Chapter 2: Supply and Demand

Supply and DemandCHAPTER 2 Chapter OutlineDefinitionsThe Supply and Demand ModelAll About DemandAll About Supply Determinants of DemandDeterminants of SupplyThe Effect of Changes in Price Expectations on the Supply and Demand ModelWhy the New EquilibriumDefinitionsSupply and Demand: the name of the most important model in all economicsPrice: the amount of money that must be paid for a unit of outputMarket: any mechanism by which buyers and sellers negotiate priceDefinitions(continued)Consumers: those people in a market who are wanting to exchange money for goods or servicesProducers: those people in a market who are wanting to exchange goods or services for moneyEquilibrium Price: the price at which no consumers wish they could have purchased more goods at that price; no producers wish that they could have sold moreEquilibrium Quantity: the amount of output exchanged at the equilibrium priceQuantity Demanded and Quantity SuppliedQuantity demanded: how much consumers are willing and able to buy at a particular price during a particular period of timeQuantity supplied: how much firms are willing and able to sell at a particular price during a particular period of timeThe Scientific Method and Ceteris ParibusScientists conduct experiments in laboratories.use replication and verification to ensure the accuracy of their conclusions.Social Scientists cannot experiment on their subjects.must use models and look at the effects of individual variables within those models.Economistshold variables constant within models to examine the effect of other variables. use the Latin phrase ceteris paribus which means “holding other things equal” to identify this is the case.Demand and SupplyDemand is the relationship between price and quantity demanded, ceteris paribus.Supply is the relationship between price and quantity supplied, ceteris paribus.The Supply and Demand ModelThe Demand ScheduleThe Demand Schedule presents, in tabular form, the price and quantity demanded for a good.PriceIndividual QDQD for 10,000$0.00550,000$0.50440,000$1.00330,000$1.50220,000$2.00110,000$2.5000Figure 1 The Demand Curve0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandThe Supply ScheduleThe Supply Schedule presents, in tabular form, the price and quantity supplied for a good.PriceIndividual QDQS for 10 firms$0.0000$0.5000$1.001,00010,000$1.502,00020,000$2.003,00030,000$2.504,00040,000Figure 2 The Supply Curve0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500SupplyEquilibrium, Shortages, and SurplusesEquilibrium is the point where the amount that consumers want to buy and the amount that firms want to sell are the same. This occurs where the supply curve and the demand curve cross.Shortage (Excess Demand): the condition where firms do not want to sell as many as consumers want to buy.Surplus (Excess Supply): the condition where firms want to sell more than consumers want to buyA Combined Supply and Demand SchedulePriceQDQSShortageSurplus$0.0050,000050,000$0.5040,000040,000$1.0030,00010,00020,000$1.5020,00020,000$2.0010,00030,00020,000$2.50040,00040,000Figure 3 The Supply and Demand Model0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500SupplyDemandEquilibriumAll About DemandThe Law of DemandThe relationship between price and quantity demanded is a negative or inverse one.Why Does the Law of Demand Make Sense?The Substitution Effectmoves people toward the good that is now cheaper or away from the good that is now more expensive The Real Balances EffectWhen a price increases it decreases your buying power causing you to buy less.The Law of Diminishing Marginal UtilityThe amount of additional happiness that you get from an additional unit of consumption falls with each additional unit.The Law of SupplyThe Law of Supply is the statement that there is a positive relationship between price and quantity supplied.Why Does the Law of Supply Make SenseBecause of Increasing Marginal Costs firms require higher prices to produce more output.Increasing Marginal Costs(and the vocabulary to see it)Revenues : money firms receive in salesProfit: money a firm makes in excess of its costsLoss: the costs that are in excess of revenuesFixed or Sunk Costs: expenses that do not change whether you produce zero or any other amountVariable Costs: costs that increase when firms increase productionIncreasing Marginal Cost(continued)Marginal Revenue: the increase in revenue associated with increasing sales by one unit.Marginal Cost: the increase in cost associated with increasing production by one unit.Because marginal costs to firms are assumed to be increasing, firms must charge higher prices in order to motivate them to produce greater output.Determinants of DemandTasteIncomeNormal GoodsInferior GoodsPrice of Other GoodsComplementSubstitutePopulation of Potential BuyersExpected PriceMovements in the Demand CurveDeterminantResult of an increase in the determinantResult of a decrease in the determinantTasteD shifts rightD shifts leftIncome-Normal GoodD shifts rightD shifts leftIncome-Inferior GoodD shifts leftD shifts rightPrice of Other Goods-Complement D shifts leftD shifts rightPrice of Other Goods-SubstituteD shifts rightD shifts leftPopulation of Potential BuyersD shifts rightD shifts leftExpected Future PriceD shifts rightD shifts leftFigure 4 The Effect of an Increase in DemandNew DemandNew Equilibrium0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyOld EquilibriumFigure 5 The Effect of a Decrease in Demand0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyOld EquilibriumNew DemandNew EquilibriumThe Determinants of Supply Price of InputsTechnologyPrice of Other Potential OutputNumber of SellersExpected Future PriceMovements in the Supply CurveDeterminantResult of an increase in the determinantResult of a decrease in the determinantPrice of InputsS shifts leftS shifts rightTechnologyS shifts rightS shifts leftPrice of Other Potential OutputsS shifts leftS shifts rightNumber of SellersS shifts rightS shifts leftExpected Future PriceS shifts leftS shifts rightFigure 6 An Increase in Supply0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyOld EquilibriumNew EquilibriumNew SupplyFigure 7 A Decrease in Supply0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyOld EquilibriumNew SupplyNew EquilibriumWhy the New Equilibrium?If there is a change in supply or demand then without a change in the price of the good, there will be a shortage or a surplus.Figure 8 A Shortage Resulting From an Increase in Demand(If the price does not increase)New Demand0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyShortageFigure 9 A Surplus Resulting From a Decrease in Demand(If the price does not fall)0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyOld EquilibriumNew DemandSurplusFigure 10 A Surplus Resulting From an Increase in Supply (If the price does not fall)0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyNew SupplySurplusFigure 11 A Shortage Resulting From a Decrease in Supply0 10 20 30 40 50PQ/t$2.50$2.00$1.50$1.00$0.500DemandSupplyNew SupplyShortage