Supply and Demand
Micro Unit 2: chapters 4, 5, 6
Chapter 4
The market forces of Supply and
Demand
Markets and Competition
• A market is a group of buyers and sellers of a
particular product.
• A competitive market is one with many buyers
and sellers, each has a negligible effect on
price.
• In a perfectly competitive market:
– All goods exactly the same
– Buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
• In this chapter, we assume markets are
perfectly competitive.
THE MARKET FORCES OF
SUPPLY AND DEMAND
3
Demand
• The quantity demanded of any good is the
amount of the good that buyers are willing
and able to purchase.
• Law of demand: the claim that the quantity
demanded of a good falls when the price of
the good rises, other things equal
THE MARKET FORCES OF
SUPPLY AND DEMAND
4
Summary: Variables that Influence Sellers
Variable
A change in this variable…
Price
…causes a movement
along the S curve
Input Prices
…shifts the S curve
Technology
…shifts the S curve
# of Sellers
…shifts the S curve
Expectations
…shifts the S curve
THE MARKET FORCES OF
SUPPLY AND DEMAND
5
Supply
• The quantity supplied of any good is the
amount that sellers are willing and able to sell.
• Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good rises, other things equal
THE MARKET FORCES OF
SUPPLY AND DEMAND
6
Summary: Variables that Influence Sellers
Variable
A change in this variable…
Price
…causes a movement
along the S curve
Input Prices
…shifts the S curve
Technology
…shifts the S curve
# of Sellers
…shifts the S curve
Expectations
…shifts the S curve
THE MARKET FORCES OF
SUPPLY AND DEMAND
7
Supply and Demand Together
P
$6.00
D
S
$5.00
$4.00
$3.00
Equilibrium:
P has reached
the level where
quantity supplied
equals
quantity demanded
$2.00
$1.00
$0.00
Q
0
5
THE MARKET FORCES OF
SUPPLY AND DEMAND
10 15 20 25 30 35
8
Equilibrium
• Equilibrium price: the price that equates
quantity supplied with quantity demanded
• Equilibrium Quantity: the quantity supplied
and quantity demanded at the equilibrium
price
• Surplus: when quantity supplied is greater
than quantity demanded
• Shortage: when quantity demanded is greater
than quantity supplied
Three Steps to Analyzing Changes in Eq’m
To determine the effects of any event,
1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes eq’m P and Q.
THE MARKET FORCES OF
SUPPLY AND DEMAND
10
Chapter 5
Elasticity and application
Elasticity
• Elasticity is a numerical measure of the
responsiveness of Qd or Qs to one of its
determinants.
• Price elasticity of demand measures how
much Qd responds to a change in P.
Price elasticity
of demand
=
Percentage change in Qd
Percentage change in P
How to calculate percentage change?
• Standard method
of computing the percentage (%) change:
End value – start value/ start value= x times 100
Problem:
The standard method gives different answers
depending on where you start.
So we use the midpoint method –
End value- start value/ midpoint = x times 100
Where midpoint is the value halfway between
the start and end value
Lessons of elasticity
• Lesson: Price elasticity is higher when close
substitutes are available.
• Lesson: Price elasticity is higher for narrowly
defined goods than broadly defined ones.
• Lesson: Price elasticity is higher for luxuries
than for necessities.
• Lesson: Price elasticity is higher in the
long run than the short run.
Types of demand
• Perfectly inelastic demand – Vertical Demand
curve with an elasticity of 0
• Inelastic demand – relatively steep demand
curve with elasticity < 1
• Unit elastic demand – Diagonal demand curve
with elasticity of 1
• Elastic demand – relatively flat demand curve
with elasticity > 1
• Perfectly elastic demand – Horizontal demand
curve with elasticity of infinity
Effects of elasticity on revenue
• If demand is elastic, then when Q decreases as
P increases, revenue falls because the %
change in Q is greater than the % change in P
• If demand is inelastic, then when Q decreases
as P increases, revenue rises because the %
change in P is greater than the % change in Q
Price Elasticity of Supply
Price elasticity
of supply
=
Percentage change in Qs
Percentage change in P
• Price elasticity of supply measures how much
Qs responds to a change in P.
 Loosely speaking, it measures sellers’
price-sensitivity.
 Again, use the midpoint method to compute the
percentage changes.
ELASTICITY AND ITS
APPLICATION
17
Different classifications of supply
• Perfectly inelastic Supply – Vertical supply
curve with a elasticity of 0
• Inelastic supply – relatively steep curve with
elasticity < 1
• Unit elastic supply – diagonal curve with
elasticity of 1
• Elastic Supply – relatively flat curve with
elasticity > 1
• Perfectly Elastic Supply – Horizontal Supply
with elasticity of infinity
Income Elasticity
• Income elasticity – measures the response of
Qd to a change In consumer income
Income elasticity
of demand
=
Percent change in Qd
Percent change in income
• Normal Good – As income increases, demand
increases – income elasticity > 0
• Inferior Good – As income increases, demand
decreases – income elasticity < 0
Cross-price elasticity
• Cross-price elasticity of demand:
measures the response of demand for one
good to changes in the price of another good
Cross-price elast.
of demand
=
% change in Qd for good 1
% change in price of good 2
• Substitutes – Cross-price elasticity> 0
• Complements – Cross-price elasticity<0
Chapter 6
Supply, Demand and Government
Policies
Government policies that change
market outcome
•Price controls
– Price ceiling: a legal maximum on the price
of a good or service Example: rent control
– Price floor: a legal minimum on the price of
a good or service Example: minimum wage
• Taxes
– The govt can make buyers or sellers pay a specific
amount on each unit bought/sold.
Price ceilings and price floors
• Price ceilings above equilibrium are not
binding, must be below equilibrium to be
considered binding
• Price floors on the other hand must be above
equilibrium in order to be binding.
Taxes
• The govt levies taxes on many goods &
services to raise revenue to pay for national
defense, public schools, etc.
• The govt can make buyers or sellers pay the
tax.
• The tax can be a % of the good’s price,
or a specific amount for each unit sold.
Taxes continued
• When a tax is placed on buyers, the demand
curve shifts left by the amount of the tax. The
same occurs for sellers with the supply curve
• Whether the tax is placed on sellers or buyers,
the end result is the same, the tax creates a
wedge between the price buyers pay and the
price sellers receive.
Tax Incidence
• Is how the burden of the tax is shared among
market participants.
• Whichever curve is more elastic, it hold less of
the burden because it is easier to leave the
market .