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Chapter III Demand , Supply, and Equilibrium

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Sellers are willing to supply more units of the good at each price. Major Causes: ... Procedure for making decisions. Objectives of decision makers ... – PowerPoint PPT presentation

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Title: Chapter III Demand , Supply, and Equilibrium


1
Chapter III Demand , Supply, and Equilibrium
  • The Single Market
  • J.F. OConnor
  • 1/19/05

2
Outline
  • Self-sufficiency versus interdependence
  • The economic problem and alternative ways of
    solving it
  • Monetary economy versus barter
  • Demand and factors affecting demand
  • Supply and factors affecting supply
  • Equilibrium in the market

3
  • Social Efficiency of the market equilibrium
  • How does the equilibrium change when the factors
    affecting demand and supply change?
  • Government intervention in the market price
    floor, price ceiling, tax and subsidy.

4
Two Contrasting Economies
  • Self-sufficiency (Subsistence)
  • Each unit, individual or family, produces the
    goods and services that it wants.
  • Each unit consumes what it produces.
  • Kentucky 1770.
  • Interdependent
  • Each unit produces little if any of the goods and
    services that it wants.
  • Each unit consumes little if any of the services
    that it produces.
  • Kentucky 2002

5
The Economic Problem
  • What goods and services will be produced and who
    will produce them? (Choice)
  • How will the goods and services be produced? (
    Organization)
  • For whom will the goods and services be produced?
    (Distribution)
  • Who makes economic decisions and by what process?
    (System)

6
Solving the Economic Problem
  • Not very complicated for the self-sufficient
    units in a subsistence economy
  • The modern economy, with its specialization,
    needs a mechanism to
    a) bring potential buyers and
    sellers of each product together
    b) coordinate the
    plans of the specialized individuals and groups
  • A system of markets is one such mechanism


7
A Modern Market
  • Barter economy goods are exchanged for other
    goods.
  • Monetary economy goods are exchanged for money.
  • We have talked about the value of oranges in
    terms of apples. We could also value all the
    other goods in the economy in terms of apples.
    Apples would then be the unit of account.
    However, we still have a problem in that we need
    a medium of exchange and apples are not too
    convenient. So we introduce money.

8
The Role of Money
  • The unit of account
  • The medium of exchange
  • A store of value
  • The importance of money in the market process is
    that it allows one to sell what one has without
    having to find a buyer who is selling what you
    want to buy.

9
Two Kinds Of Money
  • Currency
  • Demand deposits - what is in your checking
    account.
  • Be careful to distinguish income, wealth, and
    money.

10
A Single Market
  • One good, say, ice cream, and two kinds of
    people
  • Buyers
  • Sellers
  • Demand represents the intentions of buyers.
  • Supply represents the intentions of sellers.

11
Demand
  • Demand gives the relationship between the
    quantity of the good that buyers are willing and
    able to purchase and the price of the good, while
    other factors affecting quantity demanded are
    held constant.
  • We can represent demand in a table, a graph, or
    an equation. Accordingly, we talk about a demand
    schedule, curve, or function.

12
Factors Affecting Demand
  • Prices of other goods
  • Income of buyers
  • Preferences or tastes of buyers
  • Number of buyers
  • Expectations about prices
  • Advertising ?

13
Demand Schedules
Two buyers, Cath and Nick
14
Demand Curve
The market demand is the sum of the individual
demands
15
Supply
  • Supply is the relationship between the quantity
    of the good that sellers are willing and able to
    supply and the price of the good, while other
    factors affecting quantity supplied are constant.
  • We can represent supply in a table, a graph, or
    an equation. Accordingly, we talk about a supply
    schedule, curve, or function.

16
Factors Affecting Supply
  • Input prices
  • Technology of production
  • Number of sellers
  • Expectations

17
Supply Schedules
Two sellers, Ben and Jerry
18
Supply Curve
19
Market Equilibrium
  • Balancing Demand and Supply.
  • The equilibrium price is the price at which the
    quantity demanded is equal to the quantity
    supplied.
  • If you have excess demand or excess supply the
    market is not in equilibrium. Why?
  • Excess demand (shortage) increases price excess
    supply (surplus) depresses price.

20
Market Demand and Supply
21
Market Equilibrium
Equilibrium price 2 quantity 7 units
Supply
Demand
22
Markets and Social Welfare
  • Social optimal quantity of a good
  • The quantity that results in the maximum possible
    economic surplus.
  • The socially optimal quantity will occur where
    the marginal cost equals the marginal benefit.
  • Economic efficiency
  • Occurs when all goods and services are produced
    and consumed at their respective socially optimal
    levels.

23
Markets and Efficiency
  • Efficiency Principle
  • Efficiency is an important social goal.
  • Everyone can have a larger slice of a larger pie.
  • Equilibrium Principle
  • A market in equilibrium leaves no unexploited
    opportunities for individuals.
  • No cash on the table remains.
  • All opportunities for profit have been exploited.
  • Efficiency occurs when
  • the market-demand curve captures all the marginal
    benefits of the good.
  • the market-supply curve captures all the marginal
    costs of the good.

24
Terminology
  • If the goods price changes, you have a
  • change in quantity demanded
  • A movement along the demand curve
  • change in quantity supplied
  • A movement along the supply curve
  • If something else changes, you have a
  • change in demand
  • A shift of the entire demand curve
  • change in supply
  • A shift of the entire supply curve

25
Fig. 4.9 An Increase in the Quantity Demanded
Versus an Increase in Demand
26
Increase in Demand
  • Means the demand curve shifts right
  • Caused by factors other than the price of the
    good
  • For a normal good, an increase in income
  • An increase in the price of a substitute or a
    decrease in the price of a complement
  • An increase in the number of buyers
  • Change in preferences

27
Increase in Demand
28
Increase in Demand
  • Note that demand increases by 6 units but the new
    equilibrium quantity is only 3 units greater than
    old. Why?
  • Note that the increase in demand results in a
    movement up the supply curve.
  • You should analyze a decrease in demand.

29
Increase in Supply
  • Sellers are willing to supply more units of the
    good at each price.
  • Major Causes
  • decrease in input prices
  • improvement in technology of production
  • increase in the number of sellers

30
(No Transcript)
31
Increase in Supply
  • Increase in supply results in an increase in the
    equilibrium quantity and a decrease in price.
  • Note that the increase in supply results in a
    movement down the demand curve.
  • You should analyze a decrease in supply

32
Free Markets and Equilibrium
  • Free markets have an automatic tendency to
    eliminate excess supply and excess demand.
  • Surplus leads producers to decrease the price
  • Shortage leads producers to increase the price

33
Reasons for Government Activity
  • Efficiency Concerns
  • Imperfect Competition
  • Externalities
  • Public goods
  • Equity considerations
  • Distribution of outcomes
  • Distribution of endowments

34
Legislation and Markets
  • Market equilibrium does not mean that everyone
    has what they want.
  • E.G. a poor person may not be able to afford the
    item at the equilibrium price.
  • Legislators protect consumers by using
  • price ceilings
  • A maximum allowable price specified by law
  • Price signal is too low, so consumers want too
    much
  • e.g. rent controls, limits on the price of
    gasoline
  • Result in shortages

35
Legislation and Markets
  • Legislators protect producers by using
  • price floors
  • A minimum allowable price specified by law
  • For example, price supports, minimum wage
  • Price signal is too high, so consumers dont want
    as much.
  • Result in surpluses

36
Fig. 4.6 An Unregulated Housing Market
37
Fig. 4.7 Rent Controls
38
Economists and the Poor
  • Economists realize there are more effective ways
    of helping the poor than violating the free
    market system.
  • Using rent controls or price ceilings results in
    inefficiency for everyone.
  • Using a direct income transfer to the poor is a
    more efficient way to help.

39
Fig. 4.8 Price Controls in the Hamburger Market
40
and
41
Shifts in Supply
  • Favorable changes to the producer shift supply
    curve rightward.
  • lower equilibrium price
  • higher equilibrium quantity
  • Unfavorable changes to the producer shift supply
    leftward.
  • higher equilibrium price
  • lower equilibrium quantity

42
Fig. 4.10 The Effect on the Skateboard Market of
an Increase in the Price of Fiberglass
43
Shifts in Supply
  • Changes in the Cost of Production
  • Changes in Technology
  • Changes in Weather
  • Changes in Expectations

44
Fig. 4.11 The Effect on the Market for New Houses
of a Decline in Carpenters Wage Rates
45
Fig. 4.12 The Effect of Technical Change on the
Market for Manuscript Revisions
46
Shifts in Demand
  • Complements
  • Substitutes
  • Income
  • Preferences
  • Demand curve shifts rightward
  • higher equilibrium price
  • higher equilibrium quantity
  • Demand curve shifts leftward
  • lower equilibrium price
  • lower equilibrium quantity

47
Fig. 4.13 The Effect on the Market for Tennis
Balls of a Decline in Court Rental Fees
48
Complements
  • Goods that are more valuable when used in
    combination--e.g. tennis balls and tennis courts.
  • Two goods are complements in consumption if an
    increase in the price of one causes a leftward
    shift in the demand curve for the other.

49
Substitutes
  • Goods that replace each other--e.g. email
    messages and overnight letters.
  • Two goods are substitutes in consumption if an
    increase in the price of one causes a rightward
    shift in the demand curve for the other.

50
Fig. 4.14 Effect on the Market for Overnight
Letter Delivery of a Decline in the Price of
Internet Access
51
Income
  • Normal good
  • One whose demand curve shifts right when the
    incomes of buyers increase.
  • Inferior good
  • One whose demand curves shifts left when the
    incomes of buyers increase.

52
Fig. 4.15 The Effect of a Federal Pay Raise on
the Rent for Conveniently Located Apartments
53
Simultaneous Shifts
  • If, at the same time,
  • Demand decreases and Supply increases
  • Demand shifts left
  • Lower price, lower quantity
  • Supply shifts right
  • Lower price, higher quantity
  • We can predict that price will fall
  • But, what happens to quantity?
  • We must know the magnitude of the shifts

54
Fig. 4.16 Four Rules Governing the Effects of
Supply and Demand Shifts
55
Fig. 4.17 The Effects of Simultaneous Shifts in
Supply and Demand
56
Fig. 4.18 Seasonal Variation in the Air Travel
and Corn Markets
57
Economic System
  • An economic system is a set of arrangements for
    solving the economic problem.
  • Important Features
  • Ownership of resources
  • Procedure for making decisions
  • Objectives of decision makers

58
Alternative Systems
  • Pure Capitalism
  • Private ownership
  • Decentralized decision making
  • Cooperative System
  • Communal ownership
  • Democratic decision making
  • Communal Command
  • Communal ownership
  • Centralized decision making
  • Mixed Systems
  • Democratic capitalism
  • Democratic socialism

59
Mixed Open Economy
  • Consumer sovereignty
  • Substantial private ownership and private
    enterprise production.
  • Substantial use of markets to guide resource
    allocation.
  • Substantial government activity
  • Significant international trade
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