Chapter 3: Demand, Supply, and Market Equilibrium

Chapter 3Demand, Supply, and Market EquilibriumCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinMarketsInteraction between buyers and sellersMarkets may be:LocalNationalInternationalPrice is discovered in the interactions of buyers and sellersLO13-*DemandSchedule or curveAmount consumers are willing and able to purchase at a given priceOther things equalIndividual demandMarket demandLO13-*Law of DemandOther things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls.Reasons:Common senseLaw of diminishing marginal utilityIncome effect and substitution effectsLO13-* 6 5 4 3 2 1 010 20 30 40 50 60 70 80 Quantity Demanded (latte per month)Price (per latte)PQd$543211020355580Individual DemandPQDThe Demand CurveLO13-*Market DemandLO1Market Demand for Lattes, Three BuyersPriceper LatteQuantity DemandedTotal Qd per weekJoeJavaSarahCoffeeMike Cappuccino$510128304202317603353926100255603915418087542213-*Market DemandLO1SarahJoeMikeMarketQQQQPPPP$3$3$3$3353926100++=D1D2D3D(= 35 + 39 + 26)3-*Changes in DemandLO1 6 5 4 3 2 1 0Quantity Demanded (thousands of lattes per month)Price (per latte)PQD12 4 6 8 10 12 14 16 18D2D3Increase in demandDecrease in demand3-*Changes in DemandChange in consumer tastes and preferencesChange in number of buyersChange in incomeNormal goodsInferior goodsLO13-*Changes in DemandChange in prices of related goodsComplementsSubstitutesChange in consumers’ expectationsFuture pricesFuture incomeLO13-*Changes in Quantity DemandedChange in demand is a shift of the demand curveChange in quantity demanded is a movement from one point to another point on a fixed demand curveLO13-*SupplySchedule or curveThe amount producers are willing and able to sell at a given priceIndividual supplyMarket supplyLO23-*Law of SupplyOther things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls.Reason:Price acts as an incentive to producersAt some point, costs will riseLO23-*The Supply CurveLO2 5 4 3 2 1 0Price (per latte)Quantity Supplied (lattes per month)S10 20 30 40 50 60 70 Market Supply of LattesPrice per LatteQs per Month$56045033522015PQ3-*Changes in SupplyLO2$6 5 4 3 2 1 0Price (per latte)S1Quantity Supplied (thousands of lattes per month)2 4 6 8 10 12 14 16 PQS2S3Increasein supplyDecrease in supply3-*Determinants of SupplyA change in resource pricesA change in technologyA change in the number of sellersA change in taxes and subsidiesA change in prices of other goodsA change in producer expectationsLO23-*Changes in Quantity SuppliedChange in supply is a shift in the supply curveChange in the quantity supplied represents a movement along a supply curveLO23-*Market EquilibriumEquilibrium occurs where the demand curve and supply curve intersectSurplus and shortageRationing function of pricesEfficient allocationProductive efficiencyAllocative efficiencyLO33-*Market EquilibriumLO3 6 5 4 3 2 1 02 4 6 8 10 12 14 16 18Quantity of lattes (thousands per month)Price (per latte)PQd$543212,0004,0007,000 11,00016,000PQs$5432112,00010,0007,0004,0001,00073DS6,000 lattesurplus7,000 latteshortage3-*Rationing Functions of PricesThe ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent.LO33-*LO40PD4D3LO40PD1D2SIncrease in demandD increase:P, QD decrease:P, QDecrease in demandSChanges in Demand and Equilibrium3-*LO40PDS4LO4S30PDS2S1Increase in supplyS increase:P, QS decrease:P, QDecrease in supplyChanges in Supply and Equilibrium3-*Government-Set PricesPrice ceilingsSet below equilibrium priceRationing problemBlack marketsExample: Rent controlLO53-*Government-Set PricesLO5SPQDP0PCQ0ShortageQdQsCeiling$3.50 3.003-*Government-Set PricesPrice floorsPrices are set above the market priceChronic surplusesExample: Minimum wage lawsLO53-*Government-Set PricesLO5SPQDP0PfQ0SurplusQsQdFloor2.00 $3.003-*