Supply & Demand PDF

3 CHAPTER Demand, Supply, and Market Equilibrium Prepared by: Fernando Quijano...

3 CHAPTER Demand, Supply, and Market Equilibrium Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair  Firms and Households: The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into ly, and Market Equilibrium products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Input Markets and Output Markets: The Circular Flow ly, and Market Equilibrium The circular flow of economic activity shows how firms and households interact in input and output markets. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Input Markets and Output Markets: The Circular Flow Product or output ly, and Market Equilibrium markets are the markets in which goods and services are exchanged. Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Input Markets and Output Markets: The Circular Flow Goods and services flow clockwise. Firms provide ly, and Market Equilibrium goods and services; households supply labor services. Payments (usually money) flow in the opposite direction (counterclockwise) as the flow of labor services, goods, and services. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Input Markets and Output Markets: The Circular Flow Input or factor markets are the markets in which the resources used ly, and Market Equilibrium to produce products are exchanged. They include: 1- The labor market, in which households supply work for wages to firms that demand labor. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Input Markets and Output Markets: The Circular Flow 2- The capital market, in which households supply their savings, for interest or for claims to future ly, and Market Equilibrium profits, to firms that demand funds to buy capital goods. 3- The land market, in which households supply land or other real property in exchange for rent. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Input Markets and Output Markets: The Circular Flow Inputs into the production ly, and Market Equilibrium process are also called factors of production. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Demand in Product/Output Markets A household’s decision about the quantity of a particular output to ly, and Market Equilibrium demand depends on: The price of the product in question. The income available to the household. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Demand in Product/Output Markets The household’s amount of accumulated wealth. The prices of other products ly, and Market Equilibrium (substitutes and complements) available to the household. The household’s tastes and preferences. The household’s expectations about future income, wealth, and prices. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Demand in Product/Output Markets Quantity demanded is the ly, and Market Equilibrium amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Changes in Quantity Demanded Versus Changes in Demand The most important ly, and Market Equilibrium relationship in individual markets is that between market price and quantity demanded. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Changes in Quantity Demanded Versus Changes in Demand We use the ceteris paribus or “all else equal” device, to examine the ly, and Market Equilibrium relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Changes in Quantity Demanded Versus Changes in Demand Changes in price affect the ly, and Market Equilibrium quantity demanded per period. Changes in income, wealth, other prices, tastes, or expectations affect demand. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Price and Quantity Demanded: The Law of Demand A demand schedule is ly, and Market Equilibrium a table showing how much of a given product a household would be willing to buy at different prices. Demand curves are usually derived from demand schedules. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Price and Quantity Demanded: The Law of Demand The demand curve is a ly, and Market Equilibrium graph illustrating how much of a given product a household would be willing to buy at different prices. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Price and Quantity Demanded: The Law of Demand The law of demand ly, and Market Equilibrium states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price. This means that demand curves slope downward. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Other Determinants of Household Demand Income is the sum of all households wages, salaries, profits, interest ly, and Market Equilibrium payments, rents, and other forms of earnings in a given period of time. It is a flow measure. Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Other Determinants of Household Demand Normal Goods are goods for which demand goes up when income is ly, and Market Equilibrium higher and for which demand goes down when income is lower. Inferior Goods are goods for which demand falls when income rises. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Other Determinants of Household Demand Substitutes are goods that can ly, and Market Equilibrium serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Other Determinants of Household Demand Complements are goods that ly, and Market Equilibrium “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Shift of Demand Versus Movement Along a Demand Curve A change in demand is not the same as a change in ly, and Market Equilibrium quantity demanded. A higher price causes lower quantity demanded and a move along the demand curve DA. Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from DA to DB. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  A Change in Demand Versus a Change in Quantity Demanded To summarize: Change in price of a good or service leads to ly, and Market Equilibrium Change in quantity demanded (Movement along the curve). Change in income, preferences, or prices of other goods or services leads to Change in demand (Shift of curve). © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  The Impact of a Change in Income Higher income Higher income decreases the demand increases the demand for an inferior good ly, and Market Equilibrium for a normal good © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  The Impact of a Change in the Price of Related Goods Demand for complement ly, and Market Equilibrium good (ketchup) shifts left Demand for substitute good (chicken) Price of hamburger rises shifts right Quantity of hamburger demanded per month falls © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  From Household Demand to Market Demand Demand for a good or service can be defined for an individual household, ly, and Market Equilibrium or for a group of households that make up a market. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  From Household Demand to Market Demand Assuming there are only two households in the market, market demand is derived as follows: ly, and Market Equilibrium © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Supply in Product/Output Markets Supply decisions depend ly, and Market Equilibrium on profit potential. Profit is the difference between revenues and costs. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Supply in Product/Output Markets Quantity supplied represents the number of ly, and Market Equilibrium units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period. A supply schedule is a table showing how much of a product firms will supply at different prices. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Price and Quantity Supplied: The Law of Supply A supply curve is a graph illustrating how much of a product a firm will supply per period of time at different prices. ly, and Market Equilibrium © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Price and Quantity Supplied: The Law of Supply The law of supply ly, and Market Equilibrium states that there is a positive relationship between price and quantity of a good supplied. This means that supply curves typically have a positive slope. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Other Determinants of Supply The price of the good or service. The cost of producing the good, ly, and Market Equilibrium which in turn depends on: The price of required inputs (labor, capital, and land), The technologies that can be used to produce the product, The prices of related products. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Shift of Supply Versus Movement Along a Supply Curve A higher price causes higher quantity ly, and Market Equilibrium supplied, and a move along the supply curve. A change in determinants of supply other than price causes an increase in supply, or a shift of the entire supply curve, from S A to SB. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Shift of Supply Curve for Soybeans Following Development of a New Seed Strain In this example, since the factor affecting supply is not ly, and Market Equilibrium the price of soybeans but a technological change in soybean production, there is a shift of the supply curve rather than a movement along the supply curve. The technological advance means that more output can be supplied for at any given price level. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Shift of Supply Versus Movement Along a Supply Curve To summarize: Change in price of a good or service leads to ly, and Market Equilibrium Change in quantity supplied (Movement along the curve). Change in costs, input prices, technology, or prices of related goods and services leads to Change in supply (Shift of curve). © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  From Individual Supply to Market Supply The supply of a good or service can be defined for an individual firm, or ly, and Market Equilibrium for a group of firms that make up a market or an industry. Market supply is the sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  From Individual Supply to Market Supply As with market demand, market supply is the horizontal summation of ly, and Market Equilibrium individual firms’ supply curves. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Market Equilibrium Market equilibrium is the ly, and Market Equilibrium condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Market Equilibrium Only in equilibrium is ly, and Market Equilibrium quantity supplied equal to quantity demanded. At any price level other than P0, such as P1, quantity supplied does not equal quantity demanded. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Excess Demand Excess demand, or shortage, is the condition ly, and Market Equilibrium that exists when quantity demanded exceeds quantity supplied at the current price. When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Excess Supply Excess supply, or surplus, is the condition that exists ly, and Market Equilibrium when quantity supplied exceeds quantity demanded at the current price. When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Changes in Equilibrium ly, and Market Equilibrium Higher demand leads to Higher supply leads to higher equilibrium price and lower equilibrium price and higher equilibrium quantity. higher equilibrium quantity. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Changes in Equilibrium ly, and Market Equilibrium Lower demand leads to Lower supply leads to lower price and lower higher price and lower quantity exchanged. quantity exchanged. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Relative Magnitudes of Change ly, and Market Equilibrium The relative magnitudes of change in supply and demand determine the outcome of market equilibrium. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Relative Magnitudes of Change ly, and Market Equilibrium When supply and demand both increase, quantity will increase, but price may go up or down. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  Review Terms and Concepts capital market income perfect substitutes complements, inferior goods product or output markets complementary goods ly, and Market Equilibrium input or factor markets profit demand curve labor market quantity demanded demand schedule land market quantity supplied entrepreneur law of demand shift of a demand curve equilibrium law of supply substitutes excess demand or shortage market demand supply curve excess supply or surplus market supply supply schedule factors of production movement along a wealth or net worth firm demand curve households normal goods © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48  canceled slides ly, and Market Equilibrium © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48 ly, and Market Equilibrium Thank you all. © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair ‹#› of 48