Chapter 3: Supply and Demand (2)

Chapter 3Supply and DemandMarket and InteractionsA market is any place where goods are bought and sold and includes the interaction of all buyers and sellers.We must interact because we have a limited amount of time, energy, and resources, so we can’t produce everything we desire.3-*The Two MarketsFactor Market:Any place where factors of production (land, labor, capital, and entrepreneurship) are bought and sold.Product Market:Any place where finished goods and services (products) are bought and sold.3-*Figure 3.13-*Product MarketConsumers buy and producers sell in the product market.Imports and exports are also a part of the product market.Governments supply goods and services in product markets.3-*Locating MarketsA market exists wherever and whenever an exchange takes place.3-*Supply and DemandMarket transactions require two sides:SupplyPeople supply labor in the factor market.Firms supply goods and services in the product market.DemandPeople demand goods and services in the product market.Firms demand factors of production in the factor market.3-*Supply – The ability and willingness to sell (produce) specific quantities of a good at alternative prices in a given time period, ceteris paribus (other things being equal).Supply and Demand3-*Demand – The ability and willingness to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus (other things being equal).Supply and Demand3-*Demand CurveA curve describing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.The demand curve does not state actual purchases, rather only what consumers are willing and able to purchase.3-*Individual DemandA demand exists only if someone is both willing and able to pay for a good.How much someone is willing to pay for something is determined by his/her income and the opportunity cost.Opportunity cost – the most desired goods or services foregone in order to obtain something else.3-*Figure 3.23-*Law of DemandThe quantity of a good demanded in a given time period increases as its price falls, ceteris paribus.There is an inverse or negative relationship between price and quantity demanded, ceteris paribus.3-*Determinants of DemandTastes (desire for this and other goods)Income (of the consumer)Other goods (their availability and price)Expectations (for income, prices, tastes)Number of buyers3-*Shift in DemandThe demand schedule and curve remain unchanged only so long as the underlying determinants of demand remain constant.3-*Any change in one of the determinants of demand causes the demand curve to shift.The quantity demanded at any (every) given price changes.The demand curve can shift to the right (increase in demand) or to the left (decrease in demand).Shift in Demand3-*When demand increases, consumers want to buy more at each particular price.Demand curve shifts right.When demand decreases, consumers want to buy less at each particular price.Demand curve shifts left.Shift in Demand3-*Figure 3.33-*Movement versus ShiftsMovements along a demand curve are a response to price changes for that good.Shifts of the demand curve occur only when the determinants of demand change. A change in price does not shift the demand curve.3-*Market Demand The total quantities of a good or service people are willing and able to buy at alternative prices in a given time period.The sum of individual demands.Market demand is determined by the number of potential buyers and their respective tastes, incomes, other goods, and expectations.3-*Market SupplyThe total quantities of a good or service that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.The sum of individual supplies.3-*Market supply is an expression of sellers’ intentions – of their ability and willingness to sell – not a statement of actual sales.Market Supply3-*Figure 3.53-*Determinants of SupplyTechnologyFactor (or resource) costsOther goodsTaxes and subsidiesExpectationsNumber of sellers3-*Law of SupplyThe quantity of a good supplied in a given time period increases as its price increases, ceteris paribus.There is a direct or positive relationship between price and quantity supplied, ceteris paribus.3-*When supply increases, producers want to produce and sell more at each particular price.Supply curve shifts right.When supply decreases, producers want to produce and sell less at each particular price.Supply curve shifts left.Shift in Supply3-*Shifts in SupplyChanges in a quantity supplied:Movement along a given supply curve.Due to a change in the price of the good.Changes in supply: Shifts in the supply curve due to a change in one of the determinants of supply.A change in a good’s price does not shift its supply curve.3-*EquilibriumSupply interacts with demand to determine the market price.Only one price and quantity are compatible with the existing intentions of both buyers and sellers.It is the price at which the quantity of a good demanded in a given time period equals the quantity supplied.3-*Figure 3.63-*Invisible HandThe market behaves as if it is directed by some unseen force. Adam Smith (1776) called this the invisible hand.It means that the equilibrium price is determined by the collective behavior of many buyers and sellers.3-*Equilibrium PriceThe equilibrium price occurs at the intersection of the supply and demand curves.There is only one equilibrium price.The market will naturally move toward this price.3-*Market ShortageThe amount by which the quantity demanded exceeds the quantity supplied at a given price.Occurs when the selling price is lower than the equilibrium price.Sellers supply less than buyers demand at that price.Unsatisfied consumers bid up the price to the equilibrium price.3-*Market SurplusThe amount by which the quantity supplied exceeds the quantity demanded at a given price.Occurs when the selling price is higher than the equilibrium price.Sellers supply more than buyers demand at the current price.Unsatisfied sellers mark the price down to the equilibrium price.3-*Changes in EquilibriumNo equilibrium price is permanent.Equilibrium price and quantity change whenever the supply or demand curves shift.This happens when the determinants of supply or demand change.3-*Figure 3.73-*Disequilibrium PricingThe following are imposed by government and cause disequilibrium pricing.Price Ceiling:Maximum price imposed on a good or service.Price Floor:Minimum price imposed on a good or service.3-*Price CeilingsPrice ceilings have three predictable effects:They increase quantity demanded.They decrease quantity supplied.They create a market shortage.Rent controls on housing are an example.There will be less housing for everyone when rent controls are imposed.3-*Figure 3.83-*Price FloorsPrice floors have three predictable effects:They increase quantity supplied.They decrease quantity demanded.They create a market surplus.Minimum wages and price supports for agriculture are examples.3-*Figure 3.93-*A government imposed price floor may create:A wrong mix of output.An increased tax burden.An altered distribution of income.Political favoritism.Government failure – a government intervention that fails to improve economic outcomes.Price Floors3-*Market Mechanism in ActionWHAT? – Produce what consumers are willing to buy.HOW? – Profitably; at the most efficient consumption of resources.FOR WHOM? – For those willing and able to pay the market price.3-*