SUPPLY AND DEMAND
CHAPTER 2
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DEFINITIONS
• Supply and Demand: the name of the most
important model in all economics
• Price: the amount of money that must be paid for
a unit of output
• Market: any mechanism by which buyers and
sellers exchange goods or services
• Output: the good or service and/or the amount of
it sold
DEFINITIONS (CONTINUED)
• Consumers: those people in a market who are wanting
to exchange money for goods or services
• Producers: those people in a market who are wanting
to exchange goods or services for money
• Equilibrium Price: the price at which no consumers
wish they could have purchased more goods at that
price; no producers wish that they could have sold
more
• Equilibrium Quantity: the amount of output exchanged
at the equilibrium price
QUANTITY DEMANDED AND
QUANTITY SUPPLIED
• Quantity demanded: how much consumers are
willing and able to buy at a particular price during
a particular period of time
• Quantity supplied: how much firms are willing and
able to sell at a particular price during a particular
period of time
CETERIS PARIBUS
• As I talked about before economists use models to focus on
what is most important
• Models typically hold other variables constant to examine
the effect of other variables.
• For example in looking at the supply and demand for peanut
butter we typically hold the price of jelly constant
• We sometimes use the Latin phrase ceteris paribus which
means “holding other things equal” to identify this case.
DEMAND AND SUPPLY
• Demand is the relationship between price and
quantity demanded, ceteris paribus.
• Supply is the relationship between price and
quantity supplied, ceteris paribus.
FIGURING OUT THE DEMAND CURVE
• There are really two different parts to it which are similar
• One is the “extensive margin” that is who buys the good
• The second is the “intensive margin” or how much of the
good each person buys
• Guell focuses on the intensive margin, but I want to start
with the extensive as I think it is easier to think about
EXTENSIVE MARGIN
• Think about something like an ipad where there is
really no reason to buy more than one
• Suppose there are 5 people in the economy and
this is what they are willing to pay:
Name
WTP
Jim
$200
Jackie
$400
Bill
$600
Sally
$800
Lisa
$1000
DEMAND CURVE
So what does demand look like:
•
•
•
•
•
•
At $1200 I sell no ipads
At $1000 I sell to Lisa only
1400
At $800 I sell 2
1200
At $600 I sell 3
At $400 I sell 4
1000
P
And at $200 I sell5
r 800
i
600
c
e 400
200
0
0
2
ipads
4
6
INTENSIVE DEMAND
• Now suppose it is just one worker say me
• I like to go to basketball games (either pro or
college)
• Suppose the seats are all the same, how many
games would I go to?
•
•
•
•
•
•
At $200 per seat I would probably go to a game
At $50 per seat I would probably go to like 4 games a year
At $25 I would go to like 15
At $5 I would go to like 20
At $0 I would go to like 20
Thus demand slopes down for me-the larger the price the
fewer games I would go to
• Demand in the economy picks up both the
intensive and extensive margin
THE LAW OF DEMAND
The relationship between price and quantity
demanded is a negative or inverse one.
This occurs both on the extensive and
intensive margin
There are 3 reasons to expect it on the
intensive margin
The Substitution Effect
• moves people toward the good that is now cheaper or
away from the good that is now more expensive
• If the price of Mobil gas goes up I buy more Amoco
The Real Balances Effect
• When a price increases it decreases your buying
power causing you to buy less.
• If I live in New York and am spending almost all of my
money on rent, if rent doubles I have to move into
cheaper place because I can’t afford my current place
any more
The Law of Diminishing Marginal Utility
• The amount of additional happiness that you get from
an additional unit of consumption falls with each
additional unit.
• This is what was really going on with my basketball
tickets-I like going but I get tired of it if I go to two
many games
• Pretty much any good we can think of has this
characteristic
Put it all together and we are pretty confident
that demand curves slope down
p
P
q
Q
DETERMINANTS OF DEMAND
• Taste
• Income
• Normal Goods
• Inferior Goods
• Price of Other Goods
• Complement
• Substitute
• Population of Potential Buyers
• Expected Price
• Excise Taxes
• Subsidies
MOVEMENTS IN THE DEMAND CURVE
Determinant
Result of an
Result of a
increase in the decrease in the
determinant
determinant
Taste
D shifts right
D shifts left
Income-Normal Good
D shifts right
D shifts left
Income-Inferior Good
D shifts left
D shifts right
Price of Other Goods-Complement
D shifts left
D shifts right
Price of Other Goods-Substitute
D shifts right
D shifts left
Population of Potential Buyers
D shifts right
D shifts left
Expected Future Price
D shifts right
D shifts left
Excise Taxes
D shifts left
D shifts right
Subsidies
D shifts right
D shifts left
Example: Demand for Eating Out When Income Falls
p
P
q2
q1
At a given price
people eat out less
Times Eating Out
Example: Demand for ketchup when the price of beef falls
p
P
q1
q2
Ketchup
At a given price the
People want more Ketchup
A PITFALL: CONFUSING MOVEMENT
ALONG VS. SHIFTS IN DEMAND
• Price changes cause movements along a demand curve.
• Other factors will cause shifts in demand.
• These are not the same
• The “Quantity Demanded” can change either because
the price change or because the demand curve changed
Two ways that Quantity Demanded can Increase:
P
Q
SUPPLY
• Supply is more complicated and harder to think
about than demand (at least for me)
• In demand for an ipad a person buys an ipad and
brings it home
• In supply for an ipad you have to design it, buy all
the components, build it, ship it, sell it in the store
• The Law of Supply is the statement that there is a
positive relationship between price and quantity
supplied.
• If I am trying to sell something, the higher is the price
the more I will want to sell
WHY DOES THE LAW OF SUPPLY
MAKE SENSE?
• Because of Increasing Marginal Costs firms require
higher prices to produce more output.
• Because many firms produce more than one good, an
increase in the price of good A makes it (at the margin)
more profitable so resources are diverted from good B
to produce more of good A (think about the PPF)
THE SUPPLY SCHEDULE
Price
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
Individual Qs
0
0
1,000
2,000
3,000
4,000
QS for 10 firms
0
0
10,000
20,000
30,000
40,000
THE SUPPLY CURVE
P
Supply
$2.50
$2.00
$1.50
$1.00
$0.50
0
0
10
20
30
40 50
Q (in thousands)
MOVEMENTS IN THE SUPPLY CURVE
Determinant
Result of an
increase in the
determinant
Result of a
decrease in
the
determinant
Price of Inputs
S shifts left
S shifts right
Technology
S shifts right
S shifts left
Price of Other Potential Outputs
S shifts left
S shifts right
Number of Sellers
S shifts right
S shifts left
Expected Future Price
S shifts left
S shifts right
Excise Taxes
S shifts left
S shifts right
Subsidies
S shifts right
S shifts left
NUMBER OF SELLERS GOES UP
P
$2.50
At a given
price supply
will increase
$2.00
$1.50
$1.00
$0.50
0
0
10
20
30
40 50
Q (in thousands)
PRICE OF AN INPUT GOES UP
P
$2.50
$2.00
At a given
price supply $1.50
will decrease
$1.00
$0.50
0
0
10
20
30
40 50
Q (in thousands)
MARKET EQUILIBRIUM
• A competitive market is in equilibrium when price has
moved to a level at which quantity demand equals
quantity supplied of that good.
• Competitive markets have many buyers and sellers and none
is large enough to individually affect the price.
• Why do markets reach an equilibrium?
• If prices are too high, there is excess supply (a surplus) and
firms will lower prices.
• If prices are too low, there is excess demand (a shortage) and
firms will raise prices.
A COMBINED
SUPPLY AND DEMAND SCHEDULE
Price
QD
QS
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
50,000
40,000
30,000
20,000
10,000
0
0
0
10,000
20,000
30,000
40,000
Shortage Surplus
50,000
40,000
20,000
20,000
40,000
THE SUPPLY AND DEMAND MODEL
$2.50
Supply
P
$2.00
Equilibrium
$1.50
$1.00
Demand
$0.50
0
0
10
20
30
40
50
Q (in thousands)
WHAT IF PRICE TOO HIGH?
$2.50
Supply
Surplus
P
$2.00
$1.50
$1.00
Demand
$0.50
0
0
10
20
30
40
50
Q (in thousands)
WHAT IF PRICE TOO LOW?
$2.50
Supply
P
$2.00
$1.50
$1.00
Shortage
$0.50
Demand
0
0
10
20
30
40
50
Q (in thousands)
WHAT IF PRICE OF A SUBSTITUTE
INCREASES?
$2.50
Supply
$2.00
P
$1.50
New Equilibrium
Old Equilibrium
$1.00
New Demand
Demand
$0.50
0
0
10
20
30
40
50
Q/t
Demand
Increases
Prices
Quantities
Increase
Increase
WHAT IF GOOD GETS BAD REVIEWS?
$2.50
Supply
$2.00
P
$1.50
Old Equilibrium
$1.00
New Equilibrium
$0.50
Demand
New Demand
0
0
10
20
30
40
50
Q/t
Prices
Quantities
Demand
Increases
Increase
Increase
Demand
Decreases
Decrease
Decrease
TECHNOLOGY IMPROVES
$2.50
P
$2.00
Supply
New
Supply
$1.50
Old Equilibrium
$1.00
New Equilibrium
$0.50
Demand
0
0
10
20
30
40
50
Q/t
Prices
Quantities
Demand
Increases
Increase
Increase
Demand
Decreases
Decrease
Decrease
Supply Increases Fall
Increases
AN INCREASE IN COST OF AN INPUT
New
Supply
$2.50
P
$2.00
Supply
New Equilibrium
$1.50
Old Equilibrium
$1.00
$0.50
Demand
0
0
10
20
30
40
50
Q/t
Prices
Quantities
Demand
Increases
Increase
Increase
Demand
Decreases
Decrease
Decrease
Supply Increases Decrease
Increase
Supply Falls
Decrease
Increase
WHY THE NEW EQUILIBRIUM?
• If there is a change in supply or demand then without a change in
the price of the good, there will be a shortage or a surplus.
• Suppose the cost of an input increased-firms would no longer be
willing to sell at the same price
• They raise prices
• As a result consumers purchase less
AN INCREASE IN COST OF AN INPUT
New
Supply
$2.50
P
$2.00
Supply
As a result of the shortage,
employers can raise prices
to new equilibrium where
shortage goes away
$1.50
shortage
$1.00
$0.50
Demand
0
0
10
20
30
40
50
Q/t