Demand, Supply and Market Equilibrium

03

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Markets

• Interaction between buyers and sellers

• Markets may be:• Local

• National

• International

• Price is discovered in the interactions of buyers and sellers

LO1 3-2

Demand

• Schedule or curve

• Amount consumers are willing and able to purchase at a given price

• Other things equal

• Individual demand

• Market demand

LO1 3-3

Law of Demand

• Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls.

• Reasons:• Common sense• Law of diminishing marginal utility• Income effect and substitution effects

LO1 3-4

6

5

4

3

2

1

0 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P Qd

$5

4

3

2

1

10

20

35

55

80

P

Q

D

The Demand Curve

LO1

The Demand Curve

3-5

Market Demand

LO1

Market Demand for Corn, Three Buyers

Priceper bushel

Quantity Demanded Total Qd

per weekJoe Jen Jay

$5 10 12 8 30

4 20 23 17 60

3 35 39 26 100

2 55 60 39 154

1 80 87 54 221

3-6

Changes in Demand

LO1

6

5

4

3

2

1

0

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P

Q

D1

2 4 6 8 10 12 14 16 18

D2

D3

3-7

Changes in Demand

LO1

6

5

4

3

2

1

0

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P

Q

D1

2 4 6 8 10 12 14 16 18

D2

D3

Change in Demand

Change in Quantity Demanded

3-8

Determinants of Demand

• Change in consumer tastes and preferences

• Change in number of buyers

• Change in income

• Normal goods

• Inferior goods

LO1 3-9

Determinants of Demand

• Change in prices of related goods

• Complements

• Substitutes

• Change in consumers’ expectations

• Future prices

• Future income

LO1 3-10

Substitutes

• Orange Juice—Grapefruit Juice

• Cab rides—Subway rides

• Chicken—Pork

• DVDs—Blue Ray disks

• Cane Sugar—Beet Sugar

Complements

• Game Consoles—Video Games

• Blue Ray Plays—High Definition TVs

• Airline Service—Rental Cars

• Bagels—Cream Cheese

Normal and Inferior Goods•A normal good is a good for which demand increases (shifts right) when income increases.

Examples: Scotch whiskey, Swiss-made watches, lobster, air travel, vacations abroad.

•An inferior good is a good for which demand decreases (shifts left) when income increases.

Examples: macaroni, used clothing, bus service.

Determinants of Demand

LO1

Table 3.1 Determinants of Demand: Factors That Shift the Demand Curve

Determinant Examples

Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones.

Change in the number of buyers A decline in the birthrate reduces the demand for children’s toys.

Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine.

Change in the prices of related goods

A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods).

Change in consumer expectations Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans.

3-14

Supply

• Schedule or curve

• Amount producers are willing and able to sell at a given price

• Individual supply

• Market supply

LO2 3-15

Law of Supply

• Other things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls.

• Reason:

• Price acts as an incentive to producers

• At some point, costs will rise

LO2 3-16

The Supply Curve

LO2

5

4

3

2

1

0

Pri

ce (

per

bu

shel

)

Quantity supplied (bushels per week)

S

10 20 30 40 50 60 70

Supply of Corn

Price per

Bushel

Qs per

Week

$5 60

4 50

3 35

2 20

1 5

P

Q

3-17

Changes in Supply

LO2

$6

5

4

3

2

1

0

Pri

ce (

per

bu

shel

)S1

Quantity supplied (thousands of bushels per week)2 4 6 8 10 12 14 16

P

Q

S2

S3

Increasein supply

Decrease in supply

3-18

Changes in Supply

LO2

$6

5

4

3

2

1

0

Pri

ce (

per

bu

shel

)S1

Quantity supplied (thousands of bushels per week)2 4 6 8 10 12 14 16

P

Q

S2

S3

Change in Quantity Supplied

Change in Supply

3-19

Determinants of Supply

• A change in resource prices

• A change in technology

• A change in the number of sellers

• A change in taxes and subsidies

• A change in prices of other goods

• A change in producer expectations

LO2 3-20

Determinants of Supply

LO2

Table 3.2 Determinants of Supply: Factors That Shift the Supply Curve

Determinant Examples

Change in resource prices A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline.

Change in technology The development of more effective wireless technology increases the supply of cell phones.

Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education.

Change in prices of other goods An increase in the price of cucumbers decreases the supply of watermelons.

Change in producer expectations An expectation of a substantial rise in future log prices decreases the supply of logs today.

Change in the number of suppliers An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games.

3-21

Market Equilibrium

• Equilibrium occurs where the demand curve and supply curve intersect.

• Surplus and shortage

• Rationing function of prices

• Efficient allocation

• Productive efficiency

• Allocative efficiency

LO3 3-22

Market Equilibrium

LO3

6

5

4

3

2

1

0 2 4 6 8 10 12 14 16 18Bushels of Corn (thousands per week)

Pri

ce (

per

bu

shel

)P Qd

$5

4

3

2

1

2,000

4,000

7,000

11,000

16,000

P Qs

$5

4

3

2

1

12,000

10,000

7,000

4,000

1,000

7

3

D

S6,000 BushelSurplus

7,000 BushelShortage

3-23

Rationing Functions of Prices

• The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent.

LO3 3-24

Efficient Allocation

• Productive efficiency• Producing goods in the least costly way

• Using the best technology

• Using the right mix of resources

• Allocative Efficiency• Producing the right mix of goods

• The combination of goods most highly valued by society

LO3 3-25

`Changes in Demand and

Equilibrium

LO4

0

P

D4

D3

`Changes in Demand and

Equilibrium

LO4

0

P

D1

D2

S

Increase in demand

D increase:P, Q

D decrease:P, Q

Decrease in demand

S

3-26

`Changes in Demand and

Equilibrium

LO4

0

P

D

S4

`Changes in Supply and

Equilibrium

LO4

S3

0

P

D

S2S1

Increase in supply

S increase:P, Q

S decrease:P, Q

Decrease in supply

3-27

Complex Cases

LO4

TABLE 3.3 Effects of Changes in Both Supply and Demand

Change in Supply Change in DemandEffect on

Equilibrium Price

Effect on Equilibrium

Quantity

1. Increase Decrease Decrease Indeterminate

2. Decrease Increase Increase Indeterminate

3. Increase Increase Indeterminate Increase

4. Decrease Decrease Indeterminate Decrease

3-28

S′′

Simultaneous Shifts: (D, S)

S

D′

S′

D

Q

Price may rise or fall; Quantity rises

P

•A

Q

P

B•P′

Q′ Q′′

C•P′′

S′

Simultaneous Shifts: (D, S)

D

S

D′

S′

Q

Price falls; Quantity may rise or fall

P

•A

Q

P

B•P′

Q′ Q′′

C•P′′

Government Set Prices

• Price Ceilings

• Set below equilibrium price

• Rationing problem

• Black markets

• Examples: Rent controls, human organs, grain storage fees in some states.

LO5 3-31

I believe increasing the minimum wage will cause

unemployment among the unskilled and less-

educated to rise

Government Set Prices

LO5

SP

Q

D

P0

PC

Q0

Shortage

QdQs

ceiling$3.50

3.00

3-33

Government Set Prices

• Price Floors

• Prices are set above the market price

• Chronic surpluses

• Example: Minimum wage laws, Department of Agriculture loan rates.

LO5 3-34

Government Set Prices

LO5

S

P

Q

D

P0

Pf

Q0

Surplus

QsQd

floor

2.00

$3.00

3-35

P/BU

bushels0

#2 Hard KC Wheat

S

D

550 700 850

$2.52

$3.20

Surplus

A price floor of $3.20 per bushel will

produce a surplusof 300 bushels.

But what ifthe floor were set

at $2.35?

Legal Market for Human Organs

• What if we created a legal market for human organs?

• Positive effects• Increase the incentive to donate

• Eliminate the persistent shortage of eyes, livers, hearts, kidneys, etc.

3-37

Legal Market for Human Organs

• Negative effects

• Increases the cost of medical care

• Diminishes the special nature of life by commercializing it

3-38