03
Demand, Supply and Market Equilibrium
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Markets
• Interaction between buyers and
•
sellers
Markets may be:
• Local
• National
• International
• Price is discovered in the interactions
of buyers and sellers
LO1
3-2
Demand
• Schedule or curve
• Amount consumers are willing and
•
•
•
LO1
able to purchase at a given price
Other things equal
Individual demand
Market demand
3-3
Law of Demand
• Other things equal, as price falls, the
quantity demanded rises, and as
price rises, the quantity demanded
falls.
• Reasons:
• Common sense
• Law of diminishing marginal utility
• Income effect and substitution effects
LO1
3-4
The Demand Curve
P
6
P Qd
$5 10
4 20
3 35
2 55
Price (per bushel)
5
4
3
2
1
D
1 80
0
10
20
30
40
50
60
70
80
Q
Quantity Demanded (bushels per week)
LO1
3-5
Market Demand
Market Demand for Corn, Three Buyers
Price
per bushel
Joe
Jen
Jay
Total
Qd
per week
$5
10
12
8
30
4
20
23
17
60
3
35
39
26
100
2
55
60
39
154
1
80
87
54
221
Quantity Demanded
LO1
3-6
Changes in Demand
P
6
Price (per bushel)
5
4
3
2
D2
1
D1
D3
0
2
4
6
8
10
12
14
16
18
Q
Quantity Demanded (bushels per week)
LO1
3-7
Changes in Demand
P
6
Change in Demand
Price (per bushel)
5
Change in Quantity
Demanded
4
3
2
D2
1
D1
D3
0
2
4
6
8
10
12
14
16
18 Q
Quantity Demanded (bushels per week)
LO1
3-8
Determinants of Demand
• Change in consumer tastes and
•
•
LO1
preferences
Change in number of buyers
Change in income
• Normal goods
• Inferior goods
3-9
Determinants of Demand
• Change in prices of related goods
• Complements
• Substitutes
• Change in consumers’ expectations
• Future prices
• Future income
LO1
3-10
Determinants of Demand
Table 3.1 Determinants of Demand: Factors That Shift the Demand Curve
Determinant
Examples
Change in buyers’ tastes
Physical fitness rises in popularity, increasing the
demand for jogging shoes and bicycles; cell phone
popularity rises, reducing the demand for land-line
phones.
Change in the number of buyers
A decline in the birthrate reduces the demand for
children’s toys.
Change in income
A rise in incomes increases the demand for normal
goods such as restaurant meals, sports tickets, and
necklaces while reducing the demand for inferior
goods such as cabbage, turnips, and inexpensive
wine.
Change in the prices of related
goods
A reduction in airfares reduces the demand for bus
transportation (substitute goods); a decline in the price
of DVD players increases the demand for DVD movies
(complementary goods).
Change in consumer expectations
Inclement weather in South America creates an
expectation of higher future coffee bean prices,
thereby increasing today’s demand for coffee beans.
LO1
3-11
Supply
• Schedule or curve
• Amount producers are willing and
•
•
LO2
able to sell at a given price
Individual supply
Market supply
3-12
Law of Supply
• Other things equal, as the price rises,
•
LO2
the quantity supplied rises and as the
price falls, the quantity supplied falls.
Reason:
• Price acts as an incentive to
producers
• At some point, costs will rise
3-13
The Supply Curve
P
Qs
per
Week
$5
60
4
50
3
35
2
20
1
5
Price (per bushel)
Supply of Corn
Price
per
Bushel
S
5
4
3
2
1
0
10
20
30
40
50
60
70
Q
Quantity supplied (bushels per week)
LO2
3-14
Changes in Supply
P
$6
S3
S1
Price (per bushel)
5
4
Decrease
in supply
S2
3
2
Increase
in supply
1
0
2
4
6
8
10
12
14
16 Q
Quantity supplied (thousands of bushels per week)
LO2
3-15
Changes in Supply
P
$6
Change in Quantity
S3
Supplied
S1
5
Price (per bushel)
S2
4
3
2
Change in Supply
1
0
2
4
6
8
10
12
14
16 Q
Quantity supplied (thousands of bushels per week)
LO2
3-16
Determinants of Supply
• A change in resource prices
• A change in technology
• A change in the number of sellers
• A change in taxes and subsidies
• A change in prices of other goods
• A change in producer expectations
LO2
3-17
Determinants of Supply
Table 3.2 Determinants of Supply: Factors That Shift the Supply Curve
Determinant
Examples
Change in resource prices
A decrease in the price of microchips increases the
supply of computers; an increase in the price of crude
oil reduces the supply of gasoline.
Change in technology
The development of more effective wireless
technology increases the supply of cell phones.
Change in taxes and subsidies
An increase in the excise tax on cigarettes reduces the
supply of cigarettes; a decline in subsidies to state
universities reduces the supply of higher education.
Change in prices of other goods
An increase in the price of cucumbers decreases the
supply of watermelons.
Change in producer expectations
An expectation of a substantial rise in future log prices
decreases the supply of logs today.
Change in the number of suppliers
An increase in the number of tattoo parlors increases
the supply of tattoos; the formation of women’s
professional basketball leagues increases the supply
of women’s professional basketball games.
LO2
3-18
Market Equilibrium
• Equilibrium occurs where the demand
•
•
•
LO3
curve and supply curve intersect.
Surplus and shortage
Rationing function of prices
Efficient allocation
• Productive efficiency
• Allocative efficiency
3-19
Market Equilibrium
6
6,000 Bushel
Surplus
P
Qd
$5
2,000
4
4,000
3
7,000
2
11,000
1
16,000
Price (per bushel)
5
S
4
3
2
7,000 Bushel
Shortage
1
0
2
4
67
8
10
P
Qs
$5
12,000
4
10,000
3
7,000
2
4,000
1
1,000
D
12
14
16
18
Bushels of Corn (thousands per week)
LO3
3-20
Rationing Functions of Prices
• The ability of the competitive forces of
demand and supply to establish a
price at which selling and buying
decisions are consistent.
LO3
3-21
Efficient Allocation
• Productive efficiency
• Producing goods in the least costly way
• Using the best technology
• Using the right mix of resources
• Allocative Efficiency
• Producing the right mix of goods
• The combination of goods most highly
valued by society
LO3
3-22
`
Changes in Demand
and Equilibrium
D increase:
P, Q
D decrease:
P, Q
P
P
S
S
D2
D3
D1
0
0
Increase in demand
LO4
D4
Decrease in demand
3-23
` and
Changes
Changesin
inDemand
Supply
andEquilibrium
Equilibrium
S increase:
P, Q
S decrease:
P, Q
P
P
S1
S4
S2
D
D
0
0
Increase in supply
LO4
S3
Decrease in supply
3-24
Complex Cases
TABLE 3.3 Effects of Changes in Both Supply and Demand
Change in Supply Change in Demand
Effect on
Equilibrium Price
Effect on
Equilibrium
Quantity
1. Increase
Decrease
Decrease
Indeterminate
2. Decrease
Increase
Increase
Indeterminate
3. Increase
Increase
Indeterminate
Increase
4. Decrease
Decrease
Indeterminate
Decrease
LO4
3-25
Government Set Prices
• Price Ceilings
• Set below equilibrium price
• Rationing problem
• Black markets
• Example: Rent control
LO5
3-26
Government Set Prices
P
$3.50 P0
S
ceiling
3.00 PC
D
Shortage
Qs
LO5
Q0
Qd
Q
3-27
Government Set Prices
• Price Floors
• Prices are set above the market
•
LO5
price
• Chronic surpluses
Example: Minimum wage laws
3-28
Government Set Prices
P
S
Surplus
floor
$3.00 Pf
2.00 P0
D
Q
Qd
LO5
Q0
Qs
3-29
Legal Market for Human Organs
• What if we created a legal market for
•
human organs?
Positive effects
• Increase the incentive to donate
• Eliminate the persistent shortage of
eyes, livers, hearts, kidneys, etc.
3-30
Legal Market for Human Organs
• Negative effects
• Increases the cost of medical care
• Diminishes the special nature of life
by commercializing it
3-31