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Chapter 03:Supply and Demand
Copyright © 2013 by The McGraw-Hill Companies, Inc !ll rights reser"e# McGraw-Hill$Irwin
13e
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Supply and Demand
• The neat thing about gasoline prices isthat great big board outside the station
that allows you to keep constant trackof how the price of gas changes. – … or it may be a huge source of
aggravation to you.
•
Why do gasoline prices uctuate somuch?
• What causes its price to rise? … to fall?
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Supply and Demand
• The goal of this chapter is to eplainhow supply and demand really work.
– What determines the price of a good orservice?
– !ow does the price of a product a"ect its
production and consumption? – Why do prices and production levels
often change?
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#earning $b%ectives
• &'(&). *now the nature anddeterminants of market demand.
• &'(&+. *now the nature anddeterminants of market supply.
• &'(&'. *now how market prices areestablished.
•
&'(&,. *now what causes market pricesto change.• &'(&-. *now how government price
controls a"ect market outcomes.
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arket /articipants
• 0ll participants1 for the most part1 are tryingto obtain the maimum return from the scarceresources they have.
– Consumers: maimi2e the utility 3satisfaction ofunmet wants4 they can get from available incomes.
– Businesses: maimi2e pro5ts by selling goodsthat satisfy while keeping costs low.
– Government: maimi2e the general welfare ofsociety.
• These motives eplain most market activity.
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Speciali2ation and Trade
• ost of us cannot produce everythingwe want to consume. – Time1 talent1 and resource constraints.
• We should speciali2e and produce whatwe can at a lower opportunity cost thanothers.
• /roduce more than we need for
ourselves and ... – … trade the ecess for the goods we want
to consume 3which are produced by otherspecialists4.
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0pplication6 7nternational
Trade• This logic applies to international trade.
– We speciali2e in production in which we havea lower opportunity cost and sell the ecess
to other countries. – $ther countries speciali2e in production in
which they have a lower opportunity cost andsell the ecess to us.
• 8ecause of this1 both nations are able toconsume more than if they had toproduce everything for themselves.
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The 9ircular :low
• There are two markets and fourparticipants6
•
9onsumers6 – They are owners of factors of production
3e.g.1 labor4 who supply them to business5rms in the factor market and earn
income. – They purchase goods and services in the
product market.
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The 9ircular :low
• 8usiness 5rms6 they produce goods andservices for the product market using thefactors of production they bought from their
owners in the factor market.• ;overnments6 they ac
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The 9ircular :low
International
participants
Consumers
International
participants
Business
FirmsGovernments
Product
markets
Factor
markets
Goods and servicessupplied
Factors ofproduction supplied
Goods and servicesdemanded
Factors ofproduction demanded
Exports
Imports
Imports
Exports
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#ocating arkets
• 0 market eists wherever anechange 3transaction4 takes place.
•
=very market transaction involves anechange of dollars for goods andservice 3in product markets4 orresources 3in factor markets4. – 7n the circular ow1 goods and services or
resources ow one way1 and dollars owthe opposite way.
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=ercise
• Write down a product market inwhich you participated recently.
– Were you a buyer or seller?
• Write down a factor market in whichyou participated recently.
– Were you a buyer or seller?
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Supply and Demand
• Supply: the ability and willingness to sell speci5c
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The #aw of Demand
• Law of demand: the
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7ndividual Demand and arket
Demand• =ach of us has a demand for a good or a
service if we are willing and able to pay for
it.• The amount we buy depends on its price.
– 7f the price goes up1 we buy less.
– 7f the price goes down1 we buy more.
• arket demand is the collectivesummation of all buyers individualdemands.
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Demand Schedule and
9urve
! " # $0$$!$"$#0%uantity
&ri'e
()0
!)
!0
3)30
)
0
$)
$0)
0
A
B
C
D
E
F
G
H
I
:ig '.+
&ri'e%uantity
Demanded
@-& )
,- +
,& '
'- -
'& A
+- B
+& )+
)- )-
)& +&
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:actors That Set Demand 8ehavior
3Determinants of Demand4• Tastes.
• 7ncome.
• =pectations.• $ther goods6
– Substitutes.
– 9omplements.
• Cumber of buyers.
• 7f any of these factorschange1 demandbehavior changes.
• 0 demand behaviorchange is shown byshifting the demandcurve.
– 7ncrease in demand6shift the curve right.
– Decrease in demand6shift the curve left.
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9hanging Demand
3Shifting the Demand 9urve4• Demand increases 3shifts right4 when
– Taste for the good increases.
–
7ncome increases. – /rice of a substitute rises.
– /rice of a complement falls.
– :uture prices are epected to rise.
– Cumber of buyers increases.
• ice versa1 and demand decreases 3shiftsleft4.
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ovements vs. Shifts
• Chan*e in +uantity demanded: movement along a demand curve in
response to a change in price.• Chan*e in demand: a shift of the
demand curve due to a change in
one or more of the determinants ofdemand.
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ovements vs. Shifts&ri'e
!0
3)
30)
0
$)
$0
)0
(!)
! " # $0 $ $! $" $# 0 %uantity
D1Initial demand
d 1
,ovementalon* 'urve
g1
Shift indemand
D2 In'reaseddemand
d 2
ovement along the curve6 buyers behavior does not changeE buyers only react to aprice change.Shift the curve6 buyers behavior does change.
:ig '.'
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#aw of Supply
• Law of supply: the
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Supply Schedule and 9urve
/
>s&
)&
+&
-&
,&
'&
- )& )- +&
S&ri'e%uantitySupplied
-%s.
@-& +&
,& )-
'& )&
+& -
)& )
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:actors that Set Supply 8ehavior
3Determinants of Supply4
• Technology
• :actor 9osts.
• Taes andsubsidies.
• =pectations.
• $ther goods.
• Cumber of sellers.
• 7f any of these factorschange1 supply
behavior changes.• This type of change is
shown by shifting thesupply curve. –
7ncrease in supply6 shiftthe curve right.
– Decrease in supply6shift the curve left.
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9hanging Supply
3Shifting the Supply 9urve4• Supply increases 3shifts right4 when
– Cew technology lowers operating costs.
– :actor costs decrease. – Taes decrease or subsidies increase.
– :uture prices are epected to rise.
– /rice of alternative goods fall.
– Cumber of sellers increases.
• ice versa1 and supply decreases 3shiftsleft4.
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ovements vs. Shifts
• Chan*e in +uantity supplied: movement along the supply curve
due to a change in price.• Chan*e in supply: a shift in the
supply curve due to one or more
changes in the determinants ofsupply.
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ovements vs. Shifts
/
>s
7nitial supply 7ncreasedsupply
/)
/+
ovementalong curve
Shift insupply
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7ndividual Supply and arket
Supply• =ach producer is willing and able to produce
a good or service if he or she can make apro5t.
• The amount produced depends on its price. – 7f the price goes up1 more will be produced.
– 7f the price goes down1 less will be produced.
• arket supply is the collective summation ofall producers individual supplies.
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/utting a arket Together
• The interaction of buyersand sellers makes amarket.
• E+uili/rium: only one
price and
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=d F >s F >e.
• The price will notchange until there is ashift in demand or insupply.
D
S&
%
&e
%e
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=
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Jesolving a arket Surplus• ,aret surplus: the
amount by which s4 eceedsd4
at a given priceE ecesssupply.
• /rice is too high.
• >s K >d1 a surplus.
• 8uyer and seller
behaviors kick in.
• /rice will fall toe
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Jesolving a arket Shortage• ,aret shorta*e: The
amount by whichd4eceeds s4 at a givenpriceE ecess demand.
• /rice is too low.
• >s L >d1 a shortage.
•
8uyer and sellerbehaviors kick in.
• /rice will rise toe
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What 9auses the /rice to
9hange?• /rice changes when e
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Demand 7ncreases• 8uyers behavior
changes.
– Demand shifts right.
• $ld e) to
>+.
D$
S&
%
&$
%$
DShorta*e
&
%
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Demand Decreases• 8uyers behavior
changes.
– Demand shifts left.
• $ld e) to
>+
D$
S&
%
&$
%$
D
Surplus
&
%
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Supply 7ncreases
• Sellers behavior changes.
– Supply shifts right.
• $ld e) to>+.
D
S$&
%
&$
%$
S
Surplus
&
%
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Supply Decreases
• Sellers behavior changes.
– Supply shifts left.
• $ld e) to>+.
D
S$&
%
&$
%$
S
Shorta*e
&
%
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Summary6 When Do /rices
9hange?• $nly when a market is in dise
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=ercise
• 7f income increases1 demand shiftsand the price will
• 7f tastes decrease1 demand shifts
and the price will• 7f cost of inputs rise1 supply shifts
and the price will
• 7f the number of sellers increase1supply shifts and the pricewill
right
fall
left
rise
right fall
rise
left
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arket $utcomes
• The market mechanism a"ects W!0T1!$W1 and :$J W!$ to produce.
–
1245 arkets determine which goods aredesired and which are pro5table.
– 2615 /ro5t(seeking producers will strive toproduce goods in the most eNcient way.
–
768 126,5 To obtain a good1 one must beboth willing and able to purchase it.
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/rice 9ontrols
• ;overnments may impose anarbitrary maimum price 3price
ceiling4 or a minimum price 3priceoor4 on a market.
– The result is that the market cannot
reach e
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/rice 9eiling• ;overnment imposes
a maimum price lessthan /e.
• This generates a
shortage 3>d K >s4.
• The marketmechanism cannotclear the market.
• 0 permanent shortageeists.
D
S&
%
&e
%e
&ri'e'eilin*
%s %d
Shorta*e
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/rice :loor• ;overnment imposes a
minimum price greaterthan /e.
• This generates a
surplus 3>s K >d4.• The market
mechanism cannotclear the market.
•
0 permanent surpluseists.
D
S&
%
&e
%e
&ri'e9oor
%d %s
Surplus
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The =conomy Tomorrow
• There is an organ transplant market. – The supply of organs is limited by the number
of people willing to provide an organ to
transplant.• arket incentives could increase the
number of organs available. – 9ongress bans the purchase or sale of organs. –
$rgans are supplied at a price ceiling of @&. – This generates a shortage of organs. – 7ncrease the price1 and the
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Jevisiting the #earning
$b%ectives• &'(&). *now the nature and
determinants of market demand.
– 0 product has a market demand ifpeople are willing and able to buy it atsome price in the market.
–
7ts determinants are taste1 income1epectations1 other goods1 and numberof buyers.
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Jevisiting the #earning
$b%ectives• &'(&+. *now the nature and
determinants of market supply.
– 0 product has a market supply ifbusinesses are willing and able to produceand sell it at some price in the market.
– 7ts determinants are technology1 factorcosts1 taes and subsidies1 epectations1other goods1 and number of sellers.
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Jevisiting the #earning
$b%ectives• &'(&'. *now how market prices are
established.
– Demand behavior and supply behaviorinteract in a market. 0t e
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Jevisiting the #earning
$b%ectives• &'(&,. *now what causes market
prices to change.
– 0 change in demand behavior or achange in supply behavior will upsete
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Jevisiting the #earning
$b%ectives• &'(&-. *now how government price
controls a"ect market outcomes.
– 0 price ceiling imposed by governmentresults in permanent shortages.
– 0 price oor imposed by government
results in permanent surpluses.
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