Unit 2
Supply & Demand
and the
Nature and Function of Markets
Demand Basics
• Demand Schedule and Demand Curve
Demand Basics
• Demand versus Quantity Demanded
• Demand- quantities consumers are willing
and able to buy at various prices
• Quantity Demanded- quantity consumers
are willing and able to buy at a given price
Demand Basics
• Demand versus Quantity Demanded
• Demand- the whole curve
• Quantity Demanded- a point on the curve
Demand Basics
• Demand versus Quantity Demanded
• Change in Demand- the whole curve shifts
• Change in Quantity Demanded- move from
one point on the curve to another
Demand Basics
• Changes in Demand
– Consumer Income
• Normal v. Inferior Goods
– Population
– Preference/Taste
– Price of Other Goods
• Compliments
• Substitutes
– Expectation of Change in Price
Supply Basics
• Supply Schedule and Supply Curve
Supply Basics
• Supply versus Quantity Supplied
• Supply - quantities producers are willing
and able to sell at various prices
• Quantity Supplied- quantity producers are
willing and able to sell at a given price
Supply Basics
• Supply versus Quantity Supplied
• Supply - the whole curve
• Quantity Supplied- a point on the curve
Supply Basics
• Change in Supply - the whole curve shifts
• Change in Quantity Supplied- move from one
point on the curve to another
Supply Basics- Changes
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# of Producers
Technology
Price of Inputs
Substitutes of Production
Compliments of Production
Taxes and Subsidies
Other Regulations
Individual & Market Demand Curve
• Horizontal sum of individual demand curves
Individual & Market Supply Curve
• Horizontal sum of individual supply curves
What if they both shift?
• Equilibrium Price?
• Equilibrium Quantity?
• One change is certain
• The other is ambiguous
What if they both shift?
• Coffee
– New Rebecca Black Song
– New Fertilizer
What if they both shift?
• Same Shift- know Q
• Opposite Shift- know P
Equilibrium Price = Market Clearing Price
Let’s Review
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Shifts
Double Shifts
Ceilings and Floors
Shortage and Surplus
-----------------------------------------Quantifying Shortage and Surplus
Other Effects of Ceilings and Floors
If the market price is above equilibrium price…
If the market price is below equilibrium price…
S & D for Non-Smart Phones (inferior good)
• Decrease in unemployment
• Increase in the price of Smart Phones
S & D for Non-Smart Phones (inferior good)
• Decrease in unemployment
• Increase in the price of Smart Phones
* If the income effect is greater than the
substitute effect*
Agenda
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HW and Field Trip
Beyond Surpluses and Shortages
Binding v. Non-Binding Price Controls
A Closer Look at the Downward Slope
Marginal Utility Activity (HW if incomplete)
Price Controls
Effects beyond Surpluses and
Shortages
Price Controls
Effects beyond Surpluses and
Shortages
• BOTH reduce the quantity of a good
bought and sold
Price Ceilings
• Shortages
• Inefficiencies
• Black Markets
Price Ceilings- Inefficiencies
• Misallocation of Resources
– Need and willingness to pay
• Wasted Resources
– Time and money spent overcoming the
shortage
• Inefficiently Low Quality
Price Ceilings- Black Markets
• Illegal Markets
• Prices ABOVE equilibrium
– Prices account for additional cost in the form
of risk
How to stop Canal Street Sales?
Price Ceilings Non-Binding
• Set above equilibrium
• Market prices will remain below the ceiling
Price Floors Non-Binding
• Set below equilibrium
• Market prices will remain above the floor
Price Floors
• Surpluses
• Inefficiencies
• Black Markets
Price Floors- Inefficiencies
• Misallocation of Resources
– Those willing to sell at the lowest price do not
always succeed
• Wasted Resources
• Inefficiently High Quality
Price Floors- Black Markets
• Illegal Markets
• Prices below equilibrium
– Prices account for the relatively low number of
consumers willing to break the law
Is minimum wage a binding price
ceiling?
Now that you are thinking…
• Is minimum wage a binding price floor?
Why Demand Slopes Downward
and what’s up with the shape?
• Income Effect
• Substitute Effect
• Diminishing Marginal Utility
Conspicuous Goods
Why Demand Slopes Downward
and what’s up with the shape?
• Income Effect
• Substitute Effect
• Diminishing Marginal Utility
Why Demand Slopes Downward?
• Income Effect
– Higher price = Lower purchasing power
– Lower price = Higher purchasing power
– “ability to buy”
Why Demand Slopes Downward?
• Substitute Effect- think opportunity cost
– Higher price = Lower relative price of substitutes
– Lower price = Higher relative price of substitutes
Why?
• 1st pizza for full price ($10.00), get a 2nd for
$5?
Why?
• Buy one pair at regular price and get the
second pair half off?
• BOGO Days!
Why Demand Slopes Downward?
• Diminishing Marginal Utility
Why Demand Slopes Downward?
• Diminishing Marginal Utility
– MU= satisfaction (quantified in dollars) of an
additional unit of consumption
– Marginal Utility ALWAYS* decreases with
additional consumption
– Total Utility increases at a decreasing rate
Why Demand Slopes Downward?
• Diminishing Marginal Utility/Benefit
• Cost-Benefit Analysis
– How many slices will you consume?
• OPTIMAL PURCHASE RULE
– MU=P
Optimal Purchase Rule?
Optimizing Purchase of 2 or More Goods
• MU per $1
Consumer Equilibrium
• Maximize Total Utility
• MU per $1 (MU/$)
• MUx/Px = MUy/Py
Did you make any consumer
equilibrium decisions this
weekend?
Tax Incidence
Tax Incidence
• Nominal (Statutory) versus Economic Incidence
• If “law” doesn’t matter, what does?
PED
PED
• Relationship between % change in price
and % change in quantity
PED
Perfectly Inelastic = 0
Unit Elastic = 1
Perfectly Elastic =
PED
Perfectly Inelastic = 0
• Inelastic <1
Unit Elastic = 1
• Unit Elastic = 1
Perfectly Elastic =
• Elastic > 1
PED
PED
*Total Revenue Method*
• Price Decrease – TR Increase
– Elastic
• Price Decrease – TR Constant
– Unit Elastic
• Price Decrease – TR Decrease
– Inelastic
*Total Revenue Method*
• Elastic Demand
– Decrease price to Increase TR
• Unit Elastic Demand
• Inelastic Demand
– Increase Price to Increase TR
TIP of the DAY
• Remember 2 not 6
Apples
• The price has increased
• The quantity has decreased
• What likely happened?
Reminder and Update and Reminder
• PHILLY TRIP!!!!!!!!!!!!
• FRQs- moved to Tuesday
• Graphs Due Tomorrow
TIP of the DAY
• Remember 2 not 6
1. Inelastic PED- Increase in Price will
Increase Total TR
– *Increase P will Increase TR
2. Perfectly Inelastic = 0
Tip of the Day
• Study 2 days before the test as if it were
the day before
• The review will expose your weaknesses
PES- Only difference?
Other Elasticities
• Price Elasticity- % Q/ % P
• PED versus PES
• Income Elasticity of Demand
– Normal
– Inferior goods
• Cross Price Elasticity
– Complements and substitutes
Income Elasticity of Demand
• %
Q/%
– Normal
– Inferior
Income
Income Elasticity of Demand
• %
Q/%
– Normal
– Inferior
Income
Income Elasticity of Demand
• %
Q/%
Income
– Necessity
– Luxury (________)
Cross Price Elasticity
• %
Qx / %
Py
• Substitutes =
• Complements =
• Neither =
Draw TWO S & Ds
• Add a Binding Price Floor to one
• Add a Binding Price Ceiling to the other
• Shade DWL