3
C HAPTE R
Individual
Markets:
Demand & Supply
• What is a “market” ?
Buyers or Demanders
Sellers or Suppliers
Good or Service
Price
Markets Defined
A market is an institution or mechanism that
brings together buyers (demanders) and sellers
(suppliers) of particular goods and services.
•
A market may be local, national, or international
in scope.
•
Some markets are highly personal, face-to-face
exchanges; others are impersonal and remote.
–
A product market involves goods and services.
–
A resource market involves factors of production
What is Demand?
• Assume the following:
Price of the good (KD) Quantity of the good (units)
Possible
Prices
5
10
3
20
4
35
2
55
1
80
In specified time
period
Various
amounts
Graphing Demand
P
Qd
5
10
4
20
3
35
2
55
1
80
P
5
4
3
2
1
10 20 30 40 50 60 70 80
Qd
Graphing Demand
P
Qd
5
10
4
20
3
35
2
55
1
80
P
5
4
3
2
1
10 20 30 40 50 60 70 80
Qd
Demand
Demand is a schedule that shows the various
amounts of a product that consumers are willing
and able to buy at each specific price in a series
of possible prices during a specified time period.
•
The schedule shows how much buyers are willing
and able to purchase at five possible prices.
•
To be meaningful, the demand schedule must have
a period of time associated with it.
Law of demand
•
Law of demand “other things being equal, as price
increases, the corresponding quantity demanded falls”.
•
Law of demand restated, “there is an inverse
relationship between price and quantity demanded”.
•
Note the “other-things-equal” assumption refers to
consumer income and tastes, prices of related goods,
and other things besides the price of the product being
discussed.
The demand curve
1. Illustrates the inverse relationship between price and
quantity.
2. The downward slope indicates lower quantity at higher
price and higher quantity at lower price, reflecting the
Law of Demand.
Individual versus market demand
1. Transition from an individual to a market
demand schedule is accomplished by summing
individual quantities at various price levels.
2. Market curve is horizontal sum of individual
curves.
P
P
10KD
D1
5
P
DM
D2
Q d1
Consumer (1): at
price (10) demands
(5) units
8
Q d2
13
Q dM
Consumer (2): at
Market Demand:
price (10) demands at price (10) the
(8) units
demand is (8) units
Changes in Demand
• Recall: as price changes, quantity demanded
changes:
P
10KD
Change in prices of
the good will always
lead to changes in
quantity demanded!
D
7KD
5
9
Qd
As price falls from
10 to 7, Qd increases
from (5) to (9) units
This is shown by a
movement along the
demand curve
Recall: inverse
relationship between
P and Qd
Determinants of demand
This is what we mean by “other things”:
a.
Tastes
favorable change leads to an increase in demand; unfavorable
change to a decrease.
b. Number of buyers
more buyers lead to an increase in demand; fewer buyers lead to a
decrease.
c.
Income
more leads to an increase in demand; less leads to a decrease in
demand for normal goods. (The rare case of goods whose
demand varies inversely with income is called inferior goods).
d.
i.
Prices of related goods
Substitute goods (those that can be used in place of
each other): The price of the substitute good and
demand for the other good are directly related. If the
price of Coke rises (because of a supply decrease),
demand for Pepsi should increase.
ii.
Complementary goods (those that are used together
like tennis balls and rackets): When goods are
complements, there is an inverse relationship between
the price of one and the demand for the other.
e.
Expectations
consumer views about future prices, product
availability, and income can shift demand.
• Changes in determinants of demand will shift the
demand curve!
P
Increase in
demand
decrease in
demand
Qd
Note that prices
are CONSTANT
A summary of what can cause an increase in
demand.
a. Favorable change in consumer tastes.
b.Increase in the number of buyers.
c. Rising income if product is a normal good.
d.Falling incomes if product is an inferior good.
e. Increase in the price of a substitute good.
f. Decrease in the price of a complementary good.
g.Consumer expectation of higher prices or
incomes in the future.
A summary of what can cause a decrease in demand.
a.
b.
c.
d.
e.
f.
g.
Unfavorable change in consumer tastes.
Decrease in number of buyers.
Falling income if product is a normal good.
Rising income if product is an inferior good.
Decrease in price of a substitute good.
Increase in price of a complementary good.
Consumers expectation of lower prices or incomes in
the future.
G. Review the distinction between a change in quantity
demanded caused by price change and a change in
demand caused by change in determinants.
Supply
• Supply is a schedule that shows amounts of a product a
producer is willing and able to produce and sell at each
specific price in a series of possible prices during a
specified time period.
• A schedule shows what quantities will be offered at
various prices or what price will be required to induce
various quantities to be offered.
Law of supply.
•
Law of supply “producers will produce and sell
more of their product at a high price than at a low
price”.
•
Law of supply restated “There is a direct
relationship between price and quantity supplied”.
Explanation:
Given product costs, a higher price means greater
profits and thus an incentive to increase the
quantity supplied.
Supply Schedule
P
Qs
5
60
4
50
3
35
2
20
1
5
Various quantities
At different prices
Supply Schedule
P
P
Qs
5
60
4
50
3
35
2
20
1
5
5
1
4
3
2
1
10 20 30 40 50 60
QS
Changes in Qs
• Only changes in P will lead to changes in QS
• This is a movement along the S curve from one
point to the other.
• Note that the S curve remains unchanged.
P
S
New as P
increases
As P increases
Qs increases
Qs
P
S
New as P
decreases
As P increases
Qs increases
Qs
Determinants of supply:
A change in any of the supply determinants causes a
change in supply and a shift in the supply curve. An
increase in supply involves a rightward shift, and a
decrease in supply involves a leftward shift.
Six basic determinants of supply, other than price:
a. Resource prices: a rise in resource prices will cause a
decrease in supply or leftward shift in supply curve; a
decrease in resource prices will cause an increase in
supply or rightward shift in the supply curve.
b. Technology
A technological improvement means more efficient
production and lower costs, so an increase in supply or
rightward shift in the curve results.
c.
Taxes and subsidies
A business tax is treated as a cost, so decreases supply;
a subsidy lowers cost of production, so increases
supply.
d. Prices of related goods
If the price of substitute production good rises,
producers might shift production toward the higherpriced good, causing a decrease in supply of the
original good.
e.
Expectations
Expectations about the future price of a product can
cause producers to increase or decrease current supply.
f.
Number of sellers
Generally, the larger the number of sellers the greater
the supply.
Changes in S determinants: Shifts in S
P
5
4
Increase
in
Supply
S
S’
3
2
1
o
10 20 30 40 50 60 70 80
Q
Changes in S determinants: Shifts in S
P
5
S
S’
4
3
2
decrease
in
Supply
1
o
10 20 30 40 50 60 70 80
Q
Market Equilibrium
• Market Equilibrium: where quantity supplied
equals the quantity demanded.
• This is:
Qs=Qd
At
PE
Recall from D and S tables:
P
Qd
Qs
5
10
60
4
20
50
3
35
35
2
50
20
1
80
5
If P=3, then Qs = Qd
there is no surplus
(nor shortage) !
Recall from D and S tables:
P
Qd
Qs
5
10
60
4
20
50
3
35
35
2
50
20
1
80
5
This is the market
Equilibrium for our
good
The rationing function of prices
is the ability of competitive forces of supply and
demand to establish a price where buying and
selling decisions are coordinated.
MARKET DEMAND & SUPPLY
P
S
5
4
Market
Clearing
Equilibrium
3
2
1
o
D
2
4
6
78
10 12 14 16
Q
MARKET DEMAND & SUPPLY
P
5
Surplus
S
At a 4 price
4
more is being
3
supplied than
demanded
2
1
o
D
2
4
4
6
78
10 12 14 16
Q
MARKET DEMAND & SUPPLY
P
S
5
At a 2 price
4
more is being
3
demanded than
supplied
2
Shortage
1
o
D
2
4
6
78
101112 14 16
Q
MARKET DEMAND & SUPPLY
P
5
Surplus
S
4
3
2
Shortage
1
o
D
2
4
6
78
101112 14 16
Quantity of Corn
Q
Application: Government-Set Prices (Ceilings and
Floors)
Government-set prices prevent the market from reaching
the equilibrium price and quantity.
A. Price ceilings.
• The maximum legal price a seller may charge, typically
placed below equilibrium.
• Shortages result as quantity demanded exceeds quantity
supplied.
• Examples: Rent controls and gasoline price controls
B. Price floors.
• The minimum legal price a seller may charge, typically
placed below equilibrium.
• Surpluses result as quantity supplied exceeds quantity
demanded.
• Examples: Minimum wage, farm price supports
Note: The federal minimum wage, for example, will be
below equilibrium in some labor markets (large cities). In
that case the price floor has no effect.