND DEMAND MODEL
0 10 20 30 40 50
P
Q (in thousands)
$2.50 $2.00 $1.50 $1.00 $0.50 0
Supply
Demand
Equilibrium
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WHAT IF PRICE TOO HIGH?
0 10 20 30 40 50
P
Q (in thousands)
$2.50 $2.00 $1.50 $1.00 $0.50 0
Supply
Demand
Surplus
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WHAT IF PRICE TOO LOW?
0 10 20 30 40 50
P
Q (in thousands)
$2.50 $2.00 $1.50 $1.00 $0.50 0
Supply
Demand Shortage
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WHAT IF PRICE OF A SUBSTITUTE INCREASES?
New Demand
New Equilibrium
0 10 20 30 40 50
P
Q/t
$2.50 $2.00 $1.50 $1.00 $0.50 0
Demand
Supply
Old Equilibrium
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Prices Quantities
Demand Increases
Increase Increase
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WHAT IF GOOD GETS BAD REVIEWS?
New Demand
New Equilibrium
0 10 20 30 40 50
P
Q/t
$2.50 $2.00 $1.50 $1.00 $0.50 0
Demand
Supply
Old Equilibrium
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Prices Quantities
Demand Increases
Increase Increase
Demand Decreases
Decrease Decrease
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TECHNOLOGY IMPROVES
0 10 20 30 40 50
P
Q/t
$2.50 $2.00 $1.50 $1.00 $0.50 0
Demand
Supply
Old Equilibrium
New Equilibrium
New Supply
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Prices Quantities
Demand Increases
Increase Increase
Demand Decreases
Decrease Decrease
Supply Increases Fall Increases
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AN INCREASE IN COST OF AN INPUT
0 10 20 30 40 50
P
Q/t
$2.50 $2.00 $1.50 $1.00 $0.50 0
Demand
Supply
Old Equilibrium
New Equilibrium
New Supply
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Prices Quantities
Demand Increases
Increase Increase
Demand Decreases
Decrease Decrease
Supply Increases Decrease Increase
Supply Falls Increase Decrease
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WHY THE NEW EQUILIBRIUM?
• If there is a change in supply or demand then without a change in the price of the good, there will be a shortage or a surplus. • Suppose the cost of an input increased-firms would no longer be
willing to sell at the same price • They raise prices • As a result consumers purchase less
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AN INCREASE IN COST OF AN INPUT
0 10 20 30 40 50
P
Q/t
$2.50 $2.00 $1.50 $1.00 $0.50 0
Demand
Supply New Supply
shortage
As a result of the shortage, employers can raise prices to new equilibrium where shortage goes away