CHAPTER 3 DEMAND, SUPPLY, AND MARKET EQUILIBRIUM

1
CHAPTER 3 DEMAND, SUPPLY, AND MARKET EQUILIBRIUM

• AP ECONOMICS

2
MICROECONOMICS

• That part of economics that deals with behavior
  and decision making by small units, such as
  individuals and firms

3
The Market Forces of Supply and Demand

• Supply and Demand are the two words that
  economists use most often.
• Supply and Demand are the forces that make market
  economies work!
• Modern microeconomics is about supply, demand,
  and market equilibrium.

4
Markets and Competition

• The terms supply and demand refer to the behavior
  of people. . .
• . . .as they interact with one another in markets.

5
Market any institution, mechanism, or
arrangement which facilitates exchange.

• A market is a group of buyers and sellers of a
  particular good or service.
• Buyers determine demand...
• Sellers determine supply...
• Markets bring together buyers and sellers.
• Examples
• Gas station
• E-commerce site
• Local music store
• Farmers roadside stand
• NYSE
• Auctions

6
DEMAND

• For this to work there has to be wanting of a
  product
• Consumers have to desire the product and have the
  willingness and ability to buy a product
• Use schedules and graphs to represent
  approximations of consumer behavior

7
Ceteris Paribus . . .

• ...implies that all the relevant variables (e.g.
  determinants of demand) are held constant, except
  the one(s) being studied at the time.

8
DEMAND

• Demand Schedules
• a table listing that shows the quantity demanded
  at all prices that might prevail in the market at
  a given time

• Demand Curves
• graphs that plot the quantity demanded at all
  prices

9
The Concept of Demand. . .
P

• Quantity Demanded refers to the amount (quantity)
  of a good that buyers are willing and able to
  purchase at alternative prices for a given point
  in time.
• Point in time is a specific period could mean a
  day, a week, or a month

D
Q
10
LAW OF DEMAND

• Demand for an economic product varies inversely
  with its price
• Prices Quantity Demanded
• Prices Quantity Demanded
• The movement along a demand curve shows a CHANGE
  IN THE QUANTITY DEMANDED or a change in the
  quantity of the product purchased in response to
  a change in price

11
Law of Demand Market Price
P

• Law of Demand
• There exists an inverse relationship between
  Price and Quantity Demanded.
• (Negative Relationship)

D
Q
12
Example Demand For Ice Cream
Demand
Price of Ice Cream
D
Quantity of Ice Cream
13
UTILITY

• Usefulness or satisfaction from consumption
• MARGINAL UTILITY
• the extra usefulness or satisfaction a person
  gets from acquiring one more unit of a product
• Example Drinking glass of ice-cold lemonade
  after playing a hard game of tennis or basketball
  on a hot summer afternoon

14
MARGINAL UTILITY CONT.

• Consumers keep on buying a product until they
  reach a point where the last unit consumed gives
  enough, and only enough, satisfaction to justify
  the price.
• When consumers reach the point that the marginal
  utility is less than the price, you will stop
  buying.

15
DIMINISHING MARGINAL UTILITY

• The more units of a certain economic product a
  person can acquire, the less eager that person is
  to buy still more.
• As peoples wants for a particular product become
  more fully satisfied, they become less willing to
  spend their limited incomes to buy more of that
  product.
• The principle of diminishing marginal utility can
  also be used to explain the downward-sloping
  nature of the demand curve

16
EFFECTS OF QUANTITY DEMANDED

• Income Effect
• the change in the quantity demanded because of a
  change in the consumers real income when the
  price of a commodity changes
• Increases the purchasing power of a buyers money
  income enabling the buyer to purchase more of the
  product than before
• Substitution Effect
• the change in quantity demanded because of the
  change in relative price of the product
• Buyers have the incentive to substitute a less
  expensive product for similar products that are
  now relatively more expensive

17
QUANTITY DEMANDED AND DEMAND ARE NOT THE SAME

• When QUANTITY DEMANDED (Qd) changes, it does so
  because of a change in the
• price (P) of a product, and movement occurs
  along the current demand curve
• When DEMAND (D) changes, the entire demand curve
  moves or shifts. The change in demand results in
  an entirely new curve.

18
Changes in Quantity Demanded
Price
2.00
Quantity
D
7
19
Changes in Quantity Demanded
Price
2.00
1.00
Quantity
D
7
13
20
Change in Demand
Price
2.00
Quantity
D
7
21
Change in Demand
Price
2.00
D2
D
Quantity
7
10
22
Market Demand

• Adding all the quantities demanded by all
  consumers at each of the various possible prices,
  we can get from individual demand to market demand

23
Determinants of Demand

• What factors determine how much ice cream you
  will buy?
• What factors determine how much will you really
  purchase?
• Demand Shifters

24
Determinants of Demand

• Consumers Tastes and Preferences
• Number of Consumers (buyers)
• Consumers Income
• Price of Related Goods
• Consumer Expectations

25
CHANGE IN DEMAND OR SHIFT IN DEMAND

• Shift to the Right
• increase in demand

• Shift to the Left
• decrease in demand

26
GOODS

• Normal Goods
• Goods for which demand increases when income
  increases
• Most goods are normal goods
• Inferior Goods
• Goods and services for which demand decreases
  when income increases.
• Inferior is not the products quality
• Generic brand products, hamburgers, and used
  clothing

Generic
Fast Food
Used
27
Determinant of Demand Income
P

• As income increases the demand for a normal good
  will increase.

D
D2
Q
28
Determinant of Demand Income
P

• As income increases the demand for a normal good
  will increase.
• As income increases the demand for a inferior
  good decrease.

D
D2
Q
29
CAUSES FOR CHANGES IN DEMAND (DETERMINANTS)

• Consumer Income
• Consumer Tastes
• Price of Related Goods
• Substitutes
• Complements

30
Determinant of Demand Prices of Related Goods

• When the fall in price of one good reduces the
  demand for another good, the two goods are
  substitutes.

31
Determinant of Demand Prices of Related Goods

• When the fall in price of one good increases the
  demand for another good, the two goods are
  complements.

32
CHAPTER 3--SUPPLY

• AP ECONOMICS

33
SUPPLY

• The quantity of goods and services that producers
  are willing to offer at various possible prices
  other things equal during a given time period
• Example During the winter months, for example,
  jacket manufacturers offer a certain quantity of
  jackets at each price.

34
Supply of Ice Cream
Price
S
Quantity
35
LAW OF SUPPLY

• States that producers supply more goods and
  services when they can sell them at higher prices
  and fewer goods and services when they must sell
  them at lower prices
• Quantity supplied is directly related to the
  prices that producers can charge for their goods
  and services
• Example If producers of a compact disc (CD)
  players can charge 300 for their products, they
  will make more CD players than if they could
  charge only 200.
• PRICE QUANTITY SUPPLIED
• PRICE QUANTITY SUPPLIED

36
The Concept of Supply. . .
P
S

• Quantity Supplied refers to the amount
  (quantity) of a good that sellers are willing and
  able to make available for sale at alternative
  prices for a given point in time.

Q
37
QUANTITY SUPPLIED

• The amount of a good and service that a producer
  is willing to sell at each particular price
• PRICE is the key factor affecting not only
  quantity demanded but also the quantity supplied

38
Changes in Quantity Supplied
S
Price
2.00
Quantity
7
39
Changes in Quantity Supplied
S
Price
2.00
1.00
Quantity
7
1
40
SUPPLIERS WANT A PROFIT

• Suppliers actions are based on the pursuit of
  profits
• PROFIT is the amount of money remaining after
  producers have paid all of their costs
• Businesses make a profit when revenues are
  greater than the costs of production

41
COSTS OF PRODUCTION

• Wages, salaries, rent, interest on loans, bills
  for electricity, raw materials, and any other
  goods and services used to manufacture a product
• To make a PROFIT, producers must provide goods
  and services that consumers wantat prices that
  consumers are willing and able to pay

42
PROFIT MOTIVE

• Governs how individual companies make decisions
  and it also helps direct the use of resources in
  the entire market
• It can cause an increase or a decrease in
  production for one company or many companies

43
SUPPLY

• Supply Curves
• Plot the relationship on a graph between the
  price of a good or service and the quantity
  supplied

• Supply Schedule
• Lists each quantity of a product that producers
  are willing to supply at various market prices
• It shows the relationship between the price of a
  good or service and the quantity that producers
  will supply

44
CHANGES IN SUPPLY

• PRICE CHANGES affect the QUANTITY SUPPLIED
• DETERMINANTS OF SUPPLY are the non-price factors
  that can shift an entire supply curve of a
  product.

45
Change in Supply
S
Price
2.00
Quantity
7
46
Change in Supply
S
S2
Price
2.00
Quantity
7
11
47
DETERMINANTS OF SUPPLY

• Prices of resources
• Government tools
• Taxes and Subsidies and Regulations
• Technology
• Prices of related goods
• Producer expectations
• Competition or of sellers (producers)

48
Determinant of Supply Market Price
P
S

• Law of Supply
• There exists an direct (positive) relationship
  between Price and Quantity Supplied.

Q
49
RESOURCES CAUSE SHIFTS

• A change in the price of resources or factors of
  production can shift an entire supply curve
• A RESOURCE is anything that can be used in the
  production of a good or service
• Resources include raw materials, electricity, and
  workers wages 
• These resources contribute to a businesss costs
  of production

50
RESOURCES CONT.

• Any price change for a resource increases or
  decreases a businesss production costs
• When the price of a resource falls, production
  costs fall accordingly. Lower production costs
  mean that a business can supply more of the
  product for the same cost
• Lower production costs also create greater
  profits, which will cause the businesses to
  increase production even more 
• Higher production costs mean that the company
  cannot supply as much of the product at the same
  cost as before

51
TECHNOLOGY

• Makes production more efficient and less
  expensive
• This causes the costs of production to decrease
  and producers are able to supply more goods and
  services at each and every price and increase
  their profits
• Technology also has a cost
• A company may have to pay researchers or other
  companies for the desired technology

52
GOVERNMENT TOOLS

• Can cause the supply curve for goods and services
  to shift either right or left
• The three main tools are
• Taxes
• Businesses treat them as cost
• Increase in sales tax or property tax will
  increase production costs
• Reduce supply
• Subsidies
• Lowers the producers cost
• Increases supply

53
REGULATIONS

• Rules passed by the government to protect the
  public as to how companies conduct business
• REGULATIONS are designed to prevent pollution,
  discrimination, and other problems that affect
  citizens
• Loose government regulations tend to increase
  supply
• Strict government regulations tend to decrease
  supply
• Example Strict pollution controls force
  companies to spend more money on finding safe
  ways to dispose of waste and toxic materials.
  Complying with these regulations cause a
  companies production costs to increase. Supply
  curve would shift to the left because higher
  production costs lower the supply.

54
 COMPETITION

• Tends to increase supply, while a lack of
  competition tends to decrease supply
• Suppliers can leave as well as enter the market

55
PRICES OF RELATED GOODS

• Means that the changes in a products price can
  affect the supply for the products related goods
• Substitutes
• Complements
• These changes in prices can cause the supply
  curve to shift left or right

56
PRODUCER EXPECTATIONS

• Cause production decisions to change based on
  their expected future income
• Producers income depends on the prices they can
  charge for their products
• The expectations they have of future changes in
  the price of the product can affect how much of
  their product they supply to the market now
• These expectations can cause the supply curve to
  shift left or right

57
CHAPTER 3MARKET EQUILIBRIUM

• AP ECONOMICS

58
MARKET EQUILIBRIUM

• A situation in which prices are relatively
  stable, and the quantity of goods and services
  supplied is equal to the quantity demanded
• QsQd

59
Supply and Demand Together

• Equilibrium Price--Ep or Pe
• The price at which the supply and demand curve
  intersect. Quantity Supplied and Quantity
  Demanded are equal.
• Equilibrium QuantityEq or Qe
• The quantity at which the supply and demand
  curve intersect.

60
Forces of Demand and Supply. . .
Price
S
E
EP
Quantity
D
EQ
61
Forces of Demand and Supply At RestMarket
Equilibrium
Price
S
E
EP
2.00
Quantity
D
7
EQ
62
Market Equilibrium

• Changes in Demand
• Changes in Supply
• Changes in Equilibrium
• Efficient Allocation
• Productive Efficiency
• Allocative Efficiency

63
Market Equilibrium
Price
Quantity

• Supply Increase Demand Decrease
• Supply Decrease Demand Increase
• Supply Increase Demand Increase
• Supply Decrease Demand Decrease

?
?
?
?
64
SURPLUS

• Quantity Supplied gt Quantity Demanded
• QsgtQd
• Suppliers may have built up inventories in their
  warehouses, only to find that they did not
  receive enough orders for the products
• Lower their prices to attract more buyers
• Offer fewer products for sale at the next trading
  period

65
Actions of buyers and sellers that move toward
equilibrium.
Price
S
E
D
Quantity
66
Actions of buyers and sellers that move toward
equilibrium.
Excess Supply
Price
S
E
D
Quantity
67
SHORTAGE

• Quantity Demanded gt Quantity Supplied
• QdgtQs
• Producers have no more products to sell even
  though additional buyers are willing to purchase
  them at the existing price
• Suppliers wish they had charged higher prices for
  what they already sold
• Price and Quantities would have to increase in
  the next trading period

68
Actions of buyers and sellers that move toward
equilibrium.
Price
S
E
D
Quantity
69
Actions of buyers and sellers that move toward
equilibrium.
Price
S
Excess Demand
E
D
Quantity
70
EQUILIBRIUM PRICE

• Quantity Demanded Quantity Supplied
• Price that clears the market
• There is not a surplus or shortage

71
Change in demand due to hot weather
S
Price
E2
New Equilibrium
Pe
E
Pe
D2
D
Quantity
Qe
Qe
72
PRICES ARE FIXED?

• Special interest groups result in government
  policies that fix prices people either receive or
  pay
• Price supports prevent the price system from
  effectively transmitting information in the
  market
• Economists argue that fixed prices are government
  policies whose costs usually outweigh their
  benefits

73
TYPES OF FIXED COSTS

• PRICE CEILINGS
• The maximum legal price that can be charged
• Affects the allocation of resources
• Ex rental property

• PRICE FLOORS
• The lowest legal price that can be paid for a
  good or service
• Ex minimum wage

74
Government-Set Prices

• Price Ceilings on Gasoline
• Rationing Problem
• Black Markets
• Rent Controls
• Price Floors on Wheat
• Optimal Allocation of Resources

75
Government Set Prices
Price
S
Price Floors
E
D
Price Ceilings
Quantity
76
WITHOUT PRICES

• Rationing A system under which a government
  agency decides everyones fair share
• Ration Coupon A ticket or receipt that allows
  the holder to purchase a certain amount of the
  product
• Used during wartime
• Problems w/o prices
• Fairness
• High Administrative Costs
• Diminished Incentives

77
Efficient Allocation

• Productive Efficiency
• Production of a particular good in the least
  costly way
• Making available more valuable resources to
  produce other goods
• Allocative Efficiency
• Particular mix of goods and services most highly
  valued by society
• Assignment of certain resources for the
  production of these goods
• Demand reflects the marginal benefit (MB) based
  on utility
• Supply reflects the marginal cost (MC)
• Equilibrium MBMC and thus allocative efficiency