Lecture by: Jacinto Fabiosa Fall 2005 Supply and Demand.
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Transcript of Lecture by: Jacinto Fabiosa Fall 2005 Supply and Demand.
Lecture by: Jacinto Fabiosa
Fall 2005
Supply and Demand
2
Supply and Demand
• Supply and demand is an economic model
– Designed to explain how prices are determined in certain types of markets
3
Markets
• Specific location where buying and selling takes place, such as– Supermarket or a flea market
• In economics, a market is not a place but rather– A group of buyers and sellers with the potential to trade
with each other
• Economists think of the economy as a collection of individual markets
• First step in an economic analysis is to define and characterize the market or collection of markets to analyze
4
Supply
• A firm’s quantity supplied of a good is the specific amount its managers would choose to sell over some time period, given– A particular price for the good– All other constraints on the firm
• Market quantity supplied (or quantity supplied) is the specific amount of a good that all sellers in the market would choose to sell over some time period, given– A particular price for the good– All other constraints on firms
5
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 of
the good and all other constraints they must consider?
• Stresses price– The price of the good is just one variable among many that
influences quantity supplied– We’ll assume that all other influences on supply are held constant,
so we can explore the relationship between price and quantity supplied
6
The Law of Supply
• States that when the price of a good rises and 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” in
order to understand how supply reacts to price
7
The Supply Schedule and The Supply Curve
• Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices, with all other variables held constant
• Supply curve—graphical depiction of a supply schedule– Shows quantity of a good or service supplied at
various prices, with all other variables held constant
8
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 (point G).
When the price is $2.00 per bottle, 40,000 bottles are supplied (point F).
Number of Bottles per Month
Price per Bottle
9
Shifts vs. Movements Along the Supply Curve
• A change in the price of a good causes a movement along the supply curve
• A rise (fall) in price would cause a rightward (leftward) movement along the supply curve
• A drop in transportation costs will cause a shift in the supply curve itself
• Supply curve has shifted to the right of the old curve as transportation costs have dropped
• A change in any variable that affects supply—except for the good’s price—causes the supply curve to shift
10
A Shift of The Supply Curve
S2
GJ
S1
60,000
$4.00
80,000
A decrease in transportation costs shifts the supply curve for maple syrup from S1 to S2.
Number of Bottles per Month
Price per Bottle
At each price, more bottles are supplied after the shift
11
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
12
Factors That Shift the Supply Curve
• Number of Firms – An increase (decrease) in the number of sellers
—with no other changes—shifts the supply curve to the right (left)
• Expected Price– An expectation of a future price increase
(decrease) shifts the current supply curve to the left (right)
13
Factors That Shift the Supply Curve
• 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
14
Changes in Supply and in Quantity Supplied
P2
Q3 Q1 Q2
P1
P3
Quantity
Price Price increase moves us rightward along supply curve
S
Price increase moves us leftward along supply curve
15
Changes in Supply and in Quantity Supplied
Quantity
Price
S2
S1Entire supply curve shifts rightward when:• price of input ↓• price of alternate good ↓• number of firms ↑• expected price ↑• technological advance• favorable weather
16
Changes in Supply and in Quantity Supplied
Quantity
Price
S1
S2Entire supply curve shifts rightward when:• price of input ↑• price of alternate good ↑• number of firms ↓• expected price ↑• unfavorable weather
17
In Summary: Factors That Shift The Supply Curve
• The short list of shift-variables for supply that we have discussed is far from exhaustive
• In some cases, even the threat of such events can cause 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
18
Equilibrium: Putting Supply and Demand Together
• When a market is in equilibrium– Both price of good and quantity bought and sold have
settled into a state of rest– The equilibrium price and equilibrium quantity are
values for price and quantity in the market but, once achieved, 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
19
Market Equilibrium
E
HJ1.00
$3.00
D
S
50,000 75,00025,000
Excess Demand
4. until price reaches its equilibrium value of $3.00
.
2. causes the price to rise . . .
3. shrinking the excess demand . . .
1. At a price of $1.00 per bottle an excess demand of 50,000 bottles . . .
Number of Bottles per Month
Price per Bottle
20
Excess Demand: Putting Supply and Demand Together
• 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 that is available
21
Excess Supply and Price Adjustment
3. shrinking the excess supply . . .
K L
E3.00
D
S
$5.00
50,00035,000 65,000
Excess Supply at $5.00
2. causes the price to drop,
4. until price reaches its equilibrium value of $3.00.
Number of Bottles per Month
Price per Bottle
1. At a price of $5.00 per bottle an excess supply of 30,000 bottles . . .
22
Excess Supply: Putting Supply and Demand Together
• 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
23
Income Rises: What Happens When Things Change
• Income 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 along the other curve to new equilibrium point
24
Rise in Income
1. An increase in demand . . .E
F'
3.00
D1
D2
S
$4.00
50,000 60,000
3. to a new equilibrium.
5. and equilibrium quantity increases too.
2. moves us along the supply curve . . .
Number of Bottles of Maple Syrup per Period
Price per Bottle
4. Equilibrium price increases
25
An Ice Storm Hits: What Happens When Things Change
• An ice storm causes a decrease in supply– Weather is a shift variable for supply curve
• Any change that shifts the supply curve leftward in a market will increase the equilibrium price
– And decrease the equilibrium quantity in that market
26
A Shift of Supply and A New Equilibrium
E'
E3.00
D
$5.00
50,00035,000
S2 S1
Number of Bottles
Price per Bottle
27
Changes in the Market for Handheld PCs
1. An increase in supply . . .
2. and a decrease in demand . . .
5. and quantity decreased as well.
A
B$400
D2003
S2002
S2003
D2002
$500
2.45 3.33 Millions of Handheld PCs per Quarter
Price per Handheld
PC
4. Price decreased . . .
3. moved the market to a new equilibrium.
28
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 quantity will move
• When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantity—but not both– Direction of the other will depend on which curve shifts
by more
29
The Three Step Process
• Key Step 1—Characterize the Market– Decide which market or markets best suit problem
being analyzed and identify decision makers (buyers and sellers) who interact there
• Key Step 2—Find the Equilibrium– Describe conditions necessary for equilibrium in the
market, and a method for determining that equilibrium
• Key Step 3—What Happens When Things Change– Explore how events or government polices change
market equilibrium
30
Using Supply and Demand: The Invasion of Kuwait
• Why did Iraq’s invasion of Kuwait cause the price of oil to rise?– Immediately after the invasion, United States
led a worldwide embargo on oil from both Iraq and Kuwait
– A significant decrease in the oil industry’s productive capacity caused a shift in the supply curve to the left
• Price of oil increased
31
The Market For Oil
P2
D
E'
P1E
Q2 Q1
S2
S1
Barrels of Oil
Price per Barrel of Oil
32
Using Supply and Demand: The Invasion of Kuwait
• Why did the price of natural gas rise as well?– Oil is a substitute for natural gas– Rise in the price of a substitute increases
demand 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
33
The Market For Natural Gas
Cubic Feet of Natural Gas
Price per Cubic Foot of Natural
Gas
P4
P3
F
Q3 Q4
S
D2
F'
D1
34
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 distinct
things into a single whole
• Markets can be defined broadly or narrowly, depending on our purpose– How broadly or narrowly markets are defined is one of
the most important differences between Macroeconomics and Microeconomics
35
Defining Macroeconomic Markets
• Goods and services are aggregated to the highest levels– 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
36
Defining Microeconomic Markets
• Markets are defined narrowly– Focus on models that define much more
specific commodities
• Always involves some aggregation– Stops short of the broad levels of generality that
macroeconomics investigates
37
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 will usually follow these guidelines– In markets for consumer goods, we’ll view business firms as the
only sellers, and households as only buyers– In most of our discussions, we’ll be leaving out the “middleman”
38
Competition in Markets
• In imperfectly competitive markets, individual buyers or sellers can influence the price of the product
• In perfectly competitive markets (or just competitive markets), each buyer and seller takes the market price as a given
• What makes some markets imperfectly competitive and others 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 and sellers
• Or else the product of each seller is unique in some way
39
Using Supply and Demand
• Supply and demand model is designed to explain how prices are determined in perfectly competitive markets– Perfect competition is rare but many markets come
reasonably close– Perfect competition is a matter of degree rather than an
all or nothing characteristic
• Supply and demand is one of the most versatile and widely used models in the economist’s tool kit
40
Demand
• A household’s 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
• Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period, given– A particular price they must pay for the good– All other constraints on households
41
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– How much would households want to buy, at a specific price, given
real-world limits on their spending power?
• Stresses price– Price of the good is one variable among many that influences
quantity demanded– We’ll assume that all other influences on demand are held
constant, so we can explore the relationship between price and quantity demanded
42
The Law of Demand
• States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall– 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• Thus we assume that, “everything else remains the
same,” in order to understand how demand reacts to price
43
The Demand Schedule and The Demand Curve
• Demand schedule– A list showing the quantity of a good that consumers would choose
to purchase at different prices, with all other variables held constant
• 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 buyers would choose to
buy at a specific price
• Law of demand tells us that demand curves virtually always slope downward
44
Figure 1: The Demand Curve
Number of Bottles per Month
Price per Bottle
A
B
$4.00
2.00
D
40,000 60,000
At $2.00 per bottle, 60,000 bottles are demanded (point B).
When the price is $4.00 per bottle, 40,000 bottles are demanded (point A).
45
Shifts vs. Movements Along The Demand Curve
• A change in the price of a good causes a movement along the demand curve
• In Figure 1– A fall (rise) in price would cause a movement to the right (left)
along the demand curve• A change in income causes a shift in the demand curve
itself• 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 demand—except for the good’s price—causes the demand curve to shift
46
Figure 2: A Shift of The Demand Curve
B C$2.00
60,000 80,000
D1D2
An increase in income shifts the demand curve for maple syrup from D1 to D2.
Number of Bottles per Month
Price per Bottle
At each price, more bottles are demanded after the shift
47
Dangerous Curves: “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 a single point on a demand curve• When a change in the price of a good moves us along a
demand curve, it is a change in quantity demand
– The term demand means• The entire relationship between price and quantity demanded
—and represented by the entire demand curve• When something other than price changes, causing the entire
demand curve to shift, it is a change in demand
48
Income: Factors That Shift The Demand Curve
• An increase in income has effect of shifting demand for normal goods to the right– However, a rise in income shifts demand for
inferior goods to the left
• A rise in income will increase the demand for a normal good, and decrease the demand for an inferior good
49
Wealth: Factors That Shift The Demand Curve
• Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe
• An increase in wealth will– Increase demand (shift the curve rightward) for
a normal good– Decrease demand (shift the curve leftward) for
an inferior good
50
Prices of Related Goods: Factors that Shift the Demand Curve
• Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose– A rise in the price of a substitute increases the demand
for a good, shifting the demand curve to the right
• Complement—used together with the good we are interested in– A rise in the price of a complement decreases the
demand for a good, shifting the demand curve to the left
51
Other Factors That Shift the Demand Curve
• 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 the demand curve shifts to the left
52
Figure 3(a): Movements Along and Shifts of The Demand Curve
Quantity
Price
P2
Q2 Q1 Q3
P1
P3
Price increase moves us leftward along demand curve
Price increase moves us rightward along demand curve
53
Figure 3(b): Movements Along and Shifts of The Demand Curve
Quantity
Price
D2
D1
Entire demand curve shifts rightward when:• income or wealth ↑• price of substitute ↑• price of complement ↓• population ↑• expected price ↑• tastes shift toward good
54
Figure 3(c): Movements Along and Shifts of The Demand Curve
Quantity
Price
D1
D2
Entire demand curve shifts leftward when:• income or wealth ↓• price of substitute ↓• price of complement ↑• population ↓• expected price ↓• tastes shift toward good