Demand, Supply, and Equilibrium PDF

Chapter 4 Demand, Supply, and Equilibrium © 2015 Pearson Education, Inc. 4 Demand, Supply, and Equilibrium Chapter Outline 4.1 Markets 4.2 How Do Buyers Behave? 4.3 How Do Sellers Behave? 4.4 Supply and Demand in Equilibrium 4.5 What Would Happen if t...

Chapter 4 Demand, Supply, and Equilibrium © 2015 Pearson Education, Inc. 4 Demand, Supply, and Equilibrium Chapter Outline 4.1 Markets 4.2 How Do Buyers Behave? 4.3 How Do Sellers Behave? 4.4 Supply and Demand in Equilibrium 4.5 What Would Happen if the Government Tried to Dictate the Price of Gasoline? © 2015 Pearson Education, Inc.  Market  A market is an arrangement that brings together buyers & sellers & involve exchange of goods & services.  Market has two main components: Demand and Supply  Demand represent the behavior of buyers in the market  Supply represent the behavior of sellers in the market  Demand: Definition: Demand indicates how much of a good consumers are both willing and able to buy at each possible price during a given time period, other things constant. Law of Demand  The law Says that quantity demanded varies inversely with price, other things constant.  Meaning, the higher the price, the lower the quantity demanded; & lower the price, the higher the quantity demanded © 2015 Pearson Education, Inc. 4.2 How Do Buyers Behave?  Demand can either be shown in either demand schedule or demand curve. Demand Schedule  Demand schedule is a table that shows the quantity demanded at different prices, holding all else equal. Demand Curve  Demand curve is a curve that plots the quantity demanded at different prices.  Demand curve is downward sloping, meaning a negative ( an inverse) relationship between price & quantity 4.2 How Do Buyers Behave? Demand Schedule Demand Curve for an "A" Price $155.00 Price Quantity $135.00 Demanded $115.00 $20 20 $95.00 $75.00 $30 16 $55.00 $50 12 $35.00 $15.00 $100 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Quantity of an "A" $150 2 © 2015 Pearson Education, Inc. 4.2 Determinants of Demand (Factors that shifts the Demand Curve)  Beside price, there are many factors that can make consumers buy more or less of a product.  These factors are called determinants of demand as they can shift demand curve either to the right or left.  Shift demand curve to the right means increase in demand & shift the demand curve to the left, means decrease in demand. © 2015 Pearson Education, Inc.  These factors include the following: 4.2 Determinants of Demand (Factors that shifts the Demand Curve) 1. Tastes and preferences.  If the product is tasty or fashionable or has attractive design its demand will increase & demand curve will shift to the right.  However, if the product is less tasty or not fashionable or not attractive, its demand will decrease & the curve will shift to the left. 2. Quality of the product  If the product has high quality its demand will increase & demand curve will shift to the right.  However, if the product has poor quality, its demand will decrease & the curve will shift to the © 2015 Pearson Education, Inc. left. 4.2 Determinants of Demand (Factors that shifts the Demand Curve) 3. Income & wealth.  Increased income & wealth, will increase demand for normal goods & decrease demand for inferior goods. This will shift demand curve for normal good to the right & inferior good to the left.  Decreased income & wealth, will decrease demand for normal goods & increase demand for inferior goods. This will shift demand curve for normal good to the left & inferior good to the right.  Normal goods are goods whose demand increases as income increases & vice versa. They include luxuries and necessities. As consumer gets richer, demand for luxuries increases.  Inferior goods are goods whose demand increase as income decreases & vice versa. They include cheaper & second hand goods. As consumer gets richer, demand for inferior goods 4.2 Determinants of Demand (Factors that shifts the Demand Curve) 4. Availability and prices of related goods  Most products are related in terms of substitutes or complements.  If two goods are substitutes, increase price of Good A will lead to increase in demand for Good B & vice versa. Example, increase in price of Pepsi will lead to increase in demand for Coke.  If two goods are complements, increase price of Good A will lead to decrease in demand for Good B & vice versa. Example, increase in price of Petrol will lead to decrease in demand for car.  Substitute goods are goods that can replace each other as they both serve the same purpose. Example, pen & pencil, tea & coffee, shirt & T-shirt etc.  Complementary goods include car & petrol, printer & ink, tea & sugar, table & chair, etc. 4.2 Determinants of Demand (Factors that shifts the Demand Curve) 5. Number & scale of buyers  Large numbers of buyers will increase demand & shift the curve to the right.  However, small numbers of buyers will decrease demand & shift the curve to the left. 6. Buyers’ expectation about the future  Consumers high expectation of increase in future income or prices, will increase demand & shift demand curve to the right.  However, consumers expectation of fall in future prices or income will decrease demand & demand curve will shift to the left.  Demand Schedule Demand Curve for an "A" Price Quantity Price $155.00 Demanded $135.00 $20 20 $115.00 $95.00 $30 16 $75.00 $55.00 $50 12 $35.00 $100 7 $15.00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 $150 2 Quantity of an "A" Demand curve shift to the left" Demand Schedule $155.00 $135.00 Price Quantity Demanded $115.00 $95.00 $20 10 $75.00 $30 8 $55.00 $50 5 $35.00 $100 2 $15.00 0 5 10 15 20 $150 0 © 2015 Pearson Education, Inc. Demand curve shift to the right. © 2015 Pearson Education, Inc. Change in Demand & Change in Quantity Demanded Change in Quantity Demand  Change in quantity demanded is a movement from one point to another point along the same demand curve.  This movement is cause by changes in price, if price change, quantity purchased will also change. But this will not shift demand curve, there will only be movement in the same curve. Change in demand  It is a whole shift in demand curve either to the right or left.  Shift to the right means increase in demand & shift to the left means decrease in demand.  These shifts are caused by determinants of demand such tastes & preferences, income & wealth, number of buyers, etc. 4.2 Change in demand & change in quantity demanded Exhibit 4.4 Shifts of the Demand Curve vs. Movement Along the Demand Curve © 2015 Pearson Education, Inc.  Supply  Definition: Supply indicates how much of a good producers are willing and able to offer for sale per period at each possible price, other things constant Law of supply:  The law states that the quantity supplied is directly ( positively) related to its price, other things constant  Meaning, the lower the price, the lower the quantity supplied, & the higher the price, the higher the quantity © 2015 Pearson Education, Inc. supplied. Why 4.3 How Do Sellers Behave?  Supply can be shown in either supply curve or supply schedule. Supply Schedule  Supply schedule is a table that shows the quantity supplied at different prices. Supply Curve  It is a curve that plots the quantity supplied at different prices.  Supply curve is upward sloping, meaning a positive ( direct) relationship between price & quantity supplied. Upward sloping supply curve © 2015 Pearson Education, Inc. 4.3 Determinants of Supply ( factors that shifts supply Curve)  Beside price, there are many other factors that can make suppliers or producers to supply more or less.  These factors are called determinants of supply as they can shift supply curve either to the right or left.  They include: 1. input prices  Input prices refers to costs of products that include wages, interest, rent & cost of raw material.  High input prices such as high wages, rent, interest & cost of raw material, will increase costs of production. This will force firms to cut production, hence shift supply curve to the left & vice versa. 4.3 Determinants of Supply ( factors that shifts supply Curve) 2. Technology  Use of advanced technology, will decrease costs & increase production. This will increase supply & shift the supply curve to the right.  Use of poor technology, will increase costs & reduce production. This will decrease supply & shift the supply curve to the left. 3. Number and scale of sellers  Large number of sellers/ firms, will increase supply & shift supply curve to the right.  Small number of sellers/firms, will reduce supply & shift the curve to the left. 4.3 Determinants of Supply ( factors that shifts supply Curve) 4. Sellers’ expectation about the future  Expectation of future increases in price or sales or good economic conditions, will increase supply & supply curve will shift to the right.  However, expectation about a future drop in price or sales or poor economic conditions, will decrease supply & supply curve will shift to the left.  Changes ( Shifts) in Supply P $6 S3 S1 5 Decrease S2 4 in supply Price (per bushel) 3 2 1 Increase in supply 0 Q 2 4 6 8 10 12 14 16 Quantity supplied (thousands of bushels per week) LO2  Market Equilibrium  In perfect Competitive market, neither the buyers nor the sellers have power to determine prices of goods. Prices of goods & services are determined through agreement between buyers & sellers.  In other words, prices of goods are determined by forces of demand & supply.  It is determined when quantity demanded = quantity supplied.  The price in which both the buyers & sellers agreed is called equilibrium price.  The quantity bought & sold at the equilibrium price is called equilibrium © 2015 Pearson Education, Inc.  Market for Oil Price of Quantity Quantity Surplus, Shortage & Equilibrium Oil per Demand Supplied Barrel 140 29 38 Surplus = 38 – 29 = 9 120 30 40 Surplus = 40 – 30 = 10 100 35 35 Equilibrium = 35 – 35 = 0 80 40 30 Shortage = 30 – 40 = - 10 60 44 30 Shortage = 30 – 44 = - 14 © 2015 Pearson Education, Inc.  Market Equilibrium for Oil Equilibrium price = $ 100 ; Equilibrium quantity = 35  Surplus ( Excess supply)  When price of Oil increase above equilibrium, it will create problem of surplus.  Surplus occurs when Qs > Qd. This is a problem in the market as producers supply more & buyers buy less. Therefore, there will be excess supply.  To solve problem of surplus, price must drop back to equilibrium. © 2015 Pearson Education, Inc. 4.4 Supply and Demand in Equilibrium Exhibit 4.11 Excess Supply © 2015 Pearson Education, Inc.  Shortage ( Excess demand)  When price of Oil fall below equilibrium, it will create problem of shortage.  Shortage occurs when quantity supplied < quantity demanded. This is a problem in the market as producers supply less & buyers buy wants more. Therefore, there will be excess demand.  To solve problem of shortage, price must raise back to equilibrium. © 2015 Pearson Education, Inc. 4.4 Supply and Demand in Equilibrium Exhibit 4.12 Excess Demand © 2015 Pearson Education, Inc.  Changes in Equilibrium  Equilibrium price & quantity will change due to changes in demand & supply.  In other words, prices of goods & services will change because of changes in demand & supply.  Price of goods will increase due to either increase in demand only or decrease in supply only or both ( increase demand & decrease supply).  Price of goods will fall due to either decrease in demand only or increase in supply only or© 2015 both ( decrease demand Pearson Education, Inc.  Changes in Demand and Equilibrium ` Equilibrium D increase: D decrease: P, Q P, Q P P S S D2 D3 D1 D4 0 0 Increase in demand Decrease in demand LO4  Changes in `Supply and Equilibrium Equilibrium S increase: S decrease: P, Q P, Q P P S1 S2 S4 S3 D D 0 0 Increase in supply Decrease in supply LO4 4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium Ready for another one? Why do the price of roses increase right before Valentine’s Day? © 2015 Pearson Education, Inc. Demand for roses increases & shift demand curve to the right © 2015 Pearson Education, Inc. 4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium © 2015 Pearson Education, Inc. 4.4 Supply and Demand in Equilibrium Curve Shifting in Competitive Equilibrium © 2015 Pearson Education, Inc.  Price Ceiling ( maximum price)  Definition. Price ceiling is a price set by government below equilibrium price.  In Oman government use price ceiling to set price of petrol.  Purpose of price ceiling is to help majority of the society afford basic necessities. In some countries government will fix prices of basic goods & services. Problem of Price Ceiling:  Price celling create shortage in the market as quantity demanded will be more than quantity supplied because of low prices. © 2015 Pearson Education, Inc.