Chapter 2 Supply and Demand. 2 - 2 Copyright © 2012 Pearson Education. All rights reserved. Topics 1.Demand. 2.Supply. 3.Market Equilibrium. 4.Shocking.

Chapter 2

Supply and Demand

2 - 2 Copyright © 2012 Pearson Education. All rights reserved.

Topics

1. Demand.

2. Supply.

3. Market Equilibrium.

4. Shocking the Equilibrium.

5. Effects of Government Interventions.

6. When to Use the Supply-and-Demand Model.


Demand: Determinants of Demand

• The following factors determine the demand for a good: Price of the good Tastes Information Prices of other goods

• Complements and substitutes Income Government rules and regulations Other factors


Demand: The Demand Curve

• Quantity demanded - the amount of a good that consumers are willing to buy at a given price, holding constant the other factors that influence purchases.

• Demand curve - the quantity demanded at each possible price, holding constant the other factors that influence purchases


Figure 2.1 A Demand Curve

Law of Demand consumers demand more

of a good the lower its price, holding constant all

other factors that influence consumption

p,

$ p

er

kg

200 220

Demand curve for pork, D1

240 286

Q, Million kg of pork per year

0

2.30

3.30

4.30

14.30


Figure 2.2 A Shift of the Demand Curve

p, $

per

kg

220176

Effect of a 60¢ increase in the price of beef

D1

D2

232Q, Million kg of pork per year

0

3.30


The Demand Function

• The processed pork demand function is:

Q = D(p, pb, pc, Y)

where Q is the quantity of pork demanded p is the price of pork (dollars per kg) pb is the price of beef (dollars per kg) pc is the price of chicken (dollars per kg) Y is the income of consumers (thousand

dollars)


From the Demand Function to the Demand Curve

• Estimated demand function for pork:

Q = 171−20p + 20pb + 3pc + 2Y

• Using the values pb = 4, pc = 3.33 and Y = 12.5, we have

Q = 286−20p

which is the linear demand function for pork.


From the Demand Function to the Demand Curve (cont.)

If p = 0, then

Q = 286p, $

pe

r kg

200 220

Demand curve for pork, D1

240 286


0

2.30

3.30

4.30

14.30

Q = 286−20p

If p increases by $1 (to $4.30) then,

Q = 200

If p decreases by $1 (to $2.30) then,

Q = 240

If p = $3.30 then,

Q = 220In general,

Q = -20p

= slope p


Solved Problem 2.1

• How much would the price have to fall for consumers to be willing to buy 1 million more kg of pork per year?


Solved Problem 2.1

1. Express the price that consumers are willing to pay as a function of quantity.

Q = 286−20p

20p = 286 - Q

p = 14.30 − 0.05Q


Solved Problem 2.1

2. Use the inverse demand curve to determine how much the price must change for consumers to buy 1 million more kg of pork per year.

Δp = p2 − p1

= (14.30 − 0.05Q2) − (14.30 − 0.05Q1) = –0.05(Q2 − Q1) = –0.05ΔQ.

The change in quantity is ΔQ = Q2 − Q1 = (Q1 + 1)−Q1 = 1, so the change in price is Δp = –0.05.


Summing Demand Curves

• The total demand shows the total quantity demanded at each price

• The total quantity demanded at a given price is the sum of the quantity each consumer demands at that price

• Q = Q1 + Q2 = D1(p) + D2(p)


Application Aggregating the Demand for Broadband Service


Supply: Determinants of Supply

• The following factors determine the supply for a good: Price of the good Costs Government rules and regulations


Supply: The Supply Curve

• Quantity supplied - the amount of a good that firms want to sell at a given price, holding constant other factors that influence firms’ supply decisions, such as costs and government actions

• Supply curve - the quantity supplied at each possible price, holding constant the other factors that influence firms’ supply decisions


Figure 2.3 A Supply Curvep,

$ p

er k

g

220176

Supply cu rve, S1

300Q, Million kg of pork per year

0

3.30

5.30

An increase in the price…

causes a movement

along the curve….

and a decrease in the

quantity supplied….


Figure 2.4 A Shift of a Supply Curve

p, $

pe

r kg

205176

S 1S2

220


0

3.30

A $0.25 increase in the price of hogs….. shifts the supply

curve to the left

reducing the quantity supplied at the previous price.


The Supply Function

• The processed pork supply function is:

Q = S(p, ph)

where Q is the quantity of pork supplied p is the price of pork (dollars per kg) ph is the price of a hog (dollars per kg)


From the Supply Function to the Supply Curve

• Estimated demand function for pork:

Q = 178 + 40p−60ph

• Using the values ph = $1.50 per kg

Q = 88 + 40p.

• What happens to the quantity supplied if the price of processed pork increases by Δp = p2−p1?


Summing Supply Curves

• The total supply curve shows the total quantity produced by all suppliers at each price

• Horizontal sum of each producer’s supply curve Sum of all quantities supplied at a given price


Figure 2.5 Total Supply: The Sum of Domestic and Foreign Supply


Solved Problem 2.2

• How does a quota set by the United States on foreign steel imports of Q affect the total American supply curve for steel given the domestic supply, Sd in panel a of the graph, and foreign supply, Sf in panel b?


Solved Problem 2.2


Market Equilibrium

• Equilibrium - a situation in which no one wants to change his or her behavior equilibrium price is the price at which

consumers can buy as much as they want and sellers can sell as much as they want

equilibrium quantity is the quantity bought and sold at the equilibrium price


Market Equilibrium (cont.)

• Excess demand the amount by which the quantity demanded exceeds the quantity supplied at a specified price.

• Excess supply the amount by which the quantity supplied is greater than the quantity demanded at a specified price


Figure 2.6 Market Equilibriump

, $ p

er k

g

220176

D

S

e

233 246194 207

Q, Million kg of por k per year

0

3.95

3.30

2.65

Excess supply = 39

Excess demand = 39

Market equilibrium point!

Below the equilibrium price….

the quantity supplied….

is below the quantity demanded

Above the equilibrium price….

the quantity demanded….

is below the quantity supplied


Using Math to Determine the Equilibrium

• Demand: Qd = 286 − 20p

• Supply: Qs = 88 + 40p

• Equilibrium:

Qd = Qs

286 − 20p = 88 + 40p

60p = 198

P = $3.30

Q = 286 – 20(3.3) = 220


Equilibrium: Practice Problem

• The demand function for a good is Q = a−bp, and the supply function is Q = c + ep, where a, b, c, and e are positive constants. Solve for the equilibrium price and quantity in terms of these four constants.


Qd=Qs a-bp = c+epa-c = ep+bpp(e+b) = a-cp = (a-c)/(e+b)


Shocking the Equilibrium

The equilibrium changes only if a shock occurs that shifts the demand curve or the supply curve. These curves shift if one of the variables we were holding constant

changes.


Figure 2.7a Equilibrium Effects of a Shift of a Demand Curve

D1

D2

S

1760 220 228 232


Excess demand = 12

3.303.50

e2

e1

p, $

per

kg A $0.60 increase in the price

of beef shifts demand outward

At the original price there is now excess demand….

Which puts an upward pressure on the price to a new equilibrium.


Figure 2.7b Equilibrium Effects of a Shift of a Supply Curve

S1S2


3.303.55

e1

e2

D

p,

$ p

er

kg

1760 220205 215

Excess demand = 15

A $0.25 increase in the price of hogs shifts the supply curve to the left

At the original price there is now excess demand….

Which puts an upward pressure on the price to a new equilibrium.


Solved Problem 2.3

• Mathematically, how does the equilibrium price of pork vary as the price of hogs changes if the variables that affect demand are held constant at their typical values?


Solved Problem 2.3

1. Solve for the equilibrium price of pork in terms of the price of hogs.

Qd = 286−20pQs = 178 + 40p−60ph

286−20p = 178 + 40p−60ph

-60p = -108 – 60ph

-p = -1.8 – ph

2. Show how the equilibrium price of pork varies with the price of hogs.

Since Δp = Δph, any increase in the price of hogs causes an equal increase in the price of processed pork.


Equilibrium Effects of Government Interventions

• Government action can cause a shift in the supply curve, the demand curve,

or both the quantity demanded to be different from

quantity supplied


Equilibrium Effects of Government Interventions (cont.)

• Policies that shift supply curves Licensing laws, quotas

• Policies that cause demand to differ from supply Price ceilings, price floors


Figure 2.8 A Ban on Rice Imports Raises the Price in Japan

p, P

r ice

of r

ice

per

pou

nd

Q2 Q1

S (no ban)

D

Q, Tons of rice per year

p2 e2

e1p1

S (ban)–

A ban on rice imports shifts the total supply of rice in Japan…

which causes the equilibrium to change and the price to increase.


Solved Problem 2.4

• What is the effect of a United States quota on sugar of Q on the equilibrium in the U.S. sugar market? Hint: The answer depends on whether the quota binds (is low enough to affect the equilibrium).


Solved Problem 2.4


Figure 2.9 Price Ceiling on Gasoline

p, $

pe

r ga

llon

QsQ1= Qd

Price ceiling

S1

D

Q, Gallons of gasoline per monthExcess demand

e1 =p–

Supply shifts to the left….

p1

but gas stations must continue to charge a price of p1…..

which creates excess demand.


Solved Problem 2.5

• Suppose that there is a single labor market in which everyone is paid the same wage. If a binding minimum wage, w, is imposed, what happens to the equilibrium in this market?

• Answer: Show the initial equilibrium before the minimum wage

is imposed. Draw a horizontal line at the minimum wage, and

show how the market equilibrium changes.


Figure 2.10 Minimum Wage


Why Supply Need Not Equal Demand

• The quantity that firms want to sell and the quantity that consumers want to buy at a given price need not equal the actual quantity that is bought and sold. Example: price ceiling.


Perfectly Competitive Markets

• Everyone is a price taker.

• Firms sell identical products.

• Everyone has full information about the price and quality of goods.

• Costs of trading are low.


Figure 2A.1 Regression

Chapter 2 Supply and Demand. 2 - 2 Copyright © 2012 Pearson Education. All rights reserved. Topics 1.Demand. 2.Supply. 3.Market Equilibrium. 4.Shocking.

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