Chapter 3: Market Forces of Supply and Demand PDF

Part 2 SUPPLY AND DEMAND: HOW MARKETS WORK FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 3 THE MARKET FORCES OF SUPPLY AND DEMAND FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331...

Part 2 SUPPLY AND DEMAND: HOW MARKETS WORK FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 3 THE MARKET FORCES OF SUPPLY AND DEMAND FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Forces of Supply And Demand  Supply and demand are the forces that make market economies work.  Supply and demand determine prices in a market economy and how prices, in turn, allocate the economy’s scarce resources.  The model of the market based on supply and demand, like any other model, is based on a series of assumptions. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Assumptions of The Market Model The terms supply and demand refer to the behavior of people as they interact with one another in 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. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Assumption for efficient outcomes  The model of supply and demand which leads to this ‘efficient’ outcome is based on the following: ◦ Many buyers and sellers. ◦ Perfect information for all buyers and sellers. ◦ Freedom of entry and exit. ◦ Identical goods. ◦ Buyers and sellers act in self interest. ◦ Clearly defined property rights. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Competitive market  A market in which there are many buyers and many sellers so that each has a negligible impact on the market price.  Characteristics of a perfectly competitive market: ◦ All goods for sale are the same. ◦ No buyer or seller can influence market price on their own.  Because buyers and sellers must accept the market price as given, they are often called "price takers." FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Demand Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand is the claim that, other things equal, «ceteris paribus» the quantity demanded of a good falls when the price of the good rises. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  The Demand Curve: The Relationship between Price and Quantity Demanded Demand schedule Price of milk per litre (€) Quantity of milk demanded is a table that (litres per month) shows the relationship 0.00 20 between the price of 0.10 18 the good and the quantity demanded. 0.20 16 0.30 14 0.40 12 0.50 10 0.60 8 0.70 6 Rachel’s Demand 0.80 4 Schedule 0.90 2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Rachel’s Demand Schedule and Demand Curve The demand curve is a graph of the relationship between the price of a good and the quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Demand versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Shifts Versus Movements Along The Demand Curve  Ceteris paribus - other factors affecting demand are held constant so that we can analyze the effect of a change in price on demand. ◦ A shift in the demand curve is caused by a factor affecting demand other than a change in price. ◦ Movement along the demand curve. ◦ Caused by a change in the price of the product. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Changes In Quantity Demanded Price of milk A tax that raises the price milk results in a movement along the B €1.20 demand curve. A €0.60 D 0 4 8 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Terms for Shift vs. Movement Along Curve Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or # of buyers) Change in the quantity demanded: a movement along a fixed D curve occurs when P changes FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 13 9781473725331 © CENGAGE EMEA 2017  Shifts in the Demand Curve A shift in the demand curve, to the left or right. ◦ Caused by any change that alters the quantity demanded at every given price. Shifts caused by factors other than price. 1) Prices of related goods (substitutes and complements) o Substitutes: two goods for which an increase in the price of one good leads to an increase in the demand for the other. o Complements: two goods for which an increase in the price of one good leads to a decrease in the demand for the other. 2) Income ◦ A lower income means that you have less to spend in total, so you would have to spend less on some – and probably most – goods. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Demand Curve Shifts caused by factors other than price (continued) 2) Income continued. ◦ If the demand for a good falls when income falls or rises as income rises, the good is called a normal good. ◦ If the demand for a good rises when income falls, the good is called an inferior good. 3) Tastes. More people may like something 4) Number of buyers (population). 5) Advertising 6) Expectations of consumers where demand is influenced by expectations of future income and future prices FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Demand Curve Price of milk Increase in demand Decrease in demand Demand curve, D2 Demand curve, D1 Demand curve, D3 0 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 1 Demand Curve Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why? A. The price of iPods falls B. The price of music downloads falls C. The price of CDs falls  ACTIVE LEARNING 1 A. Price of iPods falls Price of music Music downloads and down-loads iPods are complements. A fall in price of iPods shifts the demand curve P1 for music downloads to the right. D1 D2 Q1 Q2 Quantity of music downloads  ACTIVE LEARNING 1 A. Price of music downloads falls Price of music The D curve down-loads does not shift. Move down along curve to a point with lower P, higher Q. P1 P2 D1 Q1 Q2 Quantity of music downloads  ACTIVE LEARNING 1 C. Price of CDs falls Price of music CDs and down-loads music downloads are substitutes. A fall in price of CDs shifts P1 demand for music downloads to the left. D2 D1 Q2 Q1 Quantity of music downloads Supply Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of supply is the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  The Supply Curve: The Relationship between Price and Quantity Supplied Supply Schedule Price of milk per litre (€) Quantity of milk supplied ◦ The supply (litres per month) schedule is a 0.00 0 table that shows the relationship 0.10 0 between the 0.20 2 price of the good 0.30 4 and the quantity supplied. 0.40 6 0.50 8 0.60 10 0.70 12 0.80 14 Richard’s Supply 0.90 16 Schedule 1.00 18 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Richard’s Supply Schedule and Supply Curve Supply Curve ◦ The supply curve is the graph of the relationship between the price of a good and the quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Supply versus Individual SupplySupply Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs) Change in the quantity supplied: a movement along a fixed S curve occurs when P changes FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 25 9781473725331 © CENGAGE EMEA 2017  Supply schedule Price of milk S C €1.50 A rise in the price milk results in a movement along the supply curve. A €0.60 Quantity of milk 0 1 5 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Shifts in the Supply Curve The supply curve shows how much producers offer for sale at any given price, holding constant all other factors that may influence producers’ decisions about how much to sell.  When any of these other factors change, the supply curve will shift. ◦ These are shown on the next slide. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Supply Curve ① Profitability of other goods in production and prices of goods in joint supply. ② Technology. ③ Natural/Social Factors such as the weather and changing attitudes. ④ Input prices – the prices of the factors of production. ⑤ Expectations of producers about the future state of the market. ⑥ A change in the number of sellers in the market. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Supply Curve Price of milk Supply curve, S3 Supply curve, S1 Supply Decrease curve, S2 in supply Increase in supply 0 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Variables That Influence Sellers Copyright©2004 South-Western ACTIVE LEARNING 2 Supply Curve Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost. C. Professional tax return preparers raise the price of the services they provide. ACTIVE LEARNING 2 A. Fall in price of tax return software Price of tax return S1 S curve does software not shift. Move down along the P1 curve to a lower P and lower Q. P2 Q2 Q1 Quantity of tax return software ACTIVE LEARNING 2 B. Fall in cost of producing the software Price of tax return S1 S2 software S curve shifts to the right: P1 at each price, Q increases. Q1 Q2 Quantity of tax return software  ACTIVE LEARNING 3 C. Professional preparers raise their price Price of tax S1 This shifts the demand return curve for tax preparation software software, not the supply curve. Quantity of tax return software Supply And Demand Together 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. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Supply And Demand Together Demand Schedule Supply Schedule price quantity price quantity At €2.00, the quantity demanded is equal to the quantity supplied in this example. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Equilibrium of Supply and Demand FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Not in Equilibrium (a) Excess Supply Price of milk Supply Surplus € 0.70 0.60 Demand 0 4 7 10 Quantity of milk Quantity Quantity demanded supplied FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Equilibrium Surplus ◦ When price > equilibrium price, then quantity supplied > quantity demanded. ◦ There is excess supply or a surplus. ◦ Suppliers will lower the price to increase sales, thereby moving toward equilibrium. Shortage ◦ When price < equilibrium price, then quantity demanded > the quantity supplied. ◦ There is excess demand or a shortage. ◦ Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cones € 2.00 1.50 Shortage Demand 0 4 7 10 Quantity of Quantity Quantity Ice-Cream supplied demanded Cones FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Equilibrium Law of supply and demand ◦ The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Three Steps to Analyzing Changes in Equilibrium ① Decide whether the event shifts the supply or demand curve (or both). ② Decide whether the curve(s) shift(s) to the left or to the right. ③ Use the supply and demand diagram to see how the shift affects equilibrium price and quantity. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  How an Increase in Demand Affects the Equilibrium Price of milk 1. Hot weather increases the demand for milk... Supply € 0.80 New equilibrium 0.60 2.... resulting Initial in a higher equilibrium price... D D 0 7 10 Quantity of 3.... and a higher milk quantity sold.  How a Decrease in Supply Affects the Equilibrium Price of milk 1. An increase in the animal feed reduces the supply of milk.. S2 S1 New € 0.80 equilibrium 0.60 Initial equilibrium 2.... resulting in a higher price of milk Demand 0 4 7 Quantity of milk 3.... and a lower quantity sold. Table: What Happens to Price and Quantity When Supply or Demand Shifts? FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION FOR USE WITH 9781473725331 MANKIW AND TAYLOR, ECONOMICS © CENGAGE 4TH EDITION EMEA 2017 9781473725331 © CENGAGE EMEA 2017 EXAMPLE: The Market for Hybrid Cars P price of hybrid cars S1 P1 D1 Q Q1 quantity of hybrid cars FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 1: A Shift in Demand EVENT TO BE ANALYZED: P Increase in price of gas. S1 STEP 2: 3: 1: P2 D shifts Thecurve shifts shiftright causes an because price increase high in of gas gas price price P1 affects makes and demand hybrids quantity for of more hybrid hybrids. relative to attractive cars. other cars. S curve does not shift, because price of gas D1 D2 does not affect cost of Q producing hybrids. Q1 Q 2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 1: A Shift in Demand Notice: When P rises, producers P supply S1 a larger quantity of hybrids, even though P2 the S curve has not shifted. P1 Always be careful to distinguish b/w a shift D1 D2 in a curve and a movement along the Q Q1 Q2 curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 2: A Shift in Supply EVENT: New technology reduces cost of producing P hybrid cars. S1 S2 STEP 1: S curve shifts because STEP 2: event affects P1 cost of production. S shifts right P2 D curve 3: does because STEP eventnot shift, reduces because production cost,shift causes The price D1 technology makes to is not one fall production moreof the factorsatthat affect Q profitable and quantity anyrise. to given Q1 Q2 demand. price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 3: A Shift in Both Supply and Demand EVENTS: price of gas rises AND P new technology reduces S1 S2 production costs STEP 1: P2 Both curves shift. P1 STEP 2: Both shift to the right. STEP 3: D1 D2 Q rises, but effect Q on P is ambiguous: Q1 Q2 If demand increases more than supply, P rises. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 3: A Shift in Both Supply and Demand EVENTS: price of gas rises AND P new technology reduces S1 S2 production costs STEP 3, cont. P1 But if supply increases more P2 than demand, P falls. D1 D2 Q Q1 Q2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 Shifts in supply and demand Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads. Event A: A fall in the price of CDs Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. Event C: Events A and B both occur. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 A. Fall in price of CDs The market for STEPS P music downloads 1. D curve shifts S1 2. D shifts left P1 3. P and Q both fall. P2 D2 D1 Q Q2 Q1 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 B. Fall in cost of royalties STEPS The market for P music downloads 1. S curve shifts (Royalties are part of sellers’ costs) S1 S2 2. S shifts right P1 3. P falls, Q rises. P2 D1 Q Q1 Q2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 C. Fall in price of CDs and fall in cost of royalties STEPS 1. Both curves shift (see parts A & B). 2. D shifts left, S shifts right. 3. P unambiguously falls. Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Summary ① Economists use the model of supply and demand to analyse competitive markets. ② In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price. ③ The demand curve shows how the quantity of a good depends upon 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 complements and substitutes, tastes, expectations, and the number of buyers. ◦ If one of these factors changes, the demand curve shifts. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Summary ④ The supply curve shows how the quantity of a good supplied depends upon 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. ⑤ Market equilibrium is determined by the intersection of the supply and demand curves. ⑥ At the equilibrium price, the quantity demanded equals the quantity supplied. ⑧ To analyse how any event influences a market, we use the supply and demand diagram to examine how the even affects the equilibrium price and quantity. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017