Econ 103 Chapter 4 Demand & Supply PDF

Principles of Microeconomics ECON 103 – 2024/25 Dr. Hussain Muhammad 1  CH 4 : Demand and Supply Markets and Competition The terms supply and demand refer to the behaviour of people as they interact with one another...

Principles of Microeconomics ECON 103 – 2024/25 Dr. Hussain Muhammad 1  CH 4 : Demand and Supply Markets and Competition The terms supply and demand refer to the behaviour of people as they interact with one another in competitive markets. A market is a group of buyers and sellers of a particular good or service. A competitive market is a market in which there are many buyers and sellers, so that each has a negligible impact on the market price. 2  CH 4 : Demand and Supply Demand The desire, ability, and willingness to buy a product or service The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. Desire? Ability? Willingness? 3  CH 4 : Demand and Supply Demand Law of Demand The law of demand states that the quantity demanded of a good falls when the price of the good rises. P= Price QD= Quantity Demanded P QD P QD  Demand Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. 4  CH 4 : Demand and Supply Demand Example: Consider the market for pizza. A market demand schedule lays out the quantity of pizzas demanded at various prices. We can graph these points (the different prices and respective quantities demanded) to make a demand curve for pizzas. Demand curve is a graph of the relationship between the price of a good and the quantity demanded. 5  CH 4 : Demand and Supply Demand Schedule Price 35 Quantity of Pizza Price of (thousands per Pizza 30 month) $ 35 4 25 $ 30 6 $ 25 8 20 $ 20 10 $ 15 12 15 $ 10 14 $ 5 16 10 Demand 5 Quantity (thousands 0 4 6 8 10 12 14 16 per month) 6  CH 4 : Demand and Supply Demand Schedule 7  CH 4 : Demand and Supply Changes in the Demand There are many variables/things that can change the demand. 1. Consumer Income As income increases the demand for a normal good will increase. Income  Demand : Income  Demand Normal good a good for which an increase in income leads to an increase in demand As income increases the demand for an inferior good will decrease. An example of an inferior good might be bus rides. As your income falls, you are less likely to buy a car or take a cab and more likely to ride a bus. 8  CH 4 : Demand and Supply Changes in the Demand 2. Prices of related goods affect on demand Substitutes are often pairs of goods that are used in place of each other, such as hot dogs and hamburgers, Tea and Coffee, sweaters and sweatshirts, and movie tickets and DVD rentals. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. Complements are often pairs of goods that are used together, such as cars and fuel, computers and software, and peanut butter and jelly. When a fall in the price of one good raises the demand for another good, the two goods are called complements. 9  CH 4 : Demand and Supply Changes in the Demand 3. Tastes: The most obvious determinant of your demand is your tastes. If you like ice cream, you buy more of it. Economists normally do not try to explain people’s tastes because tastes are based on historical and psychological forces that are beyond the realm of economics. Economists do, however, examine what happens when tastes change. 4. Expectations: Your expectations about the future may affect your demand for a good or service today. If you expect to earn a higher income next month, you may choose to save less now and spend more of your current income buying ice cream. If you expect the price of ice cream to fall tomorrow, you may be less willing to buy an ice-cream cone at today’s price. 5. Number of Buyers: Market demand also depends on the number of buyers. If the number of buyers increased, the demand in the market would increase too. 10  CH 4 : Demand and Supply Supply The desire, ability, and willingness to offer products for sale. The quantity supplied of any good or service is the amount that sellers are willing and able to sell. Supply can refer to the output of one producer or to the total output of all producers in the market (market supply). Anyone who offers an economic product for sale is a supplier. 11  CH 4 : Demand and Supply Supply Law of Supply When the price of a good rises, the quantity supplied of the good also rises, and when the price falls, the quantity supplied falls as well. P= Price QS= Quantity Supplied P QS  P QS  Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied. 12  CH 4 : Demand and Supply Supply Example: Consider the market for pizza. A market supply schedule lays out the quantity of pizzas supplied at various prices. We can graph these points (the different prices and respective quantities supplied) to make a supply curve for pizzas. Supply curve is a graph of the relationship between the price of a good and the quantity supplied. 13  CH 4 : Demand and Supply Market supply schedule Quantity of Price Pizza Supply 35 Price of (thousands Pizza per month) 30 $ 5 4 $ 10 5 25 $ 15 6 20 $ 20 8 $ 25 9 15 $ 30 10 $ 35 12 10 5 Quantity (thousands 0 4 6 8 10 12 14 16 per month) 14  CH 4 : Demand and Supply Market supply schedule 15  CH 4 : Demand and Supply Changes in the Supply There are many variables that can change the supply. 1. Input Prices: To produce their output of ice cream, sellers use various inputs: cream, sugar, flavoring, ice-cream machines, the buildings in which the ice cream is made, and the labor of workers to mix the ingredients and operate the machines. When the price of one or more of these inputs rises, producing ice cream is less profitable, and firms supply less ice cream. If input prices rise substantially, a firm might shut down and supply no ice cream at all. 16  CH 4 : Demand and Supply Changes in the Supply 2. Technology: The technology for turning inputs into ice cream is another determinant of supply. The invention of the mechanized ice-cream machine, for example, reduced the amount of labor necessary to make ice cream. By reducing firms’ costs, the advance in technology raised the supply of ice cream. 3. Expectations: The amount of ice cream a firm supplies today may depend on its expectations about the future. For example, if a firm expects the price of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today. 4. Number of Sellers: Market supply depends on the number of sellers. If the number of sellers is reduced, the supply in the market would fall. 17  CH 4 : Demand and Supply Markets Equilibrium Equilibrium A situation in which the price has reached the level where quantity supplied equals quantity demanded. QS = QD Equilibrium Price The price that balances quantity supplied and quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity The quantity supplied and the quantity demanded at the equilibrium price. On a graph, it is the quantity at which the supply and demand curves intersect. 18  CH 4 : Demand and Supply The Equilibrium of Supply and Demand 19  CH 4 : Demand and Supply The Equilibrium of Supply and Demand Price of Ice-Cream Cone Supply Equilibrium price Equilibrium $2.00 Equilibrium Demand quantity 0 1 2 3 4 5 6 7 8 9 10 11 12 13 20  CH 4 : Demand and Supply Markets Not in Equilibrium If the actual market price is higher than the equilibrium price, there will be a surplus of the goods. Surplus: A situation in which the quantity supplied is greater than the quantity demanded at a given price. QS > QD To eliminate the surplus, producers will lower the price until the market reaches equilibrium. When there is a surplus, prices generally fall, P  21  CH 4 : Demand and Supply Markets Not in Equilibrium (a) Excess Supply In panel (a), there is a Price of surplus. Because the Ice-Cream Supply market price of $2.50 is Cone Surplus above the equilibrium $2.50 price, the quantity supplied 2.00 (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by cutting Demand the price of a cone, and this moves the price toward its 0 4 7 10 Quantity of Quantity Quantity Ice-Cream equilibrium level. demanded supplied Cones  CH 4 : Demand and Supply Markets Not in Equilibrium If the actual price is lower than the equilibrium price, there will be a shortage of the goods. Shortage: A situation in which the quantity demanded is greater than the quantity supplied. QD > QS Sellers will respond to the shortage by raising the price of the good until the market reaches equilibrium. If there is a shortage, prices generally rise, P 23  CH 4 : Demand and Supply Markets Not in Equilibrium In panel (b), there is a (b) Excess Demand shortage. Because the market Price of price of $1.50 is below the Ice-Cream Supply Cone equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers $2.00 chasing too few goods, suppliers can take advantage 1.50 of the shortage by raising the Sho rtage price. Hence, in both cases, Demand the price adjustment moves the market toward the equilibrium of supply and 0 4 7 10 Quantity of demand. Quantity Quantity Ice-Cream supplied demanded Cones 24  CH 4 : Demand and Supply Conclusion How Prices Allocate Resources………! A. The model of supply and demand is a powerful tool for analyzing markets. B. Supply and demand together determine the prices of the economy’s goods and services. 1. These prices serve as signals that guide the allocation of scarce resources in the economy. 2. Prices determine who produces each good and how much of each good is produced. 25  CH 4 : Demand and Supply Summary Economists use the model of supply and demand to analyze competitive markets. In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price. The demand curve shows how the quantity of a good demanded depends on the price. According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward. In addition to price, other determinants of how much consumers want to buy include income, the prices of substitutes and complements, tastes, expectations, and the number of buyers. If one of these factors changes, the demand curve shifts. 26  CH 4 : Demand and Supply Summary The supply curve shows how the quantity of a good supplied depends on the price. According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward. In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers. If one of these factors changes, the supply curve shifts. The intersection of the supply and demand curves determines the market equilibrium. At the equilibrium price, the quantity demanded equals the quantity supplied. The behavior of buyers and sellers naturally drives markets toward their equilibrium. When the market price is above the equilibrium price, there is a surplus of the good, which causes the market price to fall. When the market price is below the equilibrium price, there is a shortage, which causes the market price to rise. 27