LectureSlides Chp4

8/8/2019 LectureSlides Chp4

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Chp. 4 1

Chapter 4

Demand and Supply


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Market Demand in Product/Goods Markets

Demand is the relation between market price

and quantity demanded of the good or service at

a given time.

Quantity demanded is the number of units of a

good or service that consumers are willing and

able to purchase in a given time period at a

specified price.


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Law of Demand

The relationship between the market price of thegood and its quantity demanded forms the basis forthe law of demand.

The law of demandstates other things remainingthe same (ceteris paribus),

If the price of the good rises, the quantitydemanded of that good decreases.

If the price of the good falls, the quantitydemanded of that good increases.

There is an inverse relation between market priceand quantity demanded of the good.


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Demand curve is a graph of the relationship

between the quantity demanded of a good and itsprice when all other influences on buying plans

remain the same.

Always graph price on the vertical axis and the

quantity demanded on the horizontal axis.

The law of demand holds along the demand

curve and thus the demand curve is downward

sloping.

Demand Curve


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Things that Shift Demand

There is a ch

ange in demand (the demandcurve shifts) if there is a change in anything thataffects potential buyers other than the price ofthe product.

An increase in demand will shift the demandcurve to the right

A decrease in demand will shift the demandcurve to the left

Recall that a change in the price of the productcauses a change in quantity demanded. It doesNOT change (shift) demand.


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(1) Change in income or wealthAn increase (decrease) in income will cause

demand for the good to rise (fall) if the good is anormal good.

An increase (decrease) in income will causedemand for the good to fall (rise) if the good is aninferior good.


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(2) Change in price of a substituteSubstitutes are goods that can serve as

replacements for one another.

An increase (decrease) in price of a substitute

will cause demand for the good to rise (fall).

Examples: Diet Pepsi and Diet Coke; Dell and HP

laptops


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(3) Change in price of a complementComplements or complementary goods are

goods that go together.

An increase (decrease) in price of a complement

will cause demand for the good to fall (rise).

Examples: chips & salsa; coffee and coffee

creamer


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(4) Changes in consumer tastes, preferences, orfashion

Examples: individuals have become more health

conscious, so demand for Diet Pepsi has increased


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(5) Changes in expectation of future income If consumers expect to earn higher (lower)

income in future, then current demand for the

good will increase (decrease).


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(6) Changes in expectation of future price of thegood

If consumers expect price of the good to rise in

future, they will stock up and current demand will

increase; If consumers expect price of the goodto fall in future, they will postpone their

purchases and current demand of the good will

decrease.


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(7) Change in number of buyersAn increase (decrease) in the number of buyers

will increase (decrease) the demand for the good

Example: number of households with single parent

or both parents working has increased, as a result

demand for daycare has increased.


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Change in Quantity Demanded vs.

Change in Demand

When the price of the good changes, there is achange in the quantity demanded of the goodand a movement along the demand curve.

When any influence other than the price of thegood changes, the demand for the goodchanges and the demand curve shifts.


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Market Supply in Product/Goods Markets

Supply is the relation between market price andquantity supplied of the good or service at a

given time.

Quantity supplied is the number of units of agood or service that firms or producers are

willing and able to sell in a given time period at a

specified price.


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Law of Supply

The relationship between the market price of the good

and its quantity supplied forms the basis for the law ofsupply.

The law ofsupplystates other things remaining thesame (ceteris paribus),

If the price of the good rises, the quantity suppliedof that good increases.

If the price of the good falls, the quantity suppliedof that good decreases.

An increase in the price of the good with no change in

input costs makes it more profitable to produce and sellthe item; this causes firms to increase production

There is a direct relation between market price andquantity supplied of the good.


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Supply curve is a graph of the relationship

between the quantity supplied of a good and itsprice when all other influences on selling plans

remain the same.

Always graph price on the vertical axis and the

quantity supplied on the horizontal axis.

The law of supply holds along the supply curve

and thus the supply curve is upward sloping.

Supply Curve


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Things that Shift Supply

There is a ch

ange in supply (the supply curveshifts) if there is a change in anything that affectspotential sellers other than the price of theproduct.

An increase in supply will shift the supply curve tothe right

A decrease in supply will shift the supply curve tothe left

Recall that a change in the price of the product

causes a change in quantity supplied. It doesNOT change (shift) supply.


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(1) Changes in Cost of Inputs (i.e. changes in inputprices)

An increase (decrease) in cost will cause supply

of the good to fall (rise).


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(2) Improvements in Production Technology Improved technology increases the efficiency of

production, thus increases supply.


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(3) Nature and Natural EventsExamples: Harvests, fire, flood, discoveries of

natural resources, etc.


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(4) Change in number of producers or firmsAn increase (decrease) in the number of firms

will increase (decrease) the supply for the good


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Change in Quantity Supplied vs.

Change in Supply

When the price of the good changes, there is achange in quantity supplied of the good and amovement along the supply curve.

When any influence on selling plans other thanthe price of the good changes, then supply ofthe good changes and the supply curve

sh

ifts.


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Trade or exchange takes place i.e. goods andservices are bought and sold when buyers andsellers meet each other in goods markets.

Marketequilibrium is the condition that existswhen quantity supplied and quantity demandedare equal the point where demand and supplycurves intersect each other.

Equilibrium price is the price at which thequantity demanded equals the quantity supplied.

Equilibrium quantity is the quantity bought andsold at the equilibrium price.

Market Equilibrium


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When demand or supply curves shift (due tothe event of change in factors other than priceof the good) the equilibrium situation will bedisturbed i.e. a disequilibrium situation willarise. Then the market will adjust towards a

new equilibrium. Two disequilibrium situations can arise

(1) Current market price is higher than equilibriumprice

(2) Current market price is lower than equilibriumprice

Disequilibrium and adjustments

towards equilibrium


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This happens when either the supply curve shiftsright or the demand curve shifts left.

Results in quantity supplied to be greater than

quantity demanded.

When quantity supplied is greater than quantity

demanded at the current price then we say that

there is an excesssupplyor a surplus in the

market.

Case 1: Current market price is higher than

equilibrium price


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A surplus causes producers to reduce marketprice until new equilibrium is reached.

As price falls producers reduce quantity supplied

As price falls consumers increase quantity

demanded

The market reaches equilibrium

Surplus and adjustment towards equilibrium


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This happens when either the supply curve shiftsleft or the demand curve shifts right.

Results in quantity demanded to be greater than

quantity supplied.

When quantity demanded is greater than quantity

supplied at the current price then we say that

there is an excess demandor a shortage in the

market.

Case 2: Current market price is less than

equilibrium price


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A shortage causes producers to increase marketprice until new equilibrium is reached.

As price rises producers increase quantity

supplied

As price rises consumers decrease quantity

demanded

The market reaches equilibrium

Shortage and adjustment towards equilibrium


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We can work out the effects of an event onequilibrium price and quantity following the steps

discussed below:

1.First draw the graph of the market whose equilibrium has

been affected.2.Has the event caused demand or supply curve to shift?

3.Once you shift the appropriate curve compare prices and

quantities at the new equilibrium point with the old

equilibrium point.

Predicting Changes in Equilibrium


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Price adjustments bring market equilibrium. But sometimes prices do not adjust. What

happens then?

Three reasons why price adjustment might not

occur are:

Price floor

Price ceiling

Sticky price

Price Rigidities


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A price flooris a minimum price below which

the good should not be sold.

A price floor is imposed when the equilibrium

price in the market is too low from the sellers

viewpoint. The result of setting a price floor will be excess

supply, or higher quantity supplied than quantity

demanded.

Examples: government price floors such as farm

price supports, minimum wage laws.

Price Floor


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Price Ceiling

A price ceilingorprice cap is a maximum price

that sellers may charge for a good.

A price ceiling is imposed when the equilibrium

price in the market is too high from the buyers

viewpoint. The result of setting a price ceiling will be excess

demand, or higher quantity demanded than

quantity supplied.

Examples: government price ceilings such as rentcontrol, caps on gasoline prices.


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Sticky Price

In some markets, a law might not restrict theprice.

But either the buyer and seller agree on a price

for a fixed period or the seller sets a price that

changes infrequently. In these markets, prices adjust slowly and not

quickly enough to avoid shortages and

surpluses.

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