Macroeconomics ECON 2302 Spring 2011 Marilyn Spencer, Ph.D.

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Macroeconomics

ECON 2302

Spring 2011

Marilyn Spencer, Ph.D.

Professor of Economics

Chapter 3

Reminder: Critical Email Issue

Please be sure your email account allows you to keep your

“Sent Mail.” I recommend that you use your Islander account to send me any and all assignments.

Sometimes emails do not go through, and I do not accept assignments that are turned in late.

The only way you can protect your grades in such an email environment is to forward your date & time stamped Sent

Mail file to me.

Reminder: Quiz #2

Watch/listen to/read the President’s State of the Union address.

Via email, by the start of class on Wed., Feb. 2, briefly describe the policies he described concerning:

Increasing US jobs

Economic growth

4 points possible

CHAPTER

3

Where Prices

Come From:

The Interaction of

Demand and Supply

The intense competition among firms selling energy drinks is a striking example of how the market responds to changes in consumer tastes.

CHAPTER

3

Where Prices Come From:

Interaction of

Demand & Supply

Chapter Outline

and

Learning Objectives

3.1 The Demand Side of the Market

Discuss the variables that influence demand.

3.2 The Supply Side of the Market

Discuss the variables that influence supply.

3.3 Market Equilibrium: Putting Demand and Supply

Together

Use a graph to illustrate market equilibrium.

3.4 The Effect of Demand and Supply Shifts on

Equilibrium

Use demand and supply graphs to predict changes in prices and quantities

Where Prices Come From:

The Interaction of Demand and Supply

Perfectly Competitive Market

conditions of:

A market that meets the

1.

2.

3.

4.

Many buyers and sellers,

All firms selling identical products

No barriers to new firms entering the market

Low cost information

3.1 LEARNING

OBJECTIVE

Discuss the variables that influence demand.

The Demand Side of the Market

Demand Schedules and Demand Curves:

Demand schedule

A table showing the relationship between the price of a product and the quantity of the product demanded.

Quantity demanded

The amount of a well defined good or service that a consumer is willing and able to purchase at a given price, during some given time period.

Demand curve

A curve that shows the relationship between the price of a well defined product and the quantity of the product demanded, during some given time period.

Market demand

The demand by all the consumers of a given good or service.

The Demand Side of the Market:

Demand

Schedules and Demand Curves

FIGURE 3-1

A Demand Schedule and Demand Curve

As price changes, consumers change the quantity of energy drinks they are willing to buy. We can show this as a

demand schedule

in a table or as a

demand curve

on a graph.

They both show that as the price of energy drinks falls, the quantity demanded rises.

When the price is $3.00, consumers buy 60 million cans/day. When the price drops to $2.50, consumers buy 70 million cans.

Therefore, the demand curve for energy drinks is downward sloping.

The Demand Side of the Market:

The Law of Demand

Law of demand

The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

The Demand Side of the Market

Individual Demand and Market Demand

Deriving the Market Demand

Curve from Individual Demand

Curves

Market demand The demand for a product by all the consumers in a given geographical area.

The Demand Side of the Market:

What Explains the Law of Demand?

Substitution effect

The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.

Income effect

The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.

The Demand Side of the Market:

Holding Everything Else Constant:

The Ceteris Paribus Condition

Ceteris paribus

(“all else equal”) condition

The requirement that when analyzing the relationship between two variables—such as price and quantity demanded— other variables must be held constant.

A shift of a demand curve is an increase or a decrease in demand. A movement along a demand curve is an increase or a decrease in the quantity demanded.

The Demand Side of the Market:

Holding Everything Else Constant:

The Ceteris Paribus Condition

FIGURE 3-2

Shifting the

Demand Curve

When consumers increase the quantity of a product they want to buy at a given price, the market demand curve shifts to the right, from

D

1 to

D

2

.

When consumers decrease the quantity of a product they want to buy at a given price, the demand curve shifts to the left, from

D

1 to

D

3

.

The Demand Side of the Market:

Variables That Shift Market Demand

Many variables other than price can influence market demand.

1.

Income

Normal good

A good for which the demand increases as income rises and decreases as income falls.

Inferior good

A good for which the demand increases as income falls and decreases as income rises.

Making the

Connection

Are Big Macs an Inferior Good?

Big Macs seem to fit the economic definition of an inferior good because demand increased as income fell. But remember that inferior goods are not necessarily of low quality, they are just goods for which consumers increase their demand as their incomes fall.

McDonald’s restaurants experienced increased sales during

2008 and 2009, despite the recession.

The Demand Side of the Market:

Variables That Shift Market Demand, cont.

2.

Prices of related goods

Substitutes

Goods and services that can be used for the same purpose.

Complements

together.

Goods and services that are used

3.

Tastes

Consumers can be influenced by an advertising campaign for a product. And our tastes can also change because of new interests, new friends, and new decisions over time.

The Demand Side of the Market:

Variables That Shift Market Demand

4.

Size of the population and demographics

Demographics

The characteristics of a population with respect to age, race, and gender.

5.

Expected future prices

Consumers choose not only which products to buy but also

when

to buy them.

Making the

Connection

The Aging of the

Baby Boom Generation

Older people have a greater D for medical care than do younger people.

Aging boomers will also have an effect on the housing market.

What other effects will the aging of the baby boom generation have on the economy?

The Demand Side of the Market:

Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market:

Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market:

Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market:

Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market: A Change in Demand versus a Change in Quantity Demanded

FIGURE 3-3

A Change in Demand versus a Change in Quantity Demanded

If the price of energy drinks falls from $3 to

$2.50, the result will be a movement along the D curve from point

A

to point

B

- an

increase in quantity demanded

from 60 M cans to 70 M cans.

If consumers’ incomes increase, or if another factor changes that makes consumers want more of the product at every price, the D curve will shift to the right—an

increase in demand

.

In this case, the increase in demand from

D

1 to

D

2 causes the quantity of energy drinks demanded at a price of $3 to increase from 60

M cans at point

A

to 80 M cans at point

C

.

Making the

Connection

Red Bull and the Future

Demand for Energy Drinks

It is important for managers to accurately forecast the demand for their products because it helps them determine how much of a good to produce.

Will Red Bull continue to grow its share of the energy drink market?

3.2 Learning

Objective

Discuss the variables that influence supply.

The Supply Side of the Market

Quantity supplied

The amount of a well defined good or service that a firm is willing and able to supply at a given price, within some given time period.

Supply Schedules and Supply Curves

Supply schedule

A table that shows the relationship between the price of a well defined product and the quantity of the product supplied, in some given time period.

Supply curve

A curve that shows the relationship between the price of a well defined product and the quantity of the product supplied, in some given time period.

The Supply Side of the Market:

Supply Schedules and Supply Curves

FIGURE 3-4

A Supply Schedule and Supply Curve

As the P changes, the makers of

Red Bull, Monster Energy,

Rockstar, and the firms producing energy drinks change the Q they are willing to supply.

We can show this as a

supply schedule

in a table or as a

supply curve

on a graph.

They both show that as the P of energy drinks rises, firms will increase the Q they supply.

At a P of $2.50 per can, firms will supply 90 M cans. At a P of

$3, firms will supply 100 M cans.

The Supply Side of the Market:

The Law of Supply

Law of supply

The rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

The Supply Side of the Market

Individual Supply and Market Supply

3 - 7

Deriving the Market

Supply Curve from the

Individual Supply Curves

The Supply Side of the Market:

FIGURE 3-5

Shifting the Supply Curve

The Law of Supply

When firms increase the Q of a product they want to sell at a given P, the S curve shifts to the right. The shift from

S

1 to

S

3 represents an

increase in supply

.

When firms decrease the Q of a product they want to sell at a given P, the supply curve shifts to the left. The shift from

S

1 to

S

2 represents a

decrease in supply

.

The Supply Side of the Market:

Variables That Shift Market Supply

The following are the most important variables that shift market supply:

1.

2.

Prices of inputs

Technological change/change in productivity

Technological change

A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.

3.

4.

5.

Prices of substitutes in production

Number of firms in the market

Expected future prices & other changes in expectations

The Supply Side of the Market:

Variables That Shift Market Supply

TABLE 3-2

Variables That Shift Market Supply Curves

The Supply Side of the Market:

Variables That Shift Market Supply

TABLE 3-2

Variables That Shift Market Supply Curves (continued)

The Supply Side of the Market:

Variables That Shift Market Supply

TABLE 3-2

Variables That Shift Market Supply Curves (continued)

The Supply Side of the Market:

Change in Supply v. Change in Quantity Supplied

FIGURE 3-6

Change in Supply v. Change in Quantity Supplied

If the P of energy drinks rises from $2 to $2.50/can, the result will be a movement up the S curve from point

A

to point

B

- an increase in quantity supplied by Red Bull, Monster

Energy, Rockstar, and others from 80 M to 90 M cans.

If the P of an input decreases, or another factor changes that makes sellers supply more of the product at every price, the S curve will shift to the right - an

increase in supply

.

The increase in supply,

S

1 to

S

2

, causes Q of energy drinks supplied at a P of $2.50 to increase from 90

M cans at point

B

to 110 M cans at point

C

.

3.3 Learning

Objective

Use a graph to illustrate market equilibrium.

Market Equilibrium:

Putting Demand & Supply Together

FIGURE 3-7

Market Equilibrium

Where the D curve crosses the S curve determines market equilibrium.

In this case, the D curve for energy drinks crosses the S curve at a P of $2 and a Q of 80 M cans/day.

Only at this point is the Q of energy drinks consumers are willing to buy equal to the Q that

Red Bull, Monster Energy,

Rockstar, and the other firms are willing to sell:

The quantity demanded is equal to the quantity supplied.

Market Equilibrium: Putting D & S Together

Market equilibrium

A situation in which quantity demanded equals quantity supplied.

Competitive market equilibrium

A market equilibrium with many buyers and many sellers.

Market Equilibrium: Putting D & S Together

How Markets Eliminate Surpluses and Shortages

Surplus

A situation in which the quantity supplied is greater than the quantity demanded.

Shortage

A situation in which the quantity demanded is greater than the quantity supplied.

Market Equilibrium: Putting D & S Together

How Markets Eliminate Surpluses and Shortages

FIGURE 3-8

The Effect of Surpluses and Shortages on the Market Price

When the market P > equilibrium, there will be a

surplus

. In the figure, a price of $2.50 for energy drinks results in 90 M cans supplied but only 70 M cans demanded, for a surplus of 20 M.

As Red Bull, Monster Energy,

Rockstar, and the others cut the P to dispose of the surplus, the P will fall to the

equilibrium

of $2.

When the market P < equilibrium, there will be a

shortage

. P of $1 results in 100 M cans demanded but only 60 M cans supplied, for a

shortage

of 40 M cans. As consumers who are unable to buy energy drinks offer to pay higher prices, the P will rise to the equilibrium of $2.

Market Equilibrium: Putting D & S Together

Demand and Supply Both Count

Keep in mind that the interaction of demand and supply determines the equilibrium price.

Neither consumers nor firms can dictate what the equilibrium price will be.

No firm can sell anything at any price unless it can find a willing buyer, and no consumer can buy anything at any price without finding a willing seller.

Solved

Problem

3-3

Demand and Supply Both Count: A Tale of Two Letters

Both D and S count when determining market P.

The D for Lincoln’s letters is much greater than the D for Booth’s letters, but the S of Booth’s letters is very small.

Historians believe that only 8 letters written by Booth exist today.

Use demand and supply graphs to predict changes in prices and quantities.

3.4 Learning

Objective

The Effect of Demand and Supply

Shifts on Equilibrium: Increase in Supply

FIGURE 3-9

The Effect of an Increase in

Supply on Equilibrium

If a firm enters a market, as Coca-

Cola entered the market for energy drinks when it launched

Full Throttle, the equilibrium price will fall, and the equilibrium quantity will rise:

1.

As Coca-Cola enters the market for energy drinks, a larger Q of energy drinks will be supplied at every P, so the market S curve shifts to the right, from

S

1 to causes a

surplus

S

2

, which of cans at the original price,

P

1

.

2.

3.

The equilibrium P falls from

P

1 to

P

2.

The equilibrium Q rises from

Q

1 to

Q

2.

Making the

Connection

The Falling Price of

LCD Televisions

An increase in S drove the P of a typical large LCD television from $4,000 in fall 2004 to $1,000 at the end of 2008, increasing the quantity demanded worldwide from 8 million to 105 million.

The Effect of Demand and Supply

Shifts on Equilibrium: Increase in Demand

FIGURE 3-10

The Effect of an Increase in Demand on Equilibrium

Increases in income cause equilibrium P & Q to rise:

1.

Because energy drinks are

normal

, as income grows, the Q demanded increases at every

P, and the market

D curve shifts right, from

D

1

D

2

, causing a

shortage

at the to original price,

P

1

.

2.

3.

The equilibrium P rises from

P

1 to

P

2.

The equilibrium Q rises from

Q

1 to

Q

2.

The Effect of Demand and Supply

Shifts on Equilibrium:

The Effect of Shifts in D and S over Time

FIGURE 3-11

Shifts in Demand and Supply over Time

In panel (a), D shifts to the right more than S, and the equilibrium price rises:

1. Demand shifts to the right more than supply.

2. Equilibrium price rises from

P

1 to

P

2

.

In panel (b), S shifts to the right more than D, and the equilibrium price falls:

1. Supply shifts to the right more than demand.

2. Equilibrium price falls from

P

1 to

P

2

.

The Effect of Demand and Supply

Shifts on Equilibrium:

The Effect of Shifts in D and S

TABLE 3-3

How Shifts in Demand and Supply Affect Equilibrium Price (P) and Quantity (Q)

SUPPLY CURVE

UNCHANGED

SUPPLY CURVE

SHIFTS TO THE RIGHT

SUPPLY CURVE

SHIFTS TO THE LEFT

DEMAND CURVE

UNCHANGED

Q

P

unchanged unchanged

Q

P

increases decreases

Q

P

decreases increases

DEMAND CURVE

SHIFTS TO THE RIGHT

Q

increases

P

increases

DEMAND CURVE

SHIFTS TO THE LEFT

Q

P

decreases decreases

Q

P

increases increases or decreases

Q

increases or decreases

P

decreases

Q

increases or decreases

P

increases

Q

P

decreases increases or decreases

Solved

Problem

3-4

High Demand and Low Prices in the Lobster Market?

Supply and demand for lobster both increase during the summer, but the increase in supply is greater than the increase in demand; therefore, equilibrium price falls.

3.4 Learning

Objective

Use demand and supply graphs to predict changes in prices and quantities.

Effect of D and S Shifts on Equilibrium

Shifts in a Curve versus Movements along a Curve

Don’t Let This Happen to

YOU!

Remember: A Change in a Good’s Price

Does Not Cause the Demand or Supply Curve to Shift!

When analyzing markets using D and S curves, remember that

when a shift in a D or S curve causes a change in equilibrium P, the change in P does not cause a further shift in D or S.

AN INSIDE

LOOK

>>

How Does Advertising Help Red Bull Increase

Demand for Its Energy Drink?

Advertising may cause an increase in the demand for Red Bull.

KEY TERMS

Ceteris paribus (“all else equal”) condition

Competitive market equilibrium

Complements

Demand curve

Demand schedule

Demographics

Income effect

Inferior good

Law of demand

Law of supply

Market demand

Market equilibrium

Normal good

Perfectly competitive market

Quantity demanded

Quantity supplied

Shortage

Substitutes

Substitution effect

Supply curve

Supply schedule

Surplus

Technological change

Reality check to have been completed before we begin Ch. 4:

Pre-read Ch. 4, including:

Review Questions:

Consumer surplus is used as a measure of a consumer’s net benefit from purchasing a good or service. Explain why consumer surplus is a measure of net benefit.

Why would economists use a term like

“deadweight loss” to describe the impact on consumer and producer surplus from a price control?”

Problems and Applications, 3 rd

4A.6, 4A.7 & 4A.8;

(2 nd

ed., p. 130, 4A.5,

ed., p. 134, 4A.5, 4A.6, 4A.7

& 4A.8; 1 st edition: 1-4 on p. 129).

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