Essential Foundations of Economics Textbook PDF

© 2021 Pearson Why does the price of avocados fluctuate? © 2021 Pearson Demand and Supply 4 CHAPTER CHECKLIST When you have completed your study of this chapter, you will be able to...

© 2021 Pearson Why does the price of avocados fluctuate? © 2021 Pearson Demand and Supply 4 CHAPTER CHECKLIST When you have completed your study of this chapter, you will be able to 1 Distinguish between quantity demanded and demand, and explain what determines demand. 2 Distinguish between quantity supplied and supply, and explain what determines supply. 3 Explain how demand and supply determine price and quantity in a market, and explain the effects of changes in demand and supply. © 2021 Pearson COMPETITIVE MARKETS A market is any arrangement that brings buyers and sellers together. A market might be a physical place or a group of buyers and sellers spread around the world who never meet. © 2021 Pearson  COMPETITIVE MARKETS In this chapter, we study a competitive market that has so many buyers and so many sellers that no individual buyer or seller can influence the price. © 2021 Pearson 4.1 DEMAND Quantity demanded is the amount of a good, service, or resource that people are willing and able to buy during a specified period at a specified price. The quantity demanded is an amount per unit of time. For example, the amount per day or per month. © 2021 Pearson 4.1 DEMAND < The Law of Demand Other things remaining the same, If the price of the good rises, the quantity demanded of that good decreases. If the price of the good falls, the quantity demanded of that good increases. © 2021 Pearson 4.1 DEMAND < Demand Schedule and Demand Curve Demand is the relationship between the quantity demanded and the price of a good when all other influences on buying plans remain the same. Demand is illustrated by a demand schedule and a demand curve. © 2021 Pearson 4.1 DEMAND Demand schedule is a list of the quantities demanded at each different price when all the other influences on buying plans remain the same. Demand curve is a graph of the relationship between the quantity demanded of a good and its price when all other influences on buying plans remain the same. © 2021 Pearson 4.1 DEMAND © 2021 Pearson 4.1 DEMAND < Individual Demand and Market Demand Market demand is the sum of the demands of all the buyers in a market. The market demand curve is the horizontal sum of the demand curves of all buyers in the market. © 2021 Pearson 4.1 DEMAND © 2021 Pearson 4.1 DEMAND < Changes in Demand Change in demand is a change in the quantity that people plan to buy when any influence other than the price of the good changes. A change in demand means that there is a new demand schedule and a new demand curve. © 2021 Pearson 4.1 DEMAND Figure 4.3 shows changes in demand. 1. When demand decreases, the demand curve shifts leftward from D0 to D1. 2. When demand increases, the demand curve shifts rightward from D0 to D2. © 2021 Pearson 4.1 DEMAND The main influences on buying plans that change demand are Prices of related goods Expected future prices Income Expected future income and credit Number of buyers Preferences © 2021 Pearson 4.1 DEMAND Prices of Related Goods A substitute is a good that can be consumed in place of another good. For example, apples and oranges are substitutes. The demand for a good increases if the price of one of its substitutes rises. The demand for a good decreases if the price of one of its substitutes falls. © 2021 Pearson 4.1 DEMAND A complement is a good that is consumed with another good. For example, ice cream and fudge sauce are complements. The demand for a good increases if the price of one of its complements falls. The demand for a good decreases if the price of one of its complements rises. © 2021 Pearson 4.1 DEMAND Expected Future Prices A rise in the expected future price of a good increases the current demand for that good. A fall in the expected future price of a good decreases current demand for that good. For example, if the price of a computer is expected to fall next month, the demand for computers today decreases. © 2021 Pearson 4.1 DEMAND Income A normal good is a good for which the demand increases if income increases and demand decreases if income decreases. An inferior good is a good for which the demand decreases if income increases and demand increases if income decreases. © 2021 Pearson 4.1 DEMAND Expected Future Income and Credit When income is expected to increase in the future, or when credit is easy to get and the cost of borrowing is low, the demand for some goods increases. When income is expected to decrease in the future, or when credit is hard to get and the cost of borrowing is high, the demand for some goods decreases. Changes in expected future income and the availability and cost of credit has the greatest effect on the demand for big ticket items such as homes and cars. © 2021 Pearson 4.1 DEMAND Number of Buyers The greater the number of buyers in a market, the larger is the demand for any good. Preferences When preferences change, the demand for one item increases and the demand for another item (or items) decreases. Preferences change when: People become better informed. New goods become available. © 2021 Pearson 4.1 DEMAND < Change in Quantity Demanded Versus Change in Demand A change in the quantity demanded is a change in the quantity of a good that people plan to buy that results from a change in the price of the good. A change in demand is a change in the quantity that people plan to buy when any influence other than the price of the good changes. © 2021 Pearson 4.1 DEMAND Figure 4.4 illustrates and summarizes the distinction. © 2021 Pearson 4.2 SUPPLY Quantity supplied is the amount of a good, service, or resource that people are willing and able to sell during a specified period at a specified price. < The Law of Supply Other things remaining the same, If the price of a good rises, the quantity supplied of that good increases. If the price of a good falls, the quantity supplied of that good decreases. © 2021 Pearson 4.2 SUPPLY < Supply Schedule and Supply Curve Supply is the relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same. Supply is illustrated by a supply schedule and a supply curve. © 2021 Pearson 4.2 SUPPLY A supply schedule is a list of the quantities supplied at each different price when all other influences on selling plans remain the same. A supply curve is a graph of the relationship between the quantity supplied and the price of the good when all other influences on selling plans remain the same. © 2021 Pearson 4.2 SUPPLY © 2021 Pearson 4.2 SUPPLY < Individual Supply and Market Supply Market supply is the sum of the supplies of all sellers in a market. The market supply curve is the horizontal sum of the supply curves of all the sellers in the market. © 2021 Pearson 4.2 SUPPLY © 2021 Pearson 4.2 SUPPLY < Changes in Supply A change in supply is a change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes. A change in supply means that there is a new supply schedule and a new supply curve. © 2021 Pearson 4.2 SUPPLY Figure 4.7 shows changes in supply. 1. When supply decreases, the supply curve shifts leftward from S0 to S1. 2. When supply increases, the supply curve shifts rightward from S0 to S2. © 2021 Pearson 4.2 SUPPLY The main influences on selling plans that change supply are Prices of related goods Prices of resources and other inputs Expected future prices Number of sellers Productivity © 2021 Pearson 4.2 SUPPLY Prices of Related Goods A change in the price of one good can bring a change in the supply of another good. A substitute in production is a good that can be produced in place of another good. For example, a truck and an SUV are substitutes in production in an auto factory. The supply of a good increases if the price of one of its substitutes in production falls. The supply a good decreases if the price of one of its substitutes in production rises. © 2021 Pearson 4.2 SUPPLY A complement in production is a good that is produced along with another good. For example, cream is a complement in production of skim milk in a dairy. The supply of a good increases if the price of one of its complements in production rises. The supply a good decreases if the price of one of its complements in production falls. © 2021 Pearson 4.2 SUPPLY Prices of Resources and Other Inputs Resource and input prices influence the cost of production. And the more it costs to produce a good, the smaller is the quantity supplied of that good. Expected Future Prices Expectations about future prices influence supply. Expectations of future prices of resources also influence supply. © 2021 Pearson 4.2 SUPPLY Number of Sellers The greater the number of sellers in a market, the larger is supply. Productivity Productivity is output per unit of input. An increase in productivity lowers costs and increases supply. For example, an advance in technology increases supply. A decrease in productivity raises costs and decreases supply. For example, a severe hurricane decreases supply. © 2021 Pearson 4.2 SUPPLY < Change in Quantity Supplied Versus Change in Supply A change in quantity supplied is a change in the quantity of a good that suppliers plan to sell that results from a change in the price of the good. A change in supply is a change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes. © 2021 Pearson 4.2 SUPPLY Figure 4.8 illustrates and summarizes the distinction. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Market equilibrium occurs when the quantity demanded equals the quantity supplied. At market equilibrium, buyers’ and sellers’ plans are consistent. Equilibrium price is the price at which the quantity demanded equals the quantity supplied. Equilibrium quantity is the quantity bought and sold at the equilibrium price. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.9 shows the equilibrium price and equilibrium quantity. 1. Market equilibrium at the intersection of the demand curve and the supply curve. 2. The equilibrium price is $1 a bottle. 3. The equilibrium quantity is10 million bottles a day. © 2021 Pearson 4.3 MARKET EQUILIBRIUM < Price: A Market’s Automatic Regulator Law of market forces When there is a shortage, the price rises. When there is a surplus, the price falls. Shortage occurs when the quantity demanded exceeds the quantity supplied. Surplus occurs when the quantity supplied exceeds the quantity demanded. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.10(a) achieves market equilibrium. At $1.50 a bottle: 1. Quantity supplied is 11 million bottles. 2. Quantity demanded is 9 million bottles. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. There is a surplus of 2 million bottles. 4. Price falls until the surplus is eliminated and the market is in equilibrium. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.10(b) achieves market equilibrium. At 75 cents a bottle: 1. Quantity demanded is 11 million bottles. 2. Quantity supplied is 9 million bottles. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. There is a shortage of 2 million bottles. 4. Price rises until the shortage is eliminated and the market is in equilibrium. © 2021 Pearson 4.3 MARKET EQUILIBRIUM < Predicting Price Changes: Three Questions We can work out the effects of an event by answering: 1.Does the event change demand or supply? 2.Does the event increase or decrease demand or supply —shift the demand curve or the supply curve rightward or leftward? 3.What are the new equilibrium price and equilibrium quantity and how have they changed? © 2021 Pearson 4.3 MARKET EQUILIBRIUM < Effects of Changes in Demand Event: A new study says that tap water is unsafe. In the market for bottled water: 1.With tap water unsafe, demand for bottled water changes. 2.The demand for bottled water increases, the demand curve shifts rightward. 3.What are the new equilibrium price and equilibrium quantity and how have they changed? © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.11(a) illustrates the outcome. 1. An increase in demand shifts the demand curve rightward. 2. At $1.00 a bottle, there is a shortage, so the price rises. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. The quantity supplied increases along the supply curve. 4. Equilibrium quantity increases. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Event: A new zero-calorie sports drink is invented. In the market for bottled water: 1.The new drink is a substitute for bottled water, so the demand for bottled water changes 2.The demand for bottled water decreases and the demand curve shifts leftward. 3.What are the new equilibrium price and equilibrium quantity and how have they changed? © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.11(b) shows the outcome. 1. A decrease in demand shifts the demand curve leftward. 2. At $1.00 a bottle, there is a surplus, so the price falls. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. Quantity supplied decreases along the supply curve. 4. Equilibrium quantity decreases. © 2021 Pearson 4.3 MARKET EQUILIBRIUM When demand changes: The supply curve does not shift. But there is a change in the quantity supplied. Equilibrium price and equilibrium quantity change in the same direction as the change in demand. © 2021 Pearson 4.3 MARKET EQUILIBRIUM < Effects of Changes in Supply Event: European water bottlers buy springs and open plants in the United States. In the market for bottled water: 1.With more suppliers of bottled water, supply changes. 2.The supply of bottled water increases and the supply curve shifts rightward. 3.What are the new equilibrium price and equilibrium quantity and how have they changed? © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.12(a) shows the outcome. 1. An increase in supply shifts the supply curve rightward. 2. At $1 a bottle, there is a surplus, so the price falls. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. Quantity demanded increases along the demand curve. 4. Equilibrium quantity increases. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Event: Drought dries up some springs in the United States. In the market for bottled water: 1.Drought changes the supply of bottled water. 2.The supply of bottled water decreases and the supply curve shifts leftward. 3.What are the new equilibrium price and equilibrium quantity and how have they changed? © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.12(b) shows the outcome. 1. A decrease in supply shifts the supply curve leftward. 2. At $1.00 a bottle, there is a shortage, so the price rises. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. Quantity demanded decreases along the demand curve. 4. Equilibrium quantity decreases. © 2021 Pearson 4.3 MARKET EQUILIBRIUM When supply changes: The demand curve does not shift. But there is a change in the quantity demanded. Equilibrium price changes in the opposite direction to the change in supply. Equilibrium quantity changes in the same direction as the change in supply. © 2021 Pearson 4.3 MARKET EQUILIBRIUM < Changes in Both Demand and Supply When two events occur at the same time, work out how each event influences the market: 1.Does each event change demand or supply? 2.Does either event increase or decrease demand or increase or decrease supply? 3.What are the new equilibrium price and equilibrium quantity and how have they changed? © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.13(a) shows the effects of an increase in both demand and supply. 1. An increase in demand shifts the demand curve rightward. An increase in supply shifts the supply curve rightward. 2. Equilibrium price might rise, fall, or not change. 3. Equilibrium quantity increases. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Increase in Both Demand and Supply Increases the equilibrium quantity. The change in the equilibrium price is ambiguous because the: Increase in demand raises the price. Increase in supply lowers the price. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.13(b) shows the effects of a decrease in both demand and supply. 1. A decrease in demand shifts the demand curve leftward. A decrease in supply shifts the supply curve leftward. 2. Equilibrium price might rise, fall or not change. 3. Equilibrium quantity decreases. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Decrease in Both Demand and Supply Decreases the equilibrium quantity. The change in the equilibrium price is ambiguous because the: Decrease in demand lowers the price Decrease in supply raises the price. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.14(a) shows the effects of a decrease in demand and an increase in supply. 1. A decrease in demand shifts the demand curve leftward. An increase in supply shifts the supply curve rightward. 2. Equilibrium price falls. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. Equilibrium quantity might increases, decrease or not change. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Decrease in Demand and Increase in Supply Lowers the equilibrium price. The change in the equilibrium quantity is ambiguous because the: Decrease in demand decreases the quantity. Increase in supply increases the quantity. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Figure 4.14(b) shows the effects of an increase in demand and a decrease in supply. 1. An increase in demand shifts the demand curve rightward. A decrease in supply shifts the supply curve leftward. 2. Equilibrium price rises. © 2021 Pearson 4.3 MARKET EQUILIBRIUM 3. Equilibrium quantity might increases, decrease or not change. © 2021 Pearson 4.3 MARKET EQUILIBRIUM Increase in Demand and Decrease in Supply Raises the equilibrium price. The change in the equilibrium quantity is ambiguous because the: Increase in demand increases the quantity. Decrease in supply decreases the quantity. © 2021 Pearson  EYE on the PAST In August each year, the Californian avocado crop winds down and the Mexican crop takes over. But if Mexican production is not ramped up enough to replace the Californian crop, the price of avocados rises. Does the price rise because demand changes? Or does the price rise because supply changes? © 2021 Pearson  EYE on the PAST The table shows the quantity and price of avocados at the end of July 2018 and the start of September 2018. What do the data tell us? Did the price rise because the demand increased or because the supply decreased? © 2021 Pearson  EYE on the PAST You know that the price rose, but how did the quantity bought change? If demand increases, the price rises and the quantity bought increases. If supply decreases, the price rises and the quantity bought decreases. Because the quantity of avocados bought decreased, the supply of avocados must have decreased. © 2021 Pearson  EYE on the PAST At the end of July 2018, the price was $1.03 and American bought 48 million pounds of avocados a week. If California’s crop winds down before Mexico’s crop is ripe, supply decreases and the supply curve shifted leftward. In 2018, the price rose to $1.29 and Americans bought only 36 million pounds of avocados a week. © 2021 Pearson