Chapter 4: Principles of Macroeconomics ECON 102 PDF

ECON 102 Principles of Macroeconomics WEI DAI AS S I S T ANT P ROF E S S OR DE P ART ME NT OF E CONOMI CS , P HI L OS OP HY AND P OL I T I CAL S CI E NCE UNI VE RS I T Y OF BRI T I S H COL UMBI A OKANAGAN CAMP US  Chapter 4 1. Understanding Markets What are markets, and...

ECON 102 Principles of Macroeconomics WEI DAI AS S I S T ANT P ROF E S S OR DE P ART ME NT OF E CONOMI CS , P HI L OS OP HY AND P OL I T I CAL S CI E NCE UNI VE RS I T Y OF BRI T I S H COL UMBI A OKANAGAN CAMP US  Chapter 4 1. Understanding Markets What are markets, and how are they organized? Equilibrium: Where Supply 2. Equilibrium Supply equals Demand Meets Demand Shortage and Surplus 3. Predicting Market Changes Shifting demand and supply 2 What is Demand? Defining, drawing, and 1. Individual Demand: What You Want, at understanding an Each Price individual’s demand curve. 2. Market Demand: What the Market Wants Ceteris Paribus The Law of Demand  Key Definition (1 of 2) Diving into the Definition Individual Demand Curve: A graph that Individual: We are referring to one plots the quantity of an item that an person (as opposed to many people). individual plans to purchase at each price. Demand: We are examining buying In other words, your demand curve decisions (as opposed to selling decisions). visually summarizes your buying plans, and how your plans vary with price: If I walk into the grocery store and see Curve: We are graphing things (sometimes these curves are straight lines). my favorite cookies are now marked at a lower price, then I plan to buy more Let’s create our first individual demand curve! cookies at this new, lower price ☺. 4  Creating Darren’s Demand Curve Price of gas Price per gallon Quantity ($ per litre) Connect the various $1.80 per litre 1 litre $1.80 quantities demanded to get $1.60 per litre 2 litres Darren’s demand curve. $1.60 $1.40 per litre 3 litres $1.40 $1.20 per litre 5 litres $1.20 $1.00 per litre 7 litres $1.00 0 1 2 3 4 5 6 7 The quantity Darren plans to buy depends on Quantity of gas demanded (litres per day) the price: the lower price, the higher the quantity demanded. 5  Individual demand curve: Ceteris paribus “Holding other things constant” (Latin: ceteris paribus) Every time you draw an individual’s demand curve, you are drawing this person’s buying plans given current economic conditions. If something important changed (e.g., Darren lost his job), then Darren’s buying plans would change, which means his individual demand curve would change. Economists know that many factors other than price can influence your demand. But first, understand what happens when the price (and only the price) changes. Push these other factors aside for the time being when drawing an individual’s demand curve. Then, later, bring other factors into consideration separately. 6  The Law of Demand As a consumer, think about how you react to high versus low prices: As the price falls lower and lower… your quantity demanded gets higher and higher. This pattern is so commonly seen among consumers that it has its own name. Law of Demand: The tendency for the quantity demanded to be higher when the price is lower. This law implies that demand curves slope down: When drawing a demand curve, think: “Demand, down to the ground.” 7  Key take-aways: Individual demand The individual demand curve plots the quantity a person plans to buy at each price, holding all other factors constant (ceteris paribus). Other factors that impact a person’s buying plans will be assessed later. The Law of Demand: As the price falls, the quantity demanded rises. Or, equivalently, as the price rises, the quantity demanded falls. 8 What is Demand? Building the market 1. Individual Demand: What You Want, at demand curve from Each Price individual demand curves. 2. Market Demand: What the Market Wants Tracing out movements along the demand curve.  Key Definition (2 of 2) Diving into the Definition Market Demand Curve: A graph plotting Individual demand curves are the building the total quantity of an item demanded by blocks of market demand: the entire market, at each price. At each price, the total quantity of gas The market demand gives business owners demanded is the sum of the quantity a sense of how much business is up for that each potential customer will grabs: demand at that price. How many customers want your The market demand curve visually restaurant’s pizza? summarizes these purchasing decisions How many applicants for a university? across the various price points. How many donations for a nonprofit? Let’s explore the four-step process you How many followers on Instagram? can use to estimate the market demand for a given product! 10  Estimating market demand (1 of 4) STEP 1: Suppose you survey a representative The Four-Step Process to Estimate sample of 300 potential customers, asking Market Demand: each person about their gas purchasing plans 1. Survey: Ask each person the quantity at various price points. they will buy at each price. 2. For each price, add up total quantity demanded by all customers. 3. Scale up the quantities to represent the whole market. 4. Plot the total quantity demanded at each price. 11  Estimating market demand (2 of 4) STEP 2: Add up how many gallons of gas each The Four-Step Process to Estimate of your 300 customers want to buy at each and Market Demand: every price. 1. Survey: Ask each person the quantity they will buy at each price. 2. For each price, add up total quantity demanded by all customers. 3. Scale up the quantities to represent the whole market. Caution: Do not add up the price each individual 4. Plot the total quantity pays at each quantity. Instead, the correct approach demanded at each price. is to add up the quantities at each price. 12  Estimating market demand (3 of 4) The Four-Step Process to STEP 3: Scale up! Our survey of 300 people is intended to Estimate Market Demand: be representative of 300 million potential customers. 1. Survey: Ask each person the Thus, we need to scale up our quantities by 1 million so quantity they will buy at each that they represent the whole market. price. 2. For each price, add up total quantity demanded by all customers. 3. Scale up the quantities to represent the whole market. 4. Plot the total quantity demanded at each price. 13  Estimating market demand (4 of 4) The Four-Step Process to STEP 4: Plot the total quantity demanded by the Estimate Market Demand: market at each price, yielding the market demand curve. Price of gas 1. Survey: Ask each person the ($ per litre) quantity they will buy at each $1.80 Market price. Price Market demand Quantity 2. For each price, add up total $1.8 $1.60 curve quantity demanded by all 0 0.8 billion customers. $1.6 $1.40 0.9 billion 3. Scale up the quantities to 0 $1.20 represent the whole market. $1.4 1 billion 0 4. Plot the total quantity $1.00 demanded at each price. $1.2 1.1 billion 0 $1.0 0.8 0.9 1 1.1 1.2 1.2 billion 0 Quantity of gas demanded 14 (billions of litres per week)  Characteristics of the Movements along the market demand curve demand curve The market demand curve is downward- The market demand summarizes the sloping: entire relationship between price and Law of demand: The total quantity quantity demand. demanded is higher when the price is lower. To assess how consumers will react to a Prices change the quantity demanded for change in the price of the good, simply both old and new customers: compare different points on the same demand curve: Lower prices mean current customers buy more units. Move from one point on the existing Lower prices bring new customers into demand curve to another point. the market. You do NOT need to draw a new demand curve to assess the impact of a price change. 15  Key Definitions Diving into the Definition A change in price causes a movement along When the price falls from $1.40 to $1.20, the the demand curve, yielding a change in the quantity demanded changes from 100 to 110 units. This is a movement along the existing quantity demanded. demand curve. Price Movement along the demand curve: A price change causes a movement from one $1.40 point on a fixed demand curve to another point on the same demand curve. $1.20 Change in the quantity demanded: The Market change in the quantity associated with demand movement along a fixed demand curve. curve 100 110 Quantity 16  Key take-aways: Market demand Market Demand Curve: The total quantity demanded by the entire market at each price. Four-step process to estimate market demand. Add up the quantities from each consumer at each price. When the price of the good changes, you simply move along the existing demand curve to that new price point. Move from one point to another point. This price change triggers a change in the quantity demanded (not a change in demand). 17 What is Supply? 1. Individual Supply: What You Sell, at Defining, drawing, and Each Price understanding an individual business’s supply curve 2. Market Supply: What the Market Sells Ceteris Paribus The Law of Supply  Suppliers come in all Can you name a seller? Amazon shapes and sizes Costco Netflix You are also a seller! Sold furniture on Facebook Marketplace or eBay. Sold your tickets to an event. If you have a job, you sell your labour in return for a wage. 19  Key Definition (1 of 2) Diving into the Definition Individual Supply Curve: A graph plotting the Individual: We are referring to one quantity of an item that a business plans to sell at each price. business (as opposed to many businesses). In other words, the supply curve visually Supply: We are examining selling summarizes the selling plans of a business, and how those plans vary with price: decisions (as opposed to buying decisions). Suppose you work part-time as a tutor. How many hours are you willing to tutor Curve: We are graphing things someone if they pay you $15 per hour? (sometimes these curves are straight lines). What if the rate increases to $30 per hour? Let’s create our first individual business’s supply curve! 20  Creating Shell's Individual Supply Curve for Gasoline Quantity (millions of gallons Connect the various quantities Price per litre per week) Price of gas ($ per litre) supplied to get Shell's supply curve $1.80 per litre 12m litres $1.80 $1.60 per litre 11m litres $1.60 $1.40 per litre 10m litres $1.20 per litre 9m litres $1.40 $1.00 per litre 8m litres $1.20 Below $1.00 per 0 litres $1.00 litre $0.5 The quantity of gasoline Shell plans to sell 0 5 8 9 10 11 12 15 depends on the price they will receive for the gas: the higher price, the higher the quantity Quantity of gas supplied (millions of litres per week) supplied. 21  An individual supply curve holds other things constant Recall, “ceteris paribus” Economists know that many factors other than (Latin phrase for “holding other things constant”) price can influence selling plans. Every time you draw an individual’s supply But first, understand what happens when curve, you are drawing this person’s selling the price (and only the price) changes. plans holding other things constant. Push these other factors aside for the time If something important changed, like being when drawing an individual’s supply the wage of oil refinery workers fell, then curve. Shell’s selling plans would change, which Then, later, bring other factors into means its individual supply curve would consideration separately. change. 22  © Worth Publishers The Law of Supply As a seller, think about how you would react to high versus low prices: As the price rises higher and higher… Your quantity supplied gets higher and higher. This pattern is so commonly seen among sellers that it has its own name. The Law of Supply: The tendency for quantity supplied to be higher when the price is higher. This law implies that supply curves slope upward: When drawing a supply curve, think: “Supply to the Sky!” 23  Key take-aways: Individual supply The individual supply curve plots the quantity a person plans to sell at each price, holding all other factors constant (ceteris paribus). Other factors that impact a person’s selling plans will be assessed later. The Law of Supply: As the price rises, the quantity supplied rises. Or, equivalently, as the price falls, the quantity supplied falls. 24 What is Supply? 1. Individual Supply: What You Sell, at Each Add up individual supply to Price discover market supply. 2. Market Supply: What the Market Sells Market supply is upward-sloping. Movements along the supply curve.  Key Definition (2 of 2) Diving into the Definition You can use the same four-step process you used Market Supply Curve: A graph plotting the when estimating market demand to estimate total quantity of an item supplied by the market supply. entire market, at each price. 1. Survey suppliers (and potential suppliers). 2. For each price, add up the total quantity Individual supply curves are the building supplied by all sellers. blocks of market supply: 3. Scale up! At each price, the total quantity of gas 4. Plot the total quantity supplied at each price. supplied is the sum of the quantity that Shortcut if suppliers are similar: each business will supply at that price. Suppose there are 100 other oil refineries that are making the same supply decisions as The market supply curve visually Shell, then at any given price the quantity summarizes these selling decisions supplied will be 100 times the quantity Shell supplies. across the various price points. 26  Using the Shortcut to Estimate Market Supply 27  The Market Supply Curve Is Upward-Sloping Reason 1: Reason 2: Because the market supply curve is A higher price means that it’s more made from adding up individual profitable to be a supplier in that industry. supply curves at each price, it inherits Current suppliers produce more units. many of the same characteristics. New suppliers enter the market. Law of Supply: A higher price leads Lower prices means it’s less profitable businesses to supply a larger quantity. to be a supplier. 28  Key Definitions Diving into the Definition When the price rises from $1.20 to $1.40, the quantity A change in price causes a movement supplied changes from 9m to 10m units. This is a along the supply curve, yielding a change movement along the existing supply curve. in the quantity supplied. Price Market Movement Along the Supply Curve: A supply $1.40 price change causes a movement from curve one point on a fixed supply curve to another point on the same curve. $1.20 Change in the Quantity Supplied: The change in quantity associated with movement along a fixed supply curve. 9 10 Quantity 29  Key take-aways: Market supply Market Supply Curve: The total quantity supplied by the entire market at each price. Four-step process to estimate market supply Add up the quantities from each supply at each price. When the price of the good changes, you simply move along the existing supply curve to that new price point. Move from one point to another point. This price change triggers a change in the quantity supplied (not a change in supply). 30  Chapter 4 (1 of 4) 1. Understanding Markets What are markets, and how are they organized? Exploring how markets help organize society. 2. Equilibrium Supply equals Demand Examples of the Shortage and Surplus markets all around us. 3. Predicting Market Changes Shifting demand and supply 31  How do we organize society such that we Organization Options can determine… Planned Economy: Centralized What goods get produced? decisions are made about what is produced, how, by whom, and who Who will produce these goods and gets what. how will they do it? Market Economy: Each individual How will you allocate these goods? makes their own production and In other words, who gets what? consumption decisions, buying and selling in markets. 32  When you buy a cup of If you are shopping on Etsy If you book a room on coffee, you are a buyer and decide to buy something, Airbnb, then you are a (demander) in the then you are a demander in demander in the online coffee market. the hand-made crafts market. rental lodging market. Market: A setting that brings together potential buyers and sellers. If you own a coffee If you have an Etsy shop, then If you list your apartment shop, then you are a you are a producer who on Airbnb, you are a producer (seller) in supplies their product in the supplier in the online the coffee market. hand-made crafts market. rental lodging market. 33  Markets are all around us! Taking a more expansive view, we even see markets form in settings in which money does not actually get exchanged. The Marriage Market If you are dating with the intention of marriage, then you are participating in the marriage market. You are considering what this person offers in terms of personality, finance, etc., and trying to decide whether to get married (i.e., make the purchase). 34  Chapter 4 (2 of 4) 1. Understanding Markets What are markets, and how are they Defining and visualizing organized? the market equilibrium. 2. Equilibrium Supply equals Demand Understanding Shortage and Surplus shortage and surplus scenarios. 3. Predicting Market Changes Shifting demand and supply 35  Key Definitions: Diving into the Definition Equilibrium: The point at which there In equilibrium: is no tendency for change. A market Every seller who wants to sell an is in equilibrium when the quantity item can find a buyer. supplied equals the quantity Every buyer who wants to buy an demanded. item can find a seller. Equilibrium Quantity: The quantity This balance between the two sides of demanded and supplied in equilibrium. the market is why there is no tendency Equilibrium Price: The price at which for the market price to change from this the market is in equilibrium. equilibrium point. 36  The Market Equilibrium At the market equilibrium, Example: The Market for Gas in Canada supply and demand are in balance, such that there is Quantity Quantity Market Equilibrium: Price Demanded Supplied When the price is $1.40, no surplus or shortage. then the quantity $1.20 110 80 demanded equals the There is a shortage in the $1.40 100 100 quantity supplied. market if the quantity $1.60 90 120 demanded exceeds the Note: All quantities are billions of gallons per week. quantity supplied. Shortage: At $1.20 the quantity demanded exceeds the quantity supplied: 110 > 80. Consumers are unable to buy as much as they There is a surplus in the want—the market is short 30 million litres. market if the quantity demanded is less than the Surplus: At $1.60 the quantity demanded is less than the quantity supplied: 90 < 120. Sellers are unable to sell as much as they quantity supplied. want—there are 30 million litres leftover (i.e., not bought). 37  Visualizing the Market Equilibrium The supply-equals-demand equilibrium C occurs where the supply and demand curves Price of gas D meet. Supply There is a surplus at $1.60 because the $1.6 D quantity supplied exceeds the quantity demanded. At $1.60, consumer is only willing to buy 90 million litres of gas per week. $1.4 C Suppliers are willing to sell 120 million litres per week. $1.2 There is a surplus of 30 million litres per E Demand week. E There is a shortage at $1.20 because the 80 90 100 110 120 quantity demanded (110) exceeds the Quantity of gas (millions of litres per week) quantity supplied (80). 38  Examining Surplus and Shortage Price At the supply-equals-demand C equilibrium there is no shortage or of gas D Supply surplus. $1.6 There is a SURPLUS whenever the price is ABOVE the equilibrium price. $1.4 D The higher the price is above the C equilibrium price, the larger the surplus. $1.2 There is a SHORTAGE whenever the E E price is BELOW the equilibrium price. Demand The lower the price is below the equilibrium price, the larger the 100 Quantity of gas shortage. (millions of litres per week) 39  When the price of gas is BELOW the equilibrium A Shortage Pushes the Price Up price level, there are too many people chasing The Supplier’s Perspective too little gas, leading to a shortage: Qd > Qs At a price of $1.2 you totally sell out of gas. Raising the price to $1.30 you still sell out of gas. Price of gas Raising the price to $1.35 you still sell all your gas. Supply You can keep raising your price and sell all your gas (more profit for you!) as long as the shortage persists. The Demander’s Perspective $1.4 At a price of $1.2 you worry the gas station will sell out of gas before you get the amount you want. $1.2 You offer to pay 10¢ above the current price in Shortage order to ensure you get all the gas you want. Demand Consumers continue to push the price up as long as 80 110 the shortage persists. Quantity of gas (millions of litres per week) 40  When the price of gas is ABOVE the equilibrium A Surplus Pushes the Price Down price level, not enough people want to buy the The Story: gas being sold, leading to a surplus: Qd < Qs At the current $1.6 price, suppliers have 30 million Price litres of unsold gas. of gas Surplus Supply Gas station owners want to sell these units and know they can attract more customers if they lower the $1.6 price. The falling price has two effects: $1.4 As the price falls, the quantity demanded rises (law of demand). As the price falls, the quantity supplied falls (law of supply). Demand The price of gas continues to fall until the surplus is eliminated and the market forces are in balance at 90 120 Quantity of gas the market equilibrium. (billions of gallons per week) 41  Concept Check: Surplus versus Shortage Which of the following scenarios depicts a market with a shortage? a. Cody owns a bakery. At the end of the day, he still has more than a dozen blueberry muffins left, so he donates them to a local food pantry. Discussion Question b. Jordan goes to Target to purchase new shoes. Because Can you think of the shoes are on sale, she buys a second pair for her examples from your sister. life in which you c. Mia goes online to preorder a new phone but discovers experienced a that the phone sold out an hour ago. shortage or surplus? d. Austin goes to purchase concert tickets for himself and a friend. He gets a discount because there are still plenty of 42 seats available.  Key take-aways: Equilibrium Equilibrium: When quantity supplied equals quantity demanded Graphically, where the supply and demand curves cross At equilibrium, there is no tendency for change. Shortage: When quantity demanded exceeds quantity supplied Graphically, whenever price is below the equilibrium price A shortage pushes the price up. Surplus: When quantity demanded is less than quantity supplied Graphically, whenever price is above the equilibrium price A surplus pushes the price down. 43  Chapter 4 (3 of 4) 1. Understanding Markets What are markets, and how are they Visualizing and organized? analyzing… 2. Equilibrium Shifts in Demand Supply equals Demand Shifts in Supply Shortage and Surplus Shifts in BOTH curves 3. Predicting Market Changes Shifting demand and supply 44  Predicting Market Change: Shifts in Demand Demand Shifters 1. Income (normal & inferior) The market demand curve summarizes people’s current buying plans, but if 2. Preferences those plans change, then the market demand curve will shift. 3. Prices of complements and substitutes If the market demand curve shifts, 4. Expectations about the future then the market moves to a new 5. Congestion and network effects equilibrium. 6. The type and number of buyers Let’s examine the market adjustment process and the new equilibrium …but not a change in price. 45 outcomes!  An Increase in Demand An increase in demand causes the demand curve to shift right. Let’s analyze Because demand increased, at the original the impact of this market change. $1.4 price there is now a shortage. Price This shortage kick-starts the adjustment of gas Supply process that pushes the price up. As the price rises, the quantity supplied rises, and the quantity demanded falls. $1.6 The price stops rising when it hits $1.6, the $1.4 point at which Qd equals Qs once again. Shortage Summary: Increased Demand An increase in demand causes an increase in both equilibrium price and quantity. Old Demand 100 120 Quantity of gas (millions of litres per week) 46  A decrease in demand causes the A Decrease in Demand demand curve to shift left. Let’s analyze the impact of this market change. Because demand decreased, at the original $1.4 price there is now a surplus. Price of gas Supply This surplus kick-starts the adjustment process that pushes the price down. Surplus As the price falls, the quantity supplied falls, $1.4 and the quantity demanded rises. The price stops falling when it hits $1.2, the $1.2 point at which Qd equals Qs once again. Old Demand Summary: Decreased Demand A decrease in demand causes a decrease in both equilibrium price and quantity. 80 100 Quantity of gas (millions of litres per week) 47  Predicting Market Change: Shifts in Supply Supply Shifters 1. Input prices The market supply curve summarizes the current selling plans, but if those 2. Productivity and technology plans change, then the supply curve will shift. 3. Other opportunities and the prices of related outputs If the market supply curve shifts, then the market moves to a new 4. Expectations about the future equilibrium. 5. The type and number of sellers Let’s examine the market adjustment process and the new equilibrium …but not a change in price. outcomes! 48  An Increase in Supply An increase in supply causes the supply curve to shift right. Let’s analyze the impact of this market change. Because supply increased, at the original $1.4 Old Supply Price price there is now a surplus. of gas Increased This surplus kick-starts the adjustment Supply Surplus process that pushes the price down. As the price falls, the quantity supplied falls, $1.4 and the quantity demanded rises. The price stops falling when it hits $1.2, the $1.2 point at which Qd equals Qs once again. Summary: Demand An increase in supply causes a decrease in 100 110 price and an increase in quantity. Quantity of gas (millions of litres per week) 49  A Decrease in Supply A decrease in supply causes the supply curve to shift left. Let’s analyze the impact of this market change. Because supply decreased, at the original $1.4 price there is now a Price shortage. of gas Decreased Supply Old Supply This shortage kick-starts the adjustment process that pushes the price up. As the price rises, the quantity supplied $1.6 rises, and the quantity demanded falls. $1.4 The price stops rising when it hits $1.6, the point at which Qd equals Qs once Shortage again. Summary: Demand A decrease in supply causes an increase in 90 100 Quantity of gas price and a decrease in quantity. (millions of litres per week) 50  Predicting Market Outcomes Let’s apply the supply-and-demand framework we have just learned to help predict real-world market outcomes. 1. Is the supply or demand curve shifting (or both)? 2. Is that shift an increase, shifting the curve to the right? Or is it a decrease, shifting the curve to the left? 3. How will prices and quantity change in the new equilibrium? 51  Example 1 Scenario: A major retailer announces plans to install charging stations for electric cars in 400 parking spaces in 120 cities. Step 1: Buyers of electric cars will have greater access to charging stations, so the Price of convenience of owning an electric car will electric cars be higher. This impacts people’s demand Supply for electric cars. Pnew Step 2: Increased convenience will increase demand for electric cars, shifting the demand curve to the right. Pold Increased (shifter: preferences) demand Step 3: At the new equilibrium, we will Old demand have an increase in both prices and quantity of electric vehicles. Qold Qnew Quantity of electric cars 52  Example 2 Scenario: Amazon announces it is developing technology to deliver orders within 30 minutes. Owners of local stores wonder how their sales will Step 1: People who buy from local be affected. stores will have a close substitute for buying goods quickly. This impacts the Price of customers’ demand for local goods. local goods Supply Step 2: Customers are now less likely to buy from local stores, shifting the Pold demand curve to the left. (shifter: preferences) Pnew Old demand Step 3: At the new equilibrium, we will Decreased have a decrease in both prices and demand quantity of goods bought from local stores. Qnew Qold Quantity of local goods 53  Example 3 Scenario: The federal government announces plans to fund research that will lower the cost Step 1: The new technology will affect of batteries used in electric cars. the seller’s marginal cost of producing each electric car. This impacts the supply Price of electric cars Old supply of electric cars. Increased Step 2: Cheaper batteries reduce the supply Pold cost of production. Lower marginal costs lead to an increase in supply, shifting the supply curve to the right. Pnew (shifter: input prices) Demand Step 3: At the new equilibrium, we will have a decrease in prices and a higher Qold Qnew Quantity quantity of electric cars sold. 54 of electric cars  Scenario: Due to a drought in Alberta, Example 4 farmers face rising water costs. Wheat farming is a water-intensive process. How will Step 1: The drought will affect the the drought affect the market for wheat? farmers’ marginal cost of producing wheat. This impacts the wheat supply curve. Price of wheat Decreased supply Step 2: The water shortage increases Old supply the farmers’ marginal costs of production, leading to a decrease in Pnew supply. The supply curve shifts to the left. Pold (shifter: input prices) Demand Step 3: At the new equilibrium, we will have higher wheat prices and a lower quantity of wheat sold. Qnew Qold Quantity 55 of wheat  Recap: Predicting Market Outcomes Effect on Effect on Equilibrium Equilibrium Quantity Price Ex. 1 Increase in Demand Rises Rises Shifts in demand cause price and quantity to move in the Ex. 2 Decrease in Demand Falls Falls same direction. Ex. 3 Increase in Supply Rises Falls Shifts in supply cause price and Ex. 4 Decrease in Supply Falls Rises quantity to move in opposite directions. 56  When BOTH Supply and Demand Shift The impact of the two shifts on equilibrium price and quantity may be ambiguous, such that your conclusion about the new equilibrium may be, “It depends”—it depends on which curve shifted the most. Let’s work through some examples! 57  When both curves shift (1 of 5) Total effect: Effect on Total effect: Effect on equilibrium price equilibrium quantity 1. Increase in demand and increase in supply 2. Increase in demand and decrease in supply Let’s go case-by-case 3. Decrease in demand and fill out the details for the four scenarios and increase in supply 4. Decrease in demand and decrease in supply 58  1. Increase in Both Supply and Demand Demand shift is big, and supply shift is small Supply shift is big, and demand shift is small Price Old supply Price Old supply Increased Increased supply supply Pnew Pold Pold Increased Pnew demand Increased Old Old demand demand demand Qold Qnew Quantity Qold Qnew Quantity 59  When both curves shift (2 of 5) Total effect: Effect on Total effect: Effect on equilibrium price equilibrium quantity 1. Increase in demand It depends Rises and increase in supply (↑P , ↓P) (↑Q , ↑Q) 2. Increase in demand and decrease in supply 3. Decrease in demand and increase in supply 4. Decrease in demand and decrease in supply 60  2. Increase in Demand and Decrease in Supply Demand shift is big, and supply shift is small Supply shift is big, and demand shift is small Price Price Decreased supply Decreased supply Pnew Old supply Pnew Old supply Pold Pold Increased Increased demand demand Old demand Old demand Qold Qnew Quantity Qnew Qold Quantity 61  When both curves shift (3 of 5) Total effect: Effect on Total effect: Effect on equilibrium price equilibrium quantity 1. Increase in demand It depends Rises and increase in supply (↑P , ↓P) (↑Q , ↑Q) 2. Increase in demand Rises It depends and decrease in supply (↑P , ↑P) (↑Q , ↓Q) 3. Decrease in demand and increase in supply 4. Decrease in demand and decrease in supply 62  3. Decrease in Demand and Increase in Supply Demand shift is big, and supply shift is small Supply shift is big, and demand shift is small Price Increased Price Old supply Old supply supply Increased supply Pold Pold Old Pnew Old Pnew demand demand Decreased Decreased demand demand Qnew Qold Quantity Qold Qnew Quantity 63  When both curves shift (4 of 5) Total effect: Effect on Total effect: Effect on equilibrium price equilibrium quantity 1. Increase in demand It depends Rises and increase in supply (↑P , ↓P) (↑Q , ↑Q) 2. Increase in demand Rises It depends and decrease in supply (↑P , ↑P) (↑Q , ↓Q) 3. Decrease in demand Falls It depends and increase in supply (↓P , ↓P) (↓Q , ↑Q) 4. Decrease in demand and decrease in supply 64  4. Decrease in Both Demand and Supply Demand shift is big, and supply shift is small Supply shift is big, and demand shift is small Decreased Decreased supply Price Price supply Old supply Pnew Old supply Pold Pold Pnew Old Old demand demand Decreased Decreased demand demand 65 Qnew Qold Quantity Qnew Qold Quantity  When both curves shift (5 of 5) Total effect: Effect on Total effect: Effect on equilibrium price equilibrium quantity 1. Increase in demand It depends Rises and increase in supply (↑P , ↓P) (↑Q , ↑Q) 2. Increase in demand Rises It depends and decrease in supply (↑P , ↑P) (↑Q , ↓Q) 3. Decrease in demand Falls It depends and increase in supply (↓P , ↓P) (↓Q , ↑Q) 4. Decrease in demand It depends Falls and decrease in supply (↓P , ↑P) (↓Q , ↓Q) 66 Interpreting Market Data (1 of 3) Tips Rule 1 If prices and quantities move in the same The supply and demand framework direction, then the demand curve has can be used to… definitely shifted. predict market outcomes when (It’s possible that the supply curve may market conditions change. also have shifted.) diagnose market outcomes you Rule 2 see in the news or happening If prices and quantities move in opposite around you. directions, then the supply curve has Let’s focus on the supply and definitely shifted. demand framework as a diagnostic (It’s possible that the demand curve may also have shifted.) tool. 67 Interpreting Market Data (2 of 3) Scenario 1: The proliferation of electronic Price Old supply book readers (the Kindle) led to a rise in the of books quantity of books sold while the average price of a book fell. Increased Pold supply Question: What do these changes in quantity and price tell us about how e- books changed the publishing market? Pnew Old demand Answer: Because price and quantity moved in opposite directions, the supply curve must have increased. Qold Qnew Quantity of books 68  Interpreting Market Data (3 of 3) Scenario 2: Price of roses Old supply On Valentine’s Day the price of roses rises, as does the quantity sold. Pnew Question: What do these changes in quantity and price tell us about the rose Pold market on Valentine’s Day? Increased Answer: Because price and quantity demand moved in same directions, the demand Old demand curve must have increased. Qold Qnew Quantity of roses 69  Key take-aways: Predicting market change Demand: Six factors can shift the demand curve (“price” is not one of them) Increased demand: increase in both equilibrium price and quantity Decreased demand: decrease in both equilibrium price and quantity Supply: Five factors can shift the supply curve (“price” is not one of them) Decreased supply: increase in price and decrease in quantity Increased supply: decrease in price and increase in quantity When BOTH supply and demand shift: Impact on equilibrium may be ambiguous. It depends on which curve shifted the most. 70 Chapter 4 take-aways 1. Understanding Markets Markets are all around us! What are markets, and how are they organized? Equilibrium is where the curves cross. 2. Equilibrium Supply equals Demand The supply-and-demand Shortage and Surplus framework helps predict and diagnose price and 3. Predicting Market Changes quantity adjustments. Shifting demand and supply 71