Supply, Demand and

Market Equilibrium

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Demand: Raw data

N ame Q uantity M aximum price

w illing to pay

M ary 1 4

B ob 1 1

Jane 1 5

Ed 1 3

Alice 1 2

1

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Demand Schedule

Price Q uantity Total Q uantity

D emanded

5 1 1

4 1 2

3 1 3

2 1 4

1 1 5

1

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Demand Curve

0

1

2

3

4

5

6

1 2 3 4 5

Quantity demanded

Pri

ce

D

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Demand: Definition

• Relationship between price and quantity

demanded at a given price

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Demand Curve

0

1

2

3

4

5

6

1 2 3 4 5

Quantity demanded

Pri

ce

D

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Demand Curve

0

1

2

3

4

5

6

1 2 3 4 5

Quantity demanded

Pri

ce

I

D

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Change in quantity demanded

due to change in price

0

1

2

3

4

5

6

1 2 3 4 5

Quantity demanded

Pri

ce

I

II

D

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Shifts in the Demand Curve

• income

• related goods

• tastes

• number of consumers

• expectations of future prices

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Demand curve shifts to the right

0

1

2

3

4

5

6

1 2 3 4 5

Quantity demanded

Pri

ce

D

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Demand curve shifts to the left

0

1

2

3

4

5

6

1 2 3 4 5

Quantity demanded

Pri

ce

D

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Demand for an intangible good

• For example, a promise exchanged for

money

• Value of the promise depends on future

events

• Examples

– loans

– insurance

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Demand for an intangible good

• Application: a futures contract

– value based on a future event

– possible events

• price of a bushel of wheat in October

• Microsoft stock price on 3rd Friday of June

• value of the Euro in $ on February 1st

• price of oil on April 21st

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Assignment

• Political futures contract

– pays $1 if Bradley is the Democratic nominee

for 2000

– pays $0 otherwise

• Price that someone is willing to pay is based

on their own prediction of a particular

outcome

• Assignment: graphing a real demand curve

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Graph of Bradley demand data

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0 5 10 15 20 25 30 35 40

Quantity Demanded

Pri

ce

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The effect of NBA party

on demand for Bradley contracts

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0 5 10 15 20 25 30 35 40

Quantity Demanded

Price

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Supply: Raw dataCo mpany N ame Q uantity M inimu m price

w illing to accept

AD C 1 3

SSW 1 2

Q W E 1 5

Y Y J 1 1

AQ D 1 4

1

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Supply Schedule

Price Q uantity Total Q uantity

Supplied

1 1 1

2 1 2

3 1 3

4 1 4

5 1 5

1

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Supply Curve

0

1

2

3

4

5

6

1 2 3 4 5

Quantity supplied

Pri

ce

S

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Supply: Definition

• Relationship between price and quantity

supplied at a given price

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Supply Curve

0

1

2

3

4

5

6

1 2 3 4 5

Quantity supplied

Pri

ce

I

S

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Change in quantity supplied due

to a change in price

0

1

2

3

4

5

6

1 2 3 4 5

Quantity supplied

Pri

ce

I

II

S

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Shifts in the Supply Curve

• prices of relevant resources

• technology

• taxes

• number of sellers

• expectations of future prices

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Supply curve shifts to the right

0

1

2

3

4

5

6

1 2 3 4 5

Quantity supplied

Pri

ce

S

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Supply curve shifts to the left

0

1

2

3

4

5

6

1 2 3 4 5

Quantity supplied

Pri

ce

S

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Supply for an intangible good

• Simplified insurance example

• Why would anyone supply car insurance?

• Seller expects that you will not have an

accident during the next year

• If you do, they pay the bills. If not, they still

keep the premium (price of policy)

• Prices depend on how likely there will be a

claim

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Political Futures Contract

• Recall our example political futures contract

• People holding this contract get $1 if

Bradley is the Democratic nominee for

2000 and $0 otherwise

• They may be willing to sell if they are not

100% sure that Bradley will be the nominee

• Assignment 4: graphing a real supply curve

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Graph of Bradley supply data

0

0.1

0.2

0.3

0.4

0.5

0.6

0 5 10 15 20 25 30 35

Quantity supplied

Pri

ce

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Effect of internet taxes on supply

of Bradley contracts

0

0.1

0.2

0.3

0.4

0.5

0.6

0 5 10 15 20 25 30 35

Quantity supplied

Pri

ce

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A Market

0

1

2

3

4

5

6

1 2 3 4 5

Quantity

Pri

ce

S

D

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Surplus

0

1

2

3

4

5

6

1 2 3 4 5

Quantity

Pri

ce

S

D

Surplus

Qd Qs

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Market adjustment to surplus

0

1

2

3

4

5

6

1 2 3 4 5

Quantity

Pri

ce

S

D

Surplus

Qd Qs

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Shortage

0

1

2

3

4

5

6

1 2 3 4 5

Quantity

Pri

ce

S

DShortage

QdQs

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Market adjustment to shortage

0

1

2

3

4

5

6

1 2 3 4 5

Quantity

Pri

ce

S

DShortage

Qd Qs

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Equilibrium

0

1

2

3

4

5

6

1 2 3 4 5

Quantity

Pri

ce

S

D

Eq.Q

Eq.P

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Government interventions:

Price controls

• The government sets a maximum price

– Example: the price of basic commodities in

many countries (milk, flour, bread, rice)

– what happens to the availability of this good?

• The government sets a minimum price for

wages

– Example: minimum wage

– what happens to the supply of labor?

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Equilibrium in the

Bradley marketBradley Nomination Market (6/99-9/99)

0

0.1

0.2

0.3

0.4

0.5

0.6

0 10 20 30 40Quantity

Pri

ce

S

D

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Supply and demand information

available in a real market

Price

Quantity

S

D

Exchanges

that already

have occurred

Offers to sell

(ask price)

Offers to buy

(bid price)

Market price

(observed)

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Supply and demand information

available in a real marketPrice

Quantity

S

D

Eq.Q Eq.Q +1

Best Ask

Best Bid

Last Trade

Note: Eq.Q. is equilibrium

quantity

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Iowa Electronic Market

• The market for Bradley contracts is run by

the Iowa Electronic Market

– real $, real time futures market run by the

Tippie Business School at the University of

Iowa

– web site: www.biz.uiowa.edu/iem

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IEM Prices: 12/10/99

Market Quotes: DCONV00

(2000 Democratic National Convention Market)

Quotes current as of 15:45:05 CST, Friday, December 10, 1999.

Symbol Bid Ask Last Low High Average

BRADLEY 0.310 0.324 0.311 0.311 0.323 0.314

GORE 0.682 0.694 0.682 0.681 0.698 0.682

DCROF 0.002 0.003 0.002 0.002 0.002 0.002

• DCROF is a contract for candidates other than Gore and

Bradley

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Assignment 7

• Choose one of the current markets running

at the IEM• Read the prospectus to make sure you understand

how the contracts work

• Using various news sources, try to determine what

events will affect prices in the IEM for two-weeks

• Using your understanding of supply and demand,

predict how prices should change

• Determine if your predictions were correct and

reconcile any discrepancies

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How do bid,ask prices happen?

• The bid and ask prices you see on the IEM

trading screen are offers to buy and sell

posted by traders in the market.

• Other information available includes:

– last traded price

– volume of trades

– historical prices

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How do you get contracts to sell?

• There are two ways to buy contracts

– Buy a bundle of contracts from the market

• each market has a set of contracts

• only one will pay $1, all others pay 0$

• keep the contracts that you think will pay off and

sell the others

– Buy from another trader

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How do you make $ in the IEM

markets?

• Buy and hold those contracts which

eventually pay $1

• Buy contracts at a low price and sell them

when the prices rise

• Sell one of each contract when sum of all

bid prices is greater than $1 (Why?)